**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, DC 20549**

 

**FORM 10-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  June 30, 2004**                                                                                          |
| ** **                                                                                                                                      |
| **OR**                                                                                                                                          |
| ** **                                                                                                                                      | ** ** | ** ** |
| **o**                                                                                                                                           | ** ** | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF  1934** |
| ** **                                                                                                                                      | ** ** | ** ** |
| **FOR THE TRANSITION PERIOD FROM           TO           ** |
|                                                                                                                                                 |  |  |  |  |

 

**Commission file number 0-13721**

 

**HICKORY TECH CORPORATION**

(Exact name of registrant as specified in itscharter)

 
| **Minnesota**                                                                       | ** ** | **41-1524393**                        |
|-------------------------------------------------------------------------------------|------------|---------------------------------------|
| (State or other jurisdiction of  incorporation or organization)                     |       | (I.R.S. Employer  Identification No.) |
|                                                                                |       |                                  |
| **221 East Hickory Street**                                                         |
| **Mankato, Minnesota 56002-3248**                                                   |
| (Address of principal executive offices and  zip code)                              |
|                                                                                |       |                                  |
| **(800) 326-5789**                                                                  |
| (Registrant’s telephone number, including  area code)                          |
|                                                                                |       |                                  |
|                                                                                |       |                                  |
| (Former name, former address and former  fiscal year, if changed since last report) |
|                                                                                     |            |                                       |  |  |

 

Indicate by check mark whether the Registrant (1) has filed all reportsrequired to be filed by Section 13 or 15(d) of the Securities Exchange Actof 1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days.  Yes  ý   No  o

 

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

 

The total number of shares of the registrant’s common stock outstandingas of June 30, 2004: 12,981,929.

 

 

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**HICKORY TECH CORPORATION**

June 30,2004

PARTI. FINANCIAL INFORMATION

ITEM1.  FINANCIAL STATEMENTS.

CONSOLIDATEDSTATEMENTS OF OPERATIONS

(UNAUDITED)

 
| ** **                                                                             | ** ** | **For Three Months Ended** |       | **For Six Months Ended** |   |
|----------------------------------------------------------------------------------------|------------|----------------------------|------------|--------------------------|--------|
| **(In  Thousands Except Per Share Amounts)**                                           | ** ** | **6/30/2004**              | ** ** | **6/30/2003**            |   | **6/30/2004** | ** ** | **6/30/2003** |   |
| OPERATING REVENUES:                                                                    |       |                       | ** ** |                     |   |   | ** ** |   |   |
| Telecom Sector                                                                         | ** ** | **$**                      | **18,847** | ** **               | $      | 18,680 |   | **$** | **38,273** | ** ** | $ | 37,248 |   |
| Information Solutions Sector                                                           | ** ** | **679**                    | ** ** | 809                      |   | **1,645** | ** ** | 1,907 |   |
| Enterprise Solutions Sector                                                            | ** ** | **3,338**                  | ** ** | 3,383                    |   | **5,633** | ** ** | 7,294 |   |
| TOTAL OPERATING REVENUES                                                               | ** ** | **22,864**                 | ** ** | 22,872                   |   | **45,551** | ** ** | 46,449 |   |
| COSTS AND EXPENSES:                                                                    |       |                       | ** ** |                     |   |   | ** ** |   |   |
| Cost of Products Sold, Enterprise Solutions                                            | ** ** | **2,296**                  | ** ** | 2,550                    |   | **3,805** | ** ** | 5,069 |   |
| Cost of Services, excluding Depreciation  and Amortization                             | ** ** | **7,871**                  | ** ** | 8,002                    |   | **16,479** | ** ** | 16,270 |   |
| Selling, General and Administrative  Expenses, excluding Depreciation and Amortization | ** ** | **3,626**                  | ** ** | 3,672                    |   | **7,282** | ** ** | 7,496 |   |
| Depreciation                                                                           | ** ** | **3,881**                  | ** ** | 3,731                    |   | **7,757** | ** ** | 7,233 |   |
| Amortization of Intangibles                                                            | ** ** | **237**                    | ** ** | 198                      |   | **473** | ** ** | 524 |   |
| TOTAL COSTS AND EXPENSES                                                               | ** ** | **17,911**                 | ** ** | 18,153                   |   | **35,796** | ** ** | 36,592 |   |
| OPERATING INCOME                                                                       | ** ** | **4,953**                  | ** ** | 4,719                    |   | **9,755** | ** ** | 9,857 |   |
| OTHER INCOME/(EXPENSE):                                                                |       |                       | ** ** |                     |   |   | ** ** |   |   |
| Equity in Net Loss of Investees                                                        | ** ** | **—**                 | ** ** | (1                       | )      | **—** | ** ** | (4 | ) |
| Interest and Other Income                                                              | ** ** | **19**                     | ** ** | 13                       |   | **34** | ** ** | 22 |   |
| Interest Expense                                                                       | ** ** | **(1,138**                 | **)**      | (1,480                   | )      | **(2,327** | **)** | (3,045 | ) |
| TOTAL OTHER INCOME/(EXPENSE)                                                           | ** ** | **(1,119**                 | **)**      | (1,468                   | )      | **(2,293** | **)** | (3,027 | ) |
|                                                                                   | ** ** | ** **                 | ** ** |                     |   | ** ** | ** ** |   |   |
| INCOME BEFORE INCOME TAXES                                                             | ** ** | **3,834**                  | ** ** | 3,251                    |   | **7,462** | ** ** | 6,830 |   |
| INCOME TAX PROVISION                                                                   | ** ** | **1,551**                  | ** ** | 1,329                    |   | **3,018** | ** ** | 2,791 |   |
| INCOME FROM CONTINUING OPERATIONS                                                      | ** ** | **2,283**                  | ** ** | 1,922                    |   | **4,444** | ** ** | 4,039 |   |
| DISCONTINUED OPERATIONS (Note 4)                                                       |       |                       | ** ** |                     |   |   | ** ** |   |   |
| Income/(Loss) from Operations of  Discontinued Component                               | ** ** | **—**                 | ** ** | 996                      |   | **(99** | **)** | 1,386 |   |
| Income Tax (Benefit)/Provision                                                         | ** ** | **—**                 | ** ** | 408                      |   | **(40** | **)** | 568 |   |
| INCOME/(LOSS) FROM DISCONTINUED OPERATIONS                                             | ** ** | **—**                 | ** ** | 588                      |   | **(59** | **)** | 818 |   |
| NET INCOME                                                                             | ** ** | **$**                      | **2,283**  | ** **               | $      | 2,510 |   | **$** | **4,385** | ** ** | $ | 4,857 |   |
|                                                                                   |       |                       | ** ** |                     |   |   | ** ** |   |   |
| Basic Earnings Per Share - Continuing  Operations:                                     | ** ** | **$**                      | **0.18**   | ** **               | $      | 0.14 |   | **$** | **0.34** | ** ** | $ | 0.29 |   |
| Basic Earnings Per Share - Discontinued  Operations:                                   | ** ** | **—**                 | ** ** | 0.04                     |   | **—** | ** ** | 0.06 |   |
| ** **                                                                             |       | **$**                      | **0.18**   | ** **               | $      | 0.18 |   | **$** | **0.34** | ** ** | $ | 0.35 |   |
| Dividends Per Share                                                                    | ** ** | **$**                      | **0.11**   | ** **               | $      | 0.11 |   | **$** | **0.22** | ** ** | $ | 0.22 |   |
| Basic Weighted Average Common Shares  Outstanding                                      | ** ** | **12,975**                 | ** ** | 13,951                   |   | **12,972** | ** ** | 13,972 |   |
|                                                                                   |       |                       | ** ** |                     |   |   | ** ** |   |   |
| Diluted Earnings Per Share - Continuing  Operations:                                   | ** ** | **$**                      | **0.18**   | ** **               | $      | 0.14 |   | **$** | **0.34** | ** ** | $ | 0.29 |   |
| Diluted Earnings Per Share - Discontinued  Operations:                                 | ** ** | **—**                 | ** ** | 0.04                     |   | **—** | ** ** | 0.06 |   |
| ** **                                                                             |       | **$**                      | **0.18**   | ** **               | $      | 0.18 |   | **$** | **0.34** | ** ** | $ | 0.35 |   |
| Diluted Weighted Average Common and  Equivalent Shares Outstanding                     | ** ** | **13,020**                 | ** ** | 13,981                   |   | **13,021** | ** ** | 13,986 |   |

 

The accompanying notes arean integral part of the consolidated financial statements.

 

1

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**HICKORY TECH CORPORATION**

June 30, 2004

CONSOLIDATEDBALANCE SHEETS

(UNAUDITED)

 
| **(In  Thousands Except Share and Per Share Amounts)**                    | ** ** | **6/30/2004** | ** **  | **12/31/2003** | ** ** |
|---------------------------------------------------------------------------|------------|---------------|-------------|----------------|------------|
| ASSETS                                                                    |       |          |        |           |       |
| CURRENT ASSETS:                                                           |       |          |        |           |       |
| Cash and Cash Equivalents                                                 | ** ** | **$**         | **233**     |           | $          | 278 |   |
| Receivables, Net of Allowance for Doubtful  Accounts of $1,338 and $1,283 | ** ** | **10,224**    |        | 9,984          |       |
| Income Taxes Receivable                                                   | ** ** | **—**    |        | 2,838          |       |
| Costs in Excess of Billings on Contracts                                  | ** ** | **619**       |        | 934            |       |
| Inventories                                                               | ** ** | **4,583**     |        | 4,453          |       |
| Deferred Income Taxes                                                     | ** ** | **1,057**     |        | 1,057          |       |
| Other                                                                     | ** ** | **2,002**     |        | 2,497          |       |
| TOTAL CURRENT ASSETS                                                      | ** ** | **18,718**    |        | 22,041         |       |
| INVESTMENTS                                                               | ** ** | **4,371**     |        | 6,710          |       |
| PROPERTY, PLANT AND EQUIPMENT                                             | ** ** | **236,263**   |        | 230,490        |       |
| Less ACCUMULATED DEPRECIATION                                             | ** ** | **124,024**   |        | 116,487        |       |
| PROPERTY, PLANT AND EQUIPMENT, NET                                        | ** ** | **112,239**   |        | 114,003        |       |
| OTHER ASSETS:                                                             |       |          |        |           |       |
| Goodwill                                                                  | ** ** | **25,086**    |        | 25,086         |       |
| Intangible Assets, Net                                                    | ** ** | **439**       |        | 481            |       |
| Financial Derivative Instruments                                          | ** ** | **3,280**     |        | 2,515          |       |
| Deferred Costs and Other                                                  | ** ** | **4,138**     |        | 4,876          |       |
| TOTAL OTHER ASSETS                                                        | ** ** | **32,943**    |        | 32,958         |       |
| TOTAL ASSETS                                                              | ** ** | **$**         | **168,271** |           | $          | 175,712 |   |
|                                                                      |       |          |        |           |       |
| LIABILITIES & SHAREHOLDERS’ EQUITY                               |       |          |        |           |       |
| CURRENT LIABILITIES:                                                      |       |          |        |           |       |
| Cash Overdraft                                                            | ** ** | **$**         | **828**     |           | $          | 1,001 |   |
| Accounts Payable                                                          | ** ** | **2,364**     |        | 3,771          |       |
| Accrued Expenses                                                          | ** ** | **3,277**     |        | 3,243          |       |
| Accrued Interest                                                          | ** ** | **68**        |        | 41             |       |
| Accrued Income Taxes                                                      | ** ** | **1,885**     |        | —         |       |
| Billings in Excess of Costs on Contracts                                  | ** ** | **188**       |        | 73             |       |
| Advanced Billings and Deposits                                            | ** ** | **2,964**     |        | 3,040          |       |
| Current Maturities of Long-Term Obligations                               | ** ** | **1,600**     |        | 1,572          |       |
| TOTAL CURRENT LIABILITIES                                                 | ** ** | **13,174**    |        | 12,741         |       |
| LONG-TERM OBLIGATIONS, Net of Current  Maturities                         | ** ** | **107,280**   |        | 118,040        |       |
| DEFERRED INCOME TAXES                                                     | ** ** | **10,628**    |        | 10,331         |       |
| DEFERRED REVENUE AND EMPLOYEE BENEFITS                                    | ** ** | **6,215**     |        | 5,883          |       |
| TOTAL LIABILITIES                                                         | ** ** | **137,297**   |        | 146,995        |       |
| COMMITMENTS AND CONTINGENCIES (Note 9)                                    | ** ** | **—**    |        | —         |       |
| SHAREHOLDERS’ EQUITY:                                                |       |          |        |           |       |
| Common Stock, no par value, $.10 stated  value                            |       |          |        |           |       |
| Shares authorized: 100,000,000                                            |       |          |        |           |       |
| Shares outstanding: 12,981,929 in 2004 and  12,967,811 in 2003            | ** ** | **1,298**     |        | 1,297          |       |
| Additional Paid-In Capital                                                | ** ** | **7,947**     |        | 7,690          |       |
| Retained Earnings                                                         | ** ** | **19,777**    |        | 18,246         |       |
| Accumulated Other Comprehensive Income  (Notes 3, 11)                     | ** ** | **1,952**     |        | 1,484          |       |
| TOTAL SHAREHOLDERS’ EQUITY                                           | ** ** | **30,974**    |        | 28,717         |       |
| TOTAL LIABILITIES & SHAREHOLDERS’  EQUITY                        | ** ** | **$**         | **168,271** |           | $          | 175,712 |   |

 

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

 

2

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**HICKORY TECH CORPORATION**

June 30, 2004

CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

 
| ** **                                                                            | ** ** | **For Six Months Ended** | ** ** |
|---------------------------------------------------------------------------------------|------------|--------------------------|------------|
| **(Dollars  In Thousands)**                                                           | ** ** | **6/30/2004**            | ** ** | **6/30/2003** | ** ** |
| CASH FLOWS FROM OPERATING ACTIVITIES:                                                 |       |                     |       |   |   |
| Net Income                                                                            | ** ** | **$**                    | **4,385**  |   | $ | 4,857 |   |
| Adjustments to Reconcile Net Income to Net  Cash Provided by Operating Activities:    |       |                     |       |   |   |
| Depreciation and Amortization                                                         | ** ** | **8,230**                |       | 9,051 |   |
| (Gain)/Loss on Sale of Assets                                                         | ** ** | **4**                    |       | (2 | ) |
| Stock-Based Compensation                                                              | ** ** | **56**                   |       | 402 |   |
| Employee Retirement Benefits and Deferred  Compensation                               | ** ** | **434**                  |       | 104 |   |
| Accrued Patronage Refunds                                                             | ** ** | **(197**                 | )          | (314 | ) |
| Equity in Net Loss of Investees                                                       | ** ** | **—**               |       | 5 |   |
| Provision for Losses on Accounts Receivable                                           | ** ** | **326**                  |       | 477 |   |
| Changes in Operating Assets and  Liabilities:                                         |       |                     |       |   |   |
| Receivables                                                                           | ** ** | **4,158**                |       | 2,546 |   |
| Inventories                                                                           | ** ** | **(130**                 | )          | (203 | ) |
| Billings and Costs on Contracts                                                       | ** ** | **431**                  |       | 312 |   |
| Accounts Payable and Accrued Expenses                                                 | ** ** | **(1,079**               | )          | (2,766 | ) |
| Advance Billings and Deposits                                                         | ** ** | **(76**                  | )          | 114 |   |
| Deferred Revenue and Employee Benefits                                                | ** ** | **(102**                 | )          | (44 | ) |
| Other                                                                                 | ** ** | **747**                  |       | 1,351 |   |
| Net Cash Provided By Operating Activities                                             | ** ** | **17,187**               |       | 15,890 |   |
| CASH FLOWS FROM INVESTING ACTIVITIES:                                                 |       |                     |       |   |   |
| Additions to Property, Plant and Equipment                                            | ** ** | **(6,240**               | )          | (4,460 | ) |
| Redemption of Investments                                                             | ** ** | **2,600**                |       | 4,100 |   |
| Purchase of Intangible Asset                                                          | ** ** | **(9**                   | )          | — |   |
| Proceeds from Sale of Assets                                                          | ** ** | **56**                   |       | 73 |   |
| Net Cash Used In Investing Activities                                                 | ** ** | **(3,593**               | )          | (287 | ) |
| CASH FLOWS FROM FINANCING ACTIVITIES:                                                 |       |                     |       |   |   |
| Change in Cash Overdraft                                                              | ** ** | **(173**                 | )          | — |   |
| Payments of Capital Lease Obligations                                                 | ** ** | **(314**                 | )          | (301 | ) |
| Repayments on Credit Facility                                                         | ** ** | **(12,000**              | )          | (14,000 | ) |
| Borrowings on Credit Facility                                                         | ** ** | **1,500**                |       | 1,250 |   |
| Proceeds from Issuance of Common Stock                                                | ** ** | **244**                  |       | 496 |   |
| Dividends Paid                                                                        | ** ** | **(2,853**               | )          | (3,074 | ) |
| Stock Repurchase/Retirement                                                           | ** ** | **(43**                  | )          | (704 | ) |
| Net Cash Used In Financing Activities                                                 | ** ** | **(13,639**              | )          | (16,333 | ) |
| NET INCREASE (DECREASE) IN CASH AND CASH  EQUIVALENTS                                 | ** ** | **(45**                  | )          | (730 | ) |
| CASH AND CASH EQUIVALENTS AT BEGINNING OF  PERIOD                                     | ** ** | **278**                  |       | 1,874 |   |
| CASH AND CASH EQUIVALENTS AT END OF PERIOD                                            | ** ** | **$**                    | **233**    |   | $ | 1,144 |   |
| SUPPLEMENTAL DISCLOSURE OF CASH FLOW  INFORMATION:                                    |       |                     |       |   |   |
| Cash Paid for Interest                                                                | ** ** | **$**                    | **2,374**  |   | $ | 3,715 |   |
| Cash Paid for Income Taxes, Net of Tax  Refunds of $1,750 and $1,600 in 2004 and 2003 | ** ** | **$**                    | **(1,745** | ) | $ | 150 |   |
| NON-CASH INVESTING ACTIVITIES:                                                        |       |                     |       |   |   |
| Property, Plant and Equipment Acquired with  Capital Leases                           | ** ** | **$**                    | **81**     |   | $ | 124 |   |

 

The accompanying notes arean integral part of the consolidated financial statements.

 

3

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**HICKORY TECH CORPORATION**

**JUNE 30, 2004**

**PART 1. FINANCIAL INFORMATION**

 

**ITEM 1. NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

NOTE 1. BASIS OF PRESENTATION

 

The accompanying unaudited condensed consolidated financial statementshave been prepared in accordance with generally accepted accounting principlesfor interim financial information and with the instructions to Form 10-Q andArticle 10 of Regulation S-X. Accordingly, they do not include all of theinformation necessary for a fair presentation of results of operations,financial position, and cash flows in conformity with accounting principlesgenerally accepted in the United States of America. In the opinion ofmanagement, the condensed consolidated financial statements reflect alladjustments (consisting only of normal recurring adjustments) considerednecessary for a fair presentation of Hickory Tech Corporation’s (HickoryTech)results for the periods presented. Operating results for interim periods arenot necessarily indicative of results that may be expected for the fiscal yearas a whole. The preparation of financial statements in conformity withaccounting principles generally accepted in the United States of Americarequires management to make estimates and assumptions that affect the reportedamounts of assets, liabilities, revenues, expenses, and related disclosures atthe date of the financial statements and during the reporting period. Actualresults could differ from these estimates. These unaudited interim condensedconsolidated financial statements should be read in conjunction withHickoryTech’s Annual Report on Form 10-K for the year ended December 31,2003.

 

The condensed consolidated financial statements of HickoryTech includeHickory Tech Corporation and its subsidiaries in the following three businesssegments: (i) Telecom Sector, (ii) Information Solutions Sector and (iii)Enterprise Solutions Sector.  During thefirst two quarters of 2003, the Information Solutions Sector had an investmentin an unconsolidated partnership, which was accounted for using the equitymethod. This partnership was dissolved in the fourth quarter of 2003. Allinter-company transactions have been eliminated from the consolidated financialstatements.

 

Certain expenses reported as operating expenses in 2003 have beenreclassified between cost of services and selling, general and administrativeexpenses to conform to the 2004 presentation. These reclassifications did notchange previously reported net income, shareholders’ equity or cash flows.

 

Cost of services include all costs related to delivery of HickoryTech’scommunications services and products. These costs include all costs ofperforming services and providing related products. It does not include costsassociated with selling, general and administrative, depreciation andamortization of property, plant and equipment and intangible assets, and costof products sold for the Enterprise Solutions Sector.

 

On December 15, 2003, HickoryTech sold its wireless business, MinnesotaSouthern Wireless Company (MSWC), to Western Wireless Corporation (WWC). Thewireless operations are reported as part of the Telecom Sector. The results ofoperations of the wireless business are reported as discontinued operations forall periods presented (see Note 4).

 

NOTE 2. EARNINGS AND CASH DIVIDENDS PER COMMON SHARE

 

Basic earnings per share is computed by dividing net income by theweighted average number of shares of common stock outstanding during theapplicable period. Shares used in the earnings per share assuming dilutioncalculation are based on the weighted average number of shares of common stockoutstanding during the quarter increased by potentially dilutive common shares.Potentially dilutive common shares include stock options and stock subscribedunder the employee stock purchase plan (ESPP).

 

4

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| ** **                          | ** ** | **For Three Months Ended** | ** ** | **For Six Months Ended** | ** ** |
|-------------------------------------|------------|----------------------------|------------|--------------------------|------------|
| ** **                          | ** ** | **6/30/2004**              | ** ** | **6/30/2003**            | ** ** | **6/30/2004** | ** ** | **6/30/2003** | ** ** |
| Weighted Average Shares Outstanding | ** ** | **12,974,669**             |       | 13,950,824               | ** ** | **12,972,130** |   | 13,972,141 |   |
| Stock Options (dilutive only)       | ** ** | **25,301**                 |       | 13,723                   | ** ** | **28,818** |   | 194 |   |
| Stock Subscribed (ESPP)             | ** ** | **20,347**                 |       | 16,746                   | ** ** | **20,347** |   | 13,980 |   |
| Total Dilutive Shares Outstanding   | ** ** | **13,020,317**             |       | 13,981,293               | ** ** | **13,021,295** |   | 13,986,315 |   |

 

Options to purchase 449,283 shares for the three and six months endedJune 30, 2004, and 493,548 shares for the three and six months endedJune 30, 2003, were not included in the computation of earnings per shareassuming dilution because their effect on earnings per share would have beenantidilutive.

 

Cash dividends are based on the number of common shares outstanding atthe respective record dates. Listed below is the number of shares outstandingas of the record date for the first two quarters of 2004 and 2003.  

 

| **Shares  Outstanding on Record Date** | ** ** | **2004**       | ** ** | **2003**   | ** ** |
|----------------------------------------|------------|----------------|------------|------------|------------|
| First Quarter (Feb. 15)                | ** ** | **12,967,886** |       | 14,003,335 |       |
| Second Quarter (May 15)                | ** ** | **12,971,954** |       | 13,942,662 |       |

 

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

 

During the first six months of 2004 and 2003, shareholders have electedto reinvest $136,000 and $134,000, respectively, of dividends into HickoryTechcommon stock pursuant to the HickoryTech Dividend Reinvestment Plan.

 

NOTE 3. COMPREHENSIVE INCOME

 

HickoryTech follows the provisions of SFAS No. 130, “ReportingComprehensive Income.” This statement established rules for the reporting ofcomprehensive income and its components. In addition to net income,HickoryTech’s comprehensive income includes changes in unrealized gains andlosses on derivative instruments qualifying and designated as cash flow hedges.Comprehensive income for the three months ended June 30, 2004 and 2003 was$3,617,000 and $3,091,000, respectively. Comprehensive income for the sixmonths ended June 30, 2004 and 2003 was $4,853,000 and $5,438,000,respectively.

 

NOTE 4. DISCONTINUED OPERATIONS

 

On December 15, 2003, HickoryTech sold its wireless business,Minnesota Southern Wireless Company (MSWC), to Western Wireless Corporation(WWC). The wireless operations are reported as part of the Telecom Sector. Theconsolidated statements of operations for all periods presented have beenrestated to reflect wireless operations as discontinued operations.

 

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

 
| ** **                        | ** ** | **For Three Months Ended** | ** ** | **For Six Months Ended** | ** ** |
|-----------------------------------|------------|----------------------------|------------|--------------------------|------------|
| **(Dollars  in Thousands)**       | ** ** | **6/30/2004**              | ** ** | **6/30/2003**            | ** ** | **6/30/2004** | ** ** | **6/30/2003** | ** ** |
| Revenues                          | ** ** | **$**                      | **—** |                     | $          | 3,968 | ** ** | **$** | **—** |   | $ | 7,361 |   |
|                              |       |                       |       |                     |       |   |   |   |   |
| Income/(Loss) Before Income Taxes | ** ** | **$**                      | **—** |                     | $          | 996 | ** ** | **$** | **(99** | **)** | $ | 1,386 |   |

 

5

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NOTE 5. INVENTORIES

 

Inventories, which consist of equipment for resale, materials andsupplies, are stated at the lower of average cost or market. Cost is determinedon a first-in first-out (FIFO) basis. Market is the net realizable value of theinventory. Obsolescence reserves are maintained for inventory with an estimatednet realizable value of less than cost.

 

NOTE 6. INTANGIBLE ASSETS

 

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

 

Effective with the adoption of this standard, HickoryTech is no longeramortizing acquired goodwill. Instead, SFAS No. 142 requires acquiredgoodwill to be evaluated for impairment using a two-step test based upon a fairvalue approach. The first step is used to identify potential impairment basedupon the fair value of the applicable reporting unit. If the fair value of thereporting unit is less than its carrying value, a second step is required todetermine the fair value of the individual assets and liabilities of thereporting unit in order to measure the amount of the goodwill impairment. Uponadoption of this standard, HickoryTech completed a transitional impairment testfor its acquired goodwill, determining fair value using primarily a discountedcash flow model. The determined fair value was sufficient to pass the firststep impairment test, and therefore no impairment was recorded.

 

On a prospective basis, HickoryTech is required to test acquiredgoodwill for impairment on an annual basis based upon a fair value approach.Additionally, goodwill shall be tested for impairment between annual tests ifan event occurs or circumstances change that would more likely than not reducethe fair value of an entity below its carrying value. As of December 31,2003, HickoryTech completed its annual impairment tests for acquired goodwillusing methodologies consistent with those applied for its transitionalimpairment tests performed as of January 1, 2002. Such testing resulted inno impairment charge to goodwill, as the determined fair value was againsufficient to pass the first step impairment test. Other indefinite-livedintangible assets will be tested between annual tests if events or changes incircumstances indicate that the asset might be impaired.

 

The carrying value of HickoryTech’s goodwill is $25,086,000 as ofJune 30, 2004 and December 31, 2003.

 

The components of HickoryTech’s other intangible assets are shown inthe following table:

 
| ** **                       | ** ** | **As of June 30, 2004** | ** ** | **As of December 31, 2003** | ** ** |
|----------------------------------|------------|------------------------------|------------|----------------------------------|------------|
| **(Dollars  in Thousands)**      | ** ** | **Gross Carrying  Amount**   | ** ** | **Accumulated  Amortization**    | ** ** | **Gross Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** |
|                             |       |                         |       |                             |       |   |   |   |   |
| Definite-Lived Intangible Assets |       |                         |       |                             |       |   |   |   |   |
| Customers                        |       | **$**                        | **830**    | ** **                       | **$**      | **391** | ** ** | $ | 821 |   | $ | 340 |   |
| Other Intangibles                |       | **100**                      | ** ** | **100**                          | ** ** | 100 |   | 100 |   |
| Total                            |       | **$**                        | **930**    | ** **                       | **$**      | **491** | ** ** | $ | 921 |   | $ | 440 |   |

 

Amortization expense related to the definite-lived intangible assetsfor the three months ended June 30, 2004 and 2003 was $26,000 and $25,000,respectively. Amortization expense related to the definite-lived intangibleassets for the six months ended June 30, 2004 and 2003 was $51,000 and$51,000, respectively.  Total estimatedamortization expense for the remaining six months of 2004 and the five yearssubsequent to 2004 is as follows: 2004 (July 1 through December 31) -$52,000; 2005 - $104,000; 2006 - $104,000; 2007 - $104,000; 2008 - $74,000 and2009 - $1,000.

 

6

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NOTE 7. RECENT ACCOUNTING DEVELOPMENTS

 

In January 2003, the FASB issued FIN No. 46, *Consolidationof Variable Interest Entities*. This interpretation provides guidanceon how to identify a variable interest entity and addresses when the assets,liabilities and results of operations of such entities must be included in acompany’s consolidated financial statements. This interpretation was effectiveimmediately for variable interest entities created after January 31, 2003and for variable interest entities in which the Company obtains an interestafter that date. For interests in variable interest entities that were acquiredprior to January 31, 2003, the Company adopted the provisions of thisinterpretation on July 1, 2003. Adoption of this statement did not resultin the consolidation or disclosure of any variable interest entities in whichthe Company maintains an interest. The Company did not absorb the majority ofthe losses or residual returns of the variable interest entities in which theCompany maintains an interest and these interests are not significant. InDecember 2003, the FASB issued a revised FIN No. 46 which clarifiescertain aspects of the accounting for variable interest entities. The revisionof FIN No. 46 had no impact on results of operations or financial position.

 

In May 2004, the FASB issued FASB Staff Position (FSP) No. FAS 106-2, *Accounting and Disclosure Requirements Related to the MedicarePrescription Drug Improvement and Modernization Act of 2003*, whichsupersedes FSP No. FAS 106-1 of the same name. This FSP outlines theappropriate accounting treatment for the effects of the new Medicare law, aswell as the required financial statement disclosures. The new law introduces aprescription drug benefit under Medicare, as well as a federal subsidy tosponsors of retiree health care benefit plans that provide a benefit that is atleast actuarially equivalent to the Medicare plan. The retiree medical plans doprovide prescription drug coverage. However, as permitted by FSP No. FAS 106-2,the Company has elected to defer recognition of the impacts of the new law onthe accumulated post-retirement benefit obligation and net periodicpost-retirement benefit expense presented in the consolidated financial statements.Specific authoritative accounting guidance on the accounting for the federalsubsidy provided for in the Act is pending. That guidance, when issued, couldrequire the Company to change previously reported information. BeginningJanuary 1, 2006, Medicare’s prescription drug plan may become the primaryplan for qualified retirees when they become age 65 and are eligible forMedicare. Thus, the Company may see a decrease in the amount of prescriptiondrug benefits to be paid beginning in 2006.

 

In December 2003, the FASB issued a revision of SFAS No. 132, *Employers’ Disclosures about Pensions and Other Post-retirementBenefits*. This statement revises the disclosures required forpension and other post-retirement benefit plans. The Company has incorporatedthe new disclosure requirements into the Notes to Consolidated FinancialStatements included in this report.

 

7

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NOTE 8. QUARTERLY SECTOR FINANCIAL SUMMARY

 
| **(Dollars  In Thousands)**                                          | ** ** | **Telecom** | ** ** | **Information  Solutions** | ** ** | **Enterprise  Solutions** | ** ** | **Corporate and  Eliminations** | ** ** | **HickoryTech  Consolidated** | ** ** |
|----------------------------------------------------------------------|------------|-------------|------------|----------------------------|------------|---------------------------|------------|---------------------------------|------------|-------------------------------|------------|
| **Three Months Ended  6/30/04**                                      |       |        |       |                       |       |                      |       |                            |       |                          |       |
| Operating Revenue from Unaffiliated  Customers                       |       | $           | 18,847     |                       | $          | 679                       |       | $                               | 3,338      |                          | $          | — |   | $ | 22,864 |   |
| Intersegment Revenues                                                |       | 69          |       | 1,127                      |       | —                    |       | (1,196                          | )          | —                        |       |
| Total                                                                |       | 18,916      |       | 1,806                      |       | 3,338                     |       | (1,196                          | )          | 22,864                        |       |
|                                                                 |       |        |       |                       |       |                      |       |                            |       |                          |       |
| Depreciation and Amortization                                        |       | 3,407       |       | 654                        |       | 44                        |       | 13                              |       | 4,118                         |       |
| Operating Income (Loss)                                              |       | 5,778       |       | (636                       | )          | (140                      | )          | (49                             | )          | 4,953                         |       |
| Interest Expense                                                     |       | 3           |       | 15                         |       | —                    |       | 1,120                           |       | 1,138                         |       |
| Income Taxes (Benefit)                                               |       | 2,338       |       | (260                       | )          | (57                       | )          | (470                            | )          | 1,551                         |       |
|                                                                 |       |        |       |                       |       |                      |       |                            |       |                          |       |
| Income (Loss) from Continuing Operations                             |       | 3,440       |       | (382                       | )          | (83                       | )          | (692                            | )          | 2,283                         |       |
| Loss from Discontinued Operations Including  Intersegment Revenues   |       | —      |       | —                     |       | —                    |       | —                          |       | —                        |       |
| Net Income (Loss)                                                    |       | 3,440       |       | (382                       | )          | (83                       | )          | (692                            | )          | 2,283                         |       |
|                                                                 |       |        |       |                       |       |                      |       |                            |       |                          |       |
| Identifiable Assets                                                  |       | 145,126     |       | 6,776                      |       | 7,661                     |       | 8,708                           |       | 168,271                       |       |
| Property, Plant and Equip., Net                                      |       | 107,198     |       | 4,514                      |       | 387                       |       | 140                             |       | 112,239                       |       |
| Capital Expenditures                                                 |       | 4,096       |       | —                     |       | 22                        |       | —                          |       | 4,118                         |       |
|                                                                 |       |        |       |                       |       |                      |       |                            |       |                          |       |
| **Three Months Ended  6/30/03**                                      |       |        |       |                       |       |                      |       |                            |       |                          |       |
| Operating Revenue from Unaffiliated  Customers                       |       | $           | 18,680     |                       | $          | 809                       |       | $                               | 3,383      |                          | $          | — |   | $ | 22,872 |   |
| Intersegment Revenues                                                |       | 68          |       | 768                        |       | —                    |       | (836                            | )          | —                        |       |
| Total                                                                |       | 18,748      |       | 1,577                      |       | 3,383                     |       | (836                            | )          | 22,872                        |       |
|                                                                 |       |        |       |                       |       |                      |       |                            |       |                          |       |
| Depreciation and Amortization                                        |       | 3,274       |       | 581                        |       | 60                        |       | 14                              |       | 3,929                         |       |
| Operating Income (Loss)                                              |       | 6,547       |       | (935                       | )          | (558                      | )          | (335                            | )          | 4,719                         |       |
| Interest Expense                                                     |       | 2           |       | 20                         |       | —                    |       | 1,458                           |       | 1,480                         |       |
| Income Taxes (Benefit)                                               |       | 2,756       |       | (336                       | )          | (232                      | )          | (859                            | )          | 1,329                         |       |
|                                                                 |       |        |       |                       |       |                      |       |                            |       |                          |       |
| Income (Loss) from Continuing Operations                             |       | 3,893       |       | (606                       | )          | (334                      | )          | (1,031                          | )          | 1,922                         |       |
| Income from Discontinued Operations  Including Intersegment Revenues |       | 419         |       | 122                        |       | —                    |       | 47                              |       | 588                           |       |
| Net Income (Loss)                                                    |       | 4,312       |       | (484                       | )          | (334                      | )          | (984                            | )          | 2,510                         |       |
|                                                                 |       |        |       |                       |       |                      |       |                            |       |                          |       |
| Identifiable Assets                                                  |       | 147,978     |       | 8,331                      |       | 10,403                    |       | 7,818                           |       | 174,530                       |       |
| Property, Plant and Equip., Net                                      |       | 109,638     |       | 5,572                      |       | 574                       |       | 223                             |       | 116,007                       |       |
| Capital Expenditures                                                 |       | 2,105       |       | —                     |       | 97                        |       | 26                              |       | 2,228                         |       |

 

8

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| **(Dollars  In Thousands)**                                          | ** ** | **Telecom** | ** ** | **Information  Solutions** | ** ** | **Enterprise  Solutions** | ** ** | **Corporate and  Eliminations** | ** ** | **HickoryTech  Consolidated** | ** ** |
|----------------------------------------------------------------------|------------|-------------|------------|----------------------------|------------|---------------------------|------------|---------------------------------|------------|-------------------------------|------------|
| **Six Months Ended  6/30/04**                                        |       |        |       |                       |       |                      |       |                            |       |                          |       |
| Operating Revenue from Unaffiliated  Customers                       |       | $           | 38,273     |                       | $          | 1,645                     |       | $                               | 5,633      |                          | $          | — |   | $ | 45,551 |   |
| Intersegment Revenues                                                |       | 138         |       | 2,174                      |       | —                    |       | (2,312                          | )          | —                        |       |
| Total                                                                |       | 38,411      |       | 3,819                      |       | 5,633                     |       | (2,312                          | )          | 45,551                        |       |
|                                                                 |       |        |       |                       |       |                      |       |                            |       |                          |       |
| Depreciation and Amortization                                        |       | 6,814       |       | 1,293                      |       | 95                        |       | 28                              |       | 8,230                         |       |
| Operating Income (Loss)                                              |       | 11,857      |       | (1,342                     | )          | (516                      | )          | (244                            | )          | 9,755                         |       |
| Interest Expense                                                     |       | 7           |       | 27                         |       | —                    |       | 2,293                           |       | 2,327                         |       |
| Income Taxes (Benefit)                                               |       | 4,798       |       | (550                       | )          | (209                      | )          | (1,021                          | )          | 3,018                         |       |
|                                                                 |       |        |       |                       |       |                      |       |                            |       |                          |       |
| Income (Loss) from Continuing Operations                             |       | 7,059       |       | (808                       | )          | (307                      | )          | (1,500                          | )          | 4,444                         |       |
| Loss from Discontinued Operations Including  Intersegment Revenues   |       | (59         | )          | —                     |       | —                    |       | —                          |       | (59                           | )          |
| Net Income (Loss)                                                    |       | 7,000       |       | (808                       | )          | (307                      | )          | (1,500                          | )          | 4,385                         |       |
|                                                                 |       |        |       |                       |       |                      |       |                            |       |                          |       |
| Identifiable Assets                                                  |       | 145,126     |       | 6,776                      |       | 7,661                     |       | 8,708                           |       | 168,271                       |       |
| Property, Plant and Equip., Net                                      |       | 107,198     |       | 4,514                      |       | 387                       |       | 140                             |       | 112,239                       |       |
| Capital Expenditures                                                 |       | 6,217       |       | 1                          |       | 22                        |       | —                          |       | 6,240                         |       |
|                                                                 |       |        |       |                       |       |                      |       |                            |       |                          |       |
| **Six Months Ended  6/30/03**                                        |       |        |       |                       |       |                      |       |                            |       |                          |       |
| Operating Revenue from Unaffiliated  Customers                       |       | $           | 37,248     |                       | $          | 1,907                     |       | $                               | 7,294      |                          | $          | — |   | $ | 46,449 |   |
| Intersegment Revenues                                                |       | 137         |       | 1,531                      |       | —                    |       | (1,668                          | )          | —                        |       |
| Total                                                                |       | 37,385      |       | 3,438                      |       | 7,294                     |       | (1,668                          | )          | 46,449                        |       |
|                                                                 |       |        |       |                       |       |                      |       |                            |       |                          |       |
| Depreciation and Amortization                                        |       | 6,459       |       | 1,125                      |       | 121                       |       | 52                              |       | 7,757                         |       |
| Operating Income (Loss)                                              |       | 12,851      |       | (1,684                     | )          | (484                      | )          | (826                            | )          | 9,857                         |       |
| Interest Expense                                                     |       | 7           |       | 38                         |       | —                    |       | 3,000                           |       | 3,045                         |       |
| Income Taxes (Benefit)                                               |       | 5,416       |       | (595                       | )          | (205                      | )          | (1,825                          | )          | 2,791                         |       |
|                                                                 |       |        |       |                       |       |                      |       |                            |       |                          |       |
| Income (Loss) from Continuing Operations                             |       | 7,601       |       | (1,102                     | )          | (295                      | )          | (2,165                          | )          | 4,039                         |       |
| Income from Discontinued Operations  Including Intersegment Revenues |       | 484         |       | 246                        |       | —                    |       | 88                              |       | 818                           |       |
| Net Income (Loss)                                                    |       | 8,085       |       | (856                       | )          | (295                      | )          | (2,077                          | )          | 4,857                         |       |
|                                                                 |       |        |       |                       |       |                      |       |                            |       |                          |       |
| Identifiable Assets                                                  |       | 147,978     |       | 8,331                      |       | 10,403                    |       | 7,818                           |       | 174,530                       |       |
| Property, Plant and Equip., Net                                      |       | 109,638     |       | 5,572                      |       | 574                       |       | 223                             |       | 116,007                       |       |
| Capital Expenditures                                                 |       | 3,156       |       | 144                        |       | 189                       |       | 153                             |       | 3,642                         |       |

 

9

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The Telecom Segment Identifiable Assets, Property Plant and Equipmentand Capital Expenditures presented above, exclude the following amounts relatedto the wireless business, which is reported as a discontinued operation:

 

| ** **                      | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|---------------------------------|------------|------------------------|------------|----------------------|------------|
| **(Dollars  in Thousands)**     | ** ** | **6/30/2004**          | ** ** | **6/30/2003**        | ** ** | **6/30/2004** | ** ** | **6/30/2003** | ** ** |
| Identifiable Assets             | ** ** | **$**                  | **—** |                 | $          | 53,203 | ** ** | **$** | **—** |   | $ | 53,203 |   |
| Property, Plant and Equip., Net | ** ** | **$**                  | **—** |                 | $          | 16,254 | ** ** | **$** | **—** |   | $ | 16,254 |   |
| Capital Expenditures            | ** ** | **$**                  | **—** |                 | $          | 497 | ** ** | **$** | **—** |   | $ | 818 |   |

 

NOTE 9. CONTINGENCIES

 

HickoryTech is involved in certain contractual disputes in the ordinarycourse of business. HickoryTech does not believe the ultimate resolution of anyof these existing matters will have a material adverse effect on its financialposition, results of operations or cash flows.

 

NOTE 10. STOCK COMPENSATION

 

At June 30, 2004, HickoryTech had four stock-based employee anddirector compensation plans, which are described more fully in the HickoryTechAnnual Report on Form 10-K for the year ended December 31, 2003.HickoryTech has elected to account for these employee and director stockcompensation plans using the intrinsic value method as permitted by AccountingPrinciples Board Opinion No. 25 and related interpretations.

 

In 2002, HickoryTech’s Board of Directors modified the terms of thestock options of a retiring officer. The modification extended the period afterretirement during which the officer could exercise his vested options. Thismodification resulted in HickoryTech recognizing $173,000 of compensationexpense during the first quarter of 2003. During the third quarter of 2003, theBoard of Directors extended the period during which this option holder canexercise his vested options to December 31, 2004. This extension will notresult in any additional compensation charges.

 

If HickoryTech had elected to recognize compensation cost based on thefair value of the options and other stock compensation as prescribed by SFASNo. 123, the following operating results would have occurred using theBlack-Scholes option-pricing model to determine the fair value of the options: 

 
| ** **                                                                                                                                    | ** ** | **For Three Months Ended** | ** ** | **For Six Months Ended** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------|------------|--------------------------|------------|
| **(Dollars  in Thousands)**                                                                                                                   | ** ** | **6/30/2004**              | ** ** | **6/30/2003**            | ** ** | **6/30/2004** | ** ** | **6/30/2003** | ** ** |
|                                                                                                                                          |       |                       | ** ** |                     |       |   | ** ** |   |   |
| Reported Net Income                                                                                                                           |       | **$**                      | **2,283**  | ** **               | $          | 2,510 |   | **$** | **4,385** | ** ** | $ | 4,857 |   |
| Add: Stock-based employee compensation  expense included in reported net income, net of related tax effects                                   |       | **12**                     | ** ** | 85                       |       | **33** | ** ** | 237 |   |
| Deduct: Total stock-based employee  compensation expense determined under fair value based method for all awards,  net of related tax effects |       | **(65**                    | **)**      | (145                     | )          | **(153** | **)** | (438 | ) |
| Pro Forma Net Income                                                                                                                          |       | **$**                      | **2,230**  | ** **               | $          | 2,450 |   | **$** | **4,265** | ** ** | $ | 4,656 |   |
|                                                                                                                                          |       | ** **                 | ** ** |                     |       | ** ** | ** ** |   |   |
| Earnings per share:                                                                                                                           |       | ** **                 | ** ** |                     |       | ** ** | ** ** |   |   |
| Basic - as reported                                                                                                                           |       | **$**                      | **0.18**   | ** **               | $          | 0.18 |   | **$** | **0.34** | ** ** | $ | 0.35 |   |
| Basic - pro forma                                                                                                                             |       | **$**                      | **0.17**   | ** **               | $          | 0.18 |   | **$** | **0.33** | ** ** | $ | 0.33 |   |
|                                                                                                                                          |       | ** **                 | ** ** |                     |       | ** ** | ** ** |   |   |
| Diluted - as reported                                                                                                                         |       | **$**                      | **0.18**   | ** **               | $          | 0.18 |   | **$** | **0.34** | ** ** | $ | 0.35 |   |
| Diluted - pro forma                                                                                                                           |       | **$**                      | **0.17**   | ** **               | $          | 0.18 |   | **$** | **0.33** | ** ** | $ | 0.33 |   |

 

10

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NOTE 11. FINANCIAL DERIVATIVE INSTRUMENTS

 

HickoryTech accounts for derivative instruments in accordance with SFASNo. 133, as amended by SFAS No. 149, “Accounting for Derivative Instruments andHedging Activities,” which requires derivative instruments to be recorded onthe balance sheet at fair value. Changes in fair value of derivativeinstruments must be recognized in earnings unless specific hedge accountingcriteria are met, in which case the gains and losses are included in othercomprehensive income rather than in earnings.

 
| **(Dollars  in Thousands)**                                               | ** ** | **Interest Rate  Swap Agreement** | ** ** |
|---------------------------------------------------------------------------|------------|-----------------------------------|------------|
|                                                                      |       |                              |       |
| Accumulated other comprehensive income  balance at December 31, 2003 |       | $                                 | 1,484      |   |
| Market value increase on interest rate swap  agreement                    |       | 468                               |       |
| Accumulated other comprehensive income  balance at June 30, 2004     |       | $                                 | 1,952      |   |

 

HickoryTech has variable rate debt instruments, which subject theCompany to interest rate risk. HickoryTech has entered into interest rate swapagreements, with remaining maturities of twelve months to forty-eight months,to manage its exposure to interest rate movements on a portion of its variablerate debt obligations. The market value of the cumulative gain or loss on thesederivative instruments is reported as a component of accumulated othercomprehensive income in shareholders’ equity and will be recognized in earningswhen the term of the swap agreement is concluded.

 

The fair value of HickoryTech’s derivatives at June 30, 2004 andDecember 31, 2003 is a net asset of $3,280,000 and $2,515,000,respectively, which is included in other assets in the accompanyingconsolidated balance sheet.

 

NOTE 12. EMPLOYEE POST-RETIREMENT BENEFITS

 

HickoryTech provides post-retirement health care and life insurance benefitsfor certain employees. HickoryTech is not currently funding thesepost-retirement benefits, but has accrued these liabilities during the firsttwo quarters of 2004 and 2003.

 
| ** **                              | ** ** | **For Three Months Ended** | ** ** | **For Six Months Ended** | ** ** |
|-----------------------------------------|------------|----------------------------|------------|--------------------------|------------|
| **(Dollars  in Thousands)**             | ** ** | **6/30/2004**              | ** ** | **6/30/2003**            | ** ** | **6/30/2004** | ** ** | **6/30/2003** | ** ** |
| Components of Net Periodic Benefit Cost |       |                       | ** ** |                     |       |   | ** ** |   |   |
| Service Cost                            | ** ** | **$**                      | **93**     | ** **               | $          | 52 |   | **$** | **186** | ** ** | $ | 105 |   |
| Interest Cost                           | ** ** | **131**                    | ** ** | 90                       |       | **262** | ** ** | 180 |   |
| Expected Return on Plan Assets          | ** ** | **—**                 | ** ** | —                   |       | **—** | ** ** | — |   |
| Amortization of Transition Obligation   | ** ** | **15**                     | ** ** | 15                       |       | **30** | ** ** | 30 |   |
| Amortization of Prior Service Cost      | ** ** | **(3**                     | **)**      | (3                       | )          | **(6** | **)** | (6 | ) |
| Recognized Net Actuarial Loss           | ** ** | **59**                     | ** ** | 25                       |       | **118** | ** ** | 49 |   |
| Net Periodic Benefit Cost               | ** ** | **$**                      | **295**    | ** **               | $          | 179 |   | **$** | **590** | ** ** | $ | 358 |   |

 
| ** **                                                   | ** ** | **2004**   | ** ** |
|--------------------------------------------------------------|------------|------------|------------|
| Employer’s Contributions                                | ** ** | ** ** | ** ** |
| Contributions Made For the Six Months Ended  06/30/04        | ** ** | **$**      | **92**     | ** ** |
| Expected Contributions for Remainder of  2004                | ** ** | **93**     | ** ** |
| Total Estimated Employer Contributions for  Fiscal Year 2004 | ** ** | **$**      | **185**    | ** ** |

 

11

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NOTE 13. REGULATORY ASSET AND LIABILITY

 

Effective January 1, 2002, the FCC, in its “MAG Order” on AccessCharge Reform, directed all rate-of-return carriers to file revisions to theirtariffs to eliminate the transport interconnection charge (TIC) as a separaterate element. In effect, the costs previously recovered through the TIC werereallocated over all other access categories, including carrier common line,transport, local switching, information surcharge and special access. The FCCmade it clear that “this tariff filing should be a revenue neutral tarifffiling.”

 

The total revenues reallocated from the TIC to the remaining accesselements were limited to the total revenues recovered from the TIC for thetwelve-month period ended June 30, 2001. These revenues were calculatedusing the carrier’s traffic volumes and the TIC rate for the twelve-monthperiod ended June 30, 2001. These calculations were prepared by anindependent third-party and approved by NECA (National Exchange CarrierAssociation). TIC was eliminated by reallocating the costs to the other accessbilling categories.

 

The FCC conducted an investigation of all tariff filings, includingNECA’s CCL (Carrier Common Line) tariff and Heartland’s Traffic Sensitive (TS)tariff, to determine if the filing parties had properly reallocated the TICcosts among the other access charge categories.

 

The FCC terminated its investigation of several tariff filings,concluding that “the carriers have substantially complied with theRate-of-Return Access Charge Reform Order and their tariffs no longer warrantinvestigation.” Despite this ruling by the FCC during the fourth quarter of2003, NECA informed HickoryTech’s Heartland subsidiary that it would not allowit to recover a portion of the TIC costs allocated to the CCL, because an incorrectTIC rate was used in the calculation.

 

As a result of this billing error, the Company recovered $611,000 ofexcess revenues from the NECA CCL pool. NECA requires Heartland to repay the$611,000 by November 2004. As of June 30, 2004, $350,000 has been repaid.

 

The FCC approved a mid-course correction to Heartland’s TS tariff as asupportable method of recouping NECA’s CCL reduction. The revision corrects theTIC rate originally used, and factors recovery of the $611,000, into the TSrate elements. HickoryTech recoups this revenue over the remaining eighteenmonths of the TS tariff, which began January 1, 2004. As of June 30,2004, HickoryTech has recognized a recovery of $204,000 of the revenue.

 

In accordance with SFAS No. 71, HickoryTech recorded a regulatory assetfor the revenue it would recoup with a balance of $407,000 at June 30,2004 and $611,000 at December 31, 2003. Similarly, HickoryTech has recorded a liability for the amounts thatwill be repaid to the NECA CCL pool with a balance of $261,000 at June 30,2004 and $611,000 at December 31, 2003.

 

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONSAND FINANCIAL CONDITION.

 

**FORWARD-LOOKING STATEMENTS**

 

Statements in this Form 10-Q that are nothistorical fact are forward-looking statements that are based on management’scurrent expectations, estimates and projections about the industry in whichHickoryTech operates and management’s beliefs and assumptions. Suchforward-looking statements are subject to important risks and uncertaintiesthat could cause HickoryTech’s future actual results to differ materially fromsuch statements. These statements are not guarantees of future performance andinvolve certain risks, uncertainties and probabilities, which are difficult topredict. Therefore, actual outcomes and results may differ materially from whatis expressed or forecasted in such forward-looking statements, whether as aresult of new information, future events or otherwise. Factors that might causesuch a difference include, but are not limited to, those contained in this“Management’s Discussion and Analysis” (Item 2) and the Cautionary Statementfor Purposes of the “Safe Harbor” Provision of the Private SecuritiesLitigation Reform Act of 1995 on pages 29-30 of HickoryTech’s Annual Report onForm 10-K for the year ended December 31, 2003, which is incorporatedherein by reference. You are cautioned not to place undue reliance on theseforward looking statements, which speak only as of the date on which they weremade. Except as otherwise required by federal securities law, HickoryTechundertakes no obligation to update any of its forward-looking statements forany reason.

 

**BUSINESSES**

 

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

 

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

 
| **TELECOM  SECTOR**                                                 |
|---------------------------------------------------------------------|
| Mankato Citizens Telephone Company (MCTC)                           |
| Mid-Communications, Inc. (Mid-Comm)                                 |
| Heartland Telecommunications Company of  Iowa, Inc. (Heartland)     |
| Cable Network, Inc. (CNI)                                           |
| Crystal Communications, Inc. (Crystal)                              |
| Minnesota Southern Wireless Company  (MSWC)-Discontinued Operations |
| **INFORMATION  SOLUTIONS SECTOR**                                   |
| National Independent Billing, Inc. (NIBI)                           |
| **ENTERPRISE  SOLUTIONS SECTOR**                                    |
| Collins Communications Systems Co.  (Collins)                       |

 

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HickoryTech and its subsidiaries are engagedin businesses that provide services to their customers for a fee. Many of theseservices are recurring, and, as a result, backlog orders and seasonality arenot significant factors. Working capital requirements primarily involve thefunding of the construction of networks and switches and maintenance of arelatively high amount of fixed assets. Other working capital requirementsinclude the payroll costs of highly skilled labor, the inventory to service itstelephone equipment customers and the carrying value of trade accountsreceivable for periods up to ninety days in the normal course of business.

 

The materials and supplies that are necessaryfor the operation of the businesses of HickoryTech and its subsidiaries areavailable from a variety of sources, and no future supply problems areanticipated. All of HickoryTech’s central office switches, as well as amajority of HickoryTech’s equipment sold in its Enterprise Solutions Sector,are supplied by Nortel. Nortel is a leading supplier of communicationsequipment, and HickoryTech’s dependence on this brand is not viewed as asignificant risk. An additional layer of network infrastructure equipment forbroadband services is provided by Nextlevel. Nextlevel, a subsidiary ofMotorola, is a newer supplier of communications equipment and the Company ismonitoring the risk of maintaining Nextlevel as a supplier.

 

**INDUSTRY SEGMENTS**

 

*TELECOM SECTOR*

 

HickoryTech’s Telecom Sector provides local exchange wireline telephoneservice, long distance, dial-up and broadband Internet access, and owns andoperates fiber optic cable facilities. This sector includes three incumbentlocal exchange carriers (ILECs): MCTC, Mid-Comm and Heartland. MCTC andMid-Comm provide telephone service in south central Minnesota, specificallyMankato (a regional hub) and eleven rural communities surrounding Mankato. Thethird ILEC, Heartland, provides telephone service for eleven rural communitiesin northwest Iowa.

 

The Telecom Sector also includes Crystal, a competitive local exchangecarrier (CLEC). Crystal provides local telephone service, long distance,dial-up and broadband Internet access and digital television on a competitivebasis. Crystal has customers in ten rural communities, encompassing eightexchanges, in Minnesota and three communities, encompassing two exchanges, inIowa that are not in HickoryTech’s ILEC service areas.  HickoryTech discontinued its service to fourother Iowa communities in 2003. In addition to the digital television serviceprovided to customers in St. Peter, Minnesota, HickoryTech will begin providingdigital television service to customers in Waseca, Minnesota in July 2004.

 

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

 

The Telecom Sector included the operations of MSWC, which was soldDecember 15, 2003. None of the remaining companies in the Telecom sectorexperienced major changes in operations during the first two quarters of 2004or 2003.

 

MCTC derives its principal revenues and income from local servicescharged to subscribers in its service area, access services charged tointerexchange carriers, and the operation of a toll tandem-switching center inMankato, Minnesota. Revenues and income for Mid-Comm are also derived fromlocal service charges in its area of operation and by providing access to longdistance services for its subscribers through the toll center in Mankato. Localand interexchange telephone access for the two companies is provided on anintegrated basis. The local and interexchange telephone access for bothtelephone companies utilize the same facilities and equipment and is managedand maintained by a common workforce. Heartland derives its principal revenuesand income from local services charged to subscribers in its service area inIowa, as well as from providing interexchange access for its subscribers.Interexchange telephone access is provided by all three of HickoryTech’stelephone subsidiaries by connecting the communications networks ofinterexchange and wireless carriers with the equipment and facilities of endusers through its switched networks or private lines.

 

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MCTC and Mid-Comm are Minnesota public utilities operating pursuant toindeterminate permits issued by the Minnesota Public Utilities Commission.Heartland is also a public utility, which operates pursuant to a certificate ofpublic convenience and necessity issued by the Iowa Utilities Board. Thesestate agencies regulate the services provided by MCTC, Mid-Comm and Heartland.CNI’s operations are not subject to regulation by the state regulatoryauthority.  Neither the Minnesota PublicUtilities Commission nor the Iowa Utilities Board regulates the rate of returnor profits of each of HickoryTech’s ILEC operations due to the size of thesecompanies relative to state regulation. In Minnesota, MCTC and Mid-Comm’s priceand service levels are monitored by regulators. MCTC’s and Mid-Comm’s localservice rates are below those of most Minnesota ILECs. Regardless of whether aparticular rate is subject to regulatory review, the ability of HickoryTech andits subsidiaries to change rates will be determined by various factors,including economic and competitive circumstances.

 

As local exchange telephone companies, MCTC, Mid-Comm and Heartlandprovide end office switching and dedicated circuits to long distanceinterexchange carriers. These relationships allow HickoryTech’s telephonesubscribers to place long distance telephone calls and gain access to thetelephone network. HickoryTech provides interexchange access for all of theindividual customers who select an alternative long distance carrier. Thisinterexchange access business is separate and distinct from HickoryTech’s ownlong distance retail business, which is operated in its Crystal subsidiary. Thelong distance interexchange carriers are significant customers of HickoryTech,but no carrier represents more than ten percent of HickoryTech’s consolidatedrevenues.

 

Alternatives to HickoryTech service include customers leasing privatelines in lieu of switched voice services and data services in or adjacent tothe territories served by HickoryTech, which permits the bypassing of localtelephone switching facilities. Additionally services provided by othercompanies utilizing various wireline or wireless technologies permit bypass ofthe local exchange network. These alternatives to local exchange servicerepresent a potential threat to HickoryTech’s long-term ability to providelocal exchange service at economical rates.

 

Competition in HickoryTech’s ILEC service area exists in one ofHeartland’s exchanges. In the city of Hawarden, Iowa, the municipal utilitiesoverbuilt the city’s telephone service infrastructure and is providing analternative to HickoryTech’s telephone service. The Hawarden CLEC has acquiredapproximately 1,000 access lines, or approximately 60% of that community’stelephone business from HickoryTech. HickoryTech management does not believethere will be significant further impact from competition in Hawarden.

 

Competition also exists for some of the HickoryTech services providedto interexchange carriers, such as customer billing services, dedicated privatelines, network switching and network routing. This competition comes primarilyfrom the interexchange carriers themselves, in that carriers may decide thatthe services provided by HickoryTech may be redirected or handled on their ownnetwork. The provision of these services is of a contractual nature or ismonth-to-month service out of a general tariff, which is a schedule ofterms, rates and conditions that is approved by the appropriate state orfederal agency. In either case, the use of these services is primarilycontrolled by the interexchange carriers. As interexchange carriers make theseservice decisions, they have the potential to reduce the Company’s revenue inthe Telecom Sector. Other services, such as directory advertising and end userequipment, are open to competition. This type of competition is based primarilyon service and experience.

 

The passage of the 1996 Telecommunications Act created the opportunityfor HickoryTech to offer communications service in territories served by othertelephone companies, and Crystal began operations in January 1998 as a newcompetitive local exchange carrier (CLEC). Crystal offers local service, longdistance, dial-up and broadband Internet access services, and digitaltelevision, on a competitive basis to customers in southern Minnesota and Iowa,which were not previously served by HickoryTech’s Telecom Sector service area.These service offerings provide customers alternatives to the incumbentcommunication providers in various communities and are offered under the brandname HickoryTech service. These services are currently offered to customers inten rural communities, encompassing eight exchanges, in Minnesota, as well asthree communities, encompassing two exchanges, in Iowa. Crystal also providesthe long distance service, dial-up and broadband Internet access services toHickoryTech’s ILEC subscribers.

 

CLEC activities require Crystal to file for authority to operate withthe appropriate public utilities commission in each state it serves. Crystalcompetes directly against existing ILECs in the areas in which it operates.Crystal is not dependent upon any single customer or small group of customers.No single customer in Crystal accounts for ten percent or more of HickoryTech’sconsolidated revenues.

 

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It is common in the ILEC industry for carriers to dispute certainaccess charges. There is currently a multi-state ILEC industry dispute with alarge RBOC (Regional Bell Operating Company) regarding certain access charges.The ILEC industry in Minnesota has jointly filed a formal complaint regardingthis dispute with the Minnesota Public Utilities Commission. On July 8,2004, this complaint was referred to the Office of Administrative Hearings fora contested case proceeding as requested in the complaint.

 

On December 15, 2003, HickoryTech sold its wireless business,Minnesota Southern Wireless Company (MSWC), to Western Wireless Corporation(WWC). The wireless operations are reported as part of the Telecom Sector. Theconsolidated statements of operations for all periods presented have beenrestated to reflect wireless operations as discontinued operations.

 

REGULATED INDUSTRY

 

ILEC Minnesota - HickoryTech’s two MinnesotaILEC subsidiaries continue to operate under an alternative form of regulationas defined in Minnesota Chapter 237, whereby companies with less than 50,000customers are regulated on price and service level rather than profit. TheMinnesota Public Utilities Commission (PUC) has been considering intrastateaccess reform and universal service for several years. In March 2004, theMinnesota PUC issued an order to refer the access reform issue to a contestedcase hearing. This process in Minnesota usually involves full development of apublic record.  The ILEC industry,interexchange carriers and state agencies are also concurrently negotiating inhopes of an agreement to transition access rate changes over several years,possibly through legislative change. The outcome of this process, whether bynegotiation and legislation or commission order resulting from a hearing willnot likely be realized until late in 2004, or later. HickoryTech cannotestimate the impact, if any, of future potential state access revenue changes.

 

ILEC Iowa - In Iowa, companies with fewer than15,000 access lines remain unregulated. HickoryTech’s Iowa ILEC subsidiaryfalls below this regulation threshold.

 

Wireline InterState - The HickoryTech ILECcompanies do not participate in the NECA traffic sensitive pool and set accessrates according to a nationwide average cost of providing access. This biannualrate process was completed in June 2003, and established traffic sensitiveinterstate rates for the period from July 1, 2003 through June 30,2005. HickoryTech ILEC companies participate in the NECA common line pool. InJuly of 2003, common line rates charged to interexchange carriers werereduced (to zero), and common line charges to end users were increased inaccordance with an October 2001 FCC order (a/k/a MAG Plan). Fundscollected are pooled, and HickoryTech revenues are based on settlementsdistributed from the pool. Pool settlements are adjusted periodically.

 

CLEC - HickoryTech’s CLEC company provideslocal exchange services in Minnesota and Iowa with less regulatory oversightthan the HickoryTech ILEC companies. Additionally, Crystal offers digitaltelevision service in the St. Peter, Minnesota market under a franchisenegotiated with the local municipality. Beginning in the third quarter of 2004, Crystal will offer digital televisionin the Waseca, Minnesota market under a franchise agreement negotiated with thelocal municipality.  Crystal also offerslong distance services. In-State services in Minnesota are regulated by thePublic Utility Commission with respect to uniform pricing statewide. In-Statelong distance service in Iowa is unregulated. Long distance services are also deregulated at the federal level (forInter-State services), but are subject to annual certification of geographicrate averaging and rate integration. Dial-up and broadband Internet access are unregulated at both the stateand federal levels.

 

Other - HickoryTech’s CLEC interstate accessrates are established in accordance with an April 2001 FCC order.  Under the final phase of this order,interstate switched access rates for HickoryTech’s CLEC were reduced to levelscomparable to those of the Incumbent LEC’s (Local Exchange Carrier) inJune of 2004.

 

The FCC has an open docket on intercarrier compensation as well asseveral dockets on Voice over Internet Protocol (VoIP). HickoryTech cannot predictthe outcome of such proceedings nor can it estimate the impact, if any, onHickoryTech.

 

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Local Number Portability - Section 251(b) of the CommunicationsAct of 1934 (the “34 Act”), as amended, requires, in part, that local exchangecarriers provide local number portability to any requesting telecommunicationscarrier. Wireless carriers are generally defined as “telecommunicationscarriers” under the 34 Act, and are therefore eligible to port numbers withwireline carriers, which is referred to as “intermodal porting”.  OnNovember 10, 2003, the FCC released a decision providing guidance onintermodal porting issues. The FCC stated that number porting from awireline carrier to a wireless carrier is required upon bona fide request wherethe coverage area of the wireless carrier (i.e. the area in which the wirelesscarrier provides service) overlaps the geographic location in which thewireline number was provisioned. Further, while the FCC required thewireless carrier to maintain the rate center designation of the number, it alsonoted that wireless carriers were not required to have either directconnections or interconnection agreements with wireline carriers nor werewireless carriers required to have numbering resources in the rate center inwhich the wireline number is located in order to subject the wireline number tointermodal porting. The FCC’s guidance requires that wireline numbers beported to wireless carriers across traditional wireline rate centers, althoughthe FCC left issues governing the payment of call routing costs to anotherpending proceeding.  This requirement took effect on November 24,2003 for wireline carriers in the top 100 Metropolitan Statistical Area’s(MSAs), and May 24, 2004 for wireline carriers operating in markets below thetop 100 MSAs. The Company’s wireline operations are conducted in markets belowthe top 100 MSAs that were subject to the later May 24, 2004 implementationdate for intermodal porting. Heartland Telecommunications Company of Iowa,however, has joined in an industry action by the Iowa TelecommunicationsAssociation to suspend the requirements for small rural carriers.  The Iowa Utilities Board has granted a 180-daystay on implementation of Local Number Portability (LNP) in rural areas whileit considers the petition, with a decision due no later than October 6,2004. As of June 30, 2004 the effects of intermodal porting on theCompany’s Minnesota wireline operations have been minimal, however, given theshort time intermodal porting has been available the Company cannot fullyquantify the long-term effects on its wireline operations of implementingintermodal porting. It is possible that these requirements, when implemented,could adversely affect the Company’s wireline operating costs and customergrowth rates. HickoryTech is also unable to quantify the revenue impact ofwireline customers that may switch to wireless alternatives.

 

Triennial Review Order - In August 2003,the FCC published a review order proposing changes in rules developed under theprovisions of Telecommunications Act of 1996 Section 251(c)(3) whichrequires incumbent local exchange carriers to make elements of their networksavailable on an unbundled basis to new entrants at cost-based rates. This orderwas immediately challenged by USTA and several carriers.  In April 2004, the Washington DCdistrict court issued a ruling overturning portions of that order so that,generally, incumbent LEC’s face reduced mandates to make their networkavailable and CLEC’s face reduced opportunities or increased costs in obtainingnetwork from the incumbent with whom they compete.

 

HickoryTech’s CLEC, Crystal Communications, has not made extensive useof the type of network elements addressed in the ruling in its CLEC business.While HickoryTech cannot fully quantify the impact of this issue, neither theFCC order or the subsequent overruling of portions of the order by the DistrictCourt are expected to have a material impact on Crystal’s business.

 

*INFORMATION SOLUTIONS SECTOR*

 

Through NIBI, HickoryTech’s Information Solutions Sector provides dataprocessing and related services, principally for HickoryTech, other localexchange telephone companies, CLECs, interexchange network carriers, wirelesscompanies, municipalities and utilities. The Information Solutions Sector’sprincipal activity is the provision of monthly batch processing of computerizeddata for HickoryTech as well as non-affiliated companies. Services fortelephone company customers include the processing of long distance telephonecalls from data sources and telephone switches, the preparation of thesubscriber telephone bills, customer record keeping, carrier access bills andgeneral accounting and payroll services. NIBI, under the brand name HickoryTechInformation Solutions, also provides certain billing clearinghouse functionsfor interexchange carriers.

 

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There are a number of companies engaged in supplying data processingservices comparable to those furnished by the Information Solutions Sector.Competition is based primarily on price and service. HickoryTech’s InformationSolutions Sector has developed an integrated billing and management systemcalled SuiteSolution. SuiteSolution can provide wireline and wireless carriersthe individual benefits of a billing platform or a total system solution.Management is unable to quantify what effect, if any, the sale of HickoryTech’swireless business may have on the marketplace for this product.

 

*ENTERPRISE SOLUTIONS SECTOR*

 

Through Collins, HickoryTech’s Enterprise Solutions Sector providestelephone and data equipment sales and services as well as the sale,installation and service of Voice over Internet Protocol (VoIP) businesssystems to companies primarily based in metropolitan Minneapolis/St. Paul,Minnesota. This sector also supports the business telephone system service forHickoryTech ILEC and CLEC operations in southern Minnesota and in Iowa. Thecustomers in the Enterprise Solutions Sector’s market are the individualbusiness end users of telecommunications service with ongoing servicerequirement offerings. Products consist of telecommunication platforms such asNortel on the voice side of the Enterprise Solutions’ business, and Cisco andBay Networks (Nortel) equipment on the data side of its business. EnterpriseSolutions specializes in the quality custom installation and maintenance ofdata wide area networking solutions.

 

Revenues are primarily earned by the sales, installation and service ofbusiness telephone and data systems. Enterprise Solutions continues itscommitment to service and support of its core product, Nortel, whileidentifying new opportunities such as call centers, computer telephoneintegration voice mail and interactive voice response systems.

 

HickoryTech’s Enterprise Solutions Sector is not dependent upon anysingle customer or small group of customers. No single customer in theEnterprise Solutions Sector accounts for ten percent or more of HickoryTech’sconsolidated revenues.

 

Enterprise Solutions does business in a competitive market where alarge number of companies compete for the sale, installation and servicing oftelecommunications equipment and Voice over Internet Protocol communicationsproducts. Competition is based primarily on price and service. No singlecompany is dominant in this market.

 

**RESULTS OF OPERATIONS**

 

CONSOLIDATED OPERATING RESULTS:

The following is a summarized discussion of consolidated results ofoperations. More detailed discussion of operating results by segment followsthis discussion.

 

OPERATING REVENUES:

Consolidated operating revenues were $22,864,000, which is $8,000 or0.03% lower in the three months ended June 30, 2004 compared to the threemonths ended June 30, 2003. Consolidated operating revenues were$45,551,000, which is $898,000 or 1.9% lower in the six months endedJune 30, 2004 compared to the six months ended June 30, 2003.  The decrease in revenues in the six months endedJune 30, 2004 compared to the six months ended June 30, 2003 can beprimarily attributed to a lower volume of business in the Enterprise SolutionsSector. This decrease was largely offset by an increase in revenues in theTelecom Sector, which was driven by revenue increases in ILEC high-speed dataand network access, as well as growth in the CLEC business.

 

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COST OF PRODUCTS SOLD, ENTERPRISE SOLUTIONS:

Cost of products sold, which is related to the Enterprise SolutionsSector was $2,296,000, which is $254,000 or 10.0% lower in the three monthsended June 30, 2004 compared to the three months ended June 30,2003.  Cost of products sold was$3,805,000, which is $1,264,000 or 24.9% lower in the six months endedJune 30, 2004 compared to the six months ended June 30, 2003.  The decrease in cost of products sold in thesecond quarter of 2004 compared to second quarter 2003 was mainly due to thedecrease in installation revenue.  Forthe six month period ended June 30, 2004 as compared to the comparable2003 period, the decrease in cost of products sold was in line with thecorresponding decrease in operating revenues in this sector, as gross profitmargins remained relatively consistent at 32.5% for the six months endedJune 30, 2004 compared to 30.5% for the same period in 2003.

 

COST OF SERVICES (excluding Depreciation and Amortization):

Cost of services, excluding depreciation and amortization decreased$131,000 or 1.6% in second quarter 2004 compared to second quarter 2003.  Cost of services, excluding depreciation andamortization increased $209,000 or 1.3% in the six months ended June 30,2004 compared to the six months ended June 30, 2003.  The increase was due primarily to increasedexpenses surrounding post-retirement health care benefits, long distance costscorresponding to the increased customer base, plant operations costs, and anincrease in bad debt expense, that were somewhat offset by decreased EnterpriseSolutions expenses.

 

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES (excluding Depreciation andAmortization):

Selling, general and administrative expenses, excluding depreciationand amortization decreased $46,000 or 1.3% in second quarter 2004 compared tosecond quarter 2003.  Selling, generaland administrative expenses, excluding depreciation and amortization decreased$214,000 or 2.9% in the six months ended June 30, 2004 compared to the sixmonths ended June 30, 2003.  Thedecrease in expense for the six months ended June 30, 2004 as compared tothe six months ended June 30, 2003 is primarily due to cost reductionmeasures implemented in the Enterprise Solutions sector as well as a decreasein corporate wages partially caused by a one time charge in 2003 for themodification of the terms of the stock options of a retiring officer. These expensedecreases were somewhat offset by an increase in Telecom sales and marketingrelated expenses. The modification of the terms of the stock options of aretiring officer extended the period after retirement during which the officercould exercise his vested options. This modification resulted in HickoryTechrecognizing $173,000 of compensation expense during the first quarter of 2003.

 

DEPRECIATION AND AMORTIZATION:

Depreciation expense was $3,881,000, which is $150,000 or 4.0% higherin the three months ended June 30, 2004 compared to the three months endedJune 30, 2003. Depreciation expense was $7,757,000, which is $524,000 or7.2% higher in the six months ended June 30, 2004 compared to the sixmonths ended June 30, 2003. The increase in depreciation expense was dueto an increase in the Telecom Sector’s network assets, as well as an increaserelated to the depreciation of billing software in the Information SolutionsSector. Amortization expense was $237,000, which is $39,000 or 19.7% higher inthe three months ended June 30, 2004 compared to the three months endedJune 30, 2003. This increase primarily relates to amortization of costs ofnew software, which began in the second quarter of 2003. For the six monthsended June 30, 2004 amortization expense was $473,000, which is $51,000lower than the comparable 2003 period. The decrease in amortization expense waslargely due to an intangible asset in the Information Solutions Sector becomingfully amortized in the second quarter of 2003.

 

OPERATING INCOME:

Operating income was $4,953,000, which is $234,000 or 5.0% higher inthe three months ended June 30, 2004 compared to the three months endedJune 30, 2003.  This increase wasdriven primarily by an increase in the operating income of the EnterpriseSolutions sector in the second quarter of 2004 as compared to the secondquarter of 2003.  Operating income was$9,755,000, which is $102,000 or 1.0% lower in the six months endedJune 30, 2004 compared to the six months ended June 30, 2003.

 

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INTEREST EXPENSE:

Interest expense decreased $342,000 or 23.1% to $1,138,000 in the threemonths ended June 30, 2004 compared to the three months endedJune 30, 2003. Interest expense decreased $718,000 or 23.6% to $2,327,000in the six months ended June 30, 2004 compared to the six months endedJune 30, 2003. The decrease in interest expense was primarily due to adecrease in total debt outstanding. The outstanding balance of the revolvingcredit facility was $108,000,000 at June 30, 2004 and $145,250,000 atJune 30, 2003.

 

INCOME TAXES:

The effective income tax rate of approximately 40.5% and 41% for secondquarter 2004 and second quarter 2003, respectively, exceeds the federalstatutory rate primarily due to state income taxes.  The effective income tax rate ofapproximately 40.5% and 41% for the six months ended June 30, 2004 andJune 30, 2003, respectively, exceeds the federal statutory rate primarilydue to state income taxes.

 

INCOME FROM CONTINUING OPERATIONS:

Consolidated income from continuing operations was $2,283,000, which is$361,000 or 18.8% higher in the three months ended June 30, 2004 comparedto the three months ended June 30, 2003. The increase in income from continuing operations for second quarter 2004as compared to the second quarter of 2003 was primarily driven by the $254,000decrease in cost of products sold, the $131,000 decrease in cost of services,and a $342,000 decrease in interest expense, all of which were explained above.  Consolidated income from continuingoperations was $4,444,000, which is $405,000 or 10.0% higher in the six monthsended June 30, 2004 compared to the six months ended June 30,2003.  The increase in income fromcontinuing operations for the six months ended June 30, 2004 compared tothe six months ended June 30,2003 can be primarily attributed to the$718,000 decrease in interest expense, coupled with the $1,264,000 decrease incost of products sold for the Enterprise Solutions sector, which, takentogether, helped offset increased depreciation and amortization expenses of$524,000, as well as the $898,000 decrease in operating revenues, all of whichare described above.

 

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SECTOR RESULTS OF OPERATIONS FROM CONTINUING OPERATIONS

 

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

 

**TELECOM SECTOR**

 
| ** **                                                                              | ** ** | **For Three Months Ended** | ** ** | **For Six Months Ended** | ** ** |
|-----------------------------------------------------------------------------------------|------------|----------------------------|------------|--------------------------|------------|
| **(Dollars  in Thousands)**                                                             | ** ** | **6/30/2004**              | ** ** | **6/30/2003**            | ** ** | **6/30/2004** | ** ** | **6/30/2003** | ** ** |
|                                                                                    |       |                       |       |                     |       |   | ** ** |   |   |
| Revenues Before Intersegment Eliminations                                               |       |                       |       |                     |       |   | ** ** |   |   |
| ILEC                                                                                    |       |                       |       |                     |       |   | ** ** |   |   |
| Local Service                                                                           | ** ** | **$**                      | **3,818**  |                     | $          | 3,765 | ** ** | **$** | **7,549** | ** ** | $ | 7,574 |   |
| Network Access                                                                          | ** ** | **8,272**                  |       | 8,407                    | ** ** | **16,949** | ** ** | 16,731 |   |
| Data                                                                                    | ** ** | **547**                    |       | 430                      | ** ** | **1,069** | ** ** | 880 |   |
| Intersegment                                                                            | ** ** | **69**                     |       | 68                       | ** ** | **138** | ** ** | 137 |   |
| Other                                                                                   | ** ** | **1,596**                  |       | 1,704                    | ** ** | **3,343** | ** ** | 3,505 |   |
| Total ILEC                                                                              | ** ** | **14,302**                 |       | 14,374                   | ** ** | **29,048** | ** ** | 28,827 |   |
|                                                                                    |       |                       |       |                     |       |   | ** ** |   |   |
| CLEC                                                                                    |       |                       |       |                     |       |   | ** ** |   |   |
| Local Service                                                                           | ** ** | **925**                    |       | 876                      | ** ** | **1,854** | ** ** | 1,715 |   |
| Network Access                                                                          | ** ** | **621**                    |       | 608                      | ** ** | **1,301** | ** ** | 1,150 |   |
| Data                                                                                    | ** ** | **399**                    |       | 284                      | ** ** | **780** | ** ** | 516 |   |
| Other                                                                                   | ** ** | **450**                    |       | 466                      | ** ** | **880** | ** ** | 898 |   |
| Total CLEC                                                                              | ** ** | **2,395**                  |       | 2,234                    | ** ** | **4,815** | ** ** | 4,279 |   |
|                                                                                    |       |                       |       |                     |       |   | ** ** |   |   |
| Long Distance                                                                           | ** ** | **1,106**                  |       | 1,095                    | ** ** | **2,334** | ** ** | 2,212 |   |
|                                                                                    |       |                       |       |                     |       |   | ** ** |   |   |
| Internet                                                                                | ** ** | **994**                    |       | 950                      | ** ** | **1,989** | ** ** | 1,891 |   |
|                                                                                    |       |                       |       |                     |       |   | ** ** |   |   |
| Digital TV                                                                              | ** ** | **119**                    |       | 95                       | ** ** | **225** | ** ** | 176 |   |
|                                                                                    |       |                       |       |                     |       |   | ** ** |   |   |
| Total Telecom Revenues                                                                  | ** ** | **$**                      | **18,916** |                     | $          | 18,748 | ** ** | **$** | **38,411** | ** ** | $ | 37,385 |   |
|                                                                                    |       |                       |       |                     |       |   | ** ** |   |   |
| Total Telecom Revenues Before Intersegment  Eliminations                                |       |                       |       |                     |       |   | ** ** |   |   |
| Unaffiliated Customers                                                                  | ** ** | **$**                      | **18,847** |                     | $          | 18,680 | ** ** | **$** | **38,273** | ** ** | $ | 37,248 |   |
| Intersegment                                                                            | ** ** | **69**                     |       | 68                       | ** ** | **138** | ** ** | 137 |   |
| ** **                                                                              |       | **18,916**                 |       | 18,748                   | ** ** | **38,411** | ** ** | 37,385 |   |
|                                                                                    |       |                       |       |                     |       |   | ** ** |   |   |
| Cost of Services, excluding Depreciation  and Amortization                              | ** ** | **7,182**                  |       | 6,662                    | ** ** | **14,662** | ** ** | 13,463 |   |
| Selling, General, and Administrative  Expenses, excluding Depreciation and Amortization | ** ** | **2,549**                  |       | 2,265                    | ** ** | **5,078** | ** ** | 4,612 |   |
| Depreciation and Amortization                                                           | ** ** | **3,407**                  |       | 3,274                    | ** ** | **6,814** | ** ** | 6,459 |   |
| Operating Income                                                                        | ** ** | **$**                      | **5,778**  |                     | $          | 6,547 | ** ** | **$** | **11,857** | ** ** | $ | 12,851 |   |
| Income from Continuing Operations, Net of  Tax                                          | ** ** | **$**                      | **3,440**  |                     | $          | 3,893 | ** ** | **$** | **7,059** | ** ** | $ | 7,601 |   |
| Income/(Loss) from Discontinued Operations                                              | ** ** | **—**                 |       | 419                      | ** ** | **(59** | **)** | 484 |   |
| Net Income                                                                              | ** ** | **$**                      | **3,440**  |                     | $          | 4,312 | ** ** | **$** | **7,000** | ** ** | $ | 8,085 |   |
|                                                                                    |       |                       |       |                     |       |   | ** ** |   |   |
| Capital Expenditures                                                                    | ** ** | **$**                      | **4,096**  |                     | $          | 2,105 | ** ** | **$** | **6,217** | ** ** | $ | 3,156 |   |

 

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| ** **                      | ** ** | **For Six Months Ended** | ** ** |
|---------------------------------|------------|--------------------------|------------|
| **(Dollars  in Thousands)**     | ** ** | **6/30/2004**            | ** ** | **6/30/2003** | ** ** |
|                            |       |                     |       |   |   |
| ILEC Access Lines               | ** ** | **60,044**               |       | 62,367 |   |
|                            |       |                     |       |   |   |
| CLEC Access Lines               |       |                     |       |   |   |
| Overbuild                       | ** ** | **10,406**               |       | 9,036 |   |
| Unbundled Network Element (UNE) | ** ** | **1,699**                |       | 1,338 |   |
| Total Service Resale (TSR)      | ** ** | **2,430**                |       | 4,162 |   |
| Total                           | ** ** | **14,535**               |       | 14,536 |   |
|                            |       |                     |       |   |   |
| Long Distance Customers         | ** ** | **40,456**               |       | 35,667 |   |
|                            |       |                     |       |   |   |
| Internet Customers              | ** ** | **16,707**               |       | 15,307 |   |
|                            |       |                     |       |   |   |
| Total Telecom Customers         | ** ** | **131,742**              |       | 127,877 |   |
|                            |       |                     |       |   |   |
| DSL Customers                   | ** ** | **8,946**                |       | 5,691 |   |

 

Telecom Sector operating revenues before intersegment eliminations were$18,916,000, which is $168,000 or 0.9% higher in the three months endedJune 30, 2004 compared to the three months ended June 30, 2003.  The increase in revenue in the second quarterof 2004 as compared to the second quarter of 2003 was due primarily to growthin CLEC. Telecom Sector operating revenues before intersegment eliminationswere $38,411,000, which is $1,026,000 or 2.7% higher in the six months endedJune 30, 2004 compared to the six months ended June 30, 2003.  For the six month period ended June 30,2004 as compared to the same period in 2003, the increase in revenue wasprimarily due to increased ILEC network access and high-speed data, as well asgrowth in the CLEC business.

 

ILEC network access revenue was $8,272,000, which is $135,000 or 1.6%lower in the three months ended June 30, 2004 compared to the three monthsended June 30, 2003. ILEC network access revenue was $16,949,000, which is$218,000 or 1.3% higher in the six months ended June 30, 2004 compared tothe six months ended June 30, 2003. The decline in ILEC network access revenue in the second quarter of 2004as compared to the second quarter of 2003 was primarily due to one timeadjustments related to disputed circuits and minutes. For the six month periodended June 30, 2004 as compared to the six month period endedJune 30, 2003 the increase in ILEC network access revenue was driven byhigher first quarter 2004 demand for dedicated lines and high-speed circuits.HickoryTech does not belong to any NECA traffic sensitive access revenuereimbursement pools, but instead, establishes access rates bi-annuallyfollowing nationwide averages of providing access. HickoryTech’s interstateaccess rates were adjusted as of July 2003. Recent industry trends, asdiscussed in the regulatory section above, suggest that access revenue maybe at a plateau and may not experience the rate of increase year over year thatthe company has historically seen. Long-term continuation of these revenues isuncertain, however, as changes in the industry occur.

 

On October 16, 2003, the United States District Court, District ofMinnesota, issued an injunction providing relief from regulation of aninterexchange carrier providing Voice over Internet Protocol (VoIP) basedservices in Minnesota. The Minnesota Public Utilities Commission has appealedthis decision. Depending on the outcome, this may result in a change in thebusiness relationship between HickoryTech ILEC businesses and the interexchangecarriers, as interconnections with certain VoIP providers may not be governedby tariffed Minnesota access charges. HickoryTech cannot, at this time,estimate the revenue impact, if any, related to this decision.

 

ILEC data revenue was $117,000 or 27.2% higher in second quarter 2004compared to second quarter 2003, and was $189,000 or 21.5% higher for the sixmonths ended June 30, 2004 compared to the six months ended June 30,2003. The increase is the result of increased Digital Subscriber Line (DSL)customers.

 

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CLEC local service revenue was $925,000, which is $49,000 or 5.6%higher in the three months ended June 30, 2004 compared to the threemonths ended June 30, 2003. CLEC local service revenue was $1,854,000,which is $139,000 or 8.1% higher in the six months ended June 30, 2004compared to the six months ended June 30, 2003. The increase in CLEC localservice revenue is driven primarily by an increase in revenues from businesscustomers and an increase in local trunking revenue due primarily to a new customerrelationship in northwest Iowa.  In thesecond quarter of 2003, HickoryTech decided to exit several exchanges in itsIowa territories that utilized a resale of services approach. As a result ofthis decision, HickoryTech stopped providing service for 734 customers. Relatedrevenues have decreased approximately $80,000 in the second quarter of 2004compared to the second quarter of 2003.  However, this decrease in revenues wasoffset by increased local service revenues in several other CLEC communities.

 

CLEC network access revenue was $13,000 or 2.1% higher in secondquarter 2004 compared to second quarter 2003. CLEC network access revenue was $151,000 or 13.1% higher in the sixmonths ended June 30, 2004 compared to the six months ended June 30,2003.  This increase is primarily theresult of increased penetration of overbuild lines in CLEC communities.

 

CLEC data revenue was $115,000 or 40.5% higher in second quarter 2004compared to second quarter 2003.  CLECdata revenue was $264,000 or 51.2% higher in the six months ended June 30,2004 compared to the six months ended June 30, 2003. The increase is theresult of increased DSL penetration in CLEC communities.

 

Long distance revenue was $11,000 or 1.0% higher in the three monthsended June 30, 2004 compared to the three months ended June 30,2003.  Long distance revenue was $122,000or 5.5% higher in the six months ended June 30, 2004 compared to the sixmonths ended June 30, 2003. This increase is the result of a correspondingincrease in customers.  HickoryTechexperienced a 4,789 or 13.4% increase in its long distance customer basebetween June 30, 2003 and June 30, 2004. Although the customer baseis increasing, revenue per customer is decreasing. The decrease in revenue percustomer is primarily the result of optional long distance services availableto customers, the increased use of Internet services and other alternatives tolong distance services.  Also, acompetitor of HickoryTech received approval from the state of Minnesota tooffer long distance services in all HickoryTech territories. This competitoralready offers local telephone service in HickoryTech’s CLEC territories andwith this approval, has the potential to create stronger competition withHickoryTech in these markets, which could result in a reduction in longdistance revenue in future periods.

 

Internet revenue was $44,000, or 4.6% higher in the three months endedJune 30, 2004 compared to the three months ended June 30, 2003.  Internet revenue was $98,000, or 5.2% higherin the six months ended June 30, 2004 compared to the six months endedJune 30, 2003.  The increase inrevenue was caused primarily by an increase in Internet customers of 1,400 or9.1% between June 30, 2003 and June 30, 2004.

 

Cost of Services, excluding Depreciation and Amortization:

Cost of services, excluding depreciation and amortization was $520,000or 7.8% higher in the second quarter of 2004 compared to the second quarter of2003.  Cost of services, excludingdepreciation and amortization was $1,199,000 or 8.9% higher in the six monthsended June 30, 2004 compared to the six months ended June 30, 2003.The increase is primarily due to increases in expenses relating to longdistance services that increased in conjunction with the corresponding increasein long distance customers and revenue, increased billing expense from theInformation Solutions sector, increased plant operation expenses, and increasedbad debt. These increases were somewhat offset by decreases in charges relatingto the decrease in Total Service Resale (TSR) customers.  In the second quarter of 2003, HickoryTechdecided to exit several exchanges in its Iowa territories, which utilized aresale of services approach. As a result of this decision, HickoryTech hasstopped providing service for 734 customers.

 

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

Selling, general and administrative expenses, excluding depreciationand amortization was $284,000 or 12.5% higher in the second quarter of 2004compared to the second quarter of 2003. Selling, general and administrative expenses, excluding depreciation andamortization was $466,000 or 10.1% higher in the six months ended June 30,2004 compared to the six months ended June 30, 2003.  This increase is primarily due to an increasein sales and marketing related expenses as well as corporate allocations. Theseincreases were partially offset by a decrease in expenses related to costreduction measures in the Iowa CLEC office that took place in the third quarterof 2003.

 

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Depreciation and Amortization:

Depreciation and amortization were $3,407,000, which is $133,000 or4.1% higher in the three months ended June 30, 2004 compared to the sameperiod in 2003.  Depreciation andamortization were $6,814,000, which is $355,000 or 5.5% higher in the sixmonths ended June 30, 2004 compared to the same period in 2003.  The increase in depreciation expense can belargely attributed to increased network infrastructure.

 

Operating and Net Income:

Operating income was $5,778,000, which is $769,000 or 11.7% lower inthe three months ended June 30, 2004 compared to the three months endedJune 30, 2003.  Net income was$3,440,000, which is $872,000 or 20.2% lower in the three months endedJune 30, 2004 compared to the three months ended June 30, 2003.  Operating income was $11,857,000, which is$994,000 or 7.7% lower in the six months ended June 30, 2004 compared tothe six months ended June 30, 2003. Net income was $7,000,000, which is $1,085,000 or 13.4% lower in the sixmonths ended June 30, 2004 compared to the six months ended June 30,2003.  These decreases in operating andnet income were driven by the increases in cost of services, depreciation andamortization, and selling, general and administrative expenses described above,offset by the increase in revenue, also described above.

 

Discontinued Operations:

On December 15, 2003, HickoryTech sold its wireless business,Minnesota Southern Wireless Company (MSWC), to Western Wireless Corporation(WWC). The wireless operations are reported as part of the Telecom sector. Theconsolidated statements of operations for all periods presented have beenrestated to reflect wireless operations as discontinued operations.

 

INFORMATION SOLUTIONS – The following tableprovides a breakdown of the Information Solutions Sector operating results.

 

**INFORMATION SOLUTIONS SECTOR**

 
| ** **                                                                              | ** ** | **For Three Months Ended** | ** ** | **For Six Months Ended** | ** ** |
|-----------------------------------------------------------------------------------------|------------|----------------------------|------------|--------------------------|------------|
| **(Dollars  in Thousands)**                                                             | ** ** | **6/30/2004**              | ** ** | **6/30/2003**            | ** ** | **6/30/2004** | ** ** | **6/30/2003** | ** ** |
| Revenues Before Eliminations                                                            |       |                       | ** ** |                     |       |   | ** ** |   |   |
| Unaffiliated Customers                                                                  | ** ** | **$**                      | **679**    | ** **               | $          | 809 |   | **$** | **1,645** | ** ** | $ | 1,907 |   |
| Intersegment                                                                            | ** ** | **1,127**                  | ** ** | 768                      |       | **2,174** | ** ** | 1,531 |   |
| ** **                                                                              |       | **1,806**                  | ** ** | 1,577                    |       | **3,819** | ** ** | 3,438 |   |
| Cost of Services, excluding Depreciation  and Amortization                              | ** ** | **1,536**                  | ** ** | 1,703                    |       | **3,422** | ** ** | 3,584 |   |
| Selling, General, and Administrative  Expenses, excluding Depreciation and Amortization | ** ** | **252**                    | ** ** | 228                      |       | **446** | ** ** | 413 |   |
| Depreciation and Amortization                                                           | ** ** | **654**                    | ** ** | 581                      |       | **1,293** | ** ** | 1,125 |   |
| Operating Loss                                                                          | ** ** | **$**                      | **(636**   | **)**                    | $          | (935 | ) | **$** | **(1,342** | **)** | $ | (1,684 | ) |
| Net Loss                                                                                | ** ** | **$**                      | **(382**   | **)**                    | $          | (606 | ) | **$** | **(808** | **)** | $ | (1,102 | ) |
|                                                                                    |       |                       | ** ** |                     |       |   | ** ** |   |   |
| Capital Expenditures                                                                    | ** ** | **$**                      | **—** | ** **               | $          | — |   | **$** | **1** | ** ** | $ | 144 |   |

 

Revenues:

Operating revenues from unaffiliated customers decreased $130,000 or16.1% in the second quarter 2004 compared to the second quarter 2003. Operatingrevenues from unaffiliated customers decreased $262,000 or 13.7% in the sixmonths ended June 30, 2004 compared to the six months ended June 30,2003.  The decrease in operating revenueswas primarily due to the loss of CABS processing customers and a decline involume to existing customers.

 

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Cost of Services, excluding Depreciation and Amortization:

Operating expenses excluding depreciation and amortization decreased$167,000 or 9.8% in the three months ended June 30, 2004 compared to thethree months ended June 30, 2003. Operating expenses excludingdepreciation and amortization decreased $162,000 or 4.5% in the six monthsended June 30, 2004 compared to the six months ended June 30,2003.  The decreases in operating expenses primarily reflect the impact ofmanagement cost reduction actions.

 

Depreciation and Amortization:

Depreciation and amortization increased $73,000 or 12.6% in secondquarter 2004 compared to second quarter 2003, and $168,000 or 14.9% for the sixmonths ended June 30, 2004 compared to the six months ended June 30,2003.  The primary reason for theincrease is due to the depreciation of a new billing system.

 

Operating and Net Loss:

Operating loss decreased $299,000 or 32.0% in second quarter 2004compared to first quarter 2003.  Net lossdecreased $224,000 or 37.0% in second quarter 2004 compared to second quarter2003.  Operating loss decreased $342,000or 20.3% in the six months ended June 30, 2004 compared to the six monthsended June 30, 2003.  Net lossdecreased $294,000 or 26.7% in the six month ended June 30, 2004 comparedto the six months ended June 30, 2003. The decrease in operating loss and net loss in second quarter 2004compared to second quarter 2003 was primarily attributable to the overall netincrease in revenues, including an increase in intersegment revenues of$359,000, coupled with a decrease in cost of services, excluding depreciationand amortization as discussed above.  Thedecrease in operating loss for the six months ended June 30, 2004 ascompared to the same period in 2003 was primarily attributable to the increasein depreciation and amortization as discussed above.

 

ENTERPRISE SOLUTIONS – The following tableprovides a breakdown of the Enterprise Solutions Sector operating results.

 

**ENTERPRISE SOLUTIONS SECTOR**

 
| ** **                                                                             | ** ** | **For Three Months Ended** |       | **For Six Months Ended** | ** ** |
|----------------------------------------------------------------------------------------|------------|----------------------------|------------|--------------------------|------------|
| **(Dollars  in Thousands)**                                                            | ** ** | **6/30/2004**              | ** ** | **6/30/2003**            |       | **6/30/2004** | ** ** | **6/30/2003** | ** ** |
| Revenues Before Intersegment Eliminations                                              |       |                       | ** ** |                     |       |   | ** ** |   |   |
| Installation                                                                           | ** ** | **$**                      | **1,227**  | ** **               | $          | 1,677 |   | **$** | **1,880** | ** ** | $ | 3,635 |   |
| Service                                                                                | ** ** | **2,111**                  | ** ** | 1,706                    |       | **3,753** | ** ** | 3,659 |   |
| ** **                                                                             |       | **3,338**                  |       | 3,383                    | ** ** | **5,633** | ** ** | 7,294 |   |
| Cost of Products Sold                                                                  | ** ** | **2,296**                  | ** ** | 2,550                    |       | **3,805** | ** ** | 5,069 |   |
| Cost of Services, excluding Depreciation  And Amortization                             | ** ** | **317**                    | ** ** | 442                      |       | **642** | ** ** | 827 |   |
| Selling, General and Administrative  Expenses, excluding Depreciation and Amortization | ** ** | **821**                    | ** ** | 889                      |       | **1,607** | ** ** | 1,761 |   |
| Depreciation and Amortization                                                          | ** ** | **44**                     | ** ** | 60                       |       | **95** | ** ** | 121 |   |
| Operating Income/(Loss)                                                                | ** ** | **$**                      | **(140**   | **)**                    | $          | (558 | ) | **$** | **(516** | **)** | $ | (484 | ) |
| Net Income/(Loss)                                                                      | ** ** | **$**                      | **(83**    | **)**                    | $          | (334 | ) | **$** | **(307** | **)** | $ | (295 | ) |
|                                                                                   |       |                       | ** ** |                     |       |   | ** ** |   |   |
| Capital Expenditures                                                                   | ** ** | **$**                      | **22**     | ** **               | $          | 97 |   | **$** | **22** | ** ** | $ | 189 |   |

 

25

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Revenues:

Operating revenues decreased $45,000 or 1.3% in the second quarter of2004 compared to the second quarter of 2003. Operating revenues decreased$1,661,000 or 22.8% in the six months ended June 30, 2004 compared to thesix months ended June 30, 2003. Installation revenue decreased $450,000 or26.8% in the second quarter of 2004 compared to the second quarter of2003.  Installation revenue decreased$1,755,000 or 48.3% in the six months ended June 30, 2004 compared to thesix months ended June 30, 2003, and is primarily due to a decrease in theinstallation of Private Branch Exchange (PBX) systems of $1,210,000 or 74.7%and a decrease in the installation of data systems of $681,000 or 40.4%. Thedecrease in installation revenue in the second quarter of 2004 compared to thesecond quarter of 2003 was primarily a result of a decrease in sales and installationsof PBX systems of $639,000 or 63.1%, which was somewhat offset by an increasein Small Business Systems (SBS) installations of $228,000 or 185.8%.  Revenues in 2003 were aided by installationsof Voice over Internet Protocol networks that were performed in a corporateoffice and on a large college campus in Minnesota during the first six monthsof 2003.  Service revenue was $405,000 or23.7% higher in the second quarter of 2004 compared to the second quarter of2003, due primarily to an increase in Move, Add, and Change (MAC) contractrevenue of $362,000 or 68.2%. For the six months ended June 30, 2004,service revenue was $94,000, or 2.6% higher compared to the same period in2003. This sector has encountered across the board reductions in demand in allof its major products and services. The reduction started in early 2002, and isbelieved to be associated with the economy’s effect on customers of thissector, and due to changing technology (i.e. voice vs. data protocol) in thecommunications products, which this sector provides. Due to the uncertainty ofthe economy, HickoryTech cannot estimate when or if customer demand for theseproducts and services may return to higher levels.

 

Cost of Products Sold:

Cost of products sold decreased $254,000 or 10.0% in the second quarterof 2004 compared to the second quarter of 2003. Cost of products sold decreased $1,264,000 or 24.9% in the six monthsended June 30, 2004 compared to the six months ended June 30,2003.  The decrease in cost of productssold in the second quarter of 2004 compared to second quarter 2004 was mainlydue to the decrease in installation revenue. For the six month period ended June 30, 2004 as compared to thecomparable 2003 period, the decrease in cost of products sold was in line withthe corresponding decrease in operating revenues in this sector, as grossprofit margins remained relatively consistent at 32.5% for the six months endedJune 30, 2004 compared to 30.5% for the same period in 2003.

 

Cost of Services, excluding Depreciation and Amortization:

Cost of services, excluding depreciation and amortization decreased$125,000 or 28.3% in the second quarter 2004 compared to the second quarter2003.  Cost of services, excludingdepreciation and amortization decreased $185,000 or 22.4% in the six monthsended June 30, 2004 compared to the six months ended June 30, 2003.The decrease in cost of services, excluding depreciation and amortization inthe first quarter 2004 compared to the first quarter 2003 was largely the resultof cost reduction measures, which included workforce reductions.

 

Selling, General and Administrative, excluding Depreciation andAmortization:

Selling, general and administrative expenses, excluding depreciationand amortization decreased $68,000 or 7.6% in the second quarter 2004 comparedto the second quarter 2003.  Selling,general and administrative expenses, excluding depreciation and amortizationdecreased $154,000 or 8.7% in the six months ended June 30, 2004 comparedto the six months ended June 30, 2003. The decrease in selling, general and administrative expenses was largelydue to cost reduction measures, which included workforce reductions.

 

Operating and Net Loss:

Operating loss was $140,000 in the three months ended June 30,2004 compared to an operating loss of $558,000 in the three months endedJune 30, 2003. Operating loss was $516,000 in the six months endedJune 30, 2004 compared to an operating loss of $484,000 in the six monthsended June 30, 2003. Net loss in the three months ended June 30, 2004was $83,000 compared to a net loss of $334,000 in the three months endedJune 30, 2003. Net loss in the six months ended June 30, 2004 was$307,000 compared to a net loss of $295,000 in the six months endedJune 30, 2003. The operating and net losses generated in the three and sixmonths ended June 30, 2004 compared to the three and six months endedJune 30, 2003 occurred for the reasons described above.

 

26

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LIQUIDITY AND CAPITAL RESOURCES

 

CASH FLOWS – Cash provided by operations was$17,187,000 in the first six months of 2004 compared to $15,890,000 in thefirst six months of 2003. Cash flows from operations in the first six months of2004 were primarily attributable to net income plus non-cash expenses fordepreciation and amortization as well as a decrease in income taxes receivable.Cash flows from operations in the first six months of 2003 were primarilyattributable to net income plus non-cash expenses for depreciation andamortization and a decrease in receivables, partially offset by decreases inaccounts payable related to the timing of payments.

 

Cash flows used in investing activities were $3,593,000 in the firstsix months of 2004 compared to cash flows used of $287,000 for the same periodin 2003. Capital expenditures were $6,240,000 during the first six months of2004 as compared to $4,460,000 for the same period in 2003. Capitalexpenditures for the six months ended June 30, 2004 were incurredprimarily to provide additional network facilities in the Telecom Sector.Management expects capital expenditures in the remainder of 2004 to beapproximately $12,000,000. As part of the 2004 capital spending, HickoryTech isinvesting in an enhanced network, including an Internet Protocol (IP) capableswitch and high capacity cable infrastructure for its ILEC market. Additionalinvestments in growth for its CLEC markets are being made as well, including anadditional $400,000 to be spent this year to provide digital television servicein Waseca, Minnesota. There were $2,600,000 redemptions of investments in thefirst six months of 2004, compared to $4,100,000 in the first six months of2003. The redemptions in the first six months of both 2004 and 2003 reflect theamount by which HickoryTech was permitted to reduce its equity investment inone of its lenders, through conditions of its debt agreements.

 

Cash flows used in financing activities were $13,639,000 for the firstsix months of 2004 compared to $16,333,000 for the first six months of 2003.Included in cash flows used in financing activities are debt repayments anddividend payments. HickoryTech made payments on its revolving credit facilityof $12,000,000 during the first six months of 2004, and $14,000,000 during thefirst six months of 2003. HickoryTech borrowed $1,500,000 on its revolvingcredit facility during the first six months of 2004, and $1,250,000 during thefirst six months of 2003. Dividend payments for the first six months of 2004were $2,853,000 compared to $3,074,000 for the same period in 2003. During thesecond quarter of 2004, HickoryTech retired 3,299 shares for $43,000 from astock compensation plan. During the first six months of 2003, HickoryTechrepurchased 53,300 common shares for $519,000, as well as retiring 18,370shares for $185,000 from a stock compensation plan.

 

WORKING CAPITAL – Working capital (i.e.current assets minus current liabilities) was $5,544,000 as of June 30,2004, compared to working capital of $9,300,000 as of December 31, 2003.The change in taxes receivable is the primary reason for this decrease. Incometaxes receivable were $2,838,000 at December 31, 2003, and income taxespayable were $1,885,000 at June 30, 2004. The ratio of current assets tocurrent liabilities was 1.4 to 1.0 as of June 30, 2004 and 1.7 to 1.0 asof December 31, 2003.

 

LONG-TERM OBLIGATIONS- HickoryTech’s long-termobligations as of June 30, 2004 were $107,280,000, excluding currentmaturities of $1,600,000. As of June 30, 2004, HickoryTech had a$138,175,000 credit facility with a syndicate of banks. The credit facility iscomprised of a $116,675,000 revolving credit component and a $21,500,000 termloan component. The available line of credit on the $116,675,000 revolvingcredit began decreasing in increments in March of 2004, and has a finalmaturity date in September 2008. However, since not all of the availablerevolving credit has been utilized as of June 30, 2004, the paymentschedule is as follows: 2006 - $25,562,000, 2007 - $32,813,000 and 2008 -$28,125,000. The term loan component requires equal quarterly principalpayments of $250,000 during the period of March 2001 toDecember 2008, and $17,000,000 in the first quarter of 2009. The weightedaverage interest rate associated with this credit facility and related instrumentsvaries with LIBOR and certain other rates and was 4.05% at June 30, 2004and 3.9% at June 30, 2003. HickoryTech has implemented fixed interestterms on various portions of the overall debt outstanding for varying terms.The longest fixed interest term, on $60,000,000 of the debt, is fixed untilJune 2008. As of June 30, 2004, HickoryTech had drawn $108,000,000 onthis credit facility and had $30,175,000 of available credit. Managementbelieves the remaining available credit is sufficient to cover future cash requirements.This includes review of the timing of future reductions in the available creditline versus the projected future levels of HickoryTech debt. Annually,management assesses the industry capital markets, and has concluded thatadequate access to alternative capital sources exists if management chooses toreplace its existing capital sources.

 

27

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HickoryTech’s Information Solutions Sector leases certain computerequipment under capital lease arrangements. During the six months endedJune 30, 2004, this sector recorded additions to property, plant andequipment of $81,000 related to these capital lease arrangements.

 

CONSTRUCTION PLANS – Beginning in 2004,HickoryTech has embarked on a five-year network enhancement program in its coretelephone property in Mankato in support of its leading broadband servicestrategy. The Company will add approximately $20,000,000 to the network overthe five-year period, in addition to the historical levels of capital spendingin 2003 and 2002. 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 to an alreadystate of the art network will give HickoryTech the capability to offer morediversified services to its core customer base.

 

OTHER - HickoryTech operates with originalequity capital, retained earnings and indebtedness in the form of bank term andrevolving lines of credit. HickoryTech believes its current level of debt tototal capital is acceptable for ongoing operations.

 

CRITICAL ACCOUNTING POLICIES

 

Management’s discussion and analysis of financial condition and resultsof operations stated in this Form 10-Q are based upon HickoryTech’sconsolidated financial statements, which have been prepared in accordance withaccounting principles generally accepted in the United States of America and,where applicable, conform to the accounting principles as prescribed by federaland state telephone utility regulatory authorities. HickoryTech presently givesaccounting recognition to the actions of regulators where appropriate, asprescribed by Statement of Financial Accounting Standards (SFAS) No. 71,“Accounting for the Effects of Certain Types of Regulation.” The preparation ofthese financial statements requires management to make estimates and judgmentsthat affect the reported amounts of assets, liabilities, revenues, and expensesand related disclosure of contingent assets and liabilities. Managementbelieves that the application of the accounting policies, which are importantto HickoryTech’s financial position and results of operations, requiressignificant judgments and estimates on the part of management.  A description of the critical accountingpolicies adhered to by HickoryTech is contained in the Management’s Discussionand Analysis of Financial Condition and Results of Operations in HickoryTech’sAnnual Report on Form 10-K for the year ended December 31, 2003. Therewere no significant changes to these critical accounting policies during thequarter ended June 30, 2004. During 2003, HickoryTech purchased aninterest rate swap contract, which is accounted for pursuant to the provisionsof SFAS No. 133 as described in Note 11 of the notes to the accompanyingfinancial statements.

 

RECENT ACCOUNTING DEVELOPMENTS

 

In January 2003, the FASB issued FIN No. 46, *Consolidationof Variable Interest Entities*. This interpretation provides guidanceon how to identify a variable interest entity and addresses when the assets,liabilities and results of operations of such entities must be included in acompany’s consolidated financial statements. This interpretation was effectiveimmediately for variable interest entities created after January 31, 2003and for variable interest entities in which the Company obtains an interestafter that date. For interests in variable interest entities that were acquiredprior to January 31, 2003, the Company adopted the provisions of thisinterpretation on July 1, 2003. Adoption of this statement did not resultin the consolidation or disclosure of any variable interest entities in whichthe Company maintains an interest. The Company did not absorb the majority ofthe losses or residual returns of the variable interest entities in which theCompany maintains an interest and these interests are not significant. InDecember 2003, the FASB issued a revised FIN No. 46 which clarifiescertain aspects of the accounting for variable interest entities. The revision ofFIN No. 46 had no impact on results of operations or financial position.

 

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In May 2004, the FASB issued FASB Staff Position (FSP) No. FAS 106-2, *Accounting and Disclosure Requirements Related to the MedicarePrescription Drug Improvement and Modernization Act of 2003*, whichsupersedes FSP No. FAS 106-1 of the same name. This FSP outlines theappropriate accounting treatment for the effects of the new Medicare law, aswell as the required financial statement disclosures. The new law introduces aprescription drug benefit under Medicare, as well as a federal subsidy tosponsors of retiree health care benefit plans that provide a benefit that is atleast actuarially equivalent to the Medicare plan. The retiree medical plans doprovide prescription drug coverage. However, as permitted by FSP No. FAS 106-2,the Company has elected to defer recognition of the impacts of the new law onthe accumulated post-retirement benefit obligation and net periodic post-retirementbenefit expense presented in the consolidated financial statements. Specificauthoritative accounting guidance on the accounting for the federal subsidyprovided for in the Act is pending. That guidance, when issued, could requirethe Company to change previously reported information. BeginningJanuary 1, 2006, Medicare’s prescription drug plan may become the primaryplan for qualified retirees when they become age 65 and are eligible forMedicare. Thus, the Company may see a decrease in the amount of prescriptiondrug benefits to be paid beginning in 2006.

 

In December 2003, the FASB issued a revision of SFAS No. 132, *Employers’ Disclosures about Pensions and Other Post-retirementBenefits*. This statement revises the disclosures required forpension and other post-retirement benefit plans. The Company has incorporatedthe new disclosure requirements into the Notes to Consolidated FinancialStatements included in this report.

 

ITEM 3. QUANTATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

HickoryTech does not have operations subject to risks of foreigncurrency fluctuations. HickoryTech does, however, use derivative financialinstruments to manage exposure to interest rate fluctuations. HickoryTech’sobjectives for holding derivatives are to minimize interest rate risks usingthe most effective methods to eliminate or reduce the impact of theseexposures. Variable rate debt instruments are subject to interest rate risk.HickoryTech has entered into interest rate swap agreements with remainingmaturities ranging from twelve to forty-eight months to manage its exposure tointerest rate movements on a portion of its variable rate debt obligations. Theeffective portion of the cumulative gain or loss on these derivativeinstruments is reported as a component of accumulated other comprehensiveincome in shareholders’ equity and is recognized in earnings when the term ofthe swap agreement is concluded. HickoryTech’s earnings are affected by changesin interest rates as a portion of its long-term debt has variable interestrates based on LIBOR. If interest rates for the portion of HickoryTech’slong-term debt based on variable rates had averaged 10% more for the quarterended June 30, 2004, HickoryTech’s interest expense for the quarter wouldhave increased $38,000.  If interestrates for the portion of HickoryTech’s long-term debt based on variable rateshad averaged 10% more for the entire six months ended June 30, 2004,HickoryTech’s interest expense for the six months ended June 30, 2004would have increased $76,000.

 

ITEM 4. CONTROLS AND PROCEDURES

 

HickoryTech carried out an evaluation under the supervision, and withthe participation of, the Company’s management, including its Chief ExecutiveOfficer (“CEO”) and Chief Financial Officer (“CFO”) of the effectiveness of theCompany’s disclosure controls and procedures (as defined in Rule 13a-15(e)under the Exchange Act) as of June 30, 2004, the end of the period coveredby this report. Disclosure controls and procedures are designed with theobjective of ensuring that information required to be disclosed in theCompany’s reports filed or submitted under the Securities Exchange Act, such asthis Form 10-Q, is recorded, processed, summarized and reported within the timeperiods specified in the Securities and Exchange Commission’s applicable rulesand forms. Based on that evaluation, the CEO and CFO have concluded that thedisclosure controls and procedures are effective to satisfy the objectives forwhich they are intended. During the quarter ended June 30, 2004, there hasbeen no change in the Company’s internal control over financial reporting (asdefined in Rule 13a-15(f) of the Exchange Act) that has materially affected oris reasonably likely to materially affect our internal control over financialreporting.

 

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PART II. OTHER INFORMATION

 

Item 1.    Legal Proceedings.

Other than routine litigation incidental to HickoryTech’s business,there are no material pending legal proceedings to which HickoryTech is a partyor to which any of its property is subject.

 

Item 2.             Changesin Securities, Use of Proceeds and Issuer Purchases of Equity Securities.

 

Informationon the Company’s purchases of equity securities during the second quarterfollows:

 
| **Period**                          | ** ** | **Total  Number of  Shares  Purchased  (a)** | ** ** | **Average  Price Paid  per Share  (b)** | ** ** | **Total Number of  Shares  Purchased as  Part of Publicly  Announced  Plans or  Programs  (c)** | ** ** | **Maximum Number  of Shares that  May Yet Be  Purchased Under  the Plans or  Programs (at end  of period)  (d)** | ** ** |
|-------------------------------------|------------|----------------------------------------------|------------|-----------------------------------------|------------|-------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------|------------|
| ** **                          | ** ** | ** **                                   | ** ** | ** **                              | ** ** | ** **                                                                                      | ** ** | ** **                                                                                                       | ** ** |
| April 1, 2004 – April 30, 2004 |       | 3,299                                        |       | 12.97                                   |       | -                                                                                               |       | N/A                                                                                                              |       |
| May 1, 2004 – May 31, 2004     |       | -                                            |       | -                                       |       | -                                                                                               |       | N/A                                                                                                              |       |
| June 1, 2004 – June 30, 2004   |       | -                                            |       | -                                       |       | -                                                                                               |       | N/A                                                                                                              |       |

 

The share purchase disclosed in the abovetable represents shares withheld to cover employee withholding taxes upon thetransfer of shares due to the departure of the employee from the Company. Thiswas in accordance with the provision of the 1993 Stock Award Plan.

 

 

Item 3.             DefaultUpon Senior Securities.

None.

 

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

 

a.                    The annual shareholders’ meetingwas held on April 26, 2004.

b.                   3 directors were elected to servethree-year terms. The names of the directors elected at the annual meeting andthe applicable votes were as follows:

 
| **Director**      | ** ** | **For**    | ** ** | **Withheld** | ** ** | **Broker  Nonvotes** | ** ** |
|-------------------|------------|------------|------------|--------------|------------|----------------------|------------|
|              |       |       |       |         |       |                 |       |
| James H. Holdrege |       | 10,253,242 |       | 389,914      |       | None                 |       |
| Lyle G. Jacobson  |       | 10,313,873 |       | 329,283      |       | None                 |       |
| Starr J. Kirklin  |       | 10,277,596 |       | 365,560      |       | None                 |       |

 

Item 5.             OtherInformation.

None.

 

Item 6.             Exhibitsand Reports on Form 8-K.

 

(a)          Exhibits

Exhibit 31(a) Certification pursuant to rule 13a-14(a) under theExchange Act, as adopted pursuant to Section 302 of the Sarbanes-Oxley Actof 2002

Exhibit 31(b) Certification pursuant to rule 13a-14(a) under theExchange Act, as adopted pursuant to Section 302 of the Sarbanes-Oxley Actof 2002

Exhibit 32(a) Certification pursuant to 18 U.S.C. 1350, as adoptedpursuant to Section 906 of the Sarbanes-Oxley Act of 2002

Exhibit 32(b) Certification pursuant to 18 U.S.C. 1350, as adoptedpursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

(b)         HickoryTech furnished a Form 8-K onApril 29, 2004 under Items 7 and 12 to disclose financial results for thefirst quarter of 2004.

 

HickoryTech filed a Form 8-K on May 27, 2004 under Item 5 announcingthe appointment of James W. Bracke to HickoryTech’s board of directors.

 

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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934,the registrant has duly caused this report to be signed on its behalf by theundersigned, thereunto duly authorized.

 
| Dated: | August 4, 2004 |                                          | HICKORY TECH CORPORATION |
|--------|---------------------|-----------------------------------------------|--------------------------|
|   |                |                                          |
|   |                |                                          |
|   | By:                 | /s/ John E. Duffy.                            |                     |
|   |                | John E. Duffy, Chief Executive Officer        |
|   |                |                                          |
|   |                |                                          |
|   | By:                 | /s/ David A. Christensen                      |                     |
|   |                | David A. Christensen, Chief Financial Officer |
|        |                     |                                               |                          |  |  |  |

 

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