**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 SECURITIESEXCHANGE ACT OF 1934**

 

**FOR THE QUARTERLY PERIOD ENDED September 30, 2004**

 

**OR**

 

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

 

**FOR THE TRANSITION PERIOD FROM              TO             **

 

**Commissionfile number   0-13721**

 

**HICKORY TECH CORPORATION**

(Exact name ofregistrant as specified in its charter)

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

 

**221 EastHickory StreetMankato, Minnesota 56002-3248**

(Address of principal executive offices and zip code)

 

**(800)326-5789**

(Registrant’s telephone number,including area code)

 

 

(Former name, former addressand 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 September 30, 2004: 13,012,133.

 

 

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**HICKORY TECH CORPORATION**

September 30,2004

PARTI. FINANCIAL INFORMATION

ITEM1.   FINANCIAL STATEMENTS.

CONSOLIDATEDSTATEMENTS OF OPERATIONS

(UNAUDITED)

 
| ** **                                                                             | ** ** | **For Three Months Ended** | ** ** | **For Nine Months Ended** | ** ** |
|----------------------------------------------------------------------------------------|------------|----------------------------|------------|---------------------------|------------|
| **(In Thousands Except Per Share Amounts)**                                            | ** ** | **9/30/2004**              | ** ** | **9/30/2003**             | ** ** | **9/30/2004** | ** ** | **9/30/2003** | ** ** |
| OPERATING  REVENUES:                                                                   |       |                       |       |                      |       |   |   |   |   |
| Telecom  Sector                                                                        | ** ** | **$**                      | **18,918** |                      | $          | 18,810 | ** ** | **$** | **57,191** |   | $ | 56,058 |   |
| Information  Solutions Sector                                                          | ** ** | **574**                    |       | 702                       | ** ** | **2,219** |   | 2,609 |   |
| Enterprise  Solutions Sector                                                           | ** ** | **2,685**                  |       | 3,565                     | ** ** | **8,318** |   | 10,859 |   |
| TOTAL  OPERATING REVENUES                                                              | ** ** | **22,177**                 |       | 23,077                    | ** ** | **67,728** |   | 69,526 |   |
| COSTS AND  EXPENSES:                                                                   |       |                       |       |                      |       |   |   |   |   |
| Cost of  Products Sold, Enterprise Solutions                                           | ** ** | **1,855**                  |       | 2,606                     | ** ** | **5,660** |   | 7,675 |   |
| Cost of  Services, excluding Depreciation and Amortization                             | ** ** | **8,378**                  |       | 8,708                     | ** ** | **24,857** |   | 24,977 |   |
| Selling,  General and Administrative Expenses, excluding Depreciation and Amortization | ** ** | **3,490**                  |       | 2,767                     | ** ** | **10,772** |   | 10,263 |   |
| Depreciation                                                                           | ** ** | **3,912**                  |       | 3,780                     | ** ** | **11,669** |   | 11,013 |   |
| Amortization  of Intangibles                                                           | ** ** | **237**                    |       | 236                       | ** ** | **710** |   | 761 |   |
| TOTAL COSTS  AND EXPENSES                                                              | ** ** | **17,872**                 |       | 18,097                    | ** ** | **53,668** |   | 54,689 |   |
| OPERATING  INCOME                                                                      | ** ** | **4,305**                  |       | 4,980                     | ** ** | **14,060** |   | 14,837 |   |
| OTHER  INCOME/(EXPENSE):                                                               |       |                       |       |                      |       |   |   |   |   |
| Equity in  Net Income/(Loss) of Investees                                              | ** ** | **—**                 |       | 1                         | ** ** | **—** |   | (4 | ) |
| Interest and  Other Income                                                             | ** ** | **10**                     |       | 10                        | ** ** | **44** |   | 33 |   |
| Interest  Expense                                                                      | ** ** | **(1,121**                 | **)**      | (1,579                    | )          | **(3,448** | **)** | (4,624 | ) |
| TOTAL OTHER  INCOME/(EXPENSE)                                                          | ** ** | **(1,111**                 | **)**      | (1,568                    | )          | **(3,404** | **)** | (4,595 | ) |
|                                                                                   |       |                       |       |                      |       |   |   |   |   |
| INCOME  BEFORE INCOME TAXES                                                            | ** ** | **3,194**                  |       | 3,412                     | ** ** | **10,656** |   | 10,242 |   |
| INCOME TAX  PROVISION                                                                  | ** ** | **1,292**                  |       | 1,395                     | ** ** | **4,310** |   | 4,186 |   |
| INCOME FROM  CONTINUING OPERATIONS                                                     | ** ** | **1,902**                  |       | 2,017                     | ** ** | **6,346** |   | 6,056 |   |
| DISCONTINUED  OPERATIONS (Note 4)                                                      |       |                       |       |                      |       |   |   |   |   |
| Loss from  Operations of Discontinued Component                                        | ** ** | **(26**                    | **)**      | (24,873                   | )          | **(125** | **)** | (23,487 | ) |
| Income Tax  Benefit                                                                    | ** ** | **(11**                    | **)**      | (2,783                    | )          | **(51** | **)** | (2,215 | ) |
| LOSS FROM  DISCONTINUED OPERATIONS                                                     | ** ** | **(15**                    | **)**      | (22,090                   | )          | **(74** | **)** | (21,272 | ) |
| NET  INCOME/(LOSS)                                                                     | ** ** | **$**                      | **1,887**  |                      | $          | (20,073 | ) | **$** | **6,272** |   | $ | (15,216 | ) |
|                                                                                   |       |                       |       |                      |       |   |   |   |   |
| Basic  Earnings Per Share - Continuing Operations:                                     | ** ** | **$**                      | **0.15**   |                      | $          | 0.14 | ** ** | **$** | **0.49** |   | $ | 0.43 |   |
| Basic  Earnings Per Share - Discontinued Operations:                                   | ** ** | **—**                 |       | (1.58                     | )          | **(0.01** | **)** | (1.52 | ) |
| ** **                                                                             |       | **$**                      | **0.15**   |                      | $          | (1.44 | ) | **$** | **0.48** | ** ** | $ | (1.09 | ) |
| Dividends  Per Share                                                                   | ** ** | **$**                      | **0.11**   |                      | $          | 0.11 | ** ** | **$** | **0.33** |   | $ | 0.33 |   |
| Basic  Weighted Average Common Shares Outstanding                                      | ** ** | **12,991**                 |       | 13,974                    | ** ** | **12,978** |   | 13,973 |   |
|                                                                                   |       |                       |       |                      |       |   |   |   |   |
| Diluted  Earnings Per Share - Continuing Operations:                                   | ** ** | **$**                      | **0.15**   |                      | $          | 0.14 | ** ** | **$** | **0.49** |   | $ | 0.43 |   |
| Diluted  Earnings Per Share - Discontinued Operations:                                 | ** ** | **—**                 |       | (1.58                     | )          | **(0.01** | **)** | (1.52 | ) |
| ** **                                                                             |       | **$**                      | **0.15**   |                      | $          | (1.44 | ) | **$** | **0.48** | ** ** | $ | (1.09 | ) |
| Diluted  Weighted Average Common and Equivalent Shares Outstanding                     | ** ** | **13,016**                 |       | 14,024                    | ** ** | **13,008** |   | 14,031 |   |

 

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

 

1

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**HICKORY TECH CORPORATION**

September 30,2004

CONSOLIDATED BALANCE SHEETS

(UNAUDITED)

 
| **(In Thousands Except Share and Per Share Amounts)**                                                                                        | ** ** | **9/30/2004** | ** **  | **12/31/2003** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------|-------------|----------------|------------|
| ASSETS                                                                                                                                       |       |          |        |           |       |
| CURRENT  ASSETS:                                                                                                                             |       |          |        |           |       |
| Cash and  Cash Equivalents                                                                                                                   | ** ** | **$**         | **598**     |           | $          | 278 |   |
| Receivables,  Net of Allowance for Doubtful Accounts of $1,414 and $1,283                                                                    | ** ** | **9,333**     |        | 9,984          |       |
| Income Taxes  Receivable                                                                                                                     | ** ** | **—**    |        | 2,838          |       |
| Costs in  Excess of Billings on Contracts                                                                                                    | ** ** | **497**       |        | 934            |       |
| Inventories                                                                                                                                  | ** ** | **4,246**     |        | 4,453          |       |
| Deferred  Income Taxes                                                                                                                       | ** ** | **1,057**     |        | 1,057          |       |
| Other                                                                                                                                        | ** ** | **2,235**     |        | 2,497          |       |
| TOTAL  CURRENT ASSETS                                                                                                                        | ** ** | **17,966**    |        | 22,041         |       |
| INVESTMENTS                                                                                                                                  | ** ** | **4,371**     |        | 6,710          |       |
| PROPERTY,  PLANT AND EQUIPMENT                                                                                                               | ** ** | **238,914**   |        | 230,490        |       |
| Less  ACCUMULATED DEPRECIATION                                                                                                               | ** ** | **127,805**   |        | 116,487        |       |
| PROPERTY,  PLANT AND EQUIPMENT, NET                                                                                                          | ** ** | **111,109**   |        | 114,003        |       |
| OTHER  ASSETS:                                                                                                                               |       |          |        |           |       |
| Goodwill                                                                                                                                     | ** ** | **25,086**    |        | 25,086         |       |
| Intangible  Assets, Net                                                                                                                      | ** ** | **413**       |        | 481            |       |
| Financial Derivative  Instruments                                                                                                            | ** ** | **2,089**     |        | 2,515          |       |
| Deferred  Costs and Other                                                                                                                    | ** ** | **3,582**     |        | 4,876          |       |
| TOTAL OTHER  ASSETS                                                                                                                          | ** ** | **31,170**    |        | 32,958         |       |
| TOTAL ASSETS                                                                                                                                 | ** ** | **$**         | **164,616** |           | $          | 175,712 |   |
|                                                                                                                                         |       |          |        |           |       |
| LIABILITIES  & SHAREHOLDERS’ EQUITY                                                                                                 |       |          |        |           |       |
| CURRENT  LIABILITIES:                                                                                                                        |       |          |        |           |       |
| Cash  Overdraft                                                                                                                              | ** ** | **$**         | **—**  |           | $          | 1,001 |   |
| Accounts  Payable                                                                                                                            | ** ** | **1,779**     |        | 3,771          |       |
| Accrued  Expenses                                                                                                                            | ** ** | **3,160**     |        | 3,243          |       |
| Accrued  Interest                                                                                                                            | ** ** | **67**        |        | 41             |       |
| Accrued  Income Taxes                                                                                                                        | ** ** | **3,166**     |        | —         |       |
| Billings in  Excess of Costs on Contracts                                                                                                    | ** ** | **153**       |        | 73             |       |
| Advanced  Billings and Deposits                                                                                                              | ** ** | **2,900**     |        | 3,040          |       |
| Current  Maturities of Long-Term Obligations                                                                                                 | ** ** | **1,500**     |        | 1,572          |       |
| TOTAL  CURRENT LIABILITIES                                                                                                                   | ** ** | **12,725**    |        | 12,741         |       |
| LONG-TERM  OBLIGATIONS, Net of Current Maturities                                                                                            | ** ** | **104,465**   |        | 118,040        |       |
| DEFERRED  INCOME TAXES                                                                                                                       | ** ** | **10,146**    |        | 10,331         |       |
| DEFERRED  REVENUE AND EMPLOYEE BENEFITS                                                                                                      | ** ** | **6,423**     |        | 5,883          |       |
| TOTAL  LIABILITIES                                                                                                                           | ** ** | **133,759**   |        | 146,995        |       |
| COMMITMENTS  AND CONTINGENCIES (Note 9)                                                                                                      | ** ** | **—**    |        | —         |       |
| SHAREHOLDERS’  EQUITY:                                                                                                                  |       |          |        |           |       |
| Common  Stock, no par value, $.10 stated value Shares authorized: 100,000,000 Shares  outstanding: 13,012,133 in 2004 and 12,967,811 in 2003 | ** ** | **1,301**     |        | 1,297          |       |
| Additional  Paid-In Capital                                                                                                                  | ** ** | **8,077**     |        | 7,690          |       |
| Retained  Earnings                                                                                                                           | ** ** | **20,236**    |        | 18,246         |       |
| Accumulated  Other Comprehensive Income (Notes 3, 11)                                                                                        | ** ** | **1,243**     |        | 1,484          |       |
| TOTAL  SHAREHOLDERS’ EQUITY                                                                                                             | ** ** | **30,857**    |        | 28,717         |       |
| TOTAL  LIABILITIES & SHAREHOLDERS’ EQUITY                                                                                           | ** ** | **$**         | **164,616** |           | $          | 175,712 |   |

 

The accompanying notes are an integral partof the consolidated financial statements.

 

2

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**HICKORY TECH CORPORATION**

September 30,2004

CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

 
| ** **                                                                            | ** ** | **For Nine Months Ended** | ** ** |
|---------------------------------------------------------------------------------------|------------|---------------------------|------------|
| **(Dollars In Thousands)**                                                            | ** ** | **9/30/2004**             | ** ** | **9/30/2003** | ** ** |
| CASH FLOWS  FROM OPERATING ACTIVITIES:                                                |       |                      |       |   |   |
| Net  Income/(Loss)                                                                    | ** ** | **$**                     | **6,272**  |   | $ | (15,216 | ) |
| Adjustments  to Reconcile Net Income/(Loss) to Net                                    |       |                      |       |   |   |
| Cash Provided  by Operating Activities:                                               |       |                      |       |   |   |
| Depreciation  and Amortization                                                        | ** ** | **12,379**                |       | 13,545 |   |
| Intangible  Asset Impairment                                                          | ** ** | **—**                |       | 21,000 |   |
| Long-Lived  Asset Impairment                                                          | ** ** | **—**                |       | 4,345 |   |
| (Gain)/Loss  on Sale of Assets                                                        | ** ** | **95**                    |       | (2 | ) |
| Loss on  Disposal of Assets                                                           | ** ** | **—**                |       | 632 |   |
| Deferred  Income Taxes                                                                | ** ** | **—**                |       | (2,976 | ) |
| Stock-Based  Compensation                                                             | ** ** | **78**                    |       | 234 |   |
| Employee  Retirement Benefits and Deferred Compensation                               | ** ** | **696**                   |       | 242 |   |
| Accrued  Patronage Refunds                                                            | ** ** | **(279**                  | **)**      | (443 | ) |
| Equity in  Net Loss of Investees                                                      | ** ** | **—**                | ** ** | 4 |   |
| Provision  for Losses on Accounts Receivable                                          | ** ** | **521**                   |       | 601 |   |
| Changes in  Operating Assets and Liabilities:                                         |       |                      |       |   |   |
| Receivables                                                                           | ** ** | **6,135**                 |       | 3,180 |   |
| Inventories                                                                           | ** ** | **207**                   |       | (69 | ) |
| Billings and  Costs on Contracts                                                      | ** ** | **517**                   |       | 1,462 |   |
| Accounts  Payable and Accrued Expenses                                                | ** ** | **(1,782**                | **)**      | (2,787 | ) |
| Advance Billings  and Deposits                                                        | ** ** | **(139**                  | **)**      | (152 | ) |
| Deferred  Revenue and Employee Benefits                                               | ** ** | **(157**                  | **)**      | (49 | ) |
| Other                                                                                 | ** ** | **942**                   |       | 1,253 |   |
| Net Cash  Provided By Operating Activities                                            | ** ** | **25,485**                |       | 24,804 |   |
|                                                                                  |       |                      |       |   |   |
| CASH FLOWS  FROM INVESTING ACTIVITIES:                                                |       |                      |       |   |   |
| Additions to  Property, Plant and Equipment                                           | ** ** | **(9,111**                | **)**      | (7,532 | ) |
| Redemption  of Investments                                                            | ** ** | **2,600**                 | ** ** | 4,100 |   |
| Purchase of  Intangible Asset                                                         | ** ** | **(9**                    | **)**      | — |   |
| Proceeds  from Sale of Assets                                                         | ** ** | **53**                    | ** ** | 97 |   |
| Net Cash  Used In Investing Activities                                                | ** ** | **(6,467**                | **)**      | (3,335 | ) |
|                                                                                  |       |                      |       |   |   |
| CASH FLOWS  FROM FINANCING ACTIVITIES:                                                |       |                      |       |   |   |
| Change in  Cash Overdraft                                                             | ** ** | **(1,001**                | **)**      | — |   |
| Payments of  Capital Lease Obligations                                                | ** ** | **(479**                  | **)**      | (385 | ) |
| Repayments  on Credit Facility                                                        | ** ** | **(15,250**               | **)**      | (18,500 | ) |
| Borrowings  on Credit Facility                                                        | ** ** | **2,000**                 |       | 1,250 |   |
| Proceeds  from Issuance of Common Stock                                               | ** ** | **356**                   |       | 628 |   |
| Dividends  Paid                                                                       | ** ** | **(4,281**                | **)**      | (4,610 | ) |
| Stock  Repurchase/Retirement                                                          | ** ** | **(43**                   | **)**      | (846 | ) |
| Net Cash  Used In Financing Activities                                                | ** ** | **(18,698**               | **)**      | (22,463 | ) |
|                                                                                  |       |                      |       |   |   |
| NET INCREASE  (DECREASE) IN CASH AND CASH EQUIVALENTS                                 | ** ** | **320**                   |       | (994 | ) |
|                                                                                  |       |                      |       |   |   |
| CASH AND  CASH EQUIVALENTS AT BEGINNING OF PERIOD                                     | ** ** | **278**                   |       | 1,874 |   |
|                                                                                  |       |                      |       |   |   |
| CASH AND  CASH EQUIVALENTS AT END OF PERIOD                                           | ** ** | **$**                     | **598**    |   | $ | 880 |   |
|                                                                                  |       |                      |       |   |   |
| SUPPLEMENTAL  DISCLOSURE OF CASH FLOW INFORMATION:                                    |       |                      |       |   |   |
| Cash Paid  for Interest                                                               | ** ** | **$**                     | **3,531**  |   | $ | 5,355 |   |
| 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**     |   | $ | 173 |   |

 

The accompanying notes are anintegral part of the consolidated financial statements.

 

3

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**HICKORY TECH CORPORATION**

**SEPTEMBER 30,2004**

**PART 1.FINANCIAL INFORMATION**

 

**ITEM 1.****     NOTES TO CONSOLIDATEDFINANCIAL STATEMENTS**

 

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 and Article 10of Regulation S-X. Accordingly, they do not include all of the informationnecessary for a fair presentation of results of operations, financial position,and cash flows in conformity with accounting principles generally accepted inthe United States of America. In the opinion of management, the condensedconsolidated financial statements reflect all adjustments (consisting only ofnormal recurring adjustments) considered necessary for a fair presentation ofHickory Tech Corporation’s (HickoryTech) results for the periods presented.Operating results for interim periods are not necessarily indicative of resultsthat may be expected for the fiscal year as a whole. The preparation offinancial statements in conformity with accounting principles generallyaccepted in the United States of America requires management to make estimatesand assumptions that affect the reported amounts of assets, liabilities,revenues, expenses, and related disclosures at the date of the financialstatements and during the reporting period. Actual results could differ fromthese estimates. These unaudited interim condensed consolidated financialstatements should be read in conjunction with HickoryTech’s Annual Report onForm 10-K for the year ended December 31, 2003.

 

The condensed consolidated financialstatements of HickoryTech include Hickory Tech Corporation and its subsidiariesin the following three business segments: (i) Telecom Sector, (ii) InformationSolutions Sector and (iii) Enterprise Solutions Sector.  During the first two quarters of 2003, theInformation Solutions Sector had an investment in an unconsolidatedpartnership, which was accounted for using the equity method. This partnershipwas dissolved in the fourth quarter of 2003. All inter-company transactionshave been eliminated from the consolidated financial statements.

 

Certain expenses reported as operatingexpenses in 2003 have been reclassified between cost of services and selling,general and administrative expenses to conform to the 2004 presentation. Thesereclassifications did not change previously reported net income, shareholders’equity or cash flows.

 

Cost of services include all costs related todelivery of HickoryTech’s communications services and products. These costsinclude all costs of performing services and providing related products. Itdoes not include costs associated with selling, general and administrative,depreciation and amortization of property, plant and equipment and intangibleassets, and cost of products sold for the Enterprise Solutions Sector.

 

On December 15,2003, HickoryTech sold its wireless business, Minnesota Southern WirelessCompany (MSWC), to Western Wireless Corporation (WWC). The wireless operationsare reported as part of the Telecom Sector. The results of operations of thewireless business are reported as discontinued operations for all periodspresented (see Note 4).

 

NOTE 2. EARNINGS AND CASH DIVIDENDS PERCOMMON SHARE

 

Basic earnings per share is computed bydividing net income by the weighted average number of shares of common stockoutstanding during the applicable period. Shares used in the earnings per shareassuming dilution calculation are based on the weighted average number ofshares of common stock outstanding during the quarter increased by potentiallydilutive common shares. Potentially dilutive common shares include stockoptions and stock subscribed under the employee stock purchase plan (ESPP).

 

4

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| ** **                           | ** ** | **For Three Months Ended** | ** ** | **For Nine Months Ended** | ** ** |
|--------------------------------------|------------|----------------------------|------------|---------------------------|------------|
| ** **                           | ** ** | **9/30/2004**              | ** ** | **9/30/2003**             | ** ** | **9/30/2004** | ** ** | **9/30/2003** | ** ** |
| Weighted  Average Shares Outstanding | ** ** | **12,990,568**             |       | 13,973,920                | ** ** | **12,978,321** |   | 13,972,741 |   |
| Stock  Options (dilutive only)       | ** ** | **23,866**                 |       | 32,952                    | ** ** | **28,281** |   | 41,236 |   |
| Stock  Subscribed (ESPP)             | ** ** | **1,158**                  |       | 17,347                    | ** ** | **1,158** |   | 16,885 |   |
| Total  Dilutive Shares Outstanding   | ** ** | **13,015,592**             |       | 14,024,219                | ** ** | **13,007,760** |   | 14,030,862 |   |

 

Options to purchase 448,033 and 408,883 shares for the three monthsended September 30, 2004 and 2003, respectively and 448,033 and 112,950shares for the nine months ended September 30, 2004 and 2003, respectively,were not included in the computation of earnings per share assuming dilutionbecause their effect on earnings per share would have been antidilutive.

 

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 three 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 |       |
| Third  Quarter (August 15)       |       | **12,981,929** |       | 13,962,261 |       |

 

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

 

During the first nine months of 2004 and 2003, shareholders haveelected to reinvest $207,000 and $202,000, respectively, of dividends intoHickoryTech common stock pursuant to the HickoryTech Dividend ReinvestmentPlan.

 

NOTE 3. COMPREHENSIVE INCOME

 

HickoryTech follows the provisions of SFAS No. 130, “Reporting ComprehensiveIncome.” This statement established rules for the reporting of comprehensiveincome and its components. In addition to net income, HickoryTech’scomprehensive income includes changes in unrealized gains and losses onderivative instruments qualifying and designated as cash flow hedges.Comprehensive income (loss) for the three months ended September 30, 2004and 2003 was $1,178,000 and ($19,497,000), respectively. Comprehensive income(loss) for the nine months ended September 30, 2004 and 2003 was$6,031,000 and ($14,059,000), 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 in discontinuedoperations are as follows:

 
| ** **                 | ** ** | **For Three Months Ended** | ** ** | **For Nine Months Ended** | ** ** |
|----------------------------|------------|----------------------------|------------|---------------------------|------------|
| **(Dollars in Thousands)** | ** ** | **9/30/2004**              | ** ** | **9/30/2003**             | ** ** | **9/30/2004** | ** ** | **9/30/2003** | ** ** |
| Revenues                   | ** ** | **$**                      | **—** |                      | $          | 4,009 | ** ** | **$** | **—** |   | $ | 11,370 |   |
|                       |       |                       |       |                      |       |   |   |   |   |
| Loss Before  Income Taxes  | ** ** | **$**                      | **(26**    | **)**                     | $          | (24,873 | ) | **$** | **(125** | **)** | $ | (23,487 | ) |

 

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, “Goodwilland Other Intangible Assets.” SFAS No. 142 established new standardsrelated to how acquired goodwill and other intangible assets are to be recordedupon their acquisition as well as how they are to be accounted for after theyhave 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 of September 30,2004 and December 31, 2003.

 

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

 
| ** **                        | ** ** | **As of September 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                         | ** ** | **$**                             | **830**    | ** **                       | **$**      | **417** |   | $ | 821 |   | $ | 340 |   |
| Other  Intangibles                | ** ** | **100**                           | ** ** | **100**                          |       | 100 |   | 100 |   |
| Total                             | ** ** | **$**                             | **930**    | ** **                       | **$**      | **517** |   | $ | 921 |   | $ | 440 |   |

 

Amortization expense related to the definite-lived intangible assetsfor the three months ended September 30, 2004 and 2003 was $26,000 and$26,000, respectively. Amortization expense related to the definite-livedintangible assets for the nine months ended September 30, 2004 and 2003was $77,000 and $77,000, respectively. Total estimated amortization expense for the remaining three months of2004 and the five years subsequent to 2004 is as follows: 2004 (October 1through December 31) - $26,000; 2005 - $104,000; 2006 - $104,000; 2007 -$104,000; 2008 - $74,000 and 2009 - $1,000.

 

6

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NOTE 7. RECENT ACCOUNTING DEVELOPMENTS

 

InMay 2004, the FASB issued FASB Staff Position (FSP) No. FAS 106-2, Accountingand Disclosure Requirements Related to the Medicare Prescription DrugImprovement and Modernization Act of 2003, which supersedes FSP No. FAS 106-1of the same name. FSP No. FAS 106-2 provides guidance on accounting for theeffects of the Act, including the federal subsidy, and requires publiccompanies to reflect the impact by the third quarter of 2004, if determinableand significant. The new Act introduces a prescription drug benefit underMedicare Part D, as well as a federal subsidy to sponsors of retiree healthcare benefit plans that provide a benefit that is at least actuariallyequivalent to the Medicare plan.  The retiree medical plan does provideprescription drug coverage. As of September 30, 2004, the Company is notable to definitively determine if the prescription drug benefits it providesare actuarially equivalent to those provided under Medicare Part D under theAct.   In addition, the Company believes the effects of the Act will notmaterially impact the financial statements as of September 30,2004 and as such the net periodic benefit cost presented in the financialstatements does not reflect any amount associated with the subsidy.

 

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 9/30/04**             |       |        |       |                       |       |                      |       |                            |       |                          |       |
| Operating  Revenue from                     |       |        |       |                       |       |                      |       |                            |       |                          |       |
| Unaffiliated  Customers                     |       | $           | 18,918     |                       | $          | 574                       |       | $                               | 2,685      |                          | $          | — |   | $ | 22,177 |   |
| Intersegment  Revenues                      |       | 68          |       | 1,078                      |       | —                    |       | (1,146                          | )          | —                        |       |
| Total                                       |       | 18,986      |       | 1,652                      |       | 2,685                     |       | (1,146                          | )          | 22,177                        |       |
|                                        |       |        |       |                       |       |                      |       |                            |       |                          |       |
| Depreciation  and Amortization              |       | 3,459       |       | 636                        |       | 40                        |       | 14                              |       | 4,149                         |       |
| Operating  Income (Loss)                    |       | 5,387       |       | (641                       | )          | (482                      | )          | 41                              |       | 4,305                         |       |
| Interest  Expense                           |       | 2           |       | 15                         |       | —                    |       | 1,104                           |       | 1,121                         |       |
| Income Taxes  (Benefit)                     |       | 2,180       |       | (266                       | )          | (195                      | )          | (427                            | )          | 1,292                         |       |
| Income  (Loss) from                         |       |        |       |                       |       |                      |       |                            |       |                          |       |
| Continuing  Operations                      |       | 3,207       |       | (390                       | )          | (287                      | )          | (628                            | )          | 1,902                         |       |
| Loss from  Discontinued Operations          |       |        |       |                       |       |                      |       |                            |       |                          |       |
| Including  Intersegment Revenues            |       | (15         | )          | —                     |       | —                    |       | —                          |       | (15                           | )          |
| Net Income  (Loss)                          |       | 3,192       |       | (390                       | )          | (287                      | )          | (628                            | )          | 1,887                         |       |
| Identifiable  Assets                        |       | 143,618     |       | 5,875                      |       | 7,526                     |       | 7,597                           |       | 164,616                       |       |
| Property,  Plant and Equip., Net            |       | 106,545     |       | 4,088                      |       | 350                       |       | 126                             |       | 111,109                       |       |
| Capital  Expenditures                       |       | 2,869       |       | —                     |       | 2                         |       | —                          |       | 2,871                         |       |
|                                        |       |        |       |                       |       |                      |       |                            |       |                          |       |
| **Three  Months Ended 9/30/03**             |       |        |       |                       |       |                      |       |                            |       |                          |       |
| Operating  Revenue from                     |       |        |       |                       |       |                      |       |                            |       |                          |       |
| Unaffiliated  Customers                     |       | $           | 18,810     |                       | $          | 702                       |       | $                               | 3,565      |                          | $          | — |   | $ | 23,077 |   |
| Intersegment  Revenues                      |       | 69          |       | 848                        |       | —                    |       | (917                            | )          | —                        |       |
| Total                                       |       | 18,879      |       | 1,550                      |       | 3,565                     |       | (917                            | )          | 23,077                        |       |
|                                        |       |        |       |                       |       |                      |       |                            |       |                          |       |
| Depreciation  and Amortization              |       | 3,319       |       | 618                        |       | 61                        |       | 18                              |       | 4,016                         |       |
| Operating  Income (Loss)                    |       | 5,803       |       | (824                       | )          | (369                      | )          | 370                             |       | 4,980                         |       |
| Interest  Expense                           |       | 3           |       | 15                         |       | —                    |       | 1,561                           |       | 1,579                         |       |
| Income Taxes  (Benefit)                     |       | 2,409       |       | (376                       | )          | (154                      | )          | (484                            | )          | 1,395                         |       |
| Income  (Loss) from                         |       |        |       |                       |       |                      |       |                            |       |                          |       |
| Continuing  Operations                      |       | 3,475       |       | (540                       | )          | (221                      | )          | (697                            | )          | 2,017                         |       |
| Income  (Loss) from Discontinued Operations |       |        |       |                       |       |                      |       |                            |       |                          |       |
| Including  Intersegment Revenues            |       | (22,286     | )          | 139                        |       | —                    |       | 57                              |       | (22,090                       | )          |
| Net Loss                                    |       | (18,811     | )          | (401                       | )          | (221                      | )          | (640                            | )          | (20,073                       | )          |
| Identifiable  Assets                        |       | 143,121     |       | 7,346                      |       | 9,627                     |       | 11,193                          |       | 171,287                       |       |
| Property,  Plant and Equip., Net            |       | 105,722     |       | 5,219                      |       | 524                       |       | 210                             |       | 111,675                       |       |
| Capital  Expenditures                       |       | 1,935       |       | 7                          |       | 12                        |       | 3                               |       | 1,957                         |       |

 

8

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| **(Dollars In Thousands)**                  | ** ** | **Telecom** | ** ** | **Information  Solutions** | ** ** | **Enterprise  Solutions** | ** ** | **Corporate and  Eliminations** | ** ** | **HickoryTech  Consolidated** | ** ** |
|---------------------------------------------|------------|-------------|------------|----------------------------|------------|---------------------------|------------|---------------------------------|------------|-------------------------------|------------|
| **Nine  Months Ended 9/30/04**              |       |        |       |                       |       |                      |       |                            |       |                          |       |
| Operating  Revenue from                     |       |        |       |                       |       |                      |       |                            |       |                          |       |
| Unaffiliated  Customers                     |       | $           | 57,191     |                       | $          | 2,219                     |       | $                               | 8,318      |                          | $          | — |   | $ | 67,728 |   |
| Intersegment  Revenues                      |       | 206         |       | 3,252                      |       | —                    |       | (3,458                          | )          | —                        |       |
| Total                                       |       | 57,397      |       | 5,471                      |       | 8,318                     |       | (3,458                          | )          | 67,728                        |       |
|                                        |       |        |       |                       |       |                      |       |                            |       |                          |       |
| Depreciation  and Amortization              |       | 10,273      |       | 1,929                      |       | 135                       |       | 42                              |       | 12,379                        |       |
| Operating  Income (Loss)                    |       | 17,244      |       | (1,983                     | )          | (998                      | )          | (203                            | )          | 14,060                        |       |
| Interest  Expense                           |       | 9           |       | 42                         |       | —                    |       | 3,397                           |       | 3,448                         |       |
| Income Taxes  (Benefit)                     |       | 6,978       |       | (816                       | )          | (404                      | )          | (1,448                          | )          | 4,310                         |       |
| Income  (Loss) from                         |       |        |       |                       |       |                      |       |                            |       |                          |       |
| Continuing  Operations                      |       | 10,266      |       | (1,198                     | )          | (594                      | )          | (2,128                          | )          | 6,346                         |       |
| Loss from  Discontinued Operations          |       |        |       |                       |       |                      |       |                            |       |                          |       |
| Including Intersegment  Revenues            |       | (74         | )          | —                     |       | —                    |       | —                          |       | (74                           | )          |
| Net Income  (Loss)                          |       | 10,192      |       | (1,198                     | )          | (594                      | )          | (2,128                          | )          | 6,272                         |       |
| Identifiable  Assets                        |       | 143,618     |       | 5,875                      |       | 7,526                     |       | 7,597                           |       | 164,616                       |       |
| Property,  Plant and Equip., Net            |       | 106,545     |       | 4,088                      |       | 350                       |       | 126                             |       | 111,109                       |       |
| Capital  Expenditures                       |       | 9,086       |       | 1                          |       | 24                        |       | —                          |       | 9,111                         |       |
|                                        |       |        |       |                       |       |                      |       |                            |       |                          |       |
| **Nine  Months Ended 9/30/03**              |       |        |       |                       |       |                      |       |                            |       |                          |       |
| Operating  Revenue from                     |       |        |       |                       |       |                      |       |                            |       |                          |       |
| Unaffiliated  Customers                     |       | $           | 56,058     |                       | $          | 2,609                     |       | $                               | 10,859     |                          | $          | — |   | $ | 69,526 |   |
| Intersegment  Revenues                      |       | 206         |       | 2,379                      |       | —                    |       | (2,585                          | )          | —                        |       |
| Total                                       |       | 56,264      |       | 4,988                      |       | 10,859                    |       | (2,585                          | )          | 69,526                        |       |
|                                        |       |        |       |                       |       |                      |       |                            |       |                          |       |
| Depreciation  and Amortization              |       | 9,779       |       | 1,743                      |       | 182                       |       | 70                              |       | 11,774                        |       |
| Operating  Income (Loss)                    |       | 18,654      |       | (2,508                     | )          | (853                      | )          | (456                            | )          | 14,837                        |       |
| Interest  Expense                           |       | 10          |       | 53                         |       | —                    |       | 4,561                           |       | 4,624                         |       |
| Income Taxes  (Benefit)                     |       | 7,675       |       | (1,142                     | )          | (359                      | )          | (1,988                          | )          | 4,186                         |       |
| Income  (Loss) from                         |       |        |       |                       |       |                      |       |                            |       |                          |       |
| Continuing  Operations                      |       | 11,076      |       | (1,643                     | )          | (516                      | )          | (2,861                          | )          | 6,056                         |       |
| Income  (Loss) from Discontinued Operations |       |        |       |                       |       |                      |       |                            |       |                          |       |
| Including Intersegment  Revenues            |       | (21,802     | )          | 386                        |       | —                    |       | 144                             |       | (21,272                       | )          |
| Net Loss                                    |       | (10,726     | )          | (1,257                     | )          | (516                      | )          | (2,717                          | )          | (15,216                       | )          |
| Identifiable  Assets                        |       | 143,121     |       | 7,346                      |       | 9,627                     |       | 11,193                          |       | 171,287                       |       |
| Property,  Plant and Equip., Net            |       | 105,722     |       | 5,219                      |       | 524                       |       | 210                             |       | 111,675                       |       |
| Capital  Expenditures                       |       | 5,091       |       | 151                        |       | 201                       |       | 156                             |       | 5,599                         |       |

 

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** | ** ** | **Nine Months Ended** | ** ** |
|----------------------------------|------------|------------------------|------------|-----------------------|------------|
| **(Dollars in Thousands)**       | ** ** | **9/30/2004**          | ** ** | **9/30/2003**         | ** ** | **9/30/2004** | ** ** | **9/30/2003** | ** ** |
| Identifiable  Assets             | ** ** | **$**                  | **—** |                  | $          | 29,662 | ** ** | **$** | **—** |   | $ | 29,662 |   |
| Property, Plant  and Equip., Net | ** ** | **$**                  | **—** |                  | $          | 14,449 | ** ** | **$** | **—** |   | $ | 14,449 |   |
| Capital  Expenditures            | ** ** | **$**                  | **—** |                  | $          | 1,116 | ** ** | **$** | **—** |   | $ | 1,934 |   |

 

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 September 30, 2004, HickoryTech had four stock-based employeeand director compensation plans, which are described more fully in theHickoryTech Annual 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 did 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 Nine Months Ended** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------|--------------|----------------------------|------------|---------------------------|------------|
| **(Dollars in Thousands)**                                                                                                                    | *** *** | **9/30/2004**              | ** ** | **9/30/2003**             | ** ** | **9/30/2004** | ** ** | **9/30/2003** | ** ** |
|                                                                                                                                          |         |                       |       |                      |       |   |   |   |   |
| Reported Net  Income                                                                                                                          | ** **   | **$**                      | **1,887**  |                      | $          | (20,073 | ) | **$** | **6,272** |   | $ | (15,216 | ) |
| Add:  Stock-based employee compensation expense included in reported net income,  net of related tax effects                                  | ** **   | **13**                     |       | (99                       | )          | **46** |   | 138 |   |
| Deduct:  Total stock-based employee compensation expense determined under fair value  based method for all awards, net of related tax effects | ** **   | **(61**                    | **)**      | 3                         | ** ** | **(214** | **)** | (435 | ) |
|                                                                                                                                          |         |                       |       |                      |       |   |   |   |   |
| Pro Forma  Net Income                                                                                                                         | ** **   | **$**                      | **1,839**  |                      | $          | (20,169 | ) | **$** | **6,104** |   | $ | (15,513 | ) |
|                                                                                                                                          |         |                       |       |                      |       |   |   |   |   |
| Earnings per  share:                                                                                                                          |         |                       |       |                      |       |   |   |   |   |
| Basic - as  reported                                                                                                                          | ** **   | **$**                      | **0.15**   |                      | $          | (1.44 | ) | **$** | **0.48** |   | $ | (1.09 | ) |
| Basic - pro  forma                                                                                                                            | ** **   | **$**                      | **0.14**   |                      | $          | (1.44 | ) | **$** | **0.47** |   | $ | (1.11 | ) |
|                                                                                                                                          |         |                       |       |                      |       |   |   |   |   |
| Diluted - as  reported                                                                                                                        | ** **   | **$**                      | **0.15**   |                      | $          | (1.44 | ) | **$** | **0.48** |   | $ | (1.09 | ) |
| Diluted -  pro forma                                                                                                                          | ** **   | **$**                      | **0.14**   |                      | $          | (1.44 | ) | **$** | **0.47** |   | $ | (1.11 | ) |

 

10

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NOTE 11. FINANCIAL DERIVATIVE INSTRUMENTS

 

HickoryTech accounts for derivativeinstruments in accordance with SFAS No. 133, as amended by SFAS No. 149, “Accountingfor Derivative Instruments and Hedging Activities,” which requires derivativeinstruments to be recorded on the balance sheet at fair value. Changes in fairvalue of derivative instruments are included in other comprehensive income.

 
| **(Dollars in Thousands)**                                                 | *** *** | **Interest Rate  Swap Agreement** | ** ** |
|----------------------------------------------------------------------------|--------------|-----------------------------------|------------|
|                                                                       |         |                              |       |
| Accumulated  other comprehensive income balance at December 31, 2003  |         | $                                 | 1,484      |   |
| Market value  decrease on interest rate swap agreement                     |         | (241                              | )          |
|                                                                       |         |                              |       |
| Accumulated  other comprehensive income balance at September 30, 2004 |         | $                                 | 1,243      |   |

 

HickoryTech has variable rate debtinstruments, which subject the Company to interest rate risk. HickoryTech hasentered into interest rate swap agreements, with remaining maturities of ninemonths to forty-five months, to manage its exposure to interest rate movementson a portion of its variable rate debt obligations. The market value of thecumulative gain or loss on these derivative instruments is reported as acomponent of accumulated other comprehensive income in shareholders’ equity andwill be recognized in earnings when the term of the swap agreement isconcluded.

 

The fair value of HickoryTech’s derivativesat September 30, 2004 and December 31, 2003 is a net asset of$2,089,000 and $2,515,000, respectively, which is included in other assets inthe accompanying consolidated balance sheet.

 

NOTE 12. EMPLOYEE POST-RETIREMENT BENEFITS

 

HickoryTech provides post-retirement healthcare and life insurance benefits for certain employees. HickoryTech is notcurrently funding these post-retirement benefits, but has accrued theseliabilities during the first three quarters of 2004 and 2003.

 
| ** **                               | *** *** | **For Three Months Ended** |       | **For Nine Months Ended** | ** ** |
|------------------------------------------|--------------|----------------------------|------------|---------------------------|------------|
| **(Dollars in Thousands)**               | *** *** | **9/30/2004**              | ** ** | **9/30/2003**             |       | **9/30/2004** | ** ** | **9/30/2003** | ** ** |
| Components  of Net Periodic Benefit Cost |         |                       | ** ** |                      |       |   | ** ** |   |   |
| Service Cost                             | ** **   | **$**                      | **93**     | ** **                | $          | 53 |   | **$** | **279** | ** ** | $ | 158 |   |
| Interest  Cost                           | ** **   | **131**                    | ** ** | 90                        |       | **393** | ** ** | 270 |   |
| Expected  Return on Plan Assets          | ** **   | **—**                 | ** ** | —                    |       | **—** | ** ** | — |   |
| Amortization  of Transition Obligation   | ** **   | **15**                     | ** ** | 15                        |       | **45** | ** ** | 45 |   |
| Amortization  of Prior Service Cost      | ** **   | **(3**                     | **)**      | (3                        | )          | **(9** | **)** | (9 | ) |
| Recognized  Net Actuarial Loss           | ** **   | **59**                     | ** ** | 24                        |       | **177** | ** ** | 73 |   |
| Net Periodic  Benefit Cost               | ** **   | **$**                      | **295**    | ** **                | $          | 179 |   | **$** | **885** | ** ** | $ | 537 |   |

 
| ** **                                                   | ** ** | **2004**   |    |
|--------------------------------------------------------------|------------|------------|---------|
| Employer’s  Contributions                               | ** ** | ** ** |    |
| Contributions  Made For the Nine Months Ended 09/30/04       | ** ** | **$**      | **138** |   |
| Expected  Contributions for Remainder of 2004                | ** ** | **47**     |    |
| Total  Estimated Employer Contributions for Fiscal Year 2004 | ** ** | **$**      | **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 anincorrect TIC 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 September 30, 2004, $507,000 hasbeen 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 September 30,2004, HickoryTech has recognized a recovery of $306,000 of the revenue.

 

In accordance with SFAS No. 71, HickoryTech recorded a regulatory assetfor the revenue it would recoup with a balance of $305,000 at September 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 $104,000 at September 30,2004 and $611,000 at December 31, 2003.

 

NOTE 14.  ABANDONED INITIATIVE

 

In September of 2003, HickoryTech abandoned a CLECinitiative.  As a result, HickoryTechwrote off property, plant and equipment with a carrying value of $632,000.  This $632,000 charge is included in theoperating expenses of the Telecom Sector in the condensed consolidatedstatement of operations.

 

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

 

**FORWARD-LOOKING STATEMENTS**

 

Statements in this Form 10-Q that are not historical fact areforward-looking statements that are based on management’s current expectations,estimates and projections about the industry in which HickoryTech operates andmanagement’s beliefs and assumptions. Such forward-looking statements aresubject to important risks and uncertainties that could cause HickoryTech’sfuture actual results to differ materially from such statements. Thesestatements are not guarantees of future performance and involve certain risks,uncertainties and probabilities, which are difficult to predict. Therefore,actual outcomes and results may differ materially from what is expressed orforecasted in such forward-looking statements, whether as a result of new information,future events or otherwise. Factors that might cause such a difference include,but are not limited to, those contained in this “Management’s Discussion andAnalysis” (Item 2) and the Cautionary Statement for Purposes of the “SafeHarbor” Provision of the Private Securities Litigation Reform Act of 1995 onpages 29-30 of HickoryTech’s Annual Report on Form 10-K for the year ended December 31,2003, which is incorporated herein by reference. You are cautioned not to placeundue reliance on these forward looking statements, which speak only as of thedate on which they were made. Except as otherwise required by federalsecurities law, HickoryTech undertakes no obligation to update any of itsforward-looking statements for any reason.

 

**BUSINESSES**

* *

HickoryTech operates in three business segments: the Telecom,Information Solutions and Enterprise Solutions Sectors. Its largest and oldestbusiness (since 1898) has been the operation of incumbent local exchangecarriers (ILECs) or traditional wireline telephone service. The ILEC businessis in HickoryTech’s Telecom Sector. In 1998, HickoryTech began its competitivelocal exchange carrier (CLEC) line of business, competing for the telephonedial tone, dial-up and broadband Internet access, data and long distancecalling business in other ILEC territories. The CLEC business is in HickoryTech’sTelecom Sector. Since 1964, HickoryTech’s Information Solutions Sector hasprovided computer data processing and software, predominantly for HickoryTech’sTelecom Sector operations and also to other telecommunications companies.HickoryTech acquired its Enterprise Solutions Sector in 1990 and it hasoperated as a telecommunications and data equipment distributor from a base inMinneapolis/St. Paul, Minnesota. HickoryTech also began its wireless operationsin 1998 by acquiring its first wholly owned wireless service license, anadditional wireless service license in 1999 and two PCS licenses in 2001.HickoryTech sold the wireless operations on December 15, 2003. The wirelessoperations are reported as part of the Telecom Sector. All financial statementsand schedules have been restated to reflect wireless operations as discontinuedoperations for all periods presented.

 

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

 

**TELECOM SECTOR**

Mankato 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 engaged in businesses that provideservices to their customers for a fee. Many of these services are recurring,and, as a result, backlog orders and seasonality are not significant factors.Working capital requirements primarily involve the funding of the constructionof networks and switches and maintenance of a relatively high amount of fixedassets. Other working capital requirements include the payroll costs of highlyskilled labor, the inventory to service its telephone equipment customers andthe carrying value of trade accounts receivable for periods up to ninety daysin the normal course of business.

 

The materials and supplies that are necessary for the operation of thebusinesses of HickoryTech and its subsidiaries are available from a variety ofsources, and no future supply problems are anticipated. All of HickoryTech’scentral office switches, as well as a majority of HickoryTech’s equipment soldin its Enterprise Solutions Sector, are supplied by Nortel. Nortel is a leadingsupplier of communications equipment, and HickoryTech’s dependence on thisbrand is not viewed as a significant risk. An additional layer of networkinfrastructure equipment for broadband services is provided by Nextlevel.Nextlevel, a subsidiary of Motorola, is a newer supplier of communicationsequipment and the Company is monitoring the risk of maintaining Nextlevel as asupplier.

 

**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 ILECs: MCTC,Mid-Comm and Heartland. MCTC and Mid-Comm provide telephone service in southcentral Minnesota, specifically Mankato (a regional hub) and eleven ruralcommunities surrounding Mankato. The third ILEC, Heartland, provides telephoneservice for eleven rural communities in northwest Iowa.

 

The Telecom Sector also includes Crystal, a CLEC. Crystal provideslocal telephone service, long distance, dial-up and broadband Internet accessand digital television on a competitive basis. Crystal has customers in tenrural communities, encompassing eight exchanges, in Minnesota and threecommunities, encompassing two exchanges, in Iowa that are not in HickoryTech’sILEC service areas.  HickoryTechdiscontinued its service to four other Iowa communities in 2003. In addition tothe digital television service provided to customers in St. Peter, Minnesota,HickoryTech began providing digital 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 sold December 15,2003. None of the remaining companies in the Telecom sector experienced majorchanges in operations during the first three quarters of 2004 or 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. Cumulatively, since 1999, theHawarden CLEC has acquired approximately 1,000 access lines, or approximately60 percent of that community’s telephone business from HickoryTech. HickoryTechmanagement does not believe there will be significant further impact fromcompetition 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 newCLEC. Crystal offers local service, long distance, dial-up and broadbandInternet access services, and digital television, on a competitive basis tocustomers in southern Minnesota and Iowa, which were not previously served byHickoryTech’s Telecom Sector service area. These service offerings providecustomers alternatives to the incumbent communication providers in variouscommunities and are offered under the brand name HickoryTech service. Theseservices are currently offered to customers in ten rural communities,encompassing eight exchanges, in Minnesota, as well as three communities,encompassing two exchanges, in Iowa. Crystal also provides the long distanceservice, dial-up and broadband Internet access services to HickoryTech’s ILECsubscribers.

 

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 with the MinnesotaPublic Utilities Commission regarding this dispute. As requested in thecomplaint, this matter was referred to the Office of Administrative Hearingsfor a contested case proceeding, which is currently in process.

 

On December 15, 2003, HickoryTech sold itswireless business, Minnesota Southern Wireless Company (MSWC), to WesternWireless Corporation (WWC). The wireless operations are reported as part of theTelecom Sector. The consolidated statements of operations for all periodspresented have been restated to reflect wireless operations as discontinuedoperations.

 

REGULATED INDUSTRY

 

ILEC Minnesota -HickoryTech’s two Minnesota ILEC subsidiaries continue to operate under analternative form of regulation as defined in Minnesota Chapter 237, whereby companieswith less than 50,000 customers are regulated on price and service level ratherthan profit. The Minnesota Public Utilities Commission (PUC) has beenconsidering intrastate access reform and universal service for several years.In June 2004, the Minnesota PUC issued an order to refer the carriercommon line (CCL) component of the access reform issue to a contested casehearing. In September, 2004, the MNPUC also referred the local switching andtransport (LST) component of the access reform issue for a separate contestedcase hearing.  Such hearings in Minnesotausually involve full development of a public record and recommendation of anadministrative law judge prior to final PUC decision.  The outcome of the CCL process will notlikely be realized until the second quarter of 2005, or later, and the schedule forthe LST process is as yet undetermined. HickoryTech cannot estimate the impact,if any, of future potential state access revenue changes.

 

On October 16, 2003, the United StatesDistrict Court, District of Minnesota, issued an injunction providing relieffrom regulation of an interexchange carrier providing Voice over InternetProtocol (VoIP) based services in Minnesota. The Minnesota PUC 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 Iowa - In Iowa,companies with fewer than 15,000 access lines remain unregulated. HickoryTech’sIowa ILEC subsidiary falls below this regulation threshold.

 

Wireline Interstate -The HickoryTech ILEC companies do not participate in the NECA traffic sensitivepool and set access rates according to either a nationwide average cost ofproviding access, or in the case of Heartland, according to its own interstatecosts. This biannual rate process was completed in June 2003, andestablished traffic sensitive interstate rates for the period from July 1,2003 through June 30, 2005. HickoryTech ILEC companies participate in theNECA common line pool. In July of 2003, common line rates charged tointerexchange carriers were reduced (to zero), and common line charges to endusers were increased in accordance with an October 2001 FCC order (a/k/aMAG Plan). End User Common Line (EUCL) funds collected are pooled, andHickoryTech revenues are based on settlements distributed from the pool. Poolsettlements are adjusted periodically.

 

CLEC - HickoryTech’sCLEC company provides local exchange services in Minnesota and Iowa with lessregulatory oversight than the HickoryTech ILEC companies. Additionally, Crystaloffers digital television service in the St. Peter, Minnesota market under afranchise negotiated with the local municipality.  Beginning in the third quarter of 2004,Crystal offers digital television in the Waseca, Minnesota market under asimilar franchise agreement.  Crystalalso offers long distance services. In-state services in Minnesota areregulated by the PUC with respect to uniform pricing statewide. In-state longdistance service in Iowa is unregulated. Long distance services are also deregulated at the federal level (forinterstate 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.

 

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Other - HickoryTech’sCLEC interstate access rates are established in accordance with an April 2001FCC order.  Under the final phase of thisorder, interstate switched access rates for HickoryTech’s CLEC were reduced tolevels comparable to those of the ILECs in June of 2004.

 

The FCC has an open docket on intercarrier compensation as well asseveral dockets on Voice over Internet Protocol (VoIP). HickoryTech cannotpredict the outcome of such proceedings nor can it estimate the impact, if any,on HickoryTech.

 

Local Number Portability - On November 10, 2003, the FCC releaseda decision providing guidance on porting between wireline and wireless networks(intermodal porting). The FCC stated that intermodal number porting isrequired upon bona fide request where the coverage area of the wireless carrier(i.e. the area in which the wireless carrier provides service) overlaps thegeographic location in which the wireline number was provisioned. The FCCleft issues governing the payment of call routing costs to another pendingproceeding.  The Company’s wireline operations were subject to a May 24,2004 implementation date for intermodal porting. Heartland TelecommunicationsCompany of Iowa, however, joined in an industry action by the IowaTelecommunications Association to suspend the requirements for small ruralcarriers.  The Iowa Utilities Board hasissued an order allowing Heartland until April 6, 2005, to implement LocalNumber Portability.  As of September 30,2004, the effects of intermodal porting on the Company’s Minnesota wirelineoperations have been minimal. However, given the short time intermodal portinghas been available, the Company cannot fully quantify the long-term effects ofimplementing intermodal porting on its wireline operations. It is possible thatthese requirements could adversely affect the Company’s wireline operatingcosts and customer growth rates. HickoryTech is also unable to quantify therevenue impact of wireline customers that may switch to wireless alternatives.

 

Triennial Review Order -In August 2003, the FCC published a review order proposing changes inrules developed under the provisions of the Telecommunications Act of 1996 Section 251(c)(3)which requires ILECs to make elements of their networks available on anunbundled basis to new entrants at model-based rates. This order wasimmediately challenged by the United States Telecom Association (USTA) andseveral carriers.  In April 2004,the Washington DC district court issued a ruling remanding the issue back tothe FCC so that, for specific unbundled network elements (UNEs), ILECs facereduced mandates to make their network available and CLECs face reducedopportunities or increased costs in obtaining network from the incumbent withwhom they compete.  In August of2004, the FCC released a Notice of Public Rule Making (NPRM) with transitionalrules for the elimination of UNEs.

 

HickoryTech’s CLEC, Crystal Communications, predominately uses its ownnetwork and has not made extensive use of the type of network elementsaddressed in the ruling.  WhileHickoryTech cannot fully quantify the impact of this issue, the FCC orders arenot expected to have a material impact on Crystal’s business.

 

*INFORMATION SOLUTIONS SECTOR*

 

Through NIBI, HickoryTech’s InformationSolutions Sector provides data processing and related services, principally forHickoryTech, other local exchange telephone companies, CLECs, interexchangenetwork carriers, wireless companies, municipalities and utilities. The InformationSolutions Sector’s principal activity is the provision of monthly batchprocessing of computerized data for HickoryTech as well as non-affiliatedcompanies. Services for telephone company customers include the processing oflong distance telephone calls from data sources and telephone switches, thepreparation of the subscriber telephone bills, customer record keeping, carrieraccess bills and general accounting and payroll services. NIBI, under the brandname HickoryTech Information Solutions, also provides certain billingclearinghouse functions for interexchange carriers.

 

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

 

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*ENTERPRISE SOLUTIONS SECTOR*

 

Through Collins, HickoryTech’s Enterprise SolutionsSector provides telephone and data equipment sales and services as well as thesale, 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 individual businessend users of telecommunications service with ongoing service requirementofferings. Products consist of telecommunication platforms such as Nortel onthe voice side of the Enterprise Solutions’ business, and Cisco and BayNetworks (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 of business telephone and data systems. EnterpriseSolutions continues its commitment to service and support of its core product,Nortel, while identifying new opportunities such as call centers, computertelephone integration voice mail and interactive voice response systems.

 

HickoryTech’s Enterprise Solutions Sector is notdependent upon any single customer or small group of customers. No singlecustomer in the Enterprise Solutions Sector accounts for ten percent or more ofHickoryTech’s consolidated revenues.

 

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

 

**RESULTS OFOPERATIONS**

 

CONSOLIDATED OPERATING RESULTS:

The following is a summarized discussion ofconsolidated results of operations. More detailed discussion of operatingresults by segment follows this discussion.

 

OPERATING REVENUES:

Consolidated operating revenues were $22,177,000, which is $900,000 or3.9% lower in the three months ended September 30, 2004 compared to thethree months ended September 30, 2003. Consolidated operating revenueswere $67,728,000, which is $1,798,000 or 2.6% lower in the nine months ended September 30,2004 compared to the nine months ended September 30, 2003.  The decrease in revenues in the three andnine months ended September 30, 2004 compared to the three and nine monthsended September 30, 2003 can be primarily attributed to a lower volume ofbusiness in the Enterprise Solutions Sector. The decrease for the nine monthsended September 30, 2004 compared to the nine months ended September 30,2003, was partially offset by an increase in revenues in the Telecom Sector,primarily growth in the CLEC business.

 

COSTOF PRODUCTS SOLD, ENTERPRISE SOLUTIONS:

Cost of products sold, which is related to the Enterprise SolutionsSector was $1,855,000, which is $751,000 or 28.8% lower in the three months endedSeptember 30, 2004 compared to the three months ended September 30,2003.  Cost of products sold was$5,660,000, which is $2,015,000 or 26.3% lower in the nine months ended September 30,2004 compared to the nine months ended September 30, 2003.  The decrease in cost of products sold for thethree and nine months ended September 30, 2004 compared to the three andnine months ended September 30, 2003 was mainly due to the decrease ininstallation revenue.  For the nine monthperiod ended September 30, 2004 compared to the same period in 2003, thedecrease in cost of products sold was in line with the corresponding decreasein operating revenues in this sector, as gross profit margins remainedrelatively consistent at 32.0% for the nine months ended September 30,2004 compared to 29.3% for the same period in 2003.

 

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COSTOF SERVICES, excluding Depreciation and Amortization:

Cost of services, excluding depreciation and amortization decreased$330,000 or 3.8% in third quarter 2004 compared to third quarter 2003.  Cost of services, excluding depreciation andamortization decreased $120,000 or 0.5% in the nine months ended September 30,2004 compared to the nine months ended September 30, 2003. The decrease inexpenses primarily reflects the impact of management cost reduction actions inthe Information Solutions and Enterprise Solutions Sectors. Also, in September of2003, HickoryTech abandoned a CLEC initiative in a specific market.  As a result of this operating decision,HickoryTech abandoned approximately $632,000 of property, plant and equipment,which was written down to a carrying value of zero in the consolidatedstatement of operations. This was recorded in the Telecom Sector results for2003. The decreases in costs for 2004 were offset by increased costssurrounding post-retirement health care benefits, long distance costscorresponding to the increased customer base, and increased plant operationscosts.

 

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES, excludingDepreciation and Amortization:

Selling,general and administrative expenses, excluding depreciation and amortizationincreased $723,000 or 26.1% in third quarter 2004 compared to third quarter2003.  Selling, general andadministrative expenses, excluding depreciation and amortization increased$509,000 or 5.0% in the nine months ended September 30, 2004 compared tothe nine months ended September 30, 2003. These expense increases wereprimarily due to costs associated with the audit of our internal controls inconnection with Section 404 of the Sarbanes-Oxley Act of 2002, an increase inregulatory fees and sales and marketing related expenses in the Telecom Sector,as well as redistributed wages and benefits of employees between departmentsdue to temporary reassignments in the Information Solutions Sector. Theseincreases were partially offset by cost reduction measures implemented in theEnterprise Solutions sector as well as a decrease in corporate wages partiallycaused by a one time charge in 2003 for the modification of the terms of thestock options of a retiring officer. The modification of the terms of the stockoptions of a retiring officer extended the period after retirement during whichthe officer could exercise his vested options. This modification resulted inHickoryTech recognizing $173,000 of compensation expense during the firstquarter of 2003.

 

DEPRECIATIONAND AMORTIZATION:

Depreciationexpense was $3,912,000, which is $132,000 or 3.5% higher in the three monthsended September 30, 2004 compared to the three months ended September 30,2003. Depreciation expense was $11,669,000, which is $656,000 or 6.0% higher inthe nine months ended September 30, 2004 compared to the nine months endedSeptember 30, 2003. The increase in depreciation expense was due to anincrease in the Telecom Sector’s network assets, as well as an increase relatedto the depreciation of billing software in the Information Solutions Sector.Amortization expense was $237,000 for the three months ended September 30,2004 and $236,000 for the three months ended September 30, 2003. For thenine months ended September 30, 2004 amortization expense was $710,000,which is $51,000 lower than the comparable 2003 period. The decrease inamortization expense was largely due to an intangible asset in the InformationSolutions Sector becoming fully amortized in the second quarter of 2003.

 

OPERATING INCOME:

Operating income was $4,305,000, which is$675,000 or 13.6% lower in the three months ended September 30, 2004compared to the three months ended September 30, 2003.  This decrease was driven by a $900,000decrease in operating revenues, a $723,000 increase in selling, general andadministrative expenses and a $132,000 increase in depreciation, offset by a$751,000 decrease in cost of products sold and a $330,000 decrease in cost ofservices, all of which are described above. Operating income was $14,060,000,which is $777,000 or 5.2% lower in the nine months ended September 30,2004 compared to the nine months ended September 30, 2003. The decreasewas due to a $1,798,000 decrease in operating revenues, a $509,000 increase inselling, general and administrative expenses and a $656,000 increase indepreciation, offset by a $2,015,000 decrease in cost of products sold for the EnterpriseSolutions Sector, a $120,000 decrease in cost of services and a $51,000decrease in amortization, all of which are described above.

 

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INTEREST EXPENSE:

Interest expense decreased $458,000 or 29.0%to $1,121,000 in the three months ended September 30, 2004 compared to thethree months ended September 30, 2003. Interest expense decreased$1,176,000 or 25.4% to $3,448,000 in the nine months ended September 30,2004 compared to the nine months ended September 30, 2003. The decrease ininterest expense was primarily due to a decrease in total debt outstanding. Theoutstanding balance of the revolving credit facility was $105,250,000 at September 30,2004 and $140,750,000 at September 30, 2003.

 

INCOME TAXES:

The effective income tax rate ofapproximately 40.5% and 40.9% for third quarter 2004 and third quarter 2003,respectively, exceeds the federal statutory rate primarily due to state incometaxes.  The effective income tax rate ofapproximately 40.4% and 40.9% for the nine months ended September 30, 2004and September 30, 2003, respectively, exceeds the federal statutory rateprimarily due to state income taxes.

 

INCOME FROM CONTINUINGOPERATIONS:

Consolidated income from continuingoperations was $1,902,000, which is $115,000 or 5.7% lower in the three monthsended September 30, 2004 compared to the three months ended September 30,2003.  The decrease in income fromcontinuing operations for third quarter 2004 as compared to the third quarterof 2003 was primarily driven by a $900,000 decrease in revenues, a $723,000increase in selling, general and administrative expenses and a $132,000increase in depreciation, offset by a $751,000 decrease in cost of productssold, a $330,000 decrease in cost of services, and a $458,000 decrease ininterest expense, all of which were explained above.  Consolidated income from continuingoperations was $6,346,000, which is $290,000 or 4.8% higher in the nine monthsended September 30, 2004 compared to the nine months ended September 30,2003.  The increase in income fromcontinuing operations for the nine months ended September 30, 2004compared to the nine months ended September 30,2003 can be primarilyattributed to the $2,015,000 decrease in cost of products sold for theEnterprise Solutions sector and the $1,176,000 decrease in interest expense,which were offset by a $1,798,000 decrease in operating revenues, a $509,000increase in selling, general and administrative expenses and a $605,000increase in depreciation and amortization expenses, all of which are describedabove. 

 

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SECTOR RESULTS OF OPERATIONS FROM CONTINUINGOPERATIONS

 

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

 

**TELECOM SECTOR**

 
| ** **                                                                              | ** ** | **For Three Months Ended** |       | **For Nine Months Ended** | ** ** |
|-----------------------------------------------------------------------------------------|------------|----------------------------|------------|---------------------------|------------|
| **(Dollars in Thousands)**                                                              | ** ** | **9/30/2004**              |       | **9/30/2003**             |       | **9/30/2004** | ** ** | **9/30/2003** | ** ** |
|                                                                                    |       |                       |       |                      |       |   | ** ** |   |   |
| Revenues  Before Intersegment Eliminations                                              |       |                       |       |                      |       |   | ** ** |   |   |
| ILEC                                                                                    |       |                       |       |                      |       |   | ** ** |   |   |
| Local  Service                                                                          | ** ** | **$**                      | **3,847**  |                      | $          | 3,791 |   | **$** | **11,396** | ** ** | $ | 11,365 |   |
| Network  Access                                                                         | ** ** | **8,062**                  |       | 8,370                     |       | **25,011** | ** ** | 25,101 |   |
| Data                                                                                    | ** ** | **524**                    |       | 467                       |       | **1,593** | ** ** | 1,347 |   |
| Intersegment                                                                            | ** ** | **68**                     |       | 69                        |       | **206** | ** ** | 206 |   |
| Other                                                                                   | ** ** | **1,635**                  |       | 1,877                     |       | **4,978** | ** ** | 5,382 |   |
| Total ILEC                                                                              | ** ** | **14,136**                 |       | 14,574                    |       | **43,184** | ** ** | 43,401 |   |
|                                                                                    |       |                       |       |                      |       |   | ** ** |   |   |
| CLEC                                                                                    |       |                       |       |                      |       |   | ** ** |   |   |
| Local  Service                                                                          | ** ** | **912**                    |       | 871                       |       | **2,766** | ** ** | 2,586 |   |
| Network  Access                                                                         | ** ** | **652**                    |       | 575                       |       | **1,953** | ** ** | 1,725 |   |
| Data                                                                                    | ** ** | **521**                    |       | 298                       |       | **1,301** | ** ** | 814 |   |
| Other                                                                                   | ** ** | **443**                    |       | 429                       |       | **1,323** | ** ** | 1,327 |   |
| Total CLEC                                                                              | ** ** | **2,528**                  |       | 2,173                     |       | **7,343** | ** ** | 6,452 |   |
|                                                                                    |       |                       |       |                      |       |   | ** ** |   |   |
| Long Distance                                                                           | ** ** | **1,165**                  |       | 1,098                     |       | **3,499** | ** ** | 3,310 |   |
|                                                                                    |       |                       |       |                      |       |   | ** ** |   |   |
| Internet                                                                                | ** ** | **1,011**                  |       | 944                       |       | **3,000** | ** ** | 2,835 |   |
|                                                                                    |       |                       |       |                      |       |   | ** ** |   |   |
| Digital TV                                                                              | ** ** | **146**                    |       | 90                        |       | **371** | ** ** | 266 |   |
|                                                                                    |       |                       |       |                      |       |   | ** ** |   |   |
| Total  Telecom Revenues                                                                 | ** ** | **$**                      | **18,986** |                      | $          | 18,879 |   | **$** | **57,397** | ** ** | $ | 56,264 |   |
|                                                                                    |       |                       |       |                      |       |   | ** ** |   |   |
| Total Telecom Revenues Before Intersegment  Eliminations                                |       |                       |       |                      |       |   | ** ** |   |   |
| Unaffiliated  Customers                                                                 | ** ** | **$**                      | **18,918** |                      | $          | 18,810 |   | **$** | **57,191** | ** ** | $ | 56,058 |   |
| Intersegment                                                                            | ** ** | **68**                     |       | 69                        |       | **206** | ** ** | 206 |   |
| ** **                                                                              |       | **18,986**                 |       | 18,879                    |       | **57,397** | ** ** | 56,264 |   |
|                                                                                    |       |                       |       |                      |       |   | ** ** |   |   |
| Cost of  Services, excluding Depreciation and Amortization                              | ** ** | **7,554**                  |       | 7,495                     |       | **22,216** | ** ** | 20,957 |   |
| Selling,  General, and Administrative Expenses, excluding Depreciation and Amortization | ** ** | **2,586**                  |       | 2,262                     |       | **7,664** | ** ** | 6,874 |   |
| Depreciation  and Amortization                                                          | ** ** | **3,459**                  |       | 3,319                     |       | **10,273** | ** ** | 9,779 |   |
| Operating  Income                                                                       | ** ** | **$**                      | **5,387**  |                      | $          | 5,803 |   | **$** | **17,244** | ** ** | $ | 18,654 |   |
|                                                                                    |       |                       |       |                      |       |   | ** ** |   |   |
| Income from  Continuing Operations, Net of Tax                                          | ** ** | **$**                      | **3,207**  |                      | $          | 3,475 |   | **$** | **10,266** | ** ** | $ | 11,076 |   |
| Loss from  Discontinued Operations                                                      | ** ** | **(15**                    | **)**      | (22,286                   | )          | **(74** | **)** | (21,802 | ) |
| Net  Income/(Loss)                                                                      | ** ** | **$**                      | **3,192**  |                      | $          | (18,811 | ) | **$** | **10,192** | ** ** | $ | (10,726 | ) |
|                                                                                    |       |                       |       |                      |       |   | ** ** |   |   |
| Capital  Expenditures                                                                   | ** ** | **$**                      | **2,869**  |                      | $          | 1,935 |   | **$** | **9,086** | ** ** | $ | 5,091 |   |

 

21

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| ** **                       | ** ** | **For Nine Months Ended** | ** ** |
|----------------------------------|------------|---------------------------|------------|
| **(Dollars in Thousands)**       | ** ** | **9/30/2004**             | ** ** | **9/30/2003** | ** ** |
|                             |       |                      |       |   |   |
| ILEC Access  Lines               | ** ** | **61,085**                |       | 63,421 |   |
|                             |       |                      |       |   |   |
| CLEC Access  Lines               |       |                      |       |   |   |
| Overbuild                        | ** ** | **10,285**                |       | 9,607 |   |
| Unbundled  Network Element (UNE) | ** ** | **1,721**                 |       | 1,492 |   |
| Total  Service Resale (TSR)      | ** ** | **2,160**                 |       | 2,938 |   |
| Total                            | ** ** | **14,166**                |       | 14,037 |   |
|                             |       |                      |       |   |   |
| Long  Distance Customers         | ** ** | **41,763**                |       | 39,663 |   |
|                             |       |                      |       |   |   |
| Internet  Customers              | ** ** | **17,090**                |       | 15,901 |   |
|                             |       |                      |       |   |   |
| Total  Telecom Customers         | ** ** | **134,104**               |       | 133,022 |   |
|                             |       |                      |       |   |   |
| DSL  Customers                   | ** ** | **9,745**                 |       | 6,694 |   |

 

Revenues:

Telecom Sector operating revenues before intersegment eliminations were$18,986,000, which is $107,000 or 0.6% higher in the three months ended September 30,2004 compared to the three months ended September 30, 2003. The increasein revenue in the third quarter of 2004 as compared to the third quarter of2003 was due primarily to growth in CLEC, mainly offset by a decrease in ILECnetwork access revenue. Telecom Sector operating revenues before intersegmenteliminations were $57,397,000, which is $1,133,000 or 2.0% higher in the ninemonths ended September 30, 2004 compared to the nine months ended September 30,2003.  For the nine month period ended September 30,2004 as compared to the same period in 2003, the increase in revenue wasprimarily due to growth in the CLEC business.

 

ILEC network access revenue was $8,062,000, which is $308,000 or 3.7% lowerin the three months ended September 30, 2004 compared to the three monthsended September 30, 2003. ILEC network access revenue was $25,011,000,which is $90,000 or 0.4% lower in the nine months ended September 30, 2004compared to the nine months ended September 30, 2003.  The decline in ILEC network access revenue inthe third quarter of 2004 as compared to the third quarter of 2003 wasprimarily due to the impact of carriers rerouting traffic. For the nine monthperiod ended September 30, 2004 as compared to the nine month period endedSeptember 30, 2003 the decrease in ILEC network access revenue was drivenby one time adjustments related to disputed circuits and minutes and the impactof carriers rerouting traffic, mainly offset by higher demand for dedicatedlines and high-speed circuits. HickoryTech does not belong to any NECA trafficsensitive access revenue reimbursement pools, but instead, establishes accessrates biannually following nationwide averages of providing access. HickoryTech’sinterstate access rates were adjusted as of July 2003. Recent industrytrends, as discussed in the regulatory section above, suggest that accessrevenues are declining and HickoryTech may not experience the rate of increaseyear over year that the Company has historically seen. Long-term continuationof these levels of revenues is uncertain, as changes in the industry occur.

 

ILEC data revenue was $57,000 or 12.2% higher in third quarter 2004compared to third quarter 2003, and was $246,000 or 18.3% higher for the ninemonths ended September 30, 2004 compared to the nine months ended September 30,2003. The increase is the result of increased Digital Subscriber Line (DSL)customers.

 

22

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CLEC local service revenue was $912,000, which is $41,000 or 4.7%higher in the three months ended September 30, 2004 compared to the threemonths ended September 30, 2003. CLEC local service revenue was$2,766,000, which is $180,000 or 7.0% higher in the nine months ended September 30,2004 compared to the nine months ended September 30, 2003. The increase inCLEC local service revenue is driven primarily by an increase in revenues frombusiness customers and an increase in local trunking revenue due primarily to anew customer relationship in northwest Iowa. However, this customerdiscontinued service in September 2004, and it is expected to have amodest impact on the CLEC growth rates. In the second quarter of 2003,HickoryTech decided to exit several exchanges in its Iowa territories thatutilized a resale of services approach. As a result of this decision,HickoryTech stopped providing service for 734 customers. This decision has hada modest impact on the growth rates of 2004 compared to 2003.

 

CLEC network access revenue was $77,000 or 13.4% higher in thirdquarter 2004 compared to third quarter 2003. CLEC network access revenue was $228,000 or 13.2% higher in the ninemonths ended September 30, 2004 compared to the nine months ended September 30,2003.  This increase is primarily theresult of increased penetration of overbuild lines in CLEC communities, and hasoccurred in spite of CLEC access rate reductions which were explained in theregulatory section above.

 

CLEC data revenue was $223,000 or 74.8% higher in third quarter 2004compared to third quarter 2003.  CLECdata revenue was $487,000 or 59.8% higher in the nine months ended September 30,2004 compared to the nine months ended September 30, 2003. The increase isthe result of increased DSL penetration in CLEC communities and an increase inEthernet revenue associated with large customers.

 

Long distance revenue was $67,000 or 6.1% higher in the three monthsended September 30, 2004 compared to the three months ended September 30,2003.  Long distance revenue was $189,000or 5.7% higher in the nine months ended September 30, 2004 compared to thenine months ended September 30, 2003. This increase is the result of acorresponding increase in customers. HickoryTech experienced a 2,100 or 5.3% increase in its long distance customerbase between September 30, 2003 and September 30, 2004. Although thecustomer base is increasing, revenue per customer is decreasing. The decreasein revenue per customer is primarily the result of optional long distanceservices available to customers, the increased use of Internet services andother alternatives to long distance services. Also, a competitor of HickoryTech received approval from the state ofMinnesota to offer long distance services in all HickoryTech territories. Thiscompetitor already offers local telephone service in HickoryTech’s CLECterritories and with this approval, has the potential to create strongercompetition with HickoryTech in these markets, which could result in areduction in long distance revenue in future periods.

 

Internet revenue was $67,000, or 7.1% higher in the three months ended September 30,2004 compared to the three months ended September 30, 2003.  Internet revenue was $165,000, or 5.8% higherin the nine months ended September 30, 2004 compared to the nine monthsended September 30, 2003.   Theincrease in revenue was caused primarily by an increase in Internet customersof 1,189 or 7.5% between September 30, 2003 and September 30, 2004.

 

Cost of Services, excluding Depreciation andAmortization:

Cost of services, excluding depreciation and amortization was $59,000or 0.8% higher in the third quarter of 2004 compared to the third quarter of2003.  Cost of services, excludingdepreciation and amortization was $1,259,000 or 6.0% higher in the nine monthsended September 30, 2004 compared to the nine months ended September 30,2003. The increases for the three and nine months ended September 30, 2004compared to the three and nine months ended September 30, 2003 areprimarily due to increases in expenses relating to long distance services thatincreased in conjunction with the corresponding increase in long distancecustomers and revenue, increased billing expense from the Information Solutionssector, and increased plant operation expenses. These increases were somewhatoffset by decreases in charges relating to the decrease in Total Service Resale(TSR) customers.  In the second quarterof 2003, HickoryTech decided to exit several exchanges in its Iowa territories,which utilized a resale of services approach. As a result of this decision,HickoryTech has stopped providing service for 734 customers. In addition, in September of2003, HickoryTech abandoned a CLEC initiative in a specific market. As a resultof this operating decision, HickoryTech abandoned approximately $632,000 ofproperty, plant and equipment, which was written down to a carrying value ofzero in the third quarter of 2003. This charge is included in the operatingexpenses of the Telecom Sector on the condensed consolidated statement of operations.

 

23

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Selling, General and Administrative Expensesexcluding Depreciation and Amortization:

Selling, general and administrative expenses, excluding depreciationand amortization was $324,000 or 14.3% higher in the third quarter of 2004compared to the third quarter of 2003. Selling, general and administrative expenses, excluding depreciation andamortization was $790,000 or 11.5% higher in the nine months ended September 30,2004 compared to the nine months ended September 30, 2003.  This increase is primarily due to an increasein sales and marketing related expenses, regulatory fees and corporateallocations.

 

Depreciation and Amortization:

Depreciation and amortization were $3,459,000, which is $140,000 or4.2% higher in the three months ended September 30, 2004 compared to thesame period in 2003.  Depreciation andamortization were $10,273,000, which is $494,000 or 5.1% higher in the ninemonths ended September 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 $5,387,000, which is $416,000 or 7.2% lower in thethree months ended September 30, 2004 compared to the three months ended September 30,2003.  Net income was $3,207,000, whichis $268,000 or 7.7% lower in the three months ended September 30, 2004compared to the three months ended September 30, 2003.  Operating income was $17,244,000, which is$1,410,000 or 7.6% lower in the nine months ended September 30, 2004compared to the nine months ended September 30, 2003.  Net income was $10,266,000, which is $810,000or 7.3% lower in the nine months ended September 30, 2004 compared to thenine months ended September 30, 2003. These decreases in operating and net income were driven by the increasesin cost of services, depreciation and amortization, and selling, general andadministrative expenses described above, slightly offset by the increase inrevenue, 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 table provides a breakdown of the Information Solutions Sectoroperating results.

 

**INFORMATION SOLUTIONS SECTOR**

 
|                                                                                    | ** ** | **For Three Months Ended** | ** ** | **For Nine Months Ended** | ** ** |
|-----------------------------------------------------------------------------------------|------------|----------------------------|------------|---------------------------|------------|
| **(Dollars in Thousands)**                                                              | ** ** | **9/30/2004**              | ** ** | **9/30/2003**             |       | **9/30/2004** | ** ** | **9/30/2003** | ** ** |
| Revenues  Before Eliminations                                                           |       |                       | ** ** |                      |       |   | ** ** |   |   |
| Unaffiliated  Customers                                                                 | ** ** | **$**                      | **574**    | ** **                | $          | 702 |   | **$** | **2,219** | ** ** | $ | 2,609 |   |
| Intersegment                                                                            | ** ** | **1,078**                  | ** ** | 848                       |       | **3,252** | ** ** | 2,379 |   |
| ** **                                                                              |       | **1,652**                  | ** ** | 1,550                     |       | **5,471** | ** ** | 4,988 |   |
| Cost of Services, excluding Depreciation  and Amortization                              | ** ** | **1,441**                  | ** ** | 1,730                     |       | **4,863** | ** ** | 5,314 |   |
| Selling, General, and Administrative  Expenses, excluding Depreciation and Amortization | ** ** | **216**                    | ** ** | 26                        |       | **662** | ** ** | 439 |   |
| Depreciation  and Amortization                                                          | ** ** | **636**                    | ** ** | 618                       |       | **1,929** | ** ** | 1,743 |   |
|                                                                                    |       |                       | ** ** |                      |       |   | ** ** |   |   |
| Operating  Loss                                                                         | ** ** | **$**                      | **(641**   | **)**                     | $          | (824 | ) | **$** | **(1,983** | **)** | $ | (2,508 | ) |
| Net Loss                                                                                | ** ** | **$**                      | **(390**   | **)**                     | $          | (540 | ) | **$** | **(1,198** | **)** | $ | (1,643 | ) |
|                                                                                    |       |                       | ** ** |                      |       |   | ** ** |   |   |
| Capital  Expenditures                                                                   | ** ** | **$**                      | **—** | ** **                | $          | 7 |   | **$** | **1** | ** ** | $ | 151 |   |

 

24

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Revenues:

Operating revenues from unaffiliated customers decreased $128,000 or18.2% in the third quarter 2004 compared to the third quarter 2003. Operatingrevenues from unaffiliated customers decreased $390,000 or 14.9% in the ninemonths ended September 30, 2004 compared to the nine months ended September 30,2003.  The decrease in operating revenueswas primarily due to the loss of CABS processing customers and a decline involume to existing customers.

 

Cost of Services, excluding Depreciation andAmortization:

Cost of services, excluding depreciation and amortization decreased$289,000 or 16.7% in the three months ended September 30, 2004 compared tothe three months ended September 30, 2003. Cost of services, excludingdepreciation and amortization decreased $451,000 or 8.5% in the nine monthsended September 30, 2004 compared to the nine months ended September 30,2003.  The decreases in operating expenses primarily reflect the impact ofmanagement cost reduction actions.

 

Selling, General, and AdministrativeExpenses, excluding Depreciation and Amortization:

Selling, general and administrative expenses, excluding depreciationand amortization increased $190,000, from $26,000 to $216,000 in the thirdquarter 2004 compared to the third quarter 2003.  Selling, general and administrative expenses,excluding depreciation and amortization increased $223,000 or 50.8% for thenine months ended September 30, 2004 compared to the nine months ended September 30,2003.  The increase is due toredistributed wages and benefits of employees between departments due totemporary reassignments.

 

Depreciation and Amortization:

Depreciation and amortization increased $18,000 or 2.9% in third quarter2004 compared to third quarter 2003, and $186,000 or 10.7% for the nine monthsended September 30, 2004 compared to the nine months ended September 30,2003.  The primary reason for theincrease is due to the depreciation of a new billing system.

 

Operating and Net Loss:

Operating loss decreased $183,000 or 22.2% in third quarter 2004compared to third quarter 2003.  Net lossdecreased $150,000 or 27.8% in third quarter 2004 compared to third quarter2003.  Operating loss decreased $525,000or 20.9% in the nine months ended September 30, 2004 compared to the ninemonths ended September 30, 2003. Net loss decreased $445,000 or 27.1% in the nine months ended September 30,2004 compared to the nine months ended September 30, 2003.  The decrease in operating loss and net lossin the three and nine months ended September 2004 compared to the threeand nine months ended September 2003 was primarily attributable to theoverall net increase in revenues, including an increase in intersegmentrevenues of $230,000 and $873,000, respectively, coupled with a decrease incost of services, excluding depreciation and amortization as discussed above.

 

25

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

 

**ENTERPRISE SOLUTIONS SECTOR**

 
|                                                                                   | ** ** | **For Three Months Ended** | ** ** | **For Nine Months Ended** | ** ** |
|----------------------------------------------------------------------------------------|------------|----------------------------|------------|---------------------------|------------|
| **(Dollars in Thousands)**                                                             | ** ** | **9/30/2004**              | ** ** | **9/30/2003**             |       | **9/30/2004** | ** ** | **9/30/2003** | ** ** |
| Revenues  Before Intersegment Eliminations                                             |       |                       | ** ** |                      |       |   | ** ** |   |   |
| Installation                                                                           | ** ** | **$**                      | **961**    | ** **                | $          | 1,698 |   | **$** | **2,841** | ** ** | $ | 5,333 |   |
| Service                                                                                | ** ** | **1,724**                  | ** ** | 1,867                     |       | **5,477** | ** ** | 5,526 |   |
| ** **                                                                             |       | **2,685**                  | ** ** | 3,565                     |       | **8,318** | ** ** | 10,859 |   |
| Cost of  Products Sold                                                                 | ** ** | **1,854**                  | ** ** | 2,606                     |       | **5,659** | ** ** | 7,675 |   |
| Cost of Services, excluding Depreciation  And Amortization                             | ** ** | **499**                    | ** ** | 369                       |       | **1,141** | ** ** | 1,196 |   |
| Selling, General and Administrative  Expenses, excluding Depreciation and Amortization | ** ** | **774**                    | ** ** | 898                       |       | **2,381** | ** ** | 2,659 |   |
| Depreciation  and Amortization                                                         | ** ** | **40**                     | ** ** | 61                        |       | **135** | ** ** | 182 |   |
|                                                                                   |       |                       | ** ** |                      |       |   | ** ** |   |   |
| Operating  Loss                                                                        | ** ** | **$**                      | **(482**   | **)**                     | $          | (369 | ) | **$** | **(998** | **)** | $ | (853 | ) |
| Net Loss                                                                               | ** ** | **$**                      | **(287**   | **)**                     | $          | (221 | ) | **$** | **(594** | **)** | $ | (516 | ) |
|                                                                                   |       |                       | ** ** |                      |       |   | ** ** |   |   |
| Capital  Expenditures                                                                  | ** ** | **$**                      | **2**      | ** **                | $          | 12 |   | **$** | **24** | ** ** | $ | 201 |   |

 

Revenues:

Operating revenues decreased $880,000 or 24.7% in the third quarter of2004 compared to the third quarter of 2003. Operating revenues decreased$2,541,000 or 23.4% in the nine months ended September 30, 2004 comparedto the nine months ended September 30, 2003. Installation revenuedecreased $737,000 or 43.4% in the third quarter of 2004 compared to the thirdquarter of 2003.  Installation revenuedecreased $2,492,000 or 46.7% in the nine months ended September 30, 2004compared to the nine months ended September 30, 2003, and is primarily dueto a decrease in the installation of Private Branch Exchange (PBX) systems of$1,313,000 or 68.5% and a decrease in the installation of data systems of$1,130,000 or 41.9%. The decrease in installation revenue in the third quarterof 2004 compared to the third quarter of 2003 was primarily a result of adecrease in sales and installations of PBX systems of $102,000 or 34.4%, and adecrease in Small Business Systems (SBS) installations of $174,000 or45.8%.  Revenues in 2003 were aided byinstallations of Voice over Internet Protocol systems that were performed in acorporate office and on a large college campus in Minnesota during the firstnine months of 2003. Service revenue was $143,000 or 7.7% lower in the thirdquarter of 2004 compared to the third quarter of 2003. For the nine monthsended September 30, 2004, service revenue was $49,000, or 0.9% lowercompared to the same period in 2003. This sector has encountered across theboard reductions in demand in all of its major products and services. Thereduction started in early 2002, and is believed to be associated with theeconomy’s effect on customers of this sector, and due to changing technology(i.e. voice vs. data protocol) in the communications products, which thissector provides. Due to the uncertainty of the economy’s effect on the specificindustries that Enterprise Solutions’ customers are in, HickoryTech cannotestimate when or if customer demand for these products and services may returnto higher levels.

 

Cost of Products Sold:

Cost of products sold decreased $752,000 or 28.9% in the third quarterof 2004 compared to the third quarter of 2003. Cost of products sold decreased $2,016,000 or 26.3% in the nine monthsended September 30, 2004 compared to the nine months ended September 30,2003.  The decrease in cost of productssold for the three and nine months ended September 30, 2004 compared tothe three and nine months ended September 30, 2003 was mainly due to thedecrease in installation revenue.  Forthe nine month period ended September 30, 2004 compared to the same periodin 2003, 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 32.0% for the nine months ended September 30,2004 compared to 29.3% for the same period in 2003.

 

26

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Cost of Services, excluding Depreciation andAmortization:

Cost of services, excluding depreciation and amortization increased$130,000 or 35.2% in the third quarter 2004 compared to the third quarter2003.  Cost of services, excludingdepreciation and amortization decreased $55,000 or 4.6% in the nine monthsended September 30, 2004 compared to the nine months ended September 30,2003. The increase in cost of services, excluding depreciation and amortizationin the third quarter 2004 compared to the third quarter 2003 was largely theresult of increased maintenance expense associated with customer contracts. Thedecrease in cost of services, excluding depreciation and amortization for thenine months ended September 30, 2004 compared to the nine months ended September 30,2003, are mainly the result of cost reduction measures, which includedworkforce reductions, which were offset by increased maintenance expenseassociated with customer contracts.

 

Selling, General and Administrative,excluding Depreciation and Amortization:

Selling, general and administrative expenses, excluding depreciationand amortization decreased $124,000 or 13.8% in the third quarter 2004 comparedto the third quarter 2003.  Selling,general and administrative expenses, excluding depreciation and amortizationdecreased $278,000 or 10.5% in the nine months ended September 30, 2004compared to the nine months ended September 30, 2003.  The decrease in selling, general andadministrative expenses was largely due to cost reduction measures, whichincluded workforce reductions.

 

Operating and Net Loss:

Operating loss was $482,000 in the three months ended September 30,2004 compared to an operating loss of $369,000 in the three months ended September 30,2003. Operating loss was $998,000 in the nine months ended September 30,2004 compared to an operating loss of $853,000 in the nine months ended September 30,2003. Net loss in the three months ended September 30, 2004 was $287,000compared to a net loss of $221,000 in the three months ended September 30,2003. Net loss in the nine months ended September 30, 2004 was $594,000compared to a net loss of $516,000 in the nine months ended September 30,2003. The operating and net losses generated in the three and nine months endedSeptember 30, 2004 compared to the three and nine months ended September 30,2003 occurred for the reasons described above.

 

LIQUIDITY AND CAPITAL RESOURCES

 

CASH FLOWS – Cashprovided by operations was $25,485,000 in the first nine months of 2004compared to $24,804,000 in the first nine months of 2003. Cash flows fromoperations in the first nine months of 2004 were primarily attributable to netincome plus non-cash expenses for depreciation and amortization as well as adecrease in income taxes receivable. Cash flows from operations in the firstnine months of 2003 were primarily attributable to net income plus non-cashexpenses for asset impairment, depreciation and amortization as well as adecrease in income taxes receivable, partially offset by an increase indeferred income taxes receivable and the decrease in accounts payable relatedto the timing of payments.

 

Cash flows used in investing activities were $6,467,000 in the firstnine months of 2004 compared to cash flows used of $3,335,000 for the sameperiod in 2003. Capital expenditures were $9,111,000 during the first ninemonths of 2004 as compared to $7,532,000 for the same period in 2003. Capitalexpenditures for the nine months ended September 30, 2004 were incurredprimarily to provide additional network facilities in the Telecom Sector.Management expects capital expenditures in the remainder of 2004 to beapproximately $7,500,000. There were $2,600,000 redemptions of investments inthe first nine months of 2004, compared to $4,100,000 in the first nine monthsof 2003. The redemptions in the first nine months of both 2004 and 2003 reflectthe amount HickoryTech received as return of capital from one of its lenders,through conditions of its debt agreements.

 

27

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Cash flows used in financing activities were $18,698,000 for the firstnine months of 2004 compared to $22,463,000 for the first nine months of 2003.Included in cash flows used in financing activities are debt repayments anddividend payments. HickoryTech made payments on its revolving credit facilityof $15,250,000 during the first nine months of 2004, and $18,500,000 during thefirst nine months of 2003. HickoryTech borrowed $2,000,000 on its revolvingcredit facility during the first nine months of 2004, and $1,250,000 during thefirst nine months of 2003. Dividend payments for the first nine months of 2004were $4,281,000 compared to $4,610,000 for the same period in 2003. During thefirst nine months of 2004, HickoryTech retired 3,299 shares for $43,000 from astock compensation plan. During the first nine months of 2003, HickoryTechrepurchased 66,600 common shares for $661,000, as well as retiring 18,370shares for $185,000 from a stock compensation plan.

 

WORKING CAPITAL – Workingcapital (i.e. current assets minus current liabilities) was $5,241,000 as of September 30,2004, compared to working capital of $9,300,000 as of December 31, 2003.The change in taxes receivable and payable are the primary reasons for thisdecrease. Income taxes receivable was $2,838,000 at December 31, 2003, andincome taxes payable was $3,166,000 at September 30, 2004. The ratio ofcurrent assets to current liabilities was 1.4 to 1.0 as of September 30,2004 and 1.7 to 1.0 as of December 31, 2003.

 

LONG-TERM OBLIGATIONS-HickoryTech’s long-term obligations as of September 30, 2004 were$104,465,000, excluding current maturities of $1,500,000. As of September 30,2004, HickoryTech had a $133,750,000 credit facility with a syndicate of banks.The credit facility is comprised of a $112,500,000 revolving credit componentand a $21,250,000 term loan component. The available line of credit on the$112,500,000 revolving credit began decreasing in increments in March of2004, and has a final maturity date in September 2008. However, since notall of the available revolving credit has been utilized as of September 30,2004, the payment schedule is as follows: 2006 - $23,062,000, 2007 -$32,813,000 and 2008 - $28,125,000. The term loan component requires equal quarterlyprincipal payments of $250,000 during the period of March 2001 to December 2008,and $17,000,000 in the first quarter of 2009. The weighted average interestrate associated with this credit facility and related instruments varies withLIBOR and certain other rates and was 4.1% at September 30, 2004 and 4.5%at September 30, 2003. HickoryTech has implemented fixed interest terms onvarious portions of the overall debt outstanding for varying terms. The longestfixed interest term, on $60,000,000 of the debt, is fixed until June 2008.Another fixed interest term, on $20,000,000 of the debt, is fixed until June,2005. As of September 30, 2004, HickoryTech had drawn $105,250,000 on thiscredit facility and had $28,500,000 of available credit. Management believesthe 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.

 

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

 

CONSTRUCTION PLANS –Beginning in 2004, HickoryTech has embarked on a five-year network enhancementprogram in its core telephone property in Mankato in support of its leadingbroadband service strategy. The Company will add approximately $20,000,000 tothe network over the five-year period, in addition to the historical levels ofcapital spending in 2003 and 2002. Management believes that the enhancementwill support the broadband product deployment strategies of the future, as wellas serving as defense against competition in its core market. These upgrades toan already state of the art network will give HickoryTech the capability tooffer more diversified services to its core customer base.

 

OTHER - HickoryTechoperates with original equity capital, retained earnings and indebtedness inthe form of bank term and revolving lines of credit. HickoryTech believes itscurrent level of debt to total capital is acceptable for ongoing operations.

 

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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, “Accountingfor the Effects of Certain Types of Regulation.” The preparation of thesefinancial statements requires management to make estimates and judgments thataffect the reported amounts of assets, liabilities, revenues, and expenses andrelated disclosure of contingent assets and liabilities. Management believesthat the application of the accounting policies, which are important toHickoryTech’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 September 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

 

InMay 2004, the FASB issued FASB Staff Position (FSP) No. FAS 106-2, Accountingand Disclosure Requirements Related to the Medicare Prescription DrugImprovement and Modernization Act of 2003, which supersedes FSP No. FAS 106-1of the same name. FSP No. FAS 106-2 provides guidance on accounting for theeffects of the Act, including the federal subsidy, and requires publiccompanies to reflect the impact by the third quarter of 2004, if determinableand significant. The new Act introduces a prescription drug benefit underMedicare Part D, as well as a federal subsidy to sponsors of retiree healthcare benefit plans that provide a benefit that is at least actuariallyequivalent to the Medicare plan.  The retiree medical plan does provideprescription drug coverage. As of September 30, 2004, the Company is notable to definitively determine if the prescription drug benefits it providesare actuarially equivalent to those provided under Medicare Part D under theAct.   In addition, the Company believes the effects of the Act will notmaterially impact the financial statements as of September 30,2004 and as such the net periodic benefit cost presented in the financialstatements does not reflect any amount associated with the subsidy.

 

ITEM 3. QUANTATIVE AND QUALITATIVEDISCLOSURES 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 using themost effective methods to eliminate or reduce the impact of these exposures.Variable rate debt instruments are subject to interest rate risk. HickoryTechhas entered into interest rate swap agreements with remaining maturitiesranging from nine to forty-five months to manage its exposure to interest ratemovements on a portion of its variable rate debt obligations. The effectiveportion of the cumulative gain or loss on these derivative instruments isreported as a component of accumulated other comprehensive income inshareholders’ equity and is recognized in earnings when the term of the swapagreement is concluded. HickoryTech’s earnings are affected by changes ininterest rates as a portion of its long-term debt has variable interest ratesbased on LIBOR. If interest rates for the portion of HickoryTech’s long-termdebt based on variable rates had averaged 10% more for the quarter ended September 30,2004, HickoryTech’s interest expense for the quarter would have increased$53,000.  If interest rates for theportion of HickoryTech’s long-term debt based on variable rates had averaged10% more for the entire nine months ended September 30, 2004, HickoryTech’sinterest expense for the nine months ended September 30, 2004 would haveincreased $129,000.

 

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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 September 30, 2004, the end of the periodcovered by this report. Disclosure controls and procedures are designed withthe objective 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 September 30, 2004,there has been no change in the Company’s internal control over financialreporting (as defined in Rule 13a-15(f) of the Exchange Act) that hasmaterially affected or is reasonably likely to materially affect our internalcontrol over financial reporting.

 

Section 404 of the Sarbanes-Oxley Act of 2002 requires that theCompany establish and maintain an adequate internal control structure andprocedures for financial reporting and assess on an on-going basis the designand operating effectiveness of internal control structure and procedures forfinancial reporting. The Company’s auditors are required to audit both thedesign and operating effectiveness of the internal controls and management’sassessment of the design and the effectiveness of its internal controls.Although no known material weaknesses exist at this time, this will be thefirst year that the Company has undergone an audit of its internal controls andprocedures, and it is possible that material weaknesses could be found. If theCompany is unable to remediate the weaknesses the auditors could be required toissue an adverse opinion on internal controls.

 

Because opinions on internal controls have not been required in thepast, it is uncertain what impact an adverse opinion would have upon theCompany’s stock price.

 

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PART II. OTHER INFORMATION

 

Item 1.             LegalProceedings.

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

 

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

None.

 

Item 3.             DefaultsUpon Senior Securities.

None.

 

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

None.

 

Item 5.             OtherInformation.

None.

 

Item 6.             Exhibits.

 

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

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

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

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

 

 

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SIGNATURES

 

                Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned,thereunto duly authorized.

 
| Dated: November 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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