---------------

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, DC 20549**

 

**FORM10-Q**

** **

| **(Mark One)** |
|----------------|
|           |   |
| **ý**     | **QUARTERLY REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|           |   |
|           | **FOR THE QUARTERLY PERIOD ENDED June 30, 2003** |
|           |   |
|           | **OR** |
|           |   |
| **o**          | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|           |   |
|           | **FOR THE TRANSITION PERIOD  FROM                TO** |

 

**Commission file number   0-13721**

 

**HICKORY TECH CORPORATION**

(Exact name of registrant asspecified in its charter)

 

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

 

Indicate by check mark whether the Registrant (1) has filed all reportsrequired to be filed by Section 13 or 15(d) of the Securities Exchange Act of1934 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 ExchangeAct).     Yes  ý      No  o

 

The total number of shares of the registrant’s common stock outstandingas of June 30, 2003: **13,975,561**.

 

 

----

 

**HICKORY TECH CORPORATION**

June 30, 2003

 

PART I. FINANCIAL INFORMATION

 

ITEM 1.   FINANCIAL STATEMENTS.

 

CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED)

 
|                                                        |   | **For Quarter Ended** |   | **For Six Months Ended** |   |
|-------------------------------------------------------------|--------|-----------------------|--------|--------------------------|--------|
| **(In Thousands Except Per Share Amounts)**                 |   | **6/30/2003**         |   | **6/30/2002**            |   | **6/30/2003** |   | **6/30/2002** |   |
| OPERATING REVENUES:                                         |   |                  |   |                     |   |   |   |   |   |
| Telecom Sector                                              |   | $                     | 22,648 |                     | $      | 21,405 |   | $ | 44,609 |   | $ | 42,122 |   |
| Information Solutions Sector                                |   | 809                   |   | 1,049                    |   | 1,907 |   | 2,083 |   |
| Enterprise Solutions Sector                                 |   | 3,383                 |   | 3,037                    |   | 7,294 |   | 6,398 |   |
| TOTAL OPERATING REVENUES                                    |   | 26,840                |   | 25,491                   |   | 53,810 |   | 50,603 |   |
|                                                        |   |                  |   |                     |   |   |   |   |   |
| COSTS AND EXPENSES:                                         |   |                  |   |                     |   |   |   |   |   |
| Cost of Sales, Enterprise Solutions                         |   | 2,550                 |   | 2,033                    |   | 5,069 |   | 4,217 |   |
| Operating Expenses, excluding Depreciation and Amortization |   | 14,013                |   | 14,290                   |   | 28,449 |   | 27,576 |   |
| Depreciation                                                |   | 4,364                 |   | 3,931                    |   | 8,526 |   | 7,744 |   |
| Amortization of Intangibles                                 |   | 199                   |   | 380                      |   | 525 |   | 741 |   |
| TOTAL COSTS AND EXPENSES                                    |   | 21,126                |   | 20,634                   |   | 42,569 |   | 40,278 |   |
|                                                        |   |                  |   |                     |   |   |   |   |   |
| OPERATING INCOME                                            |   | 5,714                 |   | 4,857                    |   | 11,241 |   | 10,325 |   |
| OTHER INCOME (EXPENSE):                                     |   |                  |   |                     |   |   |   |   |   |
| Equity in Net Income/(Loss) of Investees                    |   | (2                    | )      | 21                       |   | (5 | ) | 2 |   |
| Gain on Sale of Assets                                      |   | 2                     |   | —                   |   | 2 |   | — |   |
| Interest and Other Income                                   |   | 13                    |   | 29                       |   | 23 |   | 72 |   |
| Interest Expense                                            |   | (1,480                | )      | (1,858                   | )      | (3,045 | ) | (3,814 | ) |
| TOTAL OTHER INCOME (EXPENSE)                                |   | (1,467                | )      | (1,808                   | )      | (3,025 | ) | (3,740 | ) |
|                                                        |   |                  |   |                     |   |   |   |   |   |
| INCOME BEFORE INCOME TAXES                                  |   | 4,247                 |   | 3,049                    |   | 8,216 |   | 6,585 |   |
| INCOME TAXES                                                |   | 1,737                 |   | 1,247                    |   | 3,359 |   | 2,693 |   |
| NET INCOME                                                  |   | $                     | 2,510  |                     | $      | 1,802 |   | $ | 4,857 |   | $ | 3,892 |   |
|                                                        |   |                  |   |                     |   |   |   |   |   |
| Basic Earnings Per Share                                    |   | $                     | 0.18   |                     | $      | 0.13 |   | $ | 0.35 |   | $ | 0.28 |   |
| Dividends Per Share                                         |   | $                     | 0.11   |                     | $      | 0.11 |   | $ | 0.22 |   | $ | 0.22 |   |
| Weighted Average Common Shares Outstanding                  |   | 13,951                |   | 14,006                   |   | 13,972 |   | 13,984 |   |
|                                                        |   |                  |   |                     |   |   |   |   |   |
| Diluted Earnings Per Share                                  |   | $                     | 0.18   |                     | $      | 0.13 |   | $ | 0.35 |   | $ | 0.28 |   |
| Weighted Average Common and Equivalent Shares Outstanding   |   | 13,981                |   | 14,096                   |   | 13,986 |   | 14,078 |   |

 

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

 

1

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**HICKORY TECH CORPORATION**

June 30, 2003

CONSOLIDATED BALANCE SHEETS

(UNAUDITED)

 
| **(In Thousands Except  Share  and Per Share Amounts)**                                                                                  |   | **6/30/2003** |        | **12/31/2002** |   |
|-----------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------|-------------|----------------|--------|
| ASSETS                                                                                                                                        |   |          |        |           |   |
| CURRENT  ASSETS:                                                                                                                              |   |          |        |           |   |
| Cash  and Cash Equivalents                                                                                                                    |   | **$**         | **1,144**   |           | $      | 1,874 |   |
| Receivables,  Net of Allowance for Doubtful Accounts of $1,382 and $1,358                                                                     |   | **11,242**    |        | 11,056         |   |
| Income  Taxes Receivable                                                                                                                      |   | **13**        |        | 3,222          |   |
| Costs  in Excess of Billings on Contracts                                                                                                     |   | **1,874**     |        | 2,107          |   |
| Inventories                                                                                                                                   |   | **5,262**     |        | 5,059          |   |
| Deferred  Income Taxes                                                                                                                        |   | **951**       |        | 951            |   |
| Other                                                                                                                                         |   | **2,310**     |        | 2,840          |   |
| TOTAL  CURRENT ASSETS                                                                                                                         |   | **22,796**    |        | 27,109         |   |
|                                                                                                                                          |   |          |        |           |   |
| INVESTMENTS                                                                                                                                   |   | **6,741**     |        | 10,517         |   |
|                                                                                                                                          |   |          |        |           |   |
| PROPERTY,  PLANT AND EQUIPMENT                                                                                                                |   | **251,740**   |        | 247,375        |   |
| Less  ACCUMULATED DEPRECIATION                                                                                                                |   | **119,479**   |        | 111,101        |   |
| PROPERTY,  PLANT AND EQUIPMENT, NET                                                                                                           |   | **132,261**   |        | 136,274        |   |
|                                                                                                                                          |   |          |        |           |   |
| OTHER  ASSETS:                                                                                                                                |   |          |        |           |   |
| Goodwill                                                                                                                                      |   | **25,086**    |        | 25,086         |   |
| Intangible  Assets, Net                                                                                                                       |   | **34,583**    |        | 34,669         |   |
| Financial  Derivative Instrument                                                                                                              |   | **985**       |        | —         |   |
| Deferred  Costs and Other                                                                                                                     |   | **5,281**     |        | 6,556          |   |
| TOTAL  OTHER ASSETS                                                                                                                           |   | **65,935**    |        | 66,311         |   |
|                                                                                                                                          |   |          |        |           |   |
| TOTAL  ASSETS                                                                                                                                 |   | **$**         | **227,733** |           | $      | 240,211 |   |
|                                                                                                                                          |   |          |        |           |   |
| LIABILITIES  & SHAREHOLDERS’ EQUITY                                                                                                  |   |          |        |           |   |
| CURRENT  LIABILITIES:                                                                                                                         |   |          |        |           |   |
| Accounts  Payable                                                                                                                             |   | **$**         | **2,640**   |           | $      | 4,543 |   |
| Accrued  Expenses                                                                                                                             |   | **3,301**     |        | 3,719          |   |
| Accrued  Interest                                                                                                                             |   | **67**        |        | 512            |   |
| Billings  in Excess of Costs on Contracts                                                                                                     |   | **159**       |        | 80             |   |
| Advanced  Billings and Deposits                                                                                                               |   | **3,855**     |        | 3,741          |   |
| Current  Maturities of Long-Term Obligations                                                                                                  |   | **1,426**     |        | 1,441          |   |
| TOTAL  CURRENT LIABILITIES                                                                                                                    |   | **11,448**    |        | 14,036         |   |
|                                                                                                                                          |   |          |        |           |   |
| LONG-TERM  OBLIGATIONS, Net of Current Maturities                                                                                             |   | **144,687**   |        | 157,599        |   |
|                                                                                                                                          |   |          |        |           |   |
| DEFERRED  INCOME TAXES                                                                                                                        |   | **4,781**     |        | 4,377          |   |
|                                                                                                                                          |   |          |        |           |   |
| DEFERRED  REVENUE AND BENEFITS                                                                                                                |   | **5,664**     |        | 5,604          |   |
|                                                                                                                                          |   |          |        |           |   |
| TOTAL  LIABILITIES                                                                                                                            |   | **166,580**   |        | 181,616        |   |
|                                                                                                                                          |   |          |        |           |   |
| COMMITMENTS  AND CONTINGENCIES (Note 8)                                                                                                       |   | **—**    |        | —         |   |
|                                                                                                                                          |   |          |        |           |   |
| SHAREHOLDERS’  EQUITY:                                                                                                                   |   |          |        |           |   |
| Common  Stock, no par value, $.10 stated value  Shares authorized: 100,000,000  Shares outstanding: 13,975,561 in 2003 and 13,983,929 in 2002 |   | **1,397**     |        | 1,398          |   |
| Additional  Paid-In Capital                                                                                                                   |   | **8,566**     |        | 7,885          |   |
| Retained  Earnings                                                                                                                            |   | **50,609**    |        | 49,312         |   |
| Accumulated  Other Comprehensive Income                                                                                                       |   | **581**       |        | —         |   |
| TOTAL  SHAREHOLDERS’ EQUITY                                                                                                              |   | **61,153**    |        | 58,595         |   |
|                                                                                                                                          |   |          |        |           |   |
| TOTAL  LIABILITIES & SHAREHOLDERS’ EQUITY                                                                                            |   | **$**         | **227,733** |           | $      | 240,211 |   |

 

Theaccompanying notes are an integral part of the consolidated financialstatements.

 

2

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**HICKORY TECH CORPORATION**

June 30, 2003

 

CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

 
|                                                               |   | **For Six Months Ended** |       |
|--------------------------------------------------------------------|--------|--------------------------|------------|
| **(Dollars In Thousands)**                                         |   | **6/30/2003**            |       | **6/30/2002** |   |
| CASH  FLOWS FROM OPERATING ACTIVITIES:                             |   |                     |       |   |   |
| Net  Income                                                        |   | **$**                    | **4,857**  |   | $ | 3,892 |   |
| Adjustments  to Reconcile Net Income to Net                        |   |                     |       |   |   |
| Cash  Provided by Operating Activities:                            |   |                     |       |   |   |
| Depreciation  and Amortization                                     |   | **9,051**                |       | 8,485 |   |
| Gain  on Sale of Assets                                            |   | **(2**                   | **)**      | — |   |
| Stock-Based  Compensation                                          |   | **402**                  | ** ** | 343 |   |
| Employee  Retirement Benefits and Deferred Compensation            |   | **104**                  | ** ** | 228 |   |
| Accrued  Patronage Refunds                                         |   | **(314**                 | **)**      | (446 | ) |
| Equity  in Net (Income) Loss of Investees                          |   | **5**                    | ** ** | (2 | ) |
| Provision  for Losses on Accounts Receivable                       |   | **477**                  | ** ** | 1,647 |   |
| Changes  in Operating Assets and Liabilities:                      |   |                     | ** ** |   |   |
| Receivables                                                        |   | **2,546**                | ** ** | 2,110 |   |
| Inventories                                                        |   | **(203**                 | **)**      | (304 | ) |
| Billings  and Costs on Contracts                                   |   | **312**                  | ** ** | 1,394 |   |
| Accounts  Payable and Accrued Expenses                             |   | **(2,766**               | **)**      | (1,439 | ) |
| Advance  Billings and Deposits                                     |   | **114**                  | ** ** | (20 | ) |
| Deferred  Revenue and Benefits                                     |   | **(44**                  | **)**      | (63 | ) |
| Other                                                              |   | **1,351**                | ** ** | 744 |   |
| Net  Cash Provided By Operating Activities                         |   | **15,890**               | ** ** | 16,569 |   |
|                                                               |   |                     | ** ** |   |   |
| CASH  FLOWS FROM INVESTING ACTIVITIES:                             |   |                     | ** ** |   |   |
| Additions  to Property, Plant and Equipment                        |   | **(4,460**               | **)**      | (9,325 | ) |
| Redemption  of Investments                                         |   | **4,100**                | ** ** | 100 |   |
| Proceeds  from Sale of Assets                                      |   | **73**                   | ** ** | 184 |   |
| Net  Cash Used In Investing Activities                             |   | **(287**                 | **)**      | (9,041 | ) |
|                                                               |   |                     | ** ** |   |   |
| CASH  FLOWS FROM FINANCING ACTIVITIES:                             |   |                     | ** ** |   |   |
| Payments  of Capital Lease Obligations                             |   | **(301**                 | **)**      | (219 | ) |
| Repayments  on Credit Facility                                     |   | **(14,000**              | **)**      | (8,000 | ) |
| Borrowings  on Credit Facility                                     |   | **1,250**                | ** ** | 1,500 |   |
| Proceeds  from Issuance of Common Stock                            |   | **496**                  | ** ** | 996 |   |
| Dividends  Paid                                                    |   | **(3,074**               | **)**      | (3,078 | ) |
| Stock  Repurchase                                                  |   | **(704**                 | **)**      | — |   |
| Net  Cash Used In Financing Activities                             |   | **(16,333**              | **)**      | (8,801 | ) |
|                                                               |   |                     | ** ** |   |   |
| NET  DECREASE IN CASH AND CASH EQUIVALENTS                         |   | **(730**                 | **)**      | (1,273 | ) |
|                                                               |   |                     |       |   |   |
| CASH  AND CASH EQUIVALENTS AT BEGINNING OF PERIOD                  |   | **1,874**                |       | 2,008 |   |
|                                                               |   |                     |       |   |   |
| CASH  AND CASH EQUIVALENTS AT END OF PERIOD                        |   | **$**                    | **1,144**  |   | $ | 735 |   |
|                                                               |   |                     |       |   |   |
| SUPPLEMENTAL  DISCLOSURE OF CASH FLOW INFORMATION:                 |   |                     |       |   |   |
| Cash  Paid for Interest                                            |   | **$**                    | **3,715**  |   | $ | 3,969 |   |
| Cash  Paid for Income Taxes, Net of Tax Refunds of $1,600 and $139 |   | **$**                    | **150**    |   | $ | 116 |   |
| NON-CASH  INVESTING ACTIVITIES:                                    |   |                     |       |   |   |
| Property,  Plant and Equipment Acquired with Capital Leases        |   | **$**                    | **124**    |   | $ | 492 |   |

 

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

 

3

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**HICKORYTECH CORPORATIONJUNE 30, 2003PART 1. FINANCIAL INFORMATION**

 

**ITEM 1. NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

NOTE 1. BASIS OFPRESENTATION

 

The accompanying unaudited condensedconsolidated financial statements have been prepared in accordance withgenerally accepted accounting principles for interim financial information andwith the instructions to Form 10-Q and Article 10 of Regulation S-X.Accordingly, they do not include all of the information necessary for a fairpresentation of results of operations, financial position, and cash flows inconformity with accounting principles generally accepted in the United Statesof America. In the opinion of management, the condensed consolidated financialstatements reflect all adjustments (consisting only of normal recurringadjustments) considered necessary for a fair presentation of Hickory TechCorporation’s (HickoryTech) results for the periods presented. Operatingresults for interim periods are not necessarily indicative of results that maybe expected for the fiscal year as a whole. The preparation of financialstatements in conformity with accounting principles generally accepted in theUnited States of America requires management to make estimates and assumptionsthat affect the reported amounts of assets, liabilities, revenues, expenses,and related disclosures at the date of the financial statements and during thereporting period. Actual results could differ from these estimates. Theseunaudited interim condensed consolidated financial statements should be read inconjunction with HickoryTech’s Annual Report on Form 10-K for the year endedDecember 31, 2002.

 

The consolidated financial statements ofHickoryTech include Hickory Tech Corporation and its subsidiaries in thefollowing three business segments: (i) Telecom Sector, (ii) InformationSolutions Sector and (iii) Enterprise Solutions Sector. An investment in anunconsolidated partnership for the Information Solutions Sector is accountedfor using the equity method. The operations of this partnership ended duringthe second quarter of 2003 with dissolution to follow later in 2003. Nomaterial wind down costs are anticipated. All intercompany transactions havebeen eliminated from the consolidated financial statements.

 

Certain reclassifications were made to thefinancial statements as of and for the three months and six months endedJune 30, 2002 to conform to the 2003 presentation.  These reclassifications had no impact onpreviously reported operating revenue, net income or shareholders’ equity.

 

Operating expenses include all costs relatedto delivery of HickoryTech’s communications services and products. These costsinclude all selling, general and administrative costs and all costs ofperforming services and providing related products, except for costs associatedwith the depreciation and amortization of property, plant and equipment andintangible assets, and cost of sales for the Enterprise Solutions Sector.

 

NOTE 2. EARNINGS AND CASH DIVIDENDS PER COMMON SHARE

 

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

 

4

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|                                         |   | **For Three  Months Ended** |   | **For Six  Months Ended** |   |
|----------------------------------------------|--------|-----------------------------|--------|---------------------------|--------|
|                                         |   | **6/30/2003**               |   | **6/30/2002**             |   | **6/30/2003** |   | **6/30/2002** |   |
| Weighted Average Shares Outstanding          |   | 13,950,824                  |   | 14,006,421                |   | 13,972,141 |   | 13,983,691 |   |
| Stock Options (dilutive only)                |   | 13,723                      |   | 74,775                    |   | 194 |   | 82,222 |   |
| Weighted Average Stock Subscribed (ESPP)     |   | 16,746                      |   | 14,653                    |   | 13,980 |   | 11,967 |   |
| Weighted Average Dilutive Shares Outstanding |   | 13,981,293                  |   | 14,095,849                |   | 13,986,315 |   | 14,077,880 |   |

 

 

Options to purchase 493,548 shares for the three and six months endedJune 30, 2003 and 76,650 shares for the three and six months endedJune 30, 2002 were not included in the computation of earnings per shareassuming dilution calculation because their effect on earnings per share wouldhave been antidilutive.

 

Cash dividends are based on the number ofcommon shares outstanding at the respective record dates. Listed below are thenumber of shares outstanding as of the record date for the first two quartersof 2003 and 2002.

 
| **Shares  Outstanding on Record Date** |   | **2003**   |   | **2002**   |   |
|----------------------------------------|--------|------------|--------|------------|--------|
| First  Quarter (Feb. 15)               |   | 14,003,335 |   | 13,971,484 |   |
| Second  Quarter (May 15)          |   | 13,942,662 |   | 14,007,250 |   |

 

Dividends per share is based on the quarterlydividend per share as declared by the HickoryTech Board of Directors.

 

During the first six months of 2003 and 2002,shareholders have elected to reinvest $134,000 and $121,000, respectively, ofdividends into HickoryTech common stock pursuant to the HickoryTech DividendReinvestment Plan.

 

NOTE 3. COMPREHENSIVE INCOME

 

HickoryTech follows the provisions of SFASNo. 130, “Reporting Comprehensive Income.” This statement established rules forthe reporting of comprehensive income and its components. In addition to netearnings, comprehensive income includes changes in unrealized gains and losseson derivative instruments qualifying and designated as cash flow hedges.Comprehensive income for the three months ended June 30, 2003 andJune 30, 2002 was $3,091,000 and $1,802,000, respectively. Comprehensiveincome for the six months ended June 30, 2003 and June 30, 2002 was$5,438,000 and $3,892,000, respectively.

 

NOTE 4. INVENTORIES

 

Inventories, which consist of equipment forresale, materials and supplies, are stated at the lower of average cost ormarket.

 

NOTE 5. INTANGIBLE ASSETS

 

Effective January 1, 2002, HickoryTechadopted SFAS No. 142, “Goodwill and Other Intangible Assets.” SFAS No. 142established new standards related to how acquired goodwill and other intangibleassets are to be recorded upon their acquisition as well as how they are to beaccounted for after they have been initially recognized in the financialstatements.

 

Effective with the adoption of this standard,HickoryTech is no longer amortizing acquired goodwill. Instead, SFAS No. 142requires acquired goodwill to be evaluated for impairment using a two-step testbased upon a fair value approach. The first step is used to identify potentialimpairment, while the second step calculates the amount of impairment, if any.Upon adoption of this standard, HickoryTech completed a transitional impairmenttest for its acquired goodwill, determining the fair value using primarily adiscounted cash flow model. The determined fair value was sufficient to passthe first step impairment test, and therefore no impairment was recorded.

 

5

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Additionally, upon adoption of SFAS No. 142, HickoryTech wasrequired to reassess the useful lives of its other intangible assets.HickoryTech’s other intangible assets primarily consist of wireless FCClicenses (FCC licenses). HickoryTech’s FCC licenses have terms of ten years,but are renewable.  The renewal of FCClicenses is a routine matter involving a nominal fee and HickoryTech hasdetermined that no legal, regulatory, contractual, competitive, economic orother factors currently exist that limit the useful life of its FCC licenses.As such, effective with the adoption of SFAS No. 142, HickoryTech is nolonger amortizing FCC licenses as they are deemed to be intangible assets thathave indefinite lives.  Prospectively,HickoryTech will continue to periodically reevaluate its determination of anindefinite useful life with regards to FCC licenses. SFAS No. 142 requiresthat indefinite lived intangible assets be tested for impairment by comparingthe fair value of the assets to their carrying amount. Upon adoption of thisstandard, HickoryTech completed a transitional impairment test for FCClicenses, calculating fair value using primarily a discounted cash flow modeland corroborating marketplace transactions, and determined that there was noimpairment to be recorded. The FCC licenses were tested for impairment on anaggregate basis, which is consistent with HickoryTech’s management of thewireless business within the Telecom Sector. HickoryTech also re-assessed theuseful life of its other intangible assets and concluded that the existinglives of up to six years should be continued.

 

On a prospective basis, HickoryTechis required to test both acquired goodwill and FCC licenses for impairment onan annual basis based upon a fair value approach. Additionally, goodwill shallbe tested for impairment between annual tests if an event occurs orcircumstances change that would more likely than not reduce the fair value ofan entity below its carrying value. Other indefinite-lived intangible assetswill be tested between annual tests if events or changes in circumstancesindicate that the asset might be impaired.

 

HickoryTech will test forimpairment of acquired goodwill and FCC licenses at the end of the fourthquarter of 2003, unless events or occurrences deem it necessary to test forimpairment in an interim period.

 

The carrying value of HickoryTech’s goodwillis $25,086,000 as of June 30, 2003 and December 31, 2002.

 

The components of HickoryTech’s otherintangible assets are shown in the following table:
|                                |   | **As of June 30, 2003** |   | **As of December 31, 2002** |   |
|-------------------------------------|--------|------------------------------|--------|----------------------------------|--------|
| **(Dollars in Thousands)**          |   | **Gross Carrying  Amount**   |   | **Accumulated  Amortization**    |   | **Gross Carrying  Amount** |   | **Accumulated  Amortization** |   |
|                                |   |                         |   |                             |   |   |   |   |   |
| Definite-Lived  Intangible Assets   |   |                         |   |                             |   |   |   |   |   |
| Customers                           |   | $                            | 821    |                             | $      | 288 |   | $ | 821 |   | $ | 237 |   |
| Other  Intangibles                  |   | 150                          |   | 100                              |   | 185 |   | 100 |   |
| Total                               |   | $                            | 971    |                             | $      | 388 |   | $ | 1,006 |   | $ | 337 |   |
|                                |   |                         |   |                             |   |   |   |   |   |
| Indefinite-Lived  Intangible Assets |   |                         |   |                             |   |   |   |   |   |
| FCC  Licenses                       |   | $                            | 34,000 |                             |   |   | $ | 34,000 |   |   |   |

 

Amortization expense related to thedefinite-lived intangible assets for the three months ended June 30, 2003and 2002 was $25,000 and $123,000, respectively. Amortization expense relatedto the definite-lived intangible assets for the six months ended June 30,2003 and 2002 was $51,000 and $227,000, respectively. Total estimatedamortization expense for the remaining six months of 2003 and the five yearssubsequent to 2003 is as follows: 2003 (July 1 through December 31) -$51,000; 2004 - $102,000; 2005 - $102,000; 2006 - $102,000; 2007 - $102,000 and2008 - $74,000.

 

6

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NOTE 6. RECENT ACCOUNTING DEVELOPMENTS

 

In June 2001,the FASB issued SFAS No. 143, “Accounting for Asset Retirement Obligations.”SFAS No. 143 requires entities to record the fair value of the liability forlegal obligations associated with an asset retirement in the period in whichthe obligation is incurred. When the liability is initially recorded, theentity capitalizes the cost of the asset retirement obligation by increasingthe carrying amount of the related long-lived asset. Over time, the liabilityis accreted to its present value each period, and the capitalized cost isdepreciated over the useful life of the related asset.

 

HickoryTech’s incumbent local exchangecarrier companies (ILECs) follow the provisions of SFAS No. 71, and thereforeconform to the accounting principles as prescribed by the respective statepublic utilities commissions and other federal agencies and, where applicable,accounting principles generally accepted in the United States of America. OnDecember 20, 2002, the Federal Communications Commission (FCC) notified carriersthat they would not adopt SFAS No. 143 for regulatory accounting purposes.  At January 1, 2003, HickoryTechdetermined the amount of asset retirement obligations required to be recordedfor its ILEC companies under the provisions of SFAS No. 143 were not significant,and therefore the implementation of SFAS No. 143 on January 1, 2003 didnot impact HickoryTech’s financial position or results of operations.

 

HickoryTech’s competitive local telephonecompanies (CLEC), Enterprise Solutions, and Information Solutions  also adopted SFAS No. 143 effectiveJanuary 1, 2003. HickoryTech has determined that its competitive localtelephone companies along with Enterprise Solutions and Information Solutionsdo not have a material legal obligation to remove long-lived assets asdescribed by SFAS No. 143, and accordingly, adoption of SFAS No. 143 did notimpact HickoryTech’s financial position or results of operations.

 

HickoryTech alsoadopted the provisions of SFAS No. 143 for its wireless operations as ofJanuary 1, 2003. HickoryTech performed an analysis to identify allpotential Asset Retirement Obligations.  The legal obligations identifiedconsist of obligations to remediate leased property where cell sites arelocated. However, based upon HickoryTech’s experience and expectations, thereis significant uncertainty as to whether third parties that own these leasedproperties would enforce their remediation rights related to the sites. Therefore, pursuant to the provisions of SFAS No. 143, HickoryTech didnot record this potential asset retirement obligation upon adoption and willnot record an obligation until such time as the fair value of the obligationcan be reasonably estimated.

 

InApril 2002, the FASB issued SFAS No. 145, “Rescission of FASB StatementsNo. 4, 44, and 64, Amendment of FASB Statement No. 13, and TechnicalCorrections.” SFAS No. 145 rescinds FASB Statement No. 4, “Reporting Gains andLosses from Extinguishment of Debt,” and an amendment of that Statement, FASBStatement No. 64, “Extinguishments of Debt Made to Satisfy Sinking-FundRequirements.” SFAS No. 145 also rescinds FASB Statement No. 44, “Accountingfor Intangible Assets of Motor Carriers,” and amends FASB Statement No. 13,“Accounting for Leases.” HickoryTech adopted the provisions of SFAS No. 145 onJanuary 1, 2003.  Adoption of thisstandard had no impact on the financial statements presented in this Form 10-Q.

 

In June 2002, the FASB issued SFAS No. 146,“Accounting for Costs Associated with Exit or Disposal Activities,” whichreplaces Emerging Issues Task Force (EITF) Issue No. 94-3, “LiabilityRecognition for Certain Employee Termination Benefits and Other Costs to Exitan Activity (including Certain Costs Incurred in a Restructuring).” SFAS No.146 requires companies to recognize costs associated with exit or disposalactivities when they are incurred rather than at the date of a commitment to anexit or disposal plan. HickoryTech has engaged in no activities in the three orsix months ended June 30, 2003 that are subject to the provisions of SFASNo. 146.  Accordingly, the adoption ofSFAS No. 146 did not impact HickoryTech’s financial position or results ofoperations.

 

7

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InDecember 2002, the FASB issued SFAS No. 148, “Accounting for Stock-BasedCompensation – Transition Disclosure – an amendment of SFAS No. 123” (SFAS No.148).  This Statement amends SFAS No.123, “Accounting for Stock-Based Compensation,” to provide alternative methodsof transition for a voluntary change to the fair value based method ofaccounting for stock-based employee compensation.  In addition, this Statement amends the disclosure requirements ofSFAS No. 123 to require prominent disclosures in both annual and interim financialstatements about the method of accounting for stock-based employee compensationand the effect of the method used on reported results. The provisions of SFASNo. 148 are effective for financial statements for fiscal years ending afterDecember 15, 2002, and disclosure requirements shall be effective forinterim periods beginning after December 15, 2002.  The Company will continue to account forstock-based compensation to its employees and directors using the intrinsicvalue method prescribed by APB Opinion No. 25, and related interpretations.  The Company adopted the provisions of SFASNo. 148 and has made certain disclosures required by SFAS No. 148 in theconsolidated financial statements presented in this report. The adoption ofSFAS No. 148 did not impact HickoryTech’s financial position or results ofoperations.

 

In November 2002, the FASB issuedInterpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements forGuarantees, Including Indirect Guarantees of Indebtedness of Others.”  This interpretation elaborates on thedisclosures required in financial statements concerning obligations undercertain guarantees.  It also clarifiesthe requirements related to the recognition of liabilities by a guarantor atthe inception of certain guarantees. The disclosure requirements of this interpretation were effective forHickoryTech on December 31, 2002 but did not require any additionaldisclosures.  The recognition provisionsof the interpretation are effective for HickoryTech in 2003 and are applicableonly to guarantees issued or modified after December 31, 2002.  The adoption of Interpretation No. 45 doesnot have a material impact on the financial position or results of operationsof HickoryTech.

 

In April 2003, the FASB issued SFAS No.149, “Amendment of Statement 133 on Derivative Instruments and HedgingActivities.” This statement amends and clarifies financial accounting andreporting for derivative instruments, including certain derivative instrumentsembedded in other contracts and for hedging activities under SFAS No. 133, “Accountingfor Derivative Instruments and Hedging Activities.” SFAS No. 149 is effectivefor certain contracts entered into or modified after June 30, 2003. Thisstandard is not expected to materially impact HickoryTech’s consolidatedfinancial position or results of operations.

 

8

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NOTE 7. QUARTERLY SECTOR FINANCIAL SUMMARY

 

Business segment information for the firsttwo quarters of 2003 and 2002 is as follows. Certain amounts in 2002 have beenreclassified to conform to the 2003 presentation.

 
| **(In  Thousands)**                            |   | **Telecom** |   | **Information  Solutions** |   | **Enterprise  Solutions** |   | **Corporate and  Eliminations** |   | **HickoryTech  Consolidated** |   |
|------------------------------------------------|--------|-------------|--------|----------------------------|--------|---------------------------|--------|---------------------------------|--------|-------------------------------|--------|
| **Three Months Ended 6/30/03**                 |   |        |   |                       |   |                      |   |                            |   |                          |   |
| Operating  Revenue from Unaffiliated Customers |   | $           | 22,648 |                       | $      | 809                       |   | $                               | 3,383  |                          | $      | — |   | $ | 26,840 |   |
| Intersegment  Revenues                         |   | 68          |   | 975                        |   | —                    |   | (1,043                          | )      | —                        |   |
| Total                                          |   | 22,716      |   | 1,784                      |   | 3,383                     |   | (1,043                          | )      | 26,840                        |   |
|                                           |   |        |   |                       |   |                      |   |                            |   |                          |   |
| Depreciation  and Amortization                 |   | 3,908       |   | 581                        |   | 60                        |   | 14                              |   | 4,563                         |   |
| Operating  Income (Loss)                       |   | 7,299       |   | (728                       | )      | (558                      | )      | (299                            | )      | 5,714                         |   |
| Interest  Expense                              |   | 2           |   | 20                         |   | —                    |   | 1,458                           |   | 1,480                         |   |
| Income  Taxes                                  |   | 2,989       |   | (336                       | )      | (232                      | )      | (684                            | )      | 1,737                         |   |
| Net  Income (Loss)                             |   | 4,312       |   | (483                       | )      | (334                      | )      | (985                            | )      | 2,510                         |   |
| Identifiable  Assets                           |   | 200,423     |   | 8,331                      |   | 10,403                    |   | 8,576                           |   | 227,733                       |   |
| Property,  Plant and Equip., Net               |   | 125,892     |   | 5,572                      |   | 574                       |   | 223                             |   | 132,261                       |   |
| Capital  Expenditures                          |   | 2,602       |   | —                     |   | 97                        |   | 26                              |   | 2,725                         |   |
|                                           |   |        |   |                       |   |                      |   |                            |   |                          |   |
| **Three Months Ended 6/30/02**                 |   |        |   |                       |   |                      |   |                            |   |                          |   |
| Operating  Revenue from Unaffiliated Customers |   | $           | 21,405 |                       | $      | 1,049                     |   | $                               | 3,037  |                          | $      | — |   | $ | 25,491 |   |
| Intersegment  Revenues                         |   | 69          |   | 944                        |   | —                    |   | (1,013                          | )      | —                        |   |
| Total                                          |   | 21,474      |   | 1,993                      |   | 3,037                     |   | (1,013                          | )      | 25,491                        |   |
|                                           |   |        |   |                       |   |                      |   |                            |   |                          |   |
| Depreciation  and Amortization                 |   | 3,669       |   | 519                        |   | 66                        |   | 57                              |   | 4,311                         |   |
| Operating  Income (Loss)                       |   | 5,997       |   | (568                       | )      | (300                      | )      | (272                            | )      | 4,857                         |   |
| Interest  Expense                              |   | 4           |   | 16                         |   | —                    |   | 1,838                           |   | 1,858                         |   |
| Income  Taxes                                  |   | 2,456       |   | (257                       | )      | (130                      | )      | (822                            | )      | 1,247                         |   |
| Net  Income (Loss)                             |   | 3,541       |   | (370                       | )      | (187                      | )      | (1,182                          | )      | 1,802                         |   |
| Identifiable  Assets                           |   | 247,871     |   | 7,831                      |   | 9,077                     |   | 13,574                          |   | 278,353                       |   |
| Property,  Plant and Equip., Net               |   | 131,402     |   | 5,413                      |   | 591                       |   | 128                             |   | 137,534                       |   |
| Capital  Expenditures                          |   | 5,136       |   | 686                        |   | 15                        |   | —                          |   | 5,837                         |   |

 

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| **(In  Thousands)**                            |   | **Telecom** |   | **Information  Solutions** |   | **Enterprise  Solutions** |   | **Corporate and  Eliminations** |   | **HickoryTech  Consolidated** |   |
|------------------------------------------------|--------|-------------|--------|----------------------------|--------|---------------------------|--------|---------------------------------|--------|-------------------------------|--------|
| **Six Months Ended 6/30/03**                   |   |        |   |                       |   |                      |   |                            |   |                          |   |
| Operating  Revenue from Unaffiliated Customers |   | $           | 44,609 |                       | $      | 1,907                     |   | $                               | 7,294  |                          | $      | — |   | $ | 53,810 |   |
| Intersegment  Revenues                         |   | 137         |   | 1,948                      |   | —                    |   | (2,085                          | )      | —                        |   |
| Total                                          |   | 44,746      |   | 3,855                      |   | 7,294                     |   | (2,085                          | )      | 53,810                        |   |
|                                           |   |        |   |                       |   |                      |   |                            |   |                          |   |
| Depreciation  and Amortization                 |   | 7,753       |   | 1,125                      |   | 121                       |   | 52                              |   | 9,051                         |   |
| Operating  Income (Loss)                       |   | 13,743      |   | (1,267                     | )      | (484                      | )      | (751                            | )      | 11,241                        |   |
| Interest  Expense                              |   | 7           |   | 38                         |   | —                    |   | 3,000                           |   | 3,045                         |   |
| Income  Taxes                                  |   | 5,602       |   | (595                       | )      | (205                      | )      | (1,443                          | )      | 3,359                         |   |
| Net  Income (Loss)                             |   | 8,085       |   | (856                       | )      | (295                      | )      | (2,077                          | )      | 4,857                         |   |
| Identifiable  Assets                           |   | 200,423     |   | 8,331                      |   | 10,403                    |   | 8,576                           |   | 227,733                       |   |
| Property,  Plant and Equip., Net               |   | 125,892     |   | 5,572                      |   | 574                       |   | 223                             |   | 132,261                       |   |
| Capital  Expenditures                          |   | 3,974       |   | 144                        |   | 189                       |   | 153                             |   | 4,460                         |   |
|                                           |   |        |   |                       |   |                      |   |                            |   |                          |   |
| **Six Months Ended 6/30/02**                   |   |        |   |                       |   |                      |   |                            |   |                          |   |
| Operating  Revenue from Unaffiliated Customers |   | $           | 42,122 |                       | $      | 2,083                     |   | $                               | 6,398  |                          | $      | — |   | $ | 50,603 |   |
| Intersegment  Revenues                         |   | 137         |   | 1,859                      |   | —                    |   | (1,996                          | )      | —                        |   |
| Total                                          |   | 42,259      |   | 3,942                      |   | 6,398                     |   | (1,996                          | )      | 50,603                        |   |
|                                           |   |        |   |                       |   |                      |   |                            |   |                          |   |
| Depreciation  and Amortization                 |   | 7,207       |   | 1,029                      |   | 136                       |   | 113                             |   | 8,485                         |   |
| Operating  Income (Loss)                       |   | 12,507      |   | (1,093                     | )      | (451                      | )      | (638                            | )      | 10,325                        |   |
| Interest  Expense                              |   | 9           |   | 30                         |   | —                    |   | 3,775                           |   | 3,814                         |   |
| Income  Taxes                                  |   | 5,099       |   | (501                       | )      | (199                      | )      | (1,706                          | )      | 2,693                         |   |
| Net  Income (Loss)                             |   | 7,354       |   | (722                       | )      | (286                      | )      | (2,454                          | )      | 3,892                         |   |
| Identifiable  Assets                           |   | 247,871     |   | 7,831                      |   | 9,077                     |   | 13,574                          |   | 278,353                       |   |
| Property,  Plant and Equip., Net               |   | 131,402     |   | 5,413                      |   | 591                       |   | 128                             |   | 137,534                       |   |
| Capital  Expenditures                          |   | 7,923       |   | 1,208                      |   | 55                        |   | 139                             |   | 9,325                         |   |

 

NOTE 8. CONTINGENCIES

 

HickoryTech is involved in certaincontractual disputes in the ordinary course of business. HickoryTech does notbelieve the ultimate resolution of any of these existing matters will have amaterial adverse effect on its financial position, results of operations orcash flows.

 

NOTE 9. STOCK COMPENSATION

 

At June 30, 2003, HickoryTech has fourstock-based employee compensation plans, which are described more fully in theHickoryTech Annual Report of Form 10-K for the year ended December 31,2002.  HickoryTech has elected toaccount for these employee and director stock compensation plans using theintrinsic value method as permitted by Accounting Principles Board Opinion No.25 and related interpretations.

 

In 2002, HickoryTech’s Board of Directorsmodified the terms of the stock options of a retiring officer. The modificationextended the period after retirement during which the officer can exercise hisvested options.  This modificationresulted in HickoryTech recognizing $173,000 of compensation expense during thefirst quarter of 2003.

 

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

 
|                                                                                                             |   | **For Three Months Ended** |       | **For Six Months Ended** |       |
|------------------------------------------------------------------------------------------------------------------|--------|----------------------------|------------|--------------------------|------------|
| **(Dollars  in Thousands)**                                                                                      |   | **6/30/2003**              |       | **6/30/2002**            |       | **6/30/2003** |   | **6/30/2002** |   |
| Reported  Net Income                                                                                             |   | **$**                      | **2,510**  |                     | $          | 1,802 | ** ** | **$** | **4,857** |   | $ | 3,892 |   |
| Add: Stock-based employee compensation expense included in reported  net income                                  |   | **145**                    |       | 171                      | ** ** | **402** |   | 343 |   |
| Deduct: Total stock-based employee compensation expense determined  under fair value based method for all awards |   | **(205**                   | **)**      | (215                     | )          | **(603** | **)** | (584 | ) |
|                                                                                                             |   |                       | ** ** |                     |       |   | ** ** |   |   |
| Pro  Forma Net Income                                                                                            |   | **$**                      | **2,450**  |                     | $          | 1,758 | ** ** | **$** | **4,656** |   | $ | 3,651 |   |
|                                                                                                             |   |                       |       |                     |       |   |   |   |   |
| Earnings  per share:                                                                                             |   |                       |       |                     |       |   |   |   |   |
| Basic  - as reported                                                                                             |   | **$**                      | **0.18**   |                     | $          | 0.13 | ** ** | **$** | **0.35** |   | $ | 0.28 |   |
| Basic  - pro forma                                                                                               |   | **$**                      | **0.18**   |                     | $          | 0.13 | ** ** | **$** | **0.33** |   | $ | 0.26 |   |
|                                                                                                             |   |                       |       |                     |       |   |   |   |   |
| Diluted  - as reported                                                                                           |   | **$**                      | **0.18**   |                     | $          | 0.13 | ** ** | **$** | **0.35** |   | $ | 0.28 |   |
| Diluted  - pro forma                                                                                             |   | **$**                      | **0.18**   |                     | $          | 0.12 | ** ** | **$** | **0.33** |   | $ | 0.26 |   |

 

NOTE 10. FINANCIAL DERIVATIVE INSTRUMENTS

 

During the second quarter of 2003,HickoryTech began using derivative instruments to manage its exposure tointerest rate risks. HickoryTech’s objective is to minimize the risks of thesevariable interest rate changes that could impact earnings. HickoryTech enteredinto an interest rate swap, which fixes the interest rate on a portion of itsvariable rate debt.

 

HickoryTech accounts for derivativeinstruments in accordance with SFAS No. 133, as amended, “Accounting forDerivative Instruments and Hedging Activities,” which requires derivativeinstruments to be recorded on the balance sheet at fair value. Changes in fairvalue of derivative instruments must be recognized in earnings unless specifichedge accounting criteria are met. HickoryTech has met those criteria with its cashflow hedge and SFAS. No. 133 states that they must recognize gains and lossesin other comprehensive income rather than in earnings.

 

HickoryTech has variable rate debtinstruments which subject the company to interest rate risk. HickoryTech hasentered into interest rate swap agreements, with remaining maturities of 12months to 60 months, to manage its exposure to interest rate movements on aportion 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 andis recognized in earnings when the term of the swap agreement is concluded.

 
| **(Dollars in Thousands)**                                                 |   | **Interest Rate  Swap Agreement** |   |
|----------------------------------------------------------------------------|--------|-----------------------------------|--------|
|                                                                       |   |                              |   |
| Accumulated  other comprehensive income balance at December 31, 2002. |   | $                                 | — |   |
| Market  value increase on interest rate swap hedge contracts               |   | 581                               |   |
| Accumulated  other comprehensive income balance at June 30, 2003.     |   | $                                 | 581    |   |

 

The fair value of the HickoryTech’s derivativesat June 30, 2003 is a net asset of $985,000, which is included in otherassets in the accompanying condensed consolidated balance sheet.

 

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ITEM 2.     MANAGEMENT’S DISCUSSION ANDANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION.

 

#### **FORWARD-LOOKING STATEMENTS**

 

*Statements in this Form 10-Q that are not historical factare forward-looking statements that are based on management’s currentexpectations, estimates and projections about the industry in which HickoryTechoperates and management’s beliefs and assumptions. Such forward-lookingstatements are subject to important risks and uncertainties that could causeHickoryTech’s future actual results to differ materially from such statements.These statements are not guarantees of future performance and involve certainrisks, uncertainties and probabilities, which are difficult to predict.Therefore, actual outcomes and results may differ materially from what isexpressed or forecasted in such forward-looking statements, whether as a resultof new information, future events or otherwise.  Factors that might cause such a difference include, but are notlimited to, those contained in this “Management’s Discussion and Analysis”(Item 2) and Exhibit 99 (Cautionary Statement for Purposes of the “Safe Harbor”Provision of the Private Securities Litigation Reform Act of 1995) toHickoryTech’s Annual Report on Form 10-K for the year ended December 31,2002, 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**

 

HickoryTechoperates in three business segments: the Telecom, Information Solutions andEnterprise Solutions Sectors. Its largest and oldest business (since 1898) hasbeen the operation of incumbent local exchange carriers (ILECs) or traditionalwireline telephone service. The ILEC business is in HickoryTech’s TelecomSector. In 1998, HickoryTech began its competitive local exchange carrier(CLEC) line of business, competing for the telephone dial tone, data and longdistance calling business in other ILECs’ territories. CLEC is in HickoryTech’sTelecom Sector. HickoryTech also began its wireless operations in 1998 byacquiring its first wholly-owned wireless service license, an additionalwireless service license in 1999 and two PCS licenses in 2001. These wirelessoperations, combined with ILEC and CLEC, form HickoryTech’s Telecom Sector.Since 1964, HickoryTech’s Information Solutions Sector has provided computerdata processing and software, predominantly for HickoryTech’s Telecom Sectoroperations and also to other telecommunications companies. HickoryTech acquiredits Enterprise Solutions Sector in 1990 and it has operated as a leadingtelecommunications and data equipment distributor from a base in Minneapolis/St.Paul, Minnesota.

 

**THE COMPANY**

 

The eightsubsidiaries of HickoryTech, all of which publicly operate and conduct businessas HickoryTech, and the business segments in which they operate are:

 

**TELECOM SECTOR**

Mankato CitizensTelephone Company (MCTC)

Mid-Communications,Inc. (Mid-Comm)

HeartlandTelecommunications Company of Iowa, Inc. (Heartland)

Cable Network,Inc. (CNI)

CrystalCommunications, Inc. (Crystal)

Minnesota SouthernWireless Company (MSWC)

**INFORMATION SOLUTIONS SECTOR**

NationalIndependent Billing, Inc. (NIBI)

**ENTERPRISE SOLUTIONS SECTOR**

CollinsCommunications Systems Co. (Collins)

 

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HickoryTech andits subsidiaries are engaged in businesses that provide services to theircustomers for a fee. Many of these services are repetitive and recurring, and,as a result, backlog orders and seasonality are not significant factors.Working capital requirements primarily involve the funding of the constructionand maintenance of telephone wireline and wireless fixed assets, the payrollcosts of highly skilled labor and the inventory to service its telephoneequipment customers.

 

The materials andsupplies that are necessary for the operation of the businesses of HickoryTechand its subsidiaries are available from a variety of sources, and no futuresupply problems are anticipated. All of HickoryTech’s ILEC and CLEC centraloffice switches and wireless switches, as well as a majority of HickoryTech’sequipment sold in its Enterprise Solutions Sector, are supplied by Nortel.Nortel is a leading supplier of communications equipment, and HickoryTech’sdependence on this brand is not viewed as a significant risk. An additionallayer of network infrastructure equipment for broadband services is provided byNextlevel. Nextlevel is a newer supplier of cutting edge communicationsequipment and the Company is monitoring the risk level of maintaining Nextlevelas a supplier in light of its recent affiliation as wholly owned subsidiary ofMotorola.

 

**INDUSTRY SEGMENTS**

 

*TELECOM SECTOR*

 

HickoryTech’sTelecom Sector provides local exchange wireline and wireless telephone service,long distance, dial-up Internet access and owns and operates fiber optic cablefacilities.  This sector includes threeincumbent local exchange carriers (ILECs): MCTC, Mid-Comm and Heartland.  MCTC and Mid-Comm provide telephone servicein south central Minnesota, specifically Mankato (a regional hub) and elevenrural communities surrounding Mankato. The third ILEC, Heartland, provides telephone service for eleven ruralcommunities in northwest Iowa.

 

TheTelecom Sector also includes Crystal, a competitive local exchange carrier(CLEC). Crystal provides local telephone service, long distance and dial-upInternet access on a competitive basis. Crystal has customers in eight rural communities in Minnesota and sixrural communities in Iowa that are not in HickoryTech’s ILEC service areas.

 

HickoryTechalso owns and operates fiber optic cable facilities (CNI) in Minnesota, whichare used to transport interexchange communications as a service to telephoneindustry customers.  HickoryTech’sMinnesota ILECs and its CLEC are the primary users of the fiber optic cablefacilities.

 

TheTelecom Sector also owns and operates a wireless telephone business in south centralMinnesota. The wireless telephone business consists of the “A-side” FCCwireless license to operate in Minnesota’s Rural Service Area  10 (RSA 10), the Minneapolis/St. Paul MetroA-2 (Metro A-2) wireless license and two digital personal communicationsservices (PCS) licenses covering the Minnesota Basic Trading Areas (BTAs) ofMankato-Fairmont and Rochester-Austin-Albert Lea.

 

MCTCderives its principal revenues and income from local services charged tosubscribers in its service area, access services charged to interexchangecarriers and the operation of a toll tandem switching center in Mankato,Minnesota. Revenues and income for Mid-Comm are also derived from local servicecharges in its area of operation and by providing access to long distance servicesfor its subscribers through the toll center in Mankato. Local and interexchangetelephone access for the two companies is provided on an integrated basis. Thelocal and interexchange telephone access for both telephone companies utilizethe same facilities and equipment and is managed and maintained by a commonwork force. Heartland derives its principal revenues and income from localservices charged to subscribers in its service area in Iowa, as well as fromproviding interexchange access for its subscribers. Interexchange telephoneaccess is provided by all three of HickoryTech’s telephone subsidiaries byconnecting the communications networks of interexchange and wireless carrierswith the equipment and facilities of end users through its switched networks orprivate lines.

 

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MCTCand Mid-Comm are Minnesota public utilities operating pursuant to indeterminatepermits issued by the Minnesota Public Utilities Commission. Heartland is alsoa public utility, which operates pursuant to a certificate of publicconvenience and necessity issued by the Iowa Utilities Board. These stateagencies regulate the services provided by MCTC, Mid-Comm and Heartland.  CNI’s operations are not subject toregulation by the state regulatory authority. Neither the Minnesota Public Utilities Commission nor the Iowa UtilitiesBoard regulates the rate of return or profits of each of HickoryTech’s ILECoperations. MCTC’s and Mid-Comm’s local service rates are below those of mostMinnesota ILECs. Regardless of whether a particular rate is subject toregulatory review, the ability of HickoryTech and its subsidiaries to changerates will be determined by various factors, including economic and competitivecircumstances.

 

Aslocal exchange telephone companies, MCTC, Mid-Comm and Heartland provide endoffice switching and dedicated circuits to long distance interexchangecarriers. These relationships allow HickoryTech’s telephone subscribers toplace long distance telephone calls and gain access to the telephonenetwork.  HickoryTech provides longdistance access for all of the individual customers who select an alternativelong distance carrier.  The longdistance interexchange carriers are significant customers of HickoryTech, butno carrier represents more than ten percent of HickoryTech’s consolidatedrevenues.

 

Alternativesto HickoryTech service include customers leasing private line switched voiceand data services in or adjacent to the territories served by HickoryTech,which permits the bypassing of local telephone switching facilities. Inaddition, microwave transmission services, wireless communications, fiber opticand coaxial cable deployment and other services provided by other companiespermit bypass of the local exchange network. These alternatives to localexchange service represent a potential threat to HickoryTech’s long-termability to provide local exchange service at economical rates.

 

Competitionin HickoryTech’s ILEC service area exists in one of Heartland’s exchanges. Inthe city of Hawarden, Iowa, the municipal city government overbuilt the city’stelephone service infrastructure and is providing an alternative toHickoryTech’s telephone service. The Hawarden CLEC has acquired approximately1,000 access lines, or approximately 60%, of that community’s telephonebusiness from HickoryTech. HickoryTech management does not believe there willbe significant further impact from competition in Hawarden. HickoryTechresponds to competitive changes with active programs to market products and toengineer its infrastructure for higher customer satisfaction.

 

Competitionalso exists for some of the services provided to interexchange carriers, suchas customer billing services, dedicated private lines, and network switching. Thiscompetition comes primarily from the interexchange carriers themselves. Theprovision of these services is of a contractual nature and is primarilycontrolled by the interexchange carriers. Other services, such as directoryadvertising and wireless communications, are open to competition.  Competition is based primarily on serviceand experience.

 

Thepassage of the 1996 Telecommunications Act created the opportunity forHickoryTech to offer communications service in territories served by othertelephone companies, and Crystal began operations in January 1998 as a newcompetitive local exchange carrier (CLEC). Crystal offers local service, longdistance and dial-up Internet access services on a competitive basis tocustomers in southern Minnesota and Iowa, which are not served by HickoryTech’sTelecom Sector service area. These service offerings provide customersalternatives to the incumbent telephone carrier in various communities and areoffered under the brand name HickoryTech wireline service. These services arecurrently offered to customers in eight rural communities in Minnesota, as wellas six rural communities in Iowa. Crystal’s primary strategy is to provideservice by overbuilding with new telecommunications switching networks andtelephone lines. Crystal also provides the long distance service and dial-upInternet access services to HickoryTech’s subscribers in both ILEC and CLECmarkets.

 

CLEC activities require Crystal to file forauthority to operate with the appropriate public utilities commission in eachstate it serves. Crystal competes directly against existing ILECs in the areasin which Crystal operates. Crystal is not dependent upon any single customer orsmall group of customers. No one customer in Crystal accounts for ten percent ormore of HickoryTech’s consolidated revenues.

 

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HickoryTech,through its subsidiary MSWC, owns and operates wireless telephone businesses insouth central Minnesota and in the Minneapolis/St. Paul area. In south centralMinnesota, MSWC provides wireless service for Minnesota’s Rural Service Area 10(RSA 10), under the brand name of HickoryTech Wireless. This business is inHickoryTech’s Telecom Sector.  Thissector owns 100% of the  “A-side” FCCwireless license to operate in seven counties in south central Minnesota. Thearea overlaps and is larger than HickoryTech’s Minnesota ILEC and CLEC serviceareas and serves a population of approximately 230,000. This sector also ownsthe Minneapolis/St. Paul Metro A-2 (Metro A-2) wireless license, which wasacquired on June 1, 1999. The Metro A-2 property surrounds themetropolitan Minneapolis/St. Paul area and is located in five Minnesotacounties and in one Wisconsin county. Metro A-2 provides service to an area witha population of approximately 170,000. In addition, this sector also owns thePCS licenses for the Minnesota BTAs of Mankato-Fairmont andRochester-Austin-Albert Lea. The two BTAs are located in 16 Minnesota countiesand one Iowa county and provide service to an area with a population ofapproximately 493,000, some of which coincide with the previously mentionedwireless RSA 10 population of 230,000.

 

MSWC,which owns all four of the Company’s FCC wireless licenses, derives itsprincipal revenues and income from providing wireless telephone service to theretail customers in seven counties in south central Minnesota and from wirelessroaming traffic. MSWC also derives roaming revenue from the six countiessurrounding the metropolitan Minneapolis/St. Paul Metro A-2 area and roamingrevenues from the PCS service territory that is comprised of 17 counties. MSWCdirectly competes against local wireless and PCS companies in southernMinnesota.

 

REGULATED INDUSTRY

 

ILEC Minnesota -HickoryTech’s two Minnesota ILEC subsidiaries continue to operate under analternative form of regulation as defined in Minnesota Chapter 237, wherebycompanies with less than 50,000 customers are regulated on price and servicelevel rather than profit. The Minnesota PUC has been considering intrastateaccess reform for several years; however, no formal action has been initiated.HickoryTech cannot estimate the impact, if any, of future potential stateaccess revenue changes.

 

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

 

CLEC - HickoryTech’sCLEC companies operate in Minnesota and Iowa with less regulatory oversightthan the HickoryTech ILEC companies.

 

Wireline InterState-The HickoryTech ILEC companies do not participate in the NECA trafficsensitive pool and set access rates according to a nationwide average cost ofproviding access. This biannual rate process was recently completed 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 FCC October 2001 order (a/k/aMAG Plan). Funds collected are pooled, and HickoryTech revenues are based onsettlements distributed from the pool. Pool settlements are adjusted from timeto time. HickoryTech’s CLEC access rates are established in accordance with theFCC’s April 2001 order and no further changes are known at the presenttime.

 

Wireless –HickoryTech’s wireless business is subject to regulation by the FCC includingrules governing the construction and operation of wireless communicationsystems and licensing and technical standards for provision of wirelesscommunication services. The FCC has refrained from rate regulation of wirelesscommunications services, but retains its statutory authority to impose suchregulation. The FCC ordered wireless carriers to be able to pool telephonenumbers by November 2003. Further, the FCC has ordered that wirelesscarriers implement Local Number Portability (LNP) by November 24, 2003. Anindustry challenge of the FCC’s order in federal District Court was rejected inJune 2003. HickoryTech expects to comply with the FCC’s wireless numberportability mandate to the extent it becomes legally obligated to do so.Accordingly, at this time, the Company cannot fully quantify the effects ofimplementing wireless number portability on its communication operations.

 

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*INFORMATION SOLUTIONS SECTOR*

 

Through NIBI,HickoryTech’s Information Solutions Sector provides data processing and relatedservices, principally for HickoryTech, other local exchange telephonecompanies, CLECs, interexchange network carriers, wireless companies,municipalities and utilities. The Information Solutions Sector’s principalactivity is the provision of monthly batch processing of computerized data forHickoryTech as well as non-affiliated companies. Services for telephone companycustomers include the processing of long distance telephone calls from datasources and telephone switches, the preparation of the subscriber telephonebills, customer record keeping, carrier access bills and general accounting andpayroll services. NIBI, under the brand name HickoryTech Information Solutions,also provides certain billing clearinghouse functions for interexchangecarriers.

 

There are a numberof companies engaged in supplying data processing services comparable to thosefurnished by the Information Solutions Sector. Competition is based primarilyon price and service. HickoryTech’s Information Solutions Sector has developedan integrated billing and management system called SuiteSolution. For internaluse, SuiteSolution enables HickoryTech to become a full-service billingprovider for all aspects of the telecommunications industry on a fullyintegrated basis. For external use, SuiteSolution can provide wireline orwireless carriers the individual benefits of a billing platform, or tointegrated service providers, such as HickoryTech, a total system solution.SuiteSolution was implemented in the Company’s CLEC businesses in 2002 and inthe Company’s wireless business in the second quarter of 2003.

 

*ENTERPRISE SOLUTIONS SECTOR*

 

ThroughCollins, HickoryTech’s Enterprise Solutions Sector provides telephone and dataequipment sales and services as well as the sale, installation and service ofvoice over Internet Protocol business systems to companies primarily based inmetropolitan Minneapolis/St. Paul, Minnesota. This sector also supports thebusiness telephone system service for HickoryTech ILEC and CLEC operations insouthern Minnesota and Iowa. The customers in the Enterprise Solutions Sector’smarket are the individual business end users of telecommunications service withongoing service requirement offerings. Products consist of telecommunicationplatforms such as Nortel on the voice side of the Enterprise Solutions’business, and Cisco and Bay Networks (Nortel) equipment on the data side of itsbusiness. Enterprise Solutions specializes in the quality custom installationand maintenance of wide area networking, local networking and transportsolutions in telecommunications for end user customers.

 

Revenues areprimarily earned by the sales, installation and service of business telephonesystems. Enterprise Solutions continues its commitment to service and supportof its core product, Nortel, while identifying new opportunities such as callcenters, computer telephone integration voice mail and interactive voiceresponse systems.

 

HickoryTech’sEnterprise Solutions Sector is not dependent upon any single customer or smallgroup of customers. No one customer in the Enterprise Solutions Sector accountsfor ten percent or more of HickoryTech’s consolidated revenues.

 

There are companies competing in theequipment sales and service and voice over Internet Protocol communicationsproducts market in which Enterprise Solutions operates. Competition is basedprimarily on price and service. No one company is dominant in this field.Enterprise Solutions offers customer premises telephone and data equipmentthrough well-trained and experienced market representatives with long-termcustomer relationships. Enterprise Solutions has built a strong base of solidcustomers with ongoing needs and Enterprise Solutions’ goal is to derive 60-70%of its recurring revenue from sales to its existing customer base. TheEnterprise Solutions Sector’s activities are focused on the sale, installationand service of business telephone systems and data communications equipment tocompanies based in metropolitan Minneapolis/St. Paul, Minnesota.  This sector also supports the businesstelephone system service for HickoryTech’s ILEC and CLEC operations inMinnesota and Iowa.

 

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**RESULTSOF OPERATIONS**

 

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 operatingrevenues were $26,840,000, which is $1,349,000 or 5.3% higher in the threemonths ended June 30, 2003 compared to the three months endedJune 30, 2002. Consolidated operating revenues were $53,810,000, which is$3,207,000 or 6.3% higher in the six months ended June 30, 2003 comparedto the six months ended June 30, 2002. The revenue increase in 2003 wasprimarily attributable to a higher volume of business in the Telecom Sector andan increase in revenue in the Enterprise Solutions Sector. The Telecom Sectorincreases can be primarily attributed to the increase in the CLEC customer baseand the result of services provided under terms of a multi-year contractawarded to HickoryTech effective July 1, 2002 to provide Internet accessand video conferencing to schools and libraries in south central Minnesotaserved by the Project SOCRATES distance-learning network, and due to increasedbroadband data service lines installed. Two major reasons for the increase inthe Enterprise Solutions Sector are the completion of the installation of avoice over Internet Protocol network in a corporate office, which was begun in2002, and the installation of a voice over Internet Protocol network on a largecollege campus.

 

COST OF SALES, ENTERPRISESOLUTIONS - Cost of sales, which is related to the EnterpriseSolutions Sector was $2,550,000 which is $517,000 or 25.4% higher in the threemonths ended June 30, 2003 compared to the three months endedJune 30, 2002. Cost of sales was $5,069,000, which is $852,000 or 20.2%higher in the six months ended June 30, 2003 compared to the six monthsended June 30, 2002. Gross profit margin for this sector in the three andsix months ended June 30, 2003 was 24.6% and 30.5%, respectively comparedto 33.1% and 34.1% for the three and six months ended June 30, 2002,respectively. The increase in the cost of sales is the result of higher costsassociated with volume of business in the Enterprise Solutions Sector.

 

OPERATING EXPENSES (excluding Depreciationand Amortization) - Operating expenses excludingdepreciation and amortization was $14,013,000, which is $277,000 or 1.9% lowerin the three months ended June 30, 2003 compared to the three months endedJune 30, 2002. Operating expenses excluding depreciation and amortizationwas $28,449,000, which is $873,000 or 3.2 % higher in the six months ended June 30,2003 compared to the six months ended June 30, 2002. The decrease inexpenses in the second quarter of 2003 is primarily due to bad debt expense inthe Telecom Sector.  $1,082,000 more baddebt was recorded in the first six months of 2002 compared to the same periodin 2003, due in large part to bankruptcies of interexchange carriers in thetelecommunications industry. The decrease in bad debt was partially offset byincreased expenses in the Telecom Sector related to the growth in CLECcustomers and the costs associated with Project Socrates, a distance-learningnetwork that provides Internet access and video conferencing to schools andlibraries in south central Minnesota. The increase in operating expenses forthe six months ended June 30, 2003 compared to the same period in 2002were mainly attributed to the increased costs associated with CLEC customergrowth and Project Socrates, as previously described. Initiatives aimed atmaintaining low operating expenses have also been helpful in keeping labor andnetwork expenses from rising significantly in 2003.

 

DEPRECIATION ANDAMORTIZATION - Depreciation expense was $4,364,000, which is$433,000 or 11.0% higher in the three months ended June 30, 2003 comparedto the three months ended June 30, 2002. Depreciation expense was$8,526,000, which is $782,000 or 10.1% higher in the six months endedJune 30, 2003 compared to the six months ended June 30, 2002.Increases in the Telecom Sector’s network assets primarily account for theincrease in depreciation expense. Amortization expense was $199,000, which is$181,000 or 47.6% lower in the three months ended June 30, 2003 comparedto the three months ended June 30, 2002. Amortization expense was$525,000, which is $216,000 or 29.1% lower in the six months endedJune 30, 2003 compared to the six months ended June 30, 2002. Thedecrease in amortization expense was largely due to Wireless assets that hadbeen amortized for a portion of 2002 and were written off per SFAS 142 at theend of 2002.  Therefore, there was noamortization for these assets in 2003. In addition, an intangible asset in theInformation Solutions Sector became fully amortized in the second quarter of2003.

 

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OPERATING INCOME -Operating income was $5,714,000, which is $857,000 or 17.6% higher in the threemonths ended June 30, 2003 compared to the three months endedJune 30, 2002. Operating income was $11,241,000, which is $916,000 or 8.9%higher in the six months ended June 30, 2003 compared to the six monthsended June 30, 2002. The increase in operating income was largely due toincreased CLEC revenues and decreased bad debts in the Telecom Sector andincreased revenues in the Enterprise Solutions Sector, which were offset by theincrease in operating expenses in the Telecom Sector and the increase in thecost of sales of the Enterprise Solutions Sector, all of which are describedabove.

 

INTEREST EXPENSE -Interest expense decreased $378,000 or 20.3% to $1,480,000 in the three monthsended June 30, 2003 compared to the three months ended June 30, 2002.Interest expense decreased $769,000 or 20.2% to $3,045,000 in the six monthsended June 30, 2003 compared to the six months ended June 30, 2002.The decrease in interest expense for the period was primarily due to a decreasein the weighted average interest rate on HickoryTech’s revolving creditfacility from 4.4% on June 30, 2002 to 3.9% on June 30, 2003 and adecrease in total debt outstanding. The outstanding balance of the revolvingcredit facility was $145,250,000 at June 30, 2003 and $163,500,000 atJune 30, 2002.

 

INCOME TAXES – Theeffective income tax rate of approximately 41% in all periods presented exceedsthe federal statutory rate primarily due to state income taxes.

 

NET INCOME -Consolidated net income was $2,510,000, which is $708,000 or 39.3% higher inthe three months ended June 30, 2003 compared to the three months endedJune 30, 2002. Consolidated net income was $4,857,000, which is $965,000or 24.8% higher in the six months ended June 30, 2003 compared to the sixmonths ended June 30, 2002. The increases were due to the increase in theoperating revenues of the Telecom and Enterprise Solutions Sectors as well asthe decrease in bad debts in the Telecom Sector, which were partially offset byincreases in the Telecom Sector operating expenses and Enterprise SolutionsSector cost of sales, as described above.

 

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SECTOR RESULTS OF OPERATIONS

 

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

 

**TELECOMSECTOR**

 
|                                                     |   | **For Three Months Ended** |       | **For Six Months Ended** |       |
|----------------------------------------------------------|--------|----------------------------|------------|--------------------------|------------|
| **(Dollars  in Thousands)**                              |   | **6/30/2003**              |       | **6/30/2002**            |       | **6/30/2003** |   | **6/30/2002** |   |
|                                                     |   |                       |       |                     |       |   |   |   |   |
| Revenues  Before Intersegment Eliminations               |   |                       |       |                     |       |   |   |   |   |
| ILEC                                                     |   |                       |       |                     |       |   |   |   |   |
| Local  Service                                           |   | **$**                      | **3,770**  |                     | $          | 3,757 | ** ** | **$** | **7,569** |   | $ | 7,559 |   |
| Network  Access                                          |   | **8,407**                  |       | 7,991                    | ** ** | **16,731** |   | 16,058 |   |
| Intersegment                                             |   | **68**                     |       | 69                       | ** ** | **137** |   | 137 |   |
| Other                                                    |   | **2,128**                  |       | 2,331                    | ** ** | **4,390** |   | 4,658 |   |
| Total  ILEC                                              |   | **14,373**                 |       | 14,148                   | ** ** | **28,827** |   | 28,412 |   |
|                                                     |   |                       |       |                     |       |   |   |   |   |
| CLEC                                                     |   |                       |       |                     |       |   |   |   |   |
| Local  Service                                           |   | **928**                    |       | 697                      | ** ** | **1,836** |   | 1,396 |   |
| Other                                                    |   | **1,496**                  |       | 796                      | ** ** | **2,802** |   | 1,456 |   |
| Total  CLEC                                              |   | **2,424**                  |       | 1,493                    | ** ** | **4,638** |   | 2,852 |   |
|                                                     |   |                       |       |                     |       |   |   |   |   |
| Long  Distance                                           |   | **1,001**                  |       | 987                      | ** ** | **2,029** |   | 1,900 |   |
|                                                     |   |                       |       |                     |       |   |   |   |   |
| Internet                                                 |   | **950**                    |       | 883                      | ** ** | **1,891** |   | 1,730 |   |
|                                                     |   |                       |       |                     |       |   |   |   |   |
| Wireless                                                 |   |                       |       |                     |       |   |   |   |   |
| Service                                                  |   | **2,754**                  |       | 2,500                    | ** ** | **5,201** |   | 4,834 |   |
| Home  Roaming                                            |   | **263**                    |       | 280                      | ** ** | **437** |   | 474 |   |
| Roaming                                                  |   | **951**                    |       | 1,183                    | ** ** | **1,723** |   | 2,057 |   |
| Total  Wireless                                          |   | **3,968**                  |       | 3,963                    | ** ** | **7,361** |   | 7,365 |   |
|                                                     |   |                       |       |                     |       |   |   |   |   |
| Total  Telecom Revenues                                  |   | **$**                      | **22,716** |                     | $          | 21,474 | ** ** | **$** | **44,746** |   | $ | 42,259 |   |
|                                                     |   |                       |       |                     |       |   |   |   |   |
| Total  Telecom Revenues Before Intersegment Eliminations |   |                       |       |                     |       |   |   |   |   |
| Unaffiliated  Customers                                  |   | **$**                      | **22,648** |                     | $          | 21,405 | ** ** | **$** | **44,609** |   | $ | 42,122 |   |
| Intersegment                                             |   | **68**                     |       | 69                       | ** ** | **137** |   | 137 |   |
|                                                     |   | **22,716**                 |       | 21,474                   | ** ** | **44,746** |   | 42,259 |   |
|                                                     |   |                       |       |                     |       |   |   |   |   |
| Operating  Expenses, excluding Depr. and Amort.          |   | **11,509**                 |       | 11,808                   | ** ** | **23,250** |   | 22,545 |   |
| Depreciation  and Amortization                           |   | **3,908**                  |       | 3,669                    | ** ** | **7,753** |   | 7,207 |   |
| Operating  Income                                        |   | **$**                      | **7,299**  |                     | $          | 5,997 | ** ** | **$** | **13,743** |   | $ | 12,507 |   |
|                                                     |   |                       |       |                     |       |   |   |   |   |
| Net  Income                                              |   | **$**                      | **4,312**  |                     | $          | 3,541 | ** ** | **$** | **8,085** |   | $ | 7,354 |   |

 

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|                                                                     |   | **For Three Months Ended** |       | **For Six Months Ended** |       |
|--------------------------------------------------------------------------|--------|----------------------------|------------|--------------------------|------------|
| **(Dollars  in Thousands)**                                              |   | **6/30/2003**              |       | **6/30/2002**            |       | **6/30/2003** |   | **6/30/2002** |   |
|                                                                     |   |                       |       |                     |       |   |   |   |   |
| Operating  Income                                                        |   | **$**                      | **7,299**  |                     | $          | 5,997 | ** ** | **$** | **13,743** |   | $ | 12,507 |   |
| Depreciation  and Amortization                                           |   | **3,908**                  |       | 3,669                    | ** ** | **7,753** |   | 7,207 |   |
| Earnings  Before Interest, Taxes, Depreciation and Amortization (EBITDA) |   | **$**                      | **11,207** |                     | $          | 9,666 | ** ** | **$** | **21,496** |   | $ | 19,714 |   |
|                                                                     |   |                       |       |                     |       |   |   |   |   |
| Capital  Expenditures                                                    |   | **$**                      | **2,602**  |                     | $          | 5,136 | ** ** | **$** | **3,974** |   | $ | 7,923 |   |
|                                                                     |   |                       |       |                     |       |   |   |   |   |
| ILEC  Access Lines                                                       |   | **62,367**                 |       | 63,985                   |       |   |   |   |   |
|                                                                     |   |                       |       |                     |       |   |   |   |   |
| CLEC  Access Lines                                                       |   |                       |       |                     |       |   |   |   |   |
| Overbuild                                                                |   | **9,036**                  |       | 6,846                    |       |   |   |   |   |
| Unbundled  Network Element (UNE)                                         |   | **1,338**                  |       | 1,217                    |       |   |   |   |   |
| Total  Service Resale (TSR)                                              |   | **4,162**                  |       | 4,366                    |       |   |   |   |   |
| Total                                                                    |   | **14,536**                 |       | 12,429                   |       |   |   |   |   |
|                                                                     |   |                       |       |                     |       |   |   |   |   |
| Long  Distance Customers                                                 |   | **35,667**                 |       | 26,723                   |       |   |   |   |   |
|                                                                     |   |                       |       |                     |       |   |   |   |   |
| Internet  Customers                                                      |   | **15,307**                 |       | 13,643                   |       |   |   |   |   |
|                                                                     |   |                       |       |                     |       |   |   |   |   |
| Wireless  Customers                                                      |   | **25,961**                 |       | 25,806                   |       |   |   |   |   |
|                                                                     |   |                       |       |                     |       |   |   |   |   |
| Total  Telecom Customers                                                 |   | **153,838**                |       | 142,586                  |       |   |   |   |   |
|                                                                     |   |                       |       |                     |       |   |   |   |   |
| DSL  Customers                                                           |   | **5,691**                  |       | 2,775                    |       |   |   |   |   |

 

TelecomSector operating revenues before intersegment eliminations were $22,716,000,which is $1,242,000 or 5.8% higher in the three months ended June 30, 2003compared to the three months ended June 30, 2002. Telecom Sector operatingrevenues before intersegment eliminations were $44,746,000, which is $2,487,000or 5.9% higher in the six months ended June 30, 2003 compared to the sixmonths ended June 30, 2002. The increases in 2003 compared to 2002 wereprimarily due to increased ILEC network access, growth in the CLEC, LongDistance and Internet service revenues as well as, increased wireless servicerevenue, partially offset by a decrease in roaming revenue.

 

ILEC network access revenue was $8,407,000,which is $416,000 or 5.2% higher in the three months ended June 30, 2003compared to the three months ended June 30, 2002. ILEC network accessrevenue was $16,731,000, which is $673,000 or 4.2% higher in the six monthsended June 30, 2003 compared to the six months ended June 30, 2002.The increase in network access revenue in 2003 compared to 2002 was driven byhigher demand for dedicated lines and high-speed circuits. HickoryTech does notbelong to any NECA traffic sensitive access revenue reimbursement pools, butinstead, establishes access rates bi-annually following nationwide averages ofproviding access. The rates were adjusted as of July 2003 and HickoryTechexpects an additional revenue increase somewhere in a range of $750,000 to$1,000,000 for the six months ending December 31, 2003.

 

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CLEC local servicerevenue was $928,000, which is $231,000 or 33.1% higher in the three monthsended June 30, 2003 compared to the three months ended June 30, 2002.CLEC local service revenue was $1,836,000, which is $440,000 or 31.5% higher inthe six months ended June 30, 2003 compared to the six months endedJune 30, 2002. CLEC access lines increased 2,107 or 17.0% betweenJune 30, 2002 and June 30, 2003, which was the primary reason for theincrease. In order to align itself with the company strategy of being afacilities-based telecommunications provider, HickoryTech has decided to exit severalexchanges in its Iowa territories, which utilized a resale of servicesapproach. Approximately 1,400 customers will be affected by this plan and willhave their service revert to the incumbent ILEC in the third quarter of 2003.HickoryTech expects revenues to decrease by about $40,000 over the remainder ofthe year from the loss of these customers, but expects expenses to decreaseabout $50,000 for the same period. In addition, to coincide with this move,HickoryTech has already taken steps to consolidate its Minnesota and Iowaoperations including having the Mankato location handle all call centeractivities for Minnesota and Iowa.

 

Other CLEC revenue was$1,496,000 which is $700,000 or 87.9% higher in the three months endedJune 30, 2003 compared to the three months ended June 30, 2002. OtherCLEC revenue was $2,802,000, which is $1,346,000 or 92.4% higher in the sixmonths ended June 30, 2003compared to the six months ended June 30, 2002. Other revenue includednetwork access, high-speed data revenues and digital TV, which generally grewalong with the increase in access lines in 2003 compared to 2002. Anotherreason for the increase in other revenue in 2003 was the additional $736,000 ofrevenue recognized as a result of services provided under terms of a multi-yearcontract awarded to HickoryTech effective July 1, 2002 to provide Internetaccess and video conferencing to schools and libraries in south centralMinnesota served by the Project SOCRATES distance-learning network.

 

Longdistance revenue was $1,001,000, which is $14,000 or 1.4% higher in the threemonths ended June 30, 2003 compared to the three months endedJune 30, 2002. Long distance revenue was $2,029,000, which is $129,000 or6.8% higher in the six months ended June 30, 2003 compared to the six monthsended June 30, 2002. HickoryTech experienced an 8,944 or 33.5% increase inits long distance customer base between June 30, 2002 and June 30,2003. Although the customer base is increasing, revenue per customer isdecreasing. The decrease in revenue per customer is primarily the result ofoptional long distance services available to customers, the increased use ofInternet services and other alternatives to long distance services. Also, acompetitor of HickoryTech recently 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 a reductionin long distance revenue in future periods.

 

Internet revenue was $950,000, which is$67,000 or 7.6% higher in the three months ended June 30, 2003 compared tothe three months ended June 30, 2002. Internet revenue was $1,891,000,which is $161,000 or 9.3% higher in the six months ended June 30, 2003compared to the six months ended June 30, 2002. The increase in revenuewas caused primarily by an increase in Internet customers of 1,664 or 12.2%between June 30, 2002 and June 30, 2003. In addition to the increasein customers, Internet revenue increased due to a migration of Internetcustomers from low-price introductory rate plans to mid-range full-serviceInternet packages.

 

Wirelessservice revenue was $2,754,000, which is $254,000 or 10.2% higher in the threemonths ended June 30, 2003 compared to the three months endedJune 30, 2002. Wireless service revenue was $5,201,000, which is $367,000or 7.6% higher in the six months ended June 30, 2003 compared to the sixmonths ended June 30, 2002. The increase in service revenue was primarilythe result of increased equipment revenue and an increase in the averagerevenue per subscriber.

 

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Wireless roaming revenue was $951,000, whichis $232,000 or 19.6% lower in the three months ended June 30, 2003compared to the three months ended June 30, 2002. Wireless roaming revenuewas $1,723,000, which is $334,000 or 16.2% lower in the six months endedJune 30, 2003 compared to the six months ended June 30, 2002. Roamingminutes from other wireless carriers’ customers traveling into HickoryTech’swireless service territory have declined from historical levels, particularlydue to technological changes among other wireless providers, which re-route theroaming minutes from HickoryTech’s wireless service towers to other providers.Other PCS wireless carriers have continued to build-out PCS licenses to carrytheir own customers’ traffic rather than pay roaming to HickoryTech. Inaddition, certain carriers have negotiated lower roaming rates withHickoryTech, further eroding the roaming revenue. However, in the secondquarter of 2003 an agreement was made between HickoryTech and a major wirelesscarrier. Starting in mid-June, HickoryTech’s wireless network will carry theroaming traffic of this major wireless carrier. HickoryTech utilizes the TDMA(Time Division Multiple Access) technology platform for its wireless network.It is generally recognized in the industry that in the future, TDMA technologywill eventually be replaced with either GSM (Global Standard for MobileTelecommunications) or CDMA (Code Division Multiple Access) technology as thestandard wireless operating platform. While Hickorytech currently enjoys a partnershipwith a major wireless carrier using the TDMA technology, this partnership mayhave lower revenue impacts with the gradual customer migration to GSM or CDMAtechnology. HickoryTech is currently exploring all options available regardingpartnering with other GSM or CDMA carriers in the future.

 

Operatingexpenses excluding depreciation and amortization were $11,509,000, which is$299,000 or 2.5% lower in the three months ended June 30, 2003 compared tothe three months ended June 30, 2002. Operating expenses excludingdepreciation and amortization were $23,250,000, which is $705,000 or 3.1%higher in the six months ended June 30, 2003 compared to the six monthsended June 30, 2002. In the second quarter of 2002, HickoryTech recorded a$1,058,000 additional allowance for doubtful accounts due in large part tobankruptcies of interexchange carriers in the telecommunications industry.  If not for this amount, operating expensesexcluding depreciation and amortization would have been $759,000 or 7.1% higherin the three months ended June 30, 2003 and $1,763,000 or 8.2% higher inthe six months ended June 30, 2003 compared to the same periods in 2002.This increase in operating expenses was due primarily to the costs associatedwith the growth in CLEC customers and costs associated with Project SOCRATES, adistance-learning network that provides Internet access and video conferencingto schools and libraries in south central Minnesota.

 

Depreciation and amortization were$3,908,000, which is $239,000 or 6.5% higher in the three months endedJune 30, 2003 and $7,753,000, which is $546,000 or 7.6% higher in the sixmonths ended June 30, 2003 compared to the same periods in 2002.Depreciation expense was $3,883,000, which is $299,000 or 8.3% higher in thethree months ended June 30, 2003 and $7,728,000, which is $672,000 or 9.5%higher in the six months ended June 30, 2003 compared to the same periodsin 2002. The increase in depreciation expense can be largely attributed toincreased network infrastructure. Amortization expense was $25,000, which is$60,000 or 70.1% lower in the three months ended June 30, 2003 compared tothe three months ended June 30, 2002. Amortization expense was $25,000,which is $126,000 or 83.4% lower in the six months ended June 30, 2003compared to the six months ended June 30, 2002. The decrease inamortization expense can be largely attributed to Wireless assets that werebeing amortized in 2002 but were written off per SFAS 142 at the end of 2002(see Note 5).

 

Total operating expenses were $15,417,000,which is $60,000 or 0.4% lower in the three months ended June 30, 2003compared to the three months ended June 30, 2002. Total operating expenseswere $31,003,000, which is $1,251,000 or 4.2% higher in the six months endedJune 30, 2003 compared to the six months ended June 30, 2002 for thereasons described in the preceding two paragraphs.

 

Operating income was $7,299,000, which is$1,302,000 or 21.7% higher in the three months ended June 30, 2003compared to the three months ended June 30, 2002. Operating income was$13,743,000, which is $1,236,000 or 9.9% higher in the six months endedJune 30, 2003 compared to the six months ended June 30, 2002. Netincome was $4,312,000, which is $771,000 or 21.8% higher in the three monthsended June 30, 2003 compared to the three months ended June 30, 2002.Net income was $8,085,000, which is $731,000 or 9.9% higher in the six monthsended June 30, 2003 compared to the six months ended June 30, 2002.These increases were for the reasons described above.

 

22

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Earnings before Interest, Taxes, Depreciationand Amortization were $11,207,000, which is $1,541,000 or 15.9% higher in thethree months ended June 30, 2003 compared to the three months ended June 30.Earnings before Interest, Taxes, Depreciation and Amortization were$21,496,000, which is $1,782,000 or 9.0% higher in the six months endedJune 30, 2003 compared to the six months ended June 30. EBITDAmargins (i.e. EBITDA divided by revenues) for this sector were 49.3% and 48%for the three and six months ended June 30, 2003. The combination ofrevenues increasing $1,242,000 and the decline in operating expenses mentionedabove resulted in the increased EBITDA. EBITDA represents a non-GAAP financialmeasure. HickoryTech defines EBITDA as operating income/(loss) excludingdepreciation and amortization expense. A reconciliation of EBITDA to theoperating income is included in the preceding table. EBITDA, which is not ameasure of financial performance or liquidity under generally acceptedaccounting principles, is provided because management believes that EBITDA is auseful supplement to operating income/(loss) and other statements of operationsdata in understanding HickoryTech’s ability to service and/or incurindebtedness and is useful in measuring the performance and relative value ofHickoryTech’s business.  Because of thevariety of methods used by companies and analysts to calculate EBITDA, and thefact that EBITDA calculations may not accurately measure a company’sprofitability or its ability to meet debt service requirements, caution shouldbe used in relying on any EBITDA presentation. EBITDA should not be consideredas an indicator of operating performance or whether cash flows will be sufficientto fund cash needs.

 

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

 

**INFORMATIONSOLUTIONS SECTOR**

 
|                                                                            |   | **For Three Months Ended** |       | **For Six Months Ended** |       |
|---------------------------------------------------------------------------------|--------|----------------------------|------------|--------------------------|------------|
| **(Dollars in Thousands)**                                                      |   | **6/30/2003**              |       | **6/30/2002**            |       | **6/30/2003** |   | **6/30/2002** |   |
| Revenues Before Eliminations                                                    |   |                       |       |                     |       |   |   |   |   |
| Unaffiliated Customers                                                          |   | **$**                      | **809**    |                     | $          | 1,049 | ** ** | **$** | **1,907** |   | $ | 2,083 |   |
| Intersegment                                                                    |   | **975**                    |       | 944                      | ** ** | **1,948** |   | 1,859 |   |
|                                                                            |   | **1,784**                  |       | 1,993                    | ** ** | **3,855** |   | 3,942 |   |
| Operating Expenses, excluding Depr. and Amort.                                  |   | **1,931**                  |       | 2,042                    | ** ** | **3,997** |   | 4,006 |   |
| Depreciation and Amortization                                                   |   | **581**                    |       | 519                      | ** ** | **1,125** | ** ** | 1,029 |   |
|                                                                            |   |                       |       |                     |       |   | ** ** |   |   |
| Operating Loss                                                                  |   | **$**                      | **(728**   | **)**                    | $          | (568 | ) | **$** | **(1,267** | **)** | $ | (1,093 | ) |
| Net Loss                                                                        |   | **$**                      | **(483**   | **)**                    | $          | (370 | ) | **$** | **(856** | **)** | $ | (722 | ) |
|                                                                            |   |                       | ** ** |                     |       |   | ** ** |   |   |
| Operating Loss                                                                  |   | **$**                      | **(728**   | **)**                    | $          | (568 | ) | **$** | **(1,267** | **)** | $ | (1,093 | ) |
| Depreciation and Amortization                                                   |   | **581**                    | ** ** | 519                      |       | **1,125** | ** ** | 1,029 |   |
| Earnings (Loss) Before Interest, Taxes,  Depreciation and Amortization (EBITDA) |   | **$**                      | **(147**   | **)**                    | $          | (49 | ) | **$** | **(142** | **)** | $ | (64 | ) |
|                                                                            |   |                       | ** ** |                     |       |   | ** ** |   |   |
| Capital Expenditures                                                            |   | **$**                      | **—** | ** **               | $          | 686 | ** ** | **$** | **144** | ** ** | $ | 1,208 |   |

 

Operating revenues from unaffiliatedcustomers decreased $240,000 or 22.9% to $809,000 in the three months endedJune 30, 2003 compared to the three months ended June 30, 2002.Operating revenues from unaffiliated customers decreased $176,000 or 8.4% to$1,907,000 in the six months ended June 30, 2003 compared to the sixmonths ended June 30, 2002. The decrease in operating revenues in thethree months ended June 30, 2003 compared to the three and six months endedJune 30, 2002 can be largely attributed to a few customers who haveexperienced a significant decrease in the volume processed.

 

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Operating expenses excluding depreciation andamortization decreased $111,000 or 5.4% to $1,931,000 in the three months endedJune 30, 2003 compared to the three months ended June 30, 2002.Operating expenses excluding depreciation and amortization decreased $9,000 or0.2% to $3,997,000 in the six months ended June 30, 2003 compared to the sixmonths ended June 30, 2002.  Thedecreases in operating expenses primarily reflect decreases in variable costsas volumes declined during these periods.

 

Depreciationand amortization expense increased $62,000 or 11.9% to $581,000 in the threemonths ended June 30, 2003 compared to the three months endedJune 30, 2002. Depreciation and amortization expense increased $96,000 or9.3% to $1,125,000 in the six months ended June 30, 2003 compared to thesix months ended June 30, 2002. These net increases primarily relate toamortization of costs of new billing software.

 

Totaloperating expenses decreased $49,000 to $2,512,000 in the three months endedJune 30, 2003 compared to the three months ended June 30, 2002 andincreased $87,000 to $5,122,000 in the six months ended June 30, 2003compared to the six months ended June 30, 2002 for the reasons describedin the preceding two paragraphs.

 

Operating loss increased $160,000 or 28.2% inthe three months ended June 30, 2003 compared to the three months ended June 30,2002 and $174,000 or 15.9% in the six months ended June 30, 2003 comparedto the six months ended June 30, 2002. Net loss increased $113,000 or30.5% in the three months ended June 30, 2003 compared to the three monthsended June 30, 2002 and $134,000 or 18.6% in the six months endedJune 30, 2003 compared to the six months ended June 30, 2002. Theincrease in operating loss and net loss was primarily attributable to thedecline in revenues combined with the increase in depreciation and amortizationdiscussed above.

 

Earnings (Loss) before Interest, Taxes,Depreciation and Amortization (EBITDA) decreased $98,000 to ($147,000) in thethree months ended June 30, 2003 compared to the three months endedJune 30, 2002 and decreased $78,000 to ($142,000) in the six months ended June 30, 2003compared to the six months ended June 30, 2002. The EBITDA margin (i.e.EBITDA divided by revenues) for this sector was (8.2%) in the three monthsended June 30, 2003 compared to (2.5%) in the three months endedJune 30, 2002. The EBITDA margin for this sector was (3.7%) in the sixmonths ended June 30, 2003 compared to (1.6%) in the six months endedJune 30, 2002. The decrease in EBITDA and the EBITDA margin was primarilydue to decreased operating revenues. EBITDA represents a non-GAAP financialmeasure. HickoryTech defines EBITDA as operating income/(loss) excludingdepreciation and amortization expense. A reconciliation of EBITDA to operatingloss is included in the preceding table. EBITDA, which is not a measure of financialperformance or liquidity under generally accepted accounting principles, isprovided because management believes that EBITDA is a useful supplement tooperating income/(loss) and other statements of operations data inunderstanding HickoryTech’s ability to service and/or incur indebtedness and isuseful in measuring the performance and relative value of HickoryTech’sbusiness. Because of the variety of methods used by companies and analysts tocalculate EBITDA, and the fact that EBITDA calculations may not accuratelymeasure a company’s profitability or its ability to meet debt servicerequirements, caution should be used in relying on any EBITDA presentation.EBITDA should not be considered as an indicator of operating performance orwhether cash flows will be sufficient to fund cash needs.

 

24

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

 

**ENTERPRISESOLUTIONS SECTOR**

 
|                                                                            |   | **For Three Months Ended** |       | **For Six Months Ended** |       |
|---------------------------------------------------------------------------------|--------|----------------------------|------------|--------------------------|------------|
| **(Dollars  in Thousands)**                                                     |   | **6/30/2003**              |       | **6/30/2002**            |       | **6/30/2003** |   | **6/30/2002** |   |
| Revenues  Before Intersegment Eliminations                                      |   |                       |       |                     |       |   |   |   |   |
| Installation                                                                    |   | **$**                      | **1,677**  |                     | $          | 1,260 | ** ** | **$** | **3,635** |   | $ | 2,656 |   |
| Service                                                                         |   | **1,706**                  |       | 1,777                    | ** ** | **3,659** |   | 3,742 |   |
|                                                                            |   | **3,383**                  |       | 3,037                    | ** ** | **7,294** |   | 6,398 |   |
| Cost  of Sales                                                                  |   | **2,550**                  |       | 2,033                    | ** ** | **5,069** |   | 4,217 |   |
| Operating  Expenses, excluding Depr. and Amort.                                 |   | **1,331**                  |       | 1,238                    | ** ** | **2,588** |   | 2,496 |   |
| Depreciation  and Amortization                                                  |   | **60**                     |       | 66                       | ** ** | **121** |   | 136 |   |
|                                                                            |   |                       |       |                     |       |   | ** ** |   |   |
| Operating  Loss                                                                 |   | **$**                      | **(558**   | **)**                    | $          | (300 | ) | **$** | **(484** | **)** | $ | (451 | ) |
| Net  Loss                                                                       |   | **$**                      | **(334**   | **)**                    | $          | (187 | ) | **$** | **(295** | **)** | $ | (286 | ) |
|                                                                            |   |                       | ** ** |                     |       |   | ** ** |   |   |
| Operating  Loss                                                                 |   | **$**                      | **(558**   | **)**                    | $          | (300 | ) | **$** | **(484** | **)** | $ | (451 | ) |
| Depreciation  and Amortization                                                  |   | **60**                     | ** ** | 66                       |       | **121** | ** ** | 136 |   |
| Earnings  (Loss) Before Interest, Taxes, Depreciation and Amortization (EBITDA) |   | **$**                      | **(498**   | **)**                    | $          | (234 | ) | **$** | **(363** | **)** | $ | (315 | ) |
|                                                                            |   |                       | ** ** |                     |       |   | ** ** |   |   |
| Capital  Expenditures                                                           |   | **$**                      | **97**     | ** **               | $          | 15 | ** ** | **$** | **189** | ** ** | $ | 55 |   |

 

Operatingrevenues increased $346,000 or 11.4% to $3,383,000 in the three months endedJune 30, 2003 compared to the three months ended June 30, 2002 andincreased $896,000 or 14% to $7,294,000 in the six months ended June 30,2003 compared to the six months ended June 30, 2002. Installation revenuewas $417,000 or 33.1% higher in the three months ended June 30, 2003compared to the three months ended June 30, 2002 and $979,000 or 36.9%higher in the six months ended June 30, 2003 compared the six months endedJune 30, 2002. The increase in installation revenues in the three monthsended June 30, 2003 was****primarilya result of an increase in sales and installations of PBX systems of $469,000while the increase in installation revenues in the six months endedJune 30, 2003 was also primarily a result of an increase in sales andinstallations of PBX systems of $742,000. Installations of a voice overInternet Protocol networks were performed in a corporate office and on a largecollege campus in Minnesota during the first six months of 2003. Servicerevenue decreased****$71,000 or 4% to$1,706,000 in the three months ended June 30, 2003 compared to the threemonths ended June 30, 2002 and $83,000 or 2.2% to $3,659,000 in the sixmonths ended June 30, 2003 compared to the six months ended June 30,2002.

 

Cost of sales increased $517,000 or 25.4% to $2,550,000 in the threemonths ended June 30, 2003 compared to the three months endedJune 30, 2002 and increased $852,000 or 20.2% to $5,069,000 in the sixmonths ended June 30, 2003 compared to the six months ended June 30,2002. Gross profit margin for this sector in the three and six months endedJune 30, 2003 was 24.6% and 30.5%, respectively compared to 33.1% and34.1% for the three and six months ended June 30, 2002, respectively. Theincrease in cost of sales was the result of the increased installation workdescribed above.

 

Operating expenses excluding depreciation and amortization increased$93,000 or 7.5% to $1,331,000 in the three months ended June 30, 2003compared to the three months ended June 30, 2002 and increased $92,000 or3.7% to $2,588,000 in the six months ended June 30, 2003 compared to thesix months ended June 30, 2002. Depreciation and amortization decreased$6,000 or 9.1% in the three months ended June 30, 2003 compared to thethree months ended June 30, 2003 and decreased $15,000 or 11% in the sixmonths ended June 30, 2003 compared to the six months ended June 30,2002.

 

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Total operating expenses increased $87,000 to $1,391,000 in the threemonths ended June 30, 2003 compared to the three months endedJune 30, 2002 and $77,000 to $2,709,000 in the six months endedJune 30, 2003 compared to the six months ended June 30, 2002 for thereasons described in the preceding two paragraphs.

 

Operating loss was $558,000 in the three months endedJune 30, 2003 compared to an operating loss of $300,000 in the threemonths ended June 30, 2002.****Operatingloss was $484,000 in the six months ended June 30, 2003 compared to anoperating loss of $451,000 in the six months ended June 30, 2002. Net lossin the three months ended June 30, 2003 was $334,000 compared to a netloss of $187,000 in the three months ended June 30, 2002. Net loss in thesix months ended June 30, 2003 was $295,000 compared to a net loss of$286,000 in the six months ended June 30, 2002. The operating and netlosses generated in the three and six months ended June 30, 2003 comparedto the three and six months ended June 30, 2002 occurred for the reasonsdescribed above.

 

Earnings (Loss) before Interest, Taxes,Depreciation and Amortization decreased $264,000****or****112.8% to($498,000) in the three months ended June 30, 2003 compared to the threemonths ended June 30, 2002 and decreased $48,000****or****15.2% to($363,000) in the six months ended June 30, 2003 compared to the sixmonths ended June 30, 2002. The EBITDA margin (i.e. EBITDA divided byrevenues) for this sector was (14.7%) in the three months ended June 30,2003 compared to****(7.7%) in thethree months ended June 30, 2002.****TheEBITDA margin for this sector was (5%) in the six months ended June 30,2003 compared to****(4.9%) in the sixmonths ended June 30, 2002. The changes in EBITDA and the EBITDA marginwere primarily due to the increase in operating losses. EBITDA represents anon-GAAP financial measure. HickoryTech defines EBITDA as operatingincome/(loss) excluding depreciation and amortization expense. A reconciliationof operating loss to EBITDA is included in the preceding table. EBITDA, whichis not a measure of financial performance or liquidity under generally acceptedaccounting principles, is provided because management believes that EBITDA is auseful supplement to operating income/(loss) and other statements of operationsdata in understanding HickoryTech’s ability to service and/or incurindebtedness and is useful in measuring the performance and relative value ofHickoryTech’s business.  Because of thevariety of methods used by companies and analysts to calculate EBITDA, and thefact that EBITDA calculations may not accurately measure a company’sprofitability or its ability to meet debt service requirements, caution shouldbe used in relying on any EBITDA presentation. EBITDA should not be considered as an indicator of operating performanceor whether cash flows will be sufficient to fund cash needs.

 

LIQUIDITY AND CAPITAL RESOURCES

 

CASH FLOWS – Cashprovided by operations was $15,890,000 in the first six months of 2003 comparedto $16,569,000 in the first six months of 2002.  Cash flows from operations in the first six months of 2003 and2002 were primarily attributable to net income plus non-cash expenses fordepreciation and amortization and a decrease in receivables, partially offsetby decreases in accounts payable related to timing of payments.  The decrease in cash flows from operationsin the first six months of 2003 relative to the same period in 2002 wasprimarily due to a $1,327,000 decrease in the change in accounts payable andaccrued expenses due to timing of payment differences, a $1,170,000 decrease inthe change in the provision for losses on accounts receivable which was adirect result of carrier bankruptcies in 2002 being charged against thereserve, and a $1,082,000 decrease in the change in the billings and costs oncontracts associated with Enterprise Solution contracts with a large Minnesotacollege of $790,000 and a large specialty retailer of $500,000.  These decreases were partially offset by a$965,000 increase in the change in net income, a $607,000 increase in thechange in other assets and a $566,000 increase in the change in depreciation andamortization which was the result of normal asset addition increases across thecompany when comparing the first six months of 2003 relative to the same periodin 2002.

 

Cash flows used in investing activities were$287,000 in the first six months of 2003 compared to cash flows used of$9,041,000 for the same period in 2002. Capital expenditures relating toongoing businesses were $4,460,000 during the first six months of 2003 ascompared to $9,325,000 for the same period in 2002. In 2002, capitalexpenditures were incurred primarily to construct additional network facilitiesto provide CLEC services and continued buildout of the PCS network in theTelecom Sector. In addition, there were $4,100,000 redemptions of investmentsin the first six months of 2003, compared to $100,000 in the first six monthsof 2002.  The first six months of 2003redemption reflects the amount by which HickoryTech was permitted to reduce itsequity investment in one of its lenders, through conditions of its debtagreements.

 

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Cash flows used in financing activities were$16,333,000 for the first six months of 2003 compared to $8,801,000 for thefirst six months of 2002.  Included incash flows from financing activities are debt repayments and dividendpayments.   HickoryTech made payments onits revolving credit facility of $14,000,000 during the first six months of2003, and $8,000,000 during the first six months of 2002.  HickoryTech borrowed $1,250,000 on itsrevolving credit facility during the first six months of 2003, and $1,500,000during the first six months of 2002. Dividend payments for the first six monthsof 2003 were $3,074,000 compared to $3,078,000 for the same period in2002.  During the first six months of2003, HickoryTech also repurchased 53,300 common shares for $519,000. Inaddition, HickoryTech retired 18,370 for $185,000 from a stock compensationplan in the second quarter of 2003.

 

WORKING CAPITAL –Working capital (i.e. current assets minus current liabilities) was $11,348,000as of June 30, 2003, compared to working capital of $13,073,000 as ofDecember 31, 2002.  The ratio ofcurrent assets to current liabilities was 2.0:1.0 as of June 30, 2003 and1.9:1.0 as of December 31, 2002. Management believes adequate internal andexternal resources are available to finance ongoing operating requirements,including capital expenditures, business development, debt service and thepayment of dividends for at least the next twelve months.

 

LONG-TERM CONTRACTS, COMMITMENTS ANDOFF-BALANCE SHEET OBLIGATIONS - HickoryTech’slong-term obligations as of June 30, 2003 were $144,687,000, excludingcurrent maturities of $1,426,000. As of June 30, 2003, HickoryTech had a$182,500,000 credit facility with a syndicate of banks. The credit facility iscomprised of a $125,000,000 revolving credit component and a $57,500,000 termloan component. The available line of credit on the $125,000,000 revolvingcredit component decreases in increments beginning in March 2004 with afinal maturity date in September 2008. The term loan component requiresequal quarterly principal payments of $250,000 during the period ofMarch 2001 to December 2008, and $23,000,000 of principal paymentsper quarter for the first two quarters in 2009 and $6,000,000 in the thirdquarter of 2009. The weighted average interest rate associated with this creditfacility varies with LIBOR and certain other rates and was 3.9% atJune 30, 2003. HickoryTech has implemented fixed interest terms on variousportions of the overall debt outstanding for varying terms. The longest fixedinterest term, on $60,000,000 of the debt, is fixed until June 2008. As ofJune 30, 2003, HickoryTech had drawn $145,250,000 on this credit facilityand had $37,250,000 of available credit. Management believes the remaining availablecredit is sufficient to cover future cash requirements.

 

HickoryTech’s Information Solutions Sector leases certain computerequipment under capital lease arrangements. During the first two quarters of2003, this sector recorded additions to property, plant and equipment of$124,000 related to these capital lease arrangements.

 

The following table sets forth HickoryTech’scontractual obligations, along with the cash payments due each period:

 
|                                |   | **Payments Due by Year** |    |
|-------------------------------------|--------|--------------------------|---------|
| **(Dollars in Thousands)**          |   | **Total**                |    | **Remainder  of 2003** |   | **2004 to  2006** |   | **2007 to  2008** |   | **2009 and  after** |   |
| Contractual  Obligations            |   |                     |    |   |   |   |   |   |   |   |   |
| Long-term  Debt                     |   | $                        | 145,250 |   | $ | 500 |   | $ | 29,813 |   | $ | 62,937 |   | $ | 52,000 |   |
| Interest  on Long-term Debt         |   | 29,375                   |    | 2,891 |   | 16,731 |   | 8,522 |   | 1,231 |   |
| Capital  Lease Obligations          |   | 863                      |    | 186 |   | 677 |   | — |   | — |   |
| Interest  on Capital Leases         |   | 57                       |    | 20 |   | 37 |   | — |   | — |   |
| Operating  Leases                   |   | 3,785                    |    | 603 |   | 1,946 |   | 510 |   | 726 |   |
| Total  Contractual Cash Obligations |   | $                        | 179,330 |   | $ | 4,200 |   | $ | 49,204 |   | $ | 71,969 |   | $ | 53,957 |   |

 

Interest on Long-term Debt is estimated usingthe interest rate as of June 30, 2003.

 

27

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The total commitment to HickoryTech on itsrevolving credit facility expires as follows:

 
|                        |   | **Amount of Commitment Expiration  per Year** |    |
|-----------------------------|--------|-----------------------------------------------|---------|
| **(Dollars in Thousands)**  |   | **Total**                                     |    | **Remainder  of 2003** |   | **2004 to  2006** |   | **2007 to  2008** |   | **2009 and  after** |   |
| Revolving  Credit Component |   | $                                             | 125,000 |   | $ | — |   | $ | 64,063 |   | $ | 60,937 |   | $ | — |   |
|                             |        |                                               |         |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

OTHER - HickoryTechoperates with original equity capital, retained earnings and recent additionsto indebtedness in the form of bank term and revolving lines of credit.HickoryTech believes its current level of debt to total capital is acceptablefor ongoing operations.

 

HickoryTech accounts for derivativeinstruments in accordance with SFAS No. 133, as amended, “Accounting forDerivative Instruments and Hedging Activities,” which requires derivativeinstruments to be recorded on the balance sheet at fair value. Changes in fairvalue of derivative instruments must be recognized in earnings unless specifichedge accounting criteria are met. HickoryTech has met those criteria with itscash flow hedge and SFAS. No. 133 states that they must recognize gains andlosses in other comprehensive income rather than in earnings. HickoryTech’sadoption of SFAS No. 133 resulted in a reduction in income of $10,000, net oftax, reported as interest expenses and an increase in comprehensive income ofapproximately $581,000, net of tax, for the three and six months endedJune 30, 2003.

 

HickoryTech still uses some variable interestrate financial instruments as of June 30, 2003. HickoryTech continuallymonitors the interest rates on its bank loans and has implemented fixedinterest terms on various portions of the overall debt outstanding for varyingterms.  A lower level of interestexpense is likely to occur because of a trend of reducing levels of debt andpotentially lower weighted average interest rates.

 

In November 2002, HickoryTech beganrepurchasing its stock in over-the-counter trading under a previously announcedrepurchase plan.  HickoryTech funds therepurchase of its stock from cash flows from operations.  During the three months ended June 30,2003, HickoryTech purchased 37,200 common shares for $358,000.  During the six months ended June 30,2003, HickoryTech purchased 53,300 shares for $519,000. In addition,HickoryTech retired 18,370 shares for $185,000 from a stock compensation planin the second quarter of 2003.

 

CRITICAL ACCOUNTING POLICIES

 

This Form 10-Q is based upon HickoryTech’sconsolidated financial statements, which have been prepared in accordance withaccounting principles generally accepted in the United States of America (seeNote 1 of the notes to the financial statements included in this Form 10-Q)and, where applicable, conform to the accounting principles as prescribed byfederal and state telephone utility regulatory authorities. A description ofthe critical accounting policies adhered to by HickoryTech is contained in theManagement’s Discussion and Analysis of Financial Condition and Results ofOperations in HickoryTech’s Annual Report on Form 10-K for the year endedDecember 31, 2002.  There were nosignificant changes to these critical accounting policies during the quarterended June 30, 2003.

 

RECENT ACCOUNTING DEVELOPMENTS

 

In June 2001,the FASB issued SFAS No. 143, “Accounting for Asset Retirement Obligations.”SFAS No. 143 requires entities to record the fair value of the liability forlegal obligations associated with an asset retirement in the period in whichthe obligation is incurred. When the liability is initially recorded, theentity capitalizes the cost of the asset retirement obligation by increasingthe carrying amount of the related long-lived asset. Over time, the liabilityis accreted to its present value each period, and the capitalized cost isdepreciated over the useful life of the related asset.

 

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HickoryTech’sincumbent local exchange carrier companies (ILECs) follow the provisions ofSFAS No. 71, and therefore conform to the accounting principles as prescribedby the respective state public utilities commissions and other federal agenciesand, where applicable, accounting principles generally accepted in the UnitedStates of America. On December 20, 2002, the Federal CommunicationsCommission (FCC) notified carriers that they would not adopt SFAS No. 143 forregulatory accounting purposes.  AtJanuary 1, 2003, HickoryTech determined the amount of asset retirementobligations required to be recorded for its ILEC companies under the provisionsof SFAS No. 143 were not significant, and therefore the implementation of SFASNo. 143 on January 1, 2003 did not impact HickoryTech’s financial positionor results of operations.

 

HickoryTech’scompetitive local telephone companies (CLEC), Enterprise Solutions, andInformation Solutions also adopted SFAS No. 143 effective January 1, 2003.HickoryTech has determined that these companies do not have a material legalobligation to remove long-lived assets as described by SFAS No. 143, andaccordingly, adoption of SFAS No. 143 did not impact HickoryTech’s financialposition or results of operations.

 

HickoryTech alsoadopted the provisions of SFAS No. 143 for its wireless operations as ofJanuary 1, 2003. HickoryTech performed an analysis to identify allpotential Asset Retirement Obligations.  The legal obligations identifiedconsist of obligations to remediate leased property where cell sites arelocated. However, based upon HickoryTech’s experience and expectations, there issignificant uncertainty as to whether third parties that own these leasedproperties would enforce their remediation rights related to the sites. Therefore, pursuant to the provisions of SFAS No. 143, HickoryTech didnot record this potential asset retirement obligation upon adoption and willnot record an obligation until such time as the fair value of the obligationcan be reasonably estimated.

 

InApril 2002, the FASB issued SFAS No. 145, “Rescission of FASB StatementsNo. 4, 44, and 64, Amendment of FASB Statement No. 13, and TechnicalCorrections.” SFAS No. 145 rescinds FASB Statement No. 4, “Reporting Gains andLosses from Extinguishment of Debt,” and an amendment of that Statement, FASBStatement No. 64, “Extinguishments of Debt Made to Satisfy Sinking-FundRequirements.” SFAS No. 145 also rescinds FASB Statement No. 44, “Accountingfor Intangible Assets of Motor Carriers,” and amends FASB Statement No. 13,“Accounting for Leases.” HickoryTech adopted the provisions of SFAS No. 145 onJanuary 1, 2003.  Adoption of thisstandard had no impact on the financial statements presented in this Form 10-Q.

 

In June 2002, the FASB issued SFAS No. 146,“Accounting for Costs Associated with Exit or Disposal Activities,” whichreplaces Emerging Issues Task Force (EITF) Issue No. 94-3, “LiabilityRecognition for Certain Employee Termination Benefits and Other Costs to Exitan Activity (including Certain Costs Incurred in a Restructuring).” SFAS No.146 requires companies to recognize costs associated with exit or disposalactivities when they are incurred rather than at the date of a commitment to anexit or disposal plan. HickoryTech engaged in no activities in the three or sixmonths ended June 30, 2003 that are subject to the provisions of SFAS No.146.  Accordingly, the adoption of SFASNo. 146 did not impact HickoryTech’s financial position or results ofoperations.

 

In December 2002, the FASB issued SFASNo. 148, “Accounting for Stock-Based Compensation – Transition Disclosure – anamendment of SFAS No. 123” (SFAS No. 148). This Statement amends SFAS No. 123, “Accounting for Stock-BasedCompensation,” to provide alternative methods of transition for a voluntarychange to the fair value based method of accounting for stock-based employeecompensation.  In addition, thisStatement amends the disclosure requirements of SFAS No. 123 to requireprominent disclosures in both annual and interim financial statements about themethod of accounting for stock-based employee compensation and the effect ofthe method used on reported results. The provisions of SFAS No. 148 areeffective for financial statements for fiscal years ending afterDecember 15, 2002, and disclosure requirements shall be effective forinterim periods beginning after December 15, 2002.  The Company will continue to account forstock-based compensation to its employees and directors using the intrinsicvalue method prescribed by APB Opinion No. 25, and relatedinterpretations.  The Company adoptedthe provisions of SFAS No. 148 and has made certain disclosures required bySFAS No. 148 in the consolidated financial statements presented in this report.The adoption of SFAS No. 148 did not impact HickoryTech’s financial position orresults of operations.

 

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In November 2002, the FASB issuedInterpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements forGuarantees, Including Indirect Guarantees of Indebtedness of Others.”  This interpretation elaborates on thedisclosures required in financial statements concerning obligations undercertain guarantees.  It also clarifiesthe requirements related to the recognition of liabilities by a guarantor atthe inception of certain guarantees. The disclosure requirements of this interpretation were effective forHickoryTech on December 31, 2002 but did not require any additionaldisclosures.  The recognition provisionsof the interpretation are effective for HickoryTech in 2003 and are applicableonly to guarantees issued or modified after December 31, 2002.  The adoption of Interpretation No. 45 doesnot have a material impact on the financial position or results of operationsof HickoryTech.

 

In April 2003, the FASB issued SFAS No.149, “Amendment of Statement 133 on Derivative Instruments and HedgingActivities.” This statement amends and clarifies financial accounting andreporting for derivative instruments, including certain derivative instrumentsembedded in other contracts and for hedging activities under SFAS No. 133,“Accounting for Derivative Instruments and Hedging Activities.” SFAS No. 149 iseffective for certain contracts entered into or modified after June 30,2003. This standard is not expected to materially impact HickoryTech’sconsolidated financial position or results of operations.

 

ITEM 3. QUANTATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

HickoryTech does not have operations subject to risks of foreigncurrency fluctuations. HickoryTech does however, use derivative financialinstruments to manage exposure to interest rate fluctuations. HickoryTech’sobjectives for holding derivatives are to minimize the risks using the mosteffective 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 twelve months to sixty months to manage its exposure to interestrate movements on a portion of its variable rate debt obligations. Theeffective portion of the cumulative gain or loss on these derivativeinstruments is reported as a component of accumulated other comprehensiveincome in shareholder’s equity and is recognized in earnings when the term ofthe swap agreement is concluded. HickoryTech’s earnings are affected by changesin interest rates as a portion of its long-term debt has variable interestrates based on LIBOR. If interest rates for the portion of HickoryTech’slong-term debt based on variable rates had averaged 10% more for the entirequarter ended June 30, 2003, HickoryTech’s interest expense would haveincreased $100,000 for the three months ended June 30, 2003. If interestrates for the portion of HickoryTech’s long-term debt based on variable rateshad averaged 10% more for the entire six months ended June 30, 2003, HickoryTech’sinterest expense would have increased $213,000 for the six months endedJune 30, 2003. In case of a change of such magnitude, management may actto mitigate its exposure to the change by converting a portion of itsvariable-rate debt to fixed-rate debt.

 

ITEM 4.     CONTROLS AND PROCEDURES

 

HickoryTech carried out an evaluation under thesupervision and with the participation of our management, including our ChiefExecutive Officer (“CEO”) and Chief Financial Officer (“CFO”), of theeffectiveness of our disclosure controls and procedures as of June 30,2003, the end of the period covered by this report.  Disclosure controls and procedures are procedures that aredesigned with the objective of ensuring that information required to bedisclosed in our reports filed under the Securities Exchange Act of 1934, suchas this Form 10-Q, is recorded, processed, summarized and reported within thetime periods specified in the Securities and Exchange Commission’s rules andforms. Based on that evaluation, the CEO and CFO have concluded that thedisclosure controls and procedures are effective to satisfy the objectives forwhich they are intended. During the quarter ended June 30, 2003, there hasbeen no change in our internal control over financial reporting that hasmaterially affected or is reasonably likely to materially affect our internalcontrol over financial reporting.

 

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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.             Changesin Securities.

None

 

Item 3.             DefaultUpon Senior Securities.

None.

 

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

 

a.                     The annualshareholders’ meeting was held on April 14, 2003.

b.                    3 directorswere elected to serve three-year terms. The names of the directors elected atthe annual meeting and the applicable votes were as follows:

 
| **Director**     |   | **For**    |   | **Withheld** |   | **Broker  Nonvotes** |
|------------------|--------|------------|--------|--------------|--------|----------------------|
|             |   |       |   |         |   |                 |
| Myrita P. Craig  |   | 10,949,929 |   | 66,962       |   | None                 |
| Lyle T. Bosacker |   | 10,919,337 |   | 97,554       |   | None                 |
| John E. Duffy    |   | 10,951,360 |   | 65,261       |   | None                 |

 

 

Item 5.             OtherInformation.

 

None.

 

Item 6.             Exhibitsand Reports of Form 8-K.

 

(a)     Exhibits

 

Exhibit 31(a) Certification pursuant to rule13a-14(a) under the Exchange Act, as adopted pursuant to Section 302 of theSarbanes-Oxley Act of 2002

 

Exhibit 31(b) Certification pursuant to rule13a-14(a) under the Exchange Act, as adopted pursuant to Section 302 of theSarbanes-Oxley Act of 2002

 

Exhibit 32(a) Certification pursuant to 18U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of2002

 

Exhibit 32(b) Certification pursuant to 18U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of2002

 

(b)    HickoryTech filed a Form 8-Kon April 29, 2003 containing a press release announcing its first quarterconsolidated operating results.

 

HickoryTech filed a Form 8-K on May 30,2003 announcing a TDMA roaming agreement with a major wireless carrier.

 

HickoryTech filed a Form 8-K on June 17,2003 announcing it had effectively locked in on fixed interest rates on $100million of the company’s long-term debt.

 

HickoryTech filed a Form 8-K on June 27,2003 announcing the company’s improved expectations for the full year 2003earnings per share.

 

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SIGNATURES

 

Pursuant to the requirements of theSecurities Exchange Act of 1934, the registrant has duly caused this report tobe signed on its behalf by the undersigned, thereunto duly authorized.

 
| Dated: August 12, 2003 | 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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