**UNITED STATES**

**SECURITIESAND EXCHANGE COMMISSION**

**WASHINGTON,DC 20549**

 

**FORM 10-Q**

 
| **(Mark One)** |
|----------------|
| **ý**     | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934** |
| ** **     | ** ** |
| ** **     | **FOR THE QUARTERLY PERIOD ENDED September  30, 2005 OR** |
|           |   |
| **o**          | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934** |
| ** **     | ** ** |
| ** **     | **FOR THE TRANSITION PERIOD FROM**                         **TO**                          |

 

**Commissionfile number   0-13721**

 

**HICKORYTECH CORPORATION**

(Exact name of registrant asspecified in its charter)

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

** **

**221 EastHickory Street**

**Mankato,Minnesota 56002-3248**

(Address of principal executiveoffices and zip code)

 

**(800) 326-5789**

(Registrant’s telephone number,including area code)

 

 

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

 

Indicate by check mark whether the Registrant (1) has filed allreports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.      Yes  ý        No  o

 

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

 

The total number of shares of the registrant’s common stock outstandingas of September 30, 2005: 13,111,132.

 

 

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**HICKORY TECH CORPORATION**

September 30,2005

PART I.FINANCIAL INFORMATION

ITEM1.   FINANCIAL STATEMENTS.

CONSOLIDATEDSTATEMENTS OF OPERATIONS

(UNAUDITED)

 
| ** **                                                                             | ** ** | **For Three Months Ended** | ** ** | **For Nine Months Ended** | ** ** |
|----------------------------------------------------------------------------------------|------------|----------------------------|------------|---------------------------|------------|
| **(In Thousands Except Per Share  Amounts)**                                           | ** ** | **9/30/2005**              | ** ** | **9/30/2004**             | ** ** | **9/30/2005** | ** ** | **9/30/2004** | ** ** |
| OPERATING REVENUES:                                                                    |       |                       |       |                      |       |   |   |   |   |
| Telecom Sector                                                                         | ** ** | **$**                      | **18,383** | ** **                | $          | 18,918 |   | **$** | **57,014** | ** ** | $ | 57,191 |   |
| Information Solutions Sector                                                           | ** ** | **519**                    | ** ** | 574                       |       | **1,921** | ** ** | 2,219 |   |
| Enterprise Solutions Sector                                                            | ** ** | **3,402**                  | ** ** | 2,685                     |       | **11,745** | ** ** | 8,318 |   |
| TOTAL OPERATING REVENUES                                                               | ** ** | **22,304**                 | ** ** | 22,177                    |       | **70,680** | ** ** | 67,728 |   |
| COSTS AND EXPENSES:                                                                    |       |                       | ** ** |                      |       |   | ** ** |   |   |
| Cost of Sales, Enterprise Solutions                                                    | ** ** | **2,219**                  | ** ** | 1,855                     |       | **8,259** | ** ** | 5,660 |   |
| Cost of Services, excluding Depreciation  and Amortization                             | ** ** | **8,354**                  | ** ** | 8,378                     |       | **24,696** | ** ** | 24,857 |   |
| Selling, General and Administrative  Expenses, excluding Depreciation and Amortization | ** ** | **3,495**                  | ** ** | 3,490                     |       | **11,609** | ** ** | 10,772 |   |
| Depreciation                                                                           | ** ** | **3,544**                  | ** ** | 3,912                     |       | **11,588** | ** ** | 11,669 |   |
| Amortization of Intangibles                                                            | ** ** | **26**                     | ** ** | 237                       |       | **467** | ** ** | 710 |   |
| TOTAL COSTS AND EXPENSES                                                               | ** ** | **17,638**                 | ** ** | 17,872                    |       | **56,619** | ** ** | 53,668 |   |
| OPERATING INCOME                                                                       | ** ** | **4,666**                  | ** ** | 4,305                     |       | **14,061** | ** ** | 14,060 |   |
|                                                                                   | ** ** | ** **                 | ** ** |                      |       | ** ** | ** ** |   |   |
| OTHER INCOME/(EXPENSE):                                                                |       |                       | ** ** |                      |       |   | ** ** |   |   |
| Interest and Other Income                                                              | ** ** | **35**                     | ** ** | 10                        |       | **75** | ** ** | 44 |   |
| Interest Expense                                                                       | ** ** | **(1,124**                 | **)**      | (1,121                    | )          | **(3,128** | **)** | (3,448 | ) |
| TOTAL OTHER INCOME/(EXPENSE)                                                           | ** ** | **(1,089**                 | **)**      | (1,111                    | )          | **(3,053** | **)** | (3,404 | ) |
|                                                                                   |       |                       | ** ** |                      |       |   | ** ** |   |   |
| INCOME BEFORE INCOME TAXES                                                             | ** ** | **3,577**                  | ** ** | 3,194                     |       | **11,008** | ** ** | 10,656 |   |
| INCOME TAX PROVISION                                                                   | ** ** | **1,447**                  | ** ** | 1,292                     |       | **4,453** | ** ** | 4,310 |   |
| INCOME FROM CONTINUING OPERATIONS                                                      | ** ** | **2,130**                  | ** ** | 1,902                     |       | **6,555** | ** ** | 6,346 |   |
| DISCONTINUED OPERATIONS (Note 4)                                                       |       |                       | ** ** |                      |       |   | ** ** |   |   |
| Income/(Loss) from Operations of  Discontinued Component                               | ** ** | **37**                     | ** ** | (26                       | )          | **207** | ** ** | (125 | ) |
| Income Tax (Benefit)/Provision                                                         | ** ** | **15**                     | ** ** | (11                       | )          | **84** | ** ** | (51 | ) |
| INCOME/(LOSS) FROM DISCONTINUED OPERATIONS                                             | ** ** | **22**                     | ** ** | (15                       | )          | **123** | ** ** | (74 | ) |
| NET INCOME                                                                             | ** ** | **$**                      | **2,152**  | ** **                | $          | 1,887 |   | **$** | **6,678** | ** ** | $ | 6,272 |   |
|                                                                                   |       |                       | ** ** |                      |       |   | ** ** |   |   |
| Basic Earnings Per Share - Continuing  Operations:                                     | ** ** | **$**                      | **0.16**   | ** **                | $          | 0.15 |   | **$** | **0.50** | ** ** | $ | 0.49 |   |
| Basic Earnings Per Share - Discontinued  Operations:                                   | ** ** | **—**                 | ** ** | —                    |       | **0.01** | ** ** | (0.01 | ) |
| ** **                                                                             |       | **$**                      | **0.16**   | ** **                | $          | 0.15 |   | **$** | **0.51** | ** ** | $ | 0.48 |   |
| Dividends Per Share                                                                    | ** ** | **$**                      | **0.12**   | ** **                | $          | 0.11 |   | **$** | **0.36** | ** ** | $ | 0.33 |   |
| Basic Weighted Average Common Shares  Outstanding                                      | ** ** | **13,086**                 | ** ** | 12,991                    |       | **13,073** | ** ** | 12,978 |   |
|                                                                                   |       |                       | ** ** |                      |       |   | ** ** |   |   |
| Diluted Earnings Per Share - Continuing  Operations:                                   | ** ** | **$**                      | **0.16**   | ** **                | $          | 0.15 |   | **$** | **0.50** | ** ** | $ | 0.49 |   |
| Diluted Earnings Per Share - Discontinued  Operations:                                 | ** ** | **—**                 | ** ** | —                    |       | **0.01** | ** ** | (0.01 | ) |
| ** **                                                                             |       | **$**                      | **0.16**   | ** **                | $          | 0.15 |   | **$** | **0.51** | ** ** | $ | 0.48 |   |
| Weighted Average Common and Equivalent  Shares Outstanding                             | ** ** | **13,092**                 | ** ** | 13,016                    |       | **13,084** | ** ** | 13,008 |   |

 

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

 

1

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**HICKORY TECH CORPORATION**

September 30,2005

CONSOLIDATED BALANCE SHEETS

(UNAUDITED)

 
| **(In Thousands Except Share and  Per Share Amounts)**                    | ** ** | **9/30/2005** | ** **  | **12/31/2004** | ** ** |
|---------------------------------------------------------------------------|------------|---------------|-------------|----------------|------------|
| ASSETS                                                                    |       |          |        |           |       |
| CURRENT ASSETS:                                                           |       |          |        |           |       |
| Cash and Cash Equivalents                                                 | ** ** | **$**         | **546**     | ** **     | $          | 257 |   |
| Receivables, Net of Allowance for Doubtful  Accounts of $1,387 and $1,256 | ** ** | **9,805**     | ** **  | 9,892          |       |
| Income Taxes Receivable                                                   | ** ** | **—**    | ** **  | 204            |       |
| Costs in Excess of Billings on Contracts                                  | ** ** | **1,145**     | ** **  | 927            |       |
| Inventories, Net                                                          | ** ** | **3,101**     | ** **  | 3,182          |       |
| Deferred Income Taxes                                                     | ** ** | **1,430**     | ** **  | 1,430          |       |
| Prepaid Expenses                                                          | ** ** | **1,608**     | ** **  | 1,185          |       |
| Other                                                                     | ** ** | **962**       | ** **  | 1,214          |       |
| TOTAL CURRENT ASSETS                                                      | ** ** | **18,597**    | ** **  | 18,291         |       |
| INVESTMENTS                                                               | ** ** | **2,507**     | ** **  | 4,371          |       |
| PROPERTY, PLANT AND EQUIPMENT                                             | ** ** | **251,683**   | ** **  | 246,341        |       |
| Less ACCUMULATED DEPRECIATION                                             | ** ** | **137,835**   | ** **  | 131,649        |       |
| PROPERTY, PLANT AND EQUIPMENT, NET                                        | ** ** | **113,848**   | ** **  | 114,692        |       |
| OTHER ASSETS:                                                             |       |          | ** **  |           |       |
| Goodwill                                                                  | ** ** | **25,086**    | ** **  | 25,086         |       |
| Intangible Assets, Net                                                    | ** ** | **309**       | ** **  | 387            |       |
| Financial Derivative Instruments                                          | ** ** | **3,324**     | ** **  | 2,501          |       |
| Deferred Costs and Other                                                  | ** ** | **2,347**     | ** **  | 3,209          |       |
| TOTAL OTHER ASSETS                                                        | ** ** | **31,066**    | ** **  | 31,183         |       |
| TOTAL ASSETS                                                              | ** ** | **$**         | **166,018** | ** **     | $          | 168,537 |   |
|                                                                      |       |          | ** **  |           |       |
| LIABILITIES &  SHAREHOLDERS’ EQUITY                         |       |          | ** **  |           |       |
| CURRENT LIABILITIES:                                                      |       |          | ** **  |           |       |
| Cash Overdraft                                                            | ** ** | **$**         | **—**  | ** **     | $          | 1,680 |   |
| Accounts Payable                                                          | ** ** | **2,076**     | ** **  | 4,065          |       |
| Accrued Expenses                                                          | ** ** | **3,910**     | ** **  | 3,202          |       |
| Accrued Interest                                                          | ** ** | **75**        | ** **  | 76             |       |
| Accrued Income Taxes                                                      | ** ** | **4,727**     | ** **  | —         |       |
| Billings in Excess of Costs on Contracts                                  | ** ** | **243**       | ** **  | 260            |       |
| Advanced Billings and Deposits                                            | ** ** | **2,478**     | ** **  | 2,898          |       |
| Current Maturities of Long-Term Obligations                               | ** ** | **1,451**     | ** **  | 5,323          |       |
| TOTAL CURRENT LIABILITIES                                                 | ** ** | **14,960**    | ** **  | 17,504         |       |
| LONG-TERM OBLIGATIONS, Net of Current  Maturities                         | ** ** | **94,035**    | ** **  | 97,661         |       |
| DEFERRED INCOME TAXES                                                     | ** ** | **15,536**    | ** **  | 15,270         |       |
| DEFERRED REVENUE AND EMPLOYEE BENEFITS                                    | ** ** | **6,937**     | ** **  | 6,557          |       |
| TOTAL LIABILITIES                                                         | ** ** | **131,468**   | ** **  | 136,992        |       |
| COMMITMENTS AND CONTINGENCIES (Note 9)                                    | ** ** | **—**    | ** **  | —         |       |
| SHAREHOLDERS’ EQUITY:                                                |       |          | ** **  |           |       |
| Common Stock, no par value, $.10 stated  value                            |       |          | ** **  |           |       |
| Shares authorized: 100,000,000                                            |       |          | ** **  |           |       |
| Shares outstanding: 13,111,132 in 2005 and  13,057,106 in 2004            | ** ** | **1,311**     | ** **  | 1,306          |       |
| Additional Paid-In Capital                                                | ** ** | **9,146**     | ** **  | 8,615          |       |
| Retained Earnings                                                         | ** ** | **22,093**    | ** **  | 20,119         |       |
| Accumulated Other Comprehensive Income                                    | ** ** | **2,000**     | ** **  | 1,505          |       |
| TOTAL SHAREHOLDERS’ EQUITY                                           | ** ** | **34,550**    | ** **  | 31,545         |       |
| TOTAL LIABILITIES & SHAREHOLDERS’  EQUITY                   | ** ** | **$**         | **166,018** | ** **     | $          | 168,537 |   |

 

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

 

2

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**HICKORY TECH CORPORATION**

September 30,2005

CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

 
| ** **                                                  | ** ** | **For Nine Months Ended** | ** ** |
|-------------------------------------------------------------|------------|---------------------------|------------|
| **(Dollars In Thousands)**                                  | ** ** | **9/30/2005**             | ** ** | **9/30/2004** | ** ** |
| CASH FLOWS FROM OPERATING ACTIVITIES:                       |       |                      |       |   |   |
| Net Income                                                  | ** ** | **$**                     | **6,678**  | ** ** | $ | 6,272 |   |
| Adjustments to Reconcile Net Income to Net                  |       |                      | ** ** |   |   |
| Cash Provided by Operating Activities:                      |       |                      | ** ** |   |   |
| Depreciation and Amortization                               | ** ** | **12,055**                | ** ** | 12,379 |   |
| (Gain)/Loss on Sale of Assets                               | ** ** | **12**                    | ** ** | 95 |   |
| Stock-Based Compensation                                    | ** ** | **67**                    | ** ** | 78 |   |
| Employee Retirement Benefits and Deferred  Compensation     | ** ** | **462**                   | ** ** | 696 |   |
| Accrued Patronage Refunds                                   | ** ** | **(287**                  | **)**      | (279 | ) |
| Provision for Losses on Accounts Receivable                 | ** ** | **215**                   | ** ** | 521 |   |
| Changes in Operating Assets and  Liabilities:               |       |                      | ** ** |   |   |
| Receivables                                                 | ** ** | **4,741**                 | ** ** | 6,135 |   |
| Inventories                                                 | ** ** | **81**                    | ** ** | 207 |   |
| Billings and Costs on Contracts                             | ** ** | **(235**                  | **)**      | 517 |   |
| Accounts Payable and Accrued Expenses                       | ** ** | **(1,283**                | **)**      | (1,782 | ) |
| Advance Billings and Deposits                               | ** ** | **(420**                  | **)**      | (139 | ) |
| Deferred Revenue and Employee Benefits                      | ** ** | **(82**                   | **)**      | (157 | ) |
| Other                                                       | ** ** | **354**                   | ** ** | 942 |   |
| Net Cash Provided By Operating Activities                   | ** ** | **22,358**                | ** ** | 25,485 |   |
|                                                        |       |                      | ** ** |   |   |
| CASH FLOWS FROM INVESTING ACTIVITIES:                       |       |                      | ** ** |   |   |
| Additions to Property, Plant and Equipment                  | ** ** | **(10,136**               | **)**      | (9,111 | ) |
| Redemption of Investments                                   | ** ** | **2,100**                 | ** ** | 2,600 |   |
| Purchase of Intangible Asset                                | ** ** | **—**                | ** ** | (9 | ) |
| Proceeds from Sale of Assets                                | ** ** | **46**                    | ** ** | 53 |   |
| Net Cash Used In Investing Activities                       | ** ** | **(7,990**                | **)**      | (6,467 | ) |
|                                                        |       |                      | ** ** |   |   |
| CASH FLOWS FROM FINANCING ACTIVITIES:                       |       |                      | ** ** |   |   |
| Change in Cash Overdraft                                    | ** ** | **(1,680**                | **)**      | (1,001 | ) |
| Payments of Capital Lease Obligations                       | ** ** | **(414**                  | **)**      | (479 | ) |
| Repayments on Credit Facility                               | ** ** | **(12,750**               | **)**      | (15,250 | ) |
| Borrowings on Credit Facility                               | ** ** | **5,000**                 | ** ** | 2,000 |   |
| Proceeds from Issuance of Common Stock                      | ** ** | **469**                   | ** ** | 356 |   |
| Dividends Paid                                              | ** ** | **(4,704**                | **)**      | (4,281 | ) |
| Stock Repurchase/Retirement                                 | ** ** | **—**                | ** ** | (43 | ) |
| Net Cash Used In Financing Activities                       | ** ** | **(14,079**               | **)**      | (18,698 | ) |
|                                                        |       |                      | ** ** |   |   |
| NET INCREASE (DECREASE) IN CASH AND CASH  EQUIVALENTS       | ** ** | **289**                   | ** ** | 320 |   |
|                                                        |       |                      | ** ** |   |   |
| CASH AND CASH EQUIVALENTS AT BEGINNING OF  PERIOD           | ** ** | **257**                   | ** ** | 278 |   |
|                                                        |       |                      | ** ** |   |   |
| CASH AND CASH EQUIVALENTS AT END OF PERIOD                  | ** ** | **$**                     | **546**    | ** ** | $ | 598 |   |
|                                                        |       |                      | ** ** |   |   |
| SUPPLEMENTAL DISCLOSURE OF CASH FLOW  INFORMATION:          |       |                      | ** ** |   |   |
| Cash Paid for Interest                                      | ** ** | **$**                     | **3,259**  | ** ** | $ | 3,531 |   |
| Cash Paid (Refunded) for Income Taxes                       | ** ** | **$**                     | **(332**   | **)** | $ | (1,745 | ) |
|                                                        |       |                      | ** ** |   |   |
| NON-CASH INVESTING ACTIVITIES:                              |       |                      | ** ** |   |   |
| Property, Plant and Equipment Acquired with  Capital Leases | ** ** | **$**                     | **666**    | ** ** | $ | 81 |   |

 

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

 

3

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**HICKORYTECH CORPORATION**

**SEPTEMBER 30,2005**

**PART 1.FINANCIAL INFORMATION**

 

**ITEM 1. NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

NOTE 1. BASIS OFPRESENTATION

 

The accompanyingunaudited condensed consolidated financial statements have been prepared inaccordance with generally accepted accounting principles for interim financialinformation and with the instructions to Form 10-Q and Article 10 ofRegulation S-X. Accordingly, they do not include all of the informationnecessary for a fair statement of results of operations, financial position,and cash flows in conformity with accounting principles generally accepted inthe United States of America. In the opinion of management, the condensedconsolidated financial statements reflect all adjustments (consisting only ofnormal recurring adjustments) considered necessary for a fair statement ofHickory Tech Corporation’s (HickoryTech) results for the periods presented.Operating results for interim periods are not necessarily indicative of resultsthat may be expected for the fiscal year as a whole. The preparation offinancial statements in conformity with accounting principles generallyaccepted in the United States of America requires management to make estimatesand assumptions that affect the reported amounts of assets, liabilities,revenues, expenses, and related disclosures at the date of the financialstatements and during the reporting period. Actual results could differ fromthese estimates. These unaudited interim condensed consolidated financialstatements should be read in conjunction with HickoryTech’s Annual Report on Form 10-Kfor the year ended December 31, 2004.

 

The condensed consolidated financial statements of HickoryTech includeHickory Tech Corporation and its subsidiaries in the following three businesssegments: (i) Telecom Sector, (ii) Information Solutions Sector and (iii) EnterpriseSolutions Sector. All inter-company transactions have been eliminated from theconsolidated financial statements.

 

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

 

On December 15, 2003, HickoryTech sold its wireless business,Minnesota Southern Wireless Company (MSWC), to Western Wireless Corporation(WWC). The wireless operations are reported as part of the Telecom Sector. Theresults of operations of the wireless business are reported as discontinuedoperations for all periods presented (see Note 4).

 

NOTE 2. EARNINGS AND CASH DIVIDENDS PER COMMON SHARE

 

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

 
| ** **                           | ** ** | **For Three Months Ended** | ** ** | **For Nine Months Ended** | ** ** |
|--------------------------------------|------------|----------------------------|------------|---------------------------|------------|
| ** **                           | ** ** | **9/30/2005**              | ** ** | **9/30/2004**             | ** ** | **9/30/2005** | ** ** | **9/30/2004** | ** ** |
| Weighted  Average Shares Outstanding | ** ** | **13,086,371**             |       | 12,990,568                | ** ** | **13,072,656** |   | 12,978,321 |   |
| Stock  Options (dilutive only)       | ** ** | **3,200**                  |       | 23,866                    | ** ** | **8,964** |   | 28,281 |   |
| Stock  Subscribed (ESPP)             | ** ** | **1,948**                  |       | 1,158                     | ** ** | **1,948** |   | 1,158 |   |
| Total  Dilutive Shares Outstanding   | ** ** | **13,091,519**             |       | 13,015,592                | ** ** | **13,083,568** |   | 13,007,760 |   |

 

4

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Options to purchase 564,850 and 448,033 shares for the three monthsended September 30, 2005 and 2004, respectively, and 517,950 and 448,033shares for the nine months ended September 30, 2005 and 2004,respectively, were not included in the computation of earnings per share assumingdilution because their effect on earnings per share would have beenantidilutive.

 

Cash dividends are based on the number of common shares outstanding atthe respective record dates. Listed below is the number of shares outstandingas of the record date for the first quarter of 2005 and 2004.

 
| **Shares Outstanding on Record  Date** | ** ** | **2005**       | ** ** | **2004**   | ** ** |
|----------------------------------------|------------|----------------|------------|------------|------------|
| First  Quarter (Feb. 15)          | ** ** | **13,057,106** |       | 12,967,886 |       |
| Second  Quarter (May 15)          | ** ** | **13,073,602** |       | 12,971,954 |       |
| Third  Quarter (August 15)        | ** ** | **13,076,331** |       | 12,981,929 |       |

 

Dividends per share are based on the quarterly dividend per share asdeclared by the HickoryTech Board of Directors. HickoryTech paid dividends of $.12 per share for the third quarter of2005 and $.11 per share for the third quarter of 2004.

 

During the first nine months of 2005 and 2004, shareholders haveelected to reinvest $196,000 and $207,000, respectively, of dividends intoHickoryTech common stock pursuant to the HickoryTech Dividend ReinvestmentPlan.

 

NOTE 3. COMPREHENSIVE INCOME

 

HickoryTech follows the provisions of SFAS No. 130, “ReportingComprehensive Income.” This statement established rules for the reportingof comprehensive income and its components. In addition to net income,HickoryTech’s comprehensive income includes changes in unrealized gains andlosses on derivative instruments qualifying and designated as cash flow hedges.Comprehensive income, net of income taxes, for the three months ended September 30,2005 and 2004 was $2,597,000 and $1,178,000, respectively. Comprehensiveincome, net of income taxes, for the nine months ended September 30, 2005and 2004 was $7,173,000 and $6,031,000, respectively.

 

NOTE 4. DISCONTINUED OPERATIONS

 

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

 

Wireless business revenue andincome before income taxes included in discontinued operations are as follows:

 
| ** **                         | ** ** | **For Three Months Ended** | ** ** | **For Nine Months Ended** | ** ** |
|------------------------------------|------------|----------------------------|------------|---------------------------|------------|
| **(Dollars in Thousands)**         | ** ** | **9/30/2005**              | ** ** | **9/30/2004**             | ** ** | **9/30/2005** | ** ** | **9/30/2004** | ** ** |
| Revenues                           | ** ** | **$**                      | **—** |                      | $          | — |   | **$** | **—** |   | $ | — |   |
|                               |       |                       |       |                      |       |   |   |   |   |
| Income/(Loss)  Before Income Taxes | ** ** | **$**                      | **37**     |                      | $          | (26 | ) | **$** | **207** |   | $ | (125 | ) |

 

NOTE 5. INVENTORIES

 

Inventories, which consist of equipment for resale, materials andsupplies, are stated at the lower of average cost or market. Cost is determinedon a first-in first-out (FIFO) basis. Reserves offset the cost of inventory toarrive at the net carrying value of inventory, which is intended to approximatenet realizable value.

 

5

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NOTE 6. INTANGIBLE ASSETS

 

Goodwill assets are subject to an impairment test annually as well asupon certain events that indicate that an impairment may be present. Thegoodwill impairment test includes two steps, the first of which requiresmanagement to determine the fair value of certain of the Company’s reportingunits (as defined by SFAS No. 142). The Company determines the fair value of their reporting units byapplication of a discounted cash flow analysis. Management makes estimates thatare included in their discounted cash flow analysis based upon the bestavailable information at the time that the determinations of fair value aremade.  If circumstances change,HickoryTech’s estimates of fair value will also change and could result in adetermination of additional impairment charges to reduce the carrying value ofgoodwill.

 

The carrying value of HickoryTech’s goodwill is $25,086,000 as of September 30,2005 and December 31, 2004.

 

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

 
| ** **                        | ** ** | **As of September 30, 2005** | ** ** | **As of December 31, 2004** | ** ** |
|-----------------------------------|------------|-----------------------------------|------------|----------------------------------|------------|
| **(Dollars in Thousands)**        | ** ** | **Gross Carrying  Amount**        | ** ** | **Accumulated  Amortization**    | ** ** | **Gross Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** |
|                              |       |                              |       |                             |       |   |   |   |   |
| Definite-Lived  Intangible Assets |       |                              |       |                             |       |   |   |   |   |
| Customers                         | ** ** | **$**                             | **821**    | ** **                       | **$**      | **518** |   | $ | 821 |   | $ | 442 |   |
| Other Intangibles                 | ** ** | **109**                           | ** ** | **103**                          |       | 109 |   | 101 |   |
| Total                             | ** ** | **$**                             | **930**    | ** **                       | **$**      | **621** |   | $ | 930 |   | $ | 543 |   |

 

Amortization expense related to the definite-lived intangible assetsfor both the three months ended September 30, 2005 and 2004 was $26,000.Amortization expense related to the definite-lived intangible assets for thenine months ended September 30, 2005 and 2004 was $78,000 and $77,000,respectively.  Total estimatedamortization expense for the remaining three months of 2005 and the five yearssubsequent to 2005 is as follows: 2005 (October  1 through December 31)- $26,000; 2006 - $104,000; 2007 - $104,000; 2008 - $74,000; 2009 - $1,000 and2010 - $0.

 

NOTE 7. RECENT ACCOUNTING DEVELOPMENTS

 

In December 2004, the Financial Accounting Standards Board (‘‘FASB’’)issued SFAS No. 123(R), “Share-Based Payment,” which is a revision of SFASNo. 123 and supersedes APB Opinion No. 25. SFAS No. 123(R)requires all share-based payments to employees, including grants of employeestock options, to be valued at fair value on the date of grant, and to beexpensed over the applicable vesting period. Companies must recognizecompensation expense related to any awards that are not fully vested as of theeffective date. Compensation expense for the unvested awards will be measured basedon the fair value of the awards previously calculated in developing the proforma disclosures in accordance with the provisions of SFAS No. 123.Originally, SFAS No. 123(R) was effective for all stock-based awardsgranted beginning with the first interim period after June 15, 2005. On April 14,2005, The Securities and Exchange Commission (SEC) approved a new rule thatchanged the effective date of SFAS No. 123(R) for public companies to thefirst annual, rather than interim, periods that begin after June 15, 2005.HickoryTech is currently assessing the impact of adopting SFAS 123(R), whichmay be material in future periods, to its consolidated results of operations.For the historical impact of share-based payments to employees under SFAS No. 123,refer to the disclosures in Note 10 of the Notes to Consolidated FinancialStatements.

 

6

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NOTE 8. QUARTERLY SECTOR FINANCIAL SUMMARY

 
| **(Dollars In Thousands)**                                           | ** ** | **Telecom** | ** ** | **Information  Solutions** | ** ** | **Enterprise  Solutions** | ** ** | **Corporate and  Eliminations** | ** ** | **HickoryTech  Consolidated** | ** ** |
|----------------------------------------------------------------------|------------|-------------|------------|----------------------------|------------|---------------------------|------------|---------------------------------|------------|-------------------------------|------------|
| **Three Months Ended 9/30/05**                                       |       |        |       |                       |       |                      |       |                            |       |                          |       |
| Operating Revenue from Unaffiliated  Customers                       |       | $           | 18,383     |                       | $          | 519                       |       | $                               | 3,402      |                          | $          | — |   | $ | 22,304 |   |
| Intersegment Revenues                                                |       | 51          |       | 1,056                      |       | —                    |       | (1,107                          | )          | —                        |       |
| Total                                                                |       | 18,434      |       | 1,575                      |       | 3,402                     |       | (1,107                          | )          | 22,304                        |       |
|                                                                 |       |        |       |                       |       |                      |       |                            |       |                          |       |
| Depreciation and Amortization                                        |       | 3,123       |       | 403                        |       | 28                        |       | 16                              |       | 3,570                         |       |
| Operating Income/(Loss)                                              |       | 4,988       |       | (427                       | )          | (53                       | )          | 158                             |       | 4,666                         |       |
| Interest Expense                                                     |       | 1           |       | 13                         |       | —                    |       | 1,110                           |       | 1,124                         |       |
| Income Taxes/(Benefit)                                               |       | 2,019       |       | (178                       | )          | (22                       | )          | (372                            | )          | 1,447                         |       |
|                                                                 |       |        |       |                       |       |                      |       |                            |       |                          |       |
| Income/(Loss) from Continuing Operations                             |       | 2,970       |       | (262                       | )          | (31                       | )          | (547                            | )          | 2,130                         |       |
| Income from Discontinued Operations Including  Intersegment Revenues |       | 22          |       | —                     |       | —                    |       | —                          |       | 22                            |       |
| Net Income/(Loss)                                                    |       | 2,992       |       | (262                       | )          | (31                       | )          | (547                            | )          | 2,152                         |       |
|                                                                 |       |        |       |                       |       |                      |       |                            |       |                          |       |
| Identifiable Assets                                                  |       | 144,824     |       | 3,936                      |       | 7,918                     |       | 9,340                           |       | 166,018                       |       |
| Property, Plant and Equip., Net                                      |       | 108,575     |       | 4,936                      |       | 227                       |       | 110                             |       | 113,848                       |       |
| Capital Expenditures                                                 |       | 4,603       |       | 866                        |       | —                    |       | 39                              |       | 5,508                         |       |
|                                                                 |       |        |       |                       |       |                      |       |                            |       |                          |       |
| **Three Months Ended 9/30/04**                                       |       |        |       |                       |       |                      |       |                            |       |                          |       |
| Operating Revenue from Unaffiliated  Customers                       |       | $           | 18,918     |                       | $          | 574                       |       | $                               | 2,685      |                          | $          | — |   | $ | 22,177 |   |
| Intersegment Revenues                                                |       | 68          |       | 1,078                      |       | —                    |       | (1,146                          | )          | —                        |       |
| Total                                                                |       | 18,986      |       | 1,652                      |       | 2,685                     |       | (1,146                          | )          | 22,177                        |       |
|                                                                 |       |        |       |                       |       |                      |       |                            |       |                          |       |
| Depreciation and Amortization                                        |       | 3,459       |       | 636                        |       | 40                        |       | 14                              |       | 4,149                         |       |
| Operating Income/(Loss)                                              |       | 5,387       |       | (641                       | )          | (482                      | )          | 41                              |       | 4,305                         |       |
| Interest Expense                                                     |       | 2           |       | 15                         |       | —                    |       | 1,104                           |       | 1,121                         |       |
| Income Taxes/(Benefit)                                               |       | 2,180       |       | (266                       | )          | (195                      | )          | (427                            | )          | 1,292                         |       |
|                                                                 |       |        |       |                       |       |                      |       |                            |       |                          |       |
| Income/(Loss) from Continuing Operations                             |       | 3,207       |       | (390                       | )          | (287                      | )          | (628                            | )          | 1,902                         |       |
| Income from Discontinued Operations Including  Intersegment Revenues |       | (15         | )          | —                     |       | —                    |       | —                          |       | (15                           | )          |
| Net Income/(Loss)                                                    |       | 3,192       |       | (390                       | )          | (287                      | )          | (628                            | )          | 1,887                         |       |
| Identifiable Assets                                                  |       | 143,618     |       | 5,875                      |       | 7,526                     |       | 7,597                           |       | 164,616                       |       |
| Property, Plant and Equip., Net                                      |       | 106,545     |       | 4,088                      |       | 350                       |       | 126                             |       | 111,109                       |       |
| Capital Expenditures                                                 |       | 2,869       |       | —                     |       | 2                         |       | —                          |       | 2,871                         |       |

 

7

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| **(Dollars In Thousands)**                                           | ** ** | **Telecom** | ** ** | **Information  Solutions** | ** ** | **Enterprise  Solutions** | ** ** | **Corporate and  Eliminations** | ** ** | **HickoryTech  Consolidated** | ** ** |
|----------------------------------------------------------------------|------------|-------------|------------|----------------------------|------------|---------------------------|------------|---------------------------------|------------|-------------------------------|------------|
| **Nine  Months Ended 9/30/05**                                       |       |        |       |                       |       |                      |       |                            |       |                          |       |
| Operating Revenue from Unaffiliated  Customers                       |       | $           | 57,014     |                       | $          | 1,921                     |       | $                               | 11,745     |                          | $          | — |   | $ | 70,680 |   |
| Intersegment Revenues                                                |       | 154         |       | 3,239                      |       | —                    |       | (3,393                          | )          | —                        |       |
| Total                                                                |       | 57,168      |       | 5,160                      |       | 11,745                    |       | (3,393                          | )          | 70,680                        |       |
|                                                                 |       |        |       |                       |       |                      |       |                            |       |                          |       |
| Depreciation and Amortization                                        |       | 10,223      |       | 1,698                      |       | 91                        |       | 43                              |       | 12,055                        |       |
| Operating Income/(Loss)                                              |       | 16,216      |       | (1,796                     | )          | (207                      | )          | (152                            | )          | 14,061                        |       |
| Interest Expense                                                     |       | 4           |       | 41                         |       | —                    |       | 3,083                           |       | 3,128                         |       |
| Income Taxes/(Benefit)                                               |       | 6,563       |       | (743                       | )          | (84                       | )          | (1,283                          | )          | 4,453                         |       |
| Income/(Loss) from Continuing Operations                             |       | 9,654       |       | (1,091                     | )          | (123                      | )          | (1,885                          | )          | 6,555                         |       |
| Income from Discontinued Operations Including  Intersegment Revenues |       | 123         |       | —                     |       | —                    |       | —                          |       | 123                           |       |
| Net Income/(Loss)                                                    |       | 9,777       |       | (1,091                     | )          | (123                      | )          | (1,885                          | )          | 6,678                         |       |
|                                                                 |       |        |       |                       |       |                      |       |                            |       |                          |       |
| Identifiable Assets                                                  |       | 144,824     |       | 3,936                      |       | 7,918                     |       | 9,340                           |       | 166,018                       |       |
| Property, Plant and Equip., Net                                      |       | 108,575     |       | 4,936                      |       | 227                       |       | 110                             |       | 113,848                       |       |
| Capital Expenditures                                                 |       | 8,653       |       | 1,424                      |       | 20                        |       | 39                              |       | 10,136                        |       |
|                                                                 |       |        |       |                       |       |                      |       |                            |       |                          |       |
| **Nine Months Ended 9/30/04**                                        |       |        |       |                       |       |                      |       |                            |       |                          |       |
| Operating Revenue from Unaffiliated  Customers                       |       | $           | 57,191     |                       | $          | 2,219                     |       | $                               | 8,318      |                          | $          | — |   | $ | 67,728 |   |
| Intersegment Revenues                                                |       | 206         |       | 3,252                      |       | —                    |       | (3,458                          | )          | —                        |       |
| Total                                                                |       | 57,397      |       | 5,471                      |       | 8,318                     |       | (3,458                          | )          | 67,728                        |       |
|                                                                 |       |        |       |                       |       |                      |       |                            |       |                          |       |
| Depreciation and Amortization                                        |       | 10,273      |       | 1,929                      |       | 135                       |       | 42                              |       | 12,379                        |       |
| Operating Income/(Loss)                                              |       | 17,244      |       | (1,983                     | )          | (998                      | )          | (203                            | )          | 14,060                        |       |
| Interest Expense                                                     |       | 9           |       | 42                         |       | —                    |       | 3,397                           |       | 3,448                         |       |
| Income Taxes/(Benefit)                                               |       | 6,978       |       | (816                       | )          | (404                      | )          | (1,448                          | )          | 4,310                         |       |
|                                                                 |       |        |       |                       |       |                      |       |                            |       |                          |       |
| Income/(Loss) from Continuing Operations                             |       | 10,266      |       | (1,198                     | )          | (594                      | )          | (2,128                          | )          | 6,346                         |       |
| Loss from Discontinued Operations Including  Intersegment Revenues   |       | (74         | )          | —                     |       | —                    |       | —                          |       | (74                           | )          |
| Net Income/(Loss)                                                    |       | 10,192      |       | (1,198                     | )          | (594                      | )          | (2,128                          | )          | 6,272                         |       |
|                                                                 |       |        |       |                       |       |                      |       |                            |       |                          |       |
| Identifiable Assets                                                  |       | 143,618     |       | 5,875                      |       | 7,526                     |       | 7,597                           |       | 164,616                       |       |
| Property, Plant and Equip., Net                                      |       | 106,545     |       | 4,088                      |       | 350                       |       | 126                             |       | 111,109                       |       |
| Capital Expenditures                                                 |       | 9,086       |       | 1                          |       | 24                        |       | —                          |       | 9,111                         |       |

 

8

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NOTE 9. CONTINGENCIES

 

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

 

NOTE 10. STOCK COMPENSATION

 

As of December 31, 2004, HickoryTech had four stock-based employeeand director compensation plans, which are described more fully in theHickoryTech Annual Report on Form 10-K for the year ended December 31,2004. At the annual shareholders’ meeting on May 9, 2005, the HickoryTechshareholders approved the HickoryTech Corporation 2005 Directors’ IncentivePlan, which is described more fully in the Form 8-K filed May 12,2005. In accordance with SFAS 123 “Accounting for Stock Based Compensation,”HickoryTech has elected to account for these employee and director stockcompensation plans using the intrinsic value method as prescribed by AccountingPrinciples Board Opinion No. 25 and related interpretations.

 

If HickoryTech had elected to recognize compensation cost based on thefair value of the options and other stock compensation the following operatingresults would have occurred using the Black-Scholes option-pricing model todetermine the fair value of the options: 

 

| ** **                                                                                                                                    | ** ** | **For Three Months Ended** | ** ** | **For Nine Months Ended** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------|------------|---------------------------|------------|
| **(Dollars in Thousands)**                                                                                                                    | ** ** | **9/30/2005**              | ** ** | **9/30/2004**             | ** ** | **9/30/2005** | ** ** | **9/30/2004** | ** ** |
|                                                                                                                                          |       |                       |       |                      |       |   |   |   |   |
| Reported Net Income                                                                                                                           | ** ** | **$**                      | **2,152**  | ** **                | $          | 1,887 |   | **$** | **6,678** | ** ** | $ | 6,272 |   |
| Add: Stock-based employee compensation  expense included in reported net income, net of related tax effects                                   | ** ** | **13**                     | ** ** | 13                        |       | **40** | ** ** | 46 |   |
| Deduct: Total stock-based employee compensation  expense determined under fair value based method for all awards, net of  related tax effects | ** ** | **(44**                    | **)**      | (61                       | )          | **(170** | **)** | (214 | ) |
|                                                                                                                                          |       |                       | ** ** |                      |       |   | ** ** |   |   |
| Pro Forma Net Income                                                                                                                          | ** ** | **$**                      | **2,121**  | ** **                | $          | 1,839 |   | **$** | **6,548** | ** ** | $ | 6,104 |   |
|                                                                                                                                          |       |                       | ** ** |                      |       |   | ** ** |   |   |
| Earnings per share:                                                                                                                           |       |                       | ** ** |                      |       |   | ** ** |   |   |
| Basic - as reported                                                                                                                           | ** ** | **$**                      | **0.16**   | ** **                | $          | 0.15 |   | **$** | **0.51** | ** ** | $ | 0.48 |   |
| Basic - pro forma                                                                                                                             | ** ** | **$**                      | **0.16**   | ** **                | $          | 0.14 |   | **$** | **0.50** | ** ** | $ | 0.47 |   |
|                                                                                                                                          |       |                       | ** ** |                      |       |   | ** ** |   |   |
| Diluted - as reported                                                                                                                         | ** ** | **$**                      | **0.16**   | ** **                | $          | 0.15 |   | **$** | **0.51** | ** ** | $ | 0.48 |   |
| Diluted - pro forma                                                                                                                           | ** ** | **$**                      | **0.16**   | ** **                | $          | 0.14 |   | **$** | **0.50** | ** ** | $ | 0.47 |   |

 

NOTE 11. FINANCIAL DERIVATIVE INSTRUMENTS

 

HickoryTech accounts for derivative instruments in accordance with SFASNo. 133, as amended by SFAS No. 149, “Accounting for DerivativeInstruments and Hedging Activities,” which requires derivative instruments tobe recorded on the balance sheet at fair value. Changes in fair value ofderivative instruments must be recognized in earnings unless specific hedgeaccounting criteria are met, in which case the gains and losses are included inother comprehensive income rather than in earnings.

 

9

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| **(Dollars in Thousands, Net of  Income Taxes)**                           | ** ** | **Interest Rate  Swap Agreement** | ** ** |
|----------------------------------------------------------------------------|------------|-----------------------------------|------------|
|                                                                       |       |                              |       |
| Accumulated  other comprehensive income balance at December 31, 2004  |       | $                                 | 1,505      |   |
| Market value  increase on interest rate swap agreement                     |       | 495                               |       |
| Accumulated  other comprehensive income balance at September 30, 2005 |       | $                                 | 2,000      |   |

 

HickoryTech has variable rate debt instruments, which subject theCompany to interest rate risk. HickoryTech has utilized interest rate swapagreements to implement fixed interest terms on various portions of the overalldebt outstanding to manage its exposure to interest rate movements on a portionof its variable rate debt obligations. The current agreements result in fixedinterest terms on $70,000,000 of the outstanding debt until June 2008. Themarket value of the cumulative gain or loss on these derivative instruments isreported as a component of accumulated other comprehensive income inshareholders’ equity and will be recognized in earnings when the term of theswap agreement is concluded.

 

The fair value of HickoryTech’s derivatives at September 30, 2005and December 31, 2004 is a net asset of $3,324,000 and $2,501,000,respectively, which is included in other assets in the accompanyingconsolidated balance sheet.

 

NOTE 12. EMPLOYEE POST-RETIREMENT BENEFITS

 

HickoryTech provides post-retirement health care and life insurancebenefits for certain employees. HickoryTech is not currently funding thesepost-retirement benefits, but has accrued these liabilities during the firstthree quarters of 2005 and 2004.

 
| ** **                                                   | ** ** | **For Three Months Ended** | ** ** | **For Nine Months Ended** | ** ** |
|--------------------------------------------------------------|------------|----------------------------|------------|---------------------------|------------|
| **(Dollars in Thousands)**                                   | ** ** | **9/30/2005**              | ** ** | **9/30/2004**             | ** ** | **9/30/2005** | ** ** | **9/30/2004** | ** ** |
| Components of Net Periodic Benefit Cost                      |       |                       |       |                      |       |   |   |   |   |
| Service Cost                                                 | ** ** | **$**                      | **91**     | ** **                | $          | 93 |   | **$** | **275** | ** ** | $ | 279 |   |
| Interest Cost                                                | ** ** | **115**                    | ** ** | 131                       |       | **345** | ** ** | 393 |   |
| Expected Return on Plan Assets                               | ** ** | **—**                 | ** ** | —                    |       | **—** | ** ** | — |   |
| Amortization of Transition Obligation                        | ** ** | **15**                     | ** ** | 15                        |       | **45** | ** ** | 45 |   |
| Amortization of Prior Service Cost                           | ** ** | **(3**                     | **)**      | (3                        | )          | **(9** | **)** | (9 | ) |
| Recognized Net Actuarial Loss                                | ** ** | **44**                     | ** ** | 59                        |       | **132** | ** ** | 177 |   |
| Net Periodic Benefit Cost                                    | ** ** | **$**                      | **262**    | ** **                | $          | 295 |   | **$** | **788** | ** ** | $ | 885 |   |
|                                                         | ** ** | ** **                 | ** ** |                      |       | ** ** | ** ** |   |   |
|                                                         | ** ** | **2005**                   | ** ** |                      |       | ** ** | ** ** |   |   |
| Employer’s Contributions                                | ** ** | ** **                 | ** ** |                      |       | ** ** | ** ** |   |   |
| Contributions Made For the Nine Months  Ended 09/30/05       | ** ** | **$**                      | **146**    | ** **                |       |   | ** ** | ** ** |   |   |
| Expected Contributions for Remainder of  2005                | ** ** | **49**                     | ** ** |                      |       | ** ** | ** ** |   |   |
| Total Estimated Employer Contributions for  Fiscal Year 2005 | ** ** | **$**                      | **195**    | ** **                |       |   | ** ** | ** ** |   |   |

 

10

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NOTE 13. REGULATORY ASSET AND LIABILITY

 

Effective January 1, 2002, the Federal Communications Commission(FCC), in its “MAG (Multi Association Group) Order” on Access Charge Reform,directed all rate-of-return carriers to file revisions to their tariffs toeliminate the transport interconnection charge (TIC) as a separate rateelement. In effect, the costs previously recovered through the TIC werereallocated over all other access categories, including carrier common line,transport, local switching, information surcharge and special access. The FCCmade it clear that “this tariff filing should be a revenue neutral tarifffiling.” The total revenues reallocated from the TIC to the remaining accesselements were limited to the total revenues recovered from the TIC for thetwelve-month period ended June 30, 2001. These revenues were calculatedusing the carrier’s traffic volumes and the TIC rate for the twelve-monthperiod ended June 30, 2001. These calculations were prepared by anindependent third-party and approved by the National Exchange CarrierAssociation (NECA). TIC was eliminated by reallocating the costs to the otheraccess billing categories. The FCC conducted an investigation of all tarifffilings, including NECA’s CCL (Carrier Common Line) tariff and Heartland’sTraffic Sensitive (TS) tariff, to determine if the filing parties had properlyreallocated the TIC costs among the other access charge categories. The FCC terminatedits investigation of several tariff filings, concluding that “the carriers havesubstantially complied with the Rate-of-Return Access Charge Reform Order andtheir tariffs no longer warrant investigation.” Despite this ruling by the FCCduring the fourth quarter of 2003, NECA informed HickoryTech’s Heartlandsubsidiary that it would not allow it to recover a portion of the TIC costsallocated to the CCL, because an incorrect TIC rate was used in thecalculation. As a result of this billing error, the Company recovered $611,000of excess revenues from the NECA CCL pool. NECA required Heartland to repay the$611,000 in 2004. The FCC approved a mid-course correction to Heartland’s TStariff as a supportable method of recouping NECA’s CCL reduction. The revisioncorrects the TIC rate originally used, and factors recovery of the $611,000into the TS rate elements. HickoryTech recouped this revenue over the remainingeighteen months of the TS tariff, from January 1, 2004 to June 30,2005. In accordance with SFAS No. 71, HickoryTech recorded a regulatoryasset for the revenue it would recoup with a balance of $0 at September 30,2005 and $204,000 at December 31, 2004.

 

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

 

#### **FORWARD-LOOKINGSTATEMENTS**

 

*This Quarterly Report on Form 10-Q contains certainforward-looking statements within the meaning of Section 27A of theSecurities Act of 1933, as amended, and Section 21E of the SecuritiesExchange Act of 1934, as amended, which are subject to the “safe harbor”created by those sections. Statements in this Form 10-Q that are nothistorical fact are forward-looking statements that are based on management’scurrent expectations, estimates and projections about the industry in whichHickoryTech operates and management’s beliefs and assumptions. Forward-lookingstatements may be identified by the use of terminology such as “may,” “will,” “believes,”“does not believe,” “no reason to believe,” “expects,” “plans,” “intends,” “estimates,”“anticipated,” or “anticipates” and similar expressions, as they relate toHickoryTech or management. Such forward-looking statements are subject toimportant risks and uncertainties that could cause HickoryTech’s future actualresults to differ materially from such statements. These statements are notguarantees of future performance and involve certain risks, uncertainties andprobabilities, which are difficult to predict. Therefore, actual outcomes andresults may differ materially from what is expressed or forecasted in suchforward-looking statements, whether as a result of new information, futureevents or otherwise. Factors that might cause such a difference include, butare not limited to, those contained in this “Management’s Discussion andAnalysis” (Item 2) and the Cautionary Statement for Purposes of the “SafeHarbor” Provision of the Private Securities Litigation Reform Act of 1995 on pages 28-29of HickoryTech’s Annual Report on Form 10-K for the year ended December 31,2004, 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.*

 

11

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**BUSINESSES**

 

*HickoryTech operates in three business segments: theTelecom, Information Solutions and Enterprise Solutions Sectors. Its largestand oldest business (since 1898) has been the operation of incumbent localexchange carriers (ILECs) or traditional wireline telephone service. The ILECbusiness is in HickoryTech’s Telecom Sector. In 1998, HickoryTech began itscompetitive local exchange carrier (CLEC) line of business, competing for thetelephone dial tone, dial-up and broadband Internet access, data, digital TVand long distance calling business in incumbent LEC (local exchange carrier)territories owned by others. The CLEC business is in HickoryTech’s TelecomSector. Since 1964, HickoryTech’s Information Solutions Sector has providedcomputer data processing and software, predominantly for HickoryTech’s TelecomSector operations and also to other telecommunications companies. HickoryTechacquired its Enterprise Solutions Sector in 1990 and it operates as atelecommunications, data and Internet Protocol equipment distributor from abase in Minneapolis/St. Paul, Minnesota. HickoryTech also began its wirelessoperations in 1998 by acquiring its first wholly owned wireless servicelicense, an additional wireless service license in 1999 and two PCS licenses in2001. HickoryTech sold the wireless operations on December 15, 2003. Thewireless operations are reported as part of the Telecom Sector. The results ofoperations of the wireless business are reported as discontinued operations forall periods presented.*

* *

*The eight subsidiaries of HickoryTech, all of which publiclyoperate and conduct business as HickoryTech, and the business segments in whichthey operate are:*

* *

**TELECOM SECTOR**

Mankato Citizens Telephone Company (MCTC)

Mid-Communications, Inc. (Mid-Comm)

Heartland Telecommunications Company of Iowa, Inc.(Heartland)

Cable Network, Inc. (CNI)

Crystal Communications, Inc. (Crystal)

Minnesota Southern Wireless Company(MSWC)-Discontinued Operations

**INFORMATION SOLUTIONS SECTOR**

National Independent Billing, Inc. (NIBI)

**ENTERPRISE SOLUTIONS SECTOR**

Collins Communications Systems Co. (Collins)

 

*HickoryTech and its subsidiaries are engaged in businessesthat provide services to their customers for a fee. Many of these services arerecurring, and, as a result, backlog orders and seasonality are not significantfactors. Working capital requirements primarily involve financing the constructionof networks involving switches and cable, and maintaining a high amount offixed assets. Other working capital requirements include the payroll costs ofhighly skilled labor, the inventory to service its capital projects andmaintenance of the network and telephone equipment customers, and the carryingvalue of trade accounts receivable, which may take several months to collect inthe normal course of business.*

* *

*The materials and supplies that are necessary for theoperation of the businesses of HickoryTech and its subsidiaries are availablefrom a variety of sources. All of HickoryTech’s central office switches, aswell as a majority of HickoryTech’s equipment sold in its Enterprise SolutionsSector, are supplied by Nortel and Cisco. Nortel and Cisco are leadingsuppliers of communications and data equipment, and HickoryTech’s dependence onthese brands is not viewed as a significant risk. An additional layer ofnetwork infrastructure equipment for broadband services is provided byNextlevel.*

* *

**INDUSTRY SEGMENTS**

 

*HickoryTech reports the business operations of Telephone,Communications Services, and Wireless Services as a single segment referred toas the Telecom Sector. The results of operations of the wireless business arereported as discontinued operations for all periods presented. The other twobusiness segments are the Information Solutions and Enterprise SolutionsSectors.*

 

12

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*TELECOMSECTOR*

 

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

 

The Telecom Sector also includes Crystal, a CLEC. Crystal provideslocal telephone service, long distance, dial-up and broadband Internet accessand digital TV on a competitive basis. Crystal also connects communicationnetworks of interexchange and wireless carriers with the equipment andfacilities of end users. Crystal has customers in ten rural communities,encompassing eight exchanges, in Minnesota and three communities, encompassingtwo exchanges, in Iowa that are not in HickoryTech’s ILEC service areas.Crystal also provides digital TV service in four communities in addition to itstelephone services listed above. They include St. Peter, initiated in 2001,Waseca, in July 2004, New Richland and Ellendale, Minnesota, in June 2005.Most recently Crystal began offering service in a fifth community, St. Clair,Minnesota, in September 2005 where Mid-Comm provides telephone service.

 

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

 

The Telecom Sector included the operations of MSWC, which was sold December 15,2003. None of the remaining companies in the Telecom Sector experienced majorchanges in operations during 2005 or 2004.

 

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

 

MCTC and Mid-Comm are Minnesota public utilities operating pursuant toindeterminate permits issued by the Minnesota Public Utilities Commission.Heartland is also a public utility, which operates pursuant to a certificate ofpublic convenience and necessity issued by the Iowa Utilities Board. Thesestate agencies regulate the services provided by MCTC, Mid-Comm and Heartland.CNI’s operations are not subject to regulation by the state regulatoryauthority. Neither the Minnesota Public Utilities Commission nor the IowaUtilities Board regulates the rate of return or profits of each of HickoryTech’sILEC operations due to the size of these companies relative to stateregulation. In Minnesota, MCTC and Mid-Comm’s price and service levels aremonitored by regulators. MCTC’s and Mid-Comm’s local service rates are belowthose of most Minnesota incumbent LECs. HickoryTech and its subsidiaries maychange rates determined by various factors, including economic and competitivecircumstances.

 

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

 

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

 

Competition in HickoryTech’s ILEC service area exists in one ofHeartland’s exchanges. In the city of Hawarden, Iowa the municipal utilitiesoverbuilt the city’s telephone service infrastructure in 1999 and is providingan alternative to HickoryTech’s telephone service. HickoryTech estimates theHawarden CLEC has approximately 1,400 access lines, or approximately 70 percentof that exchange’s telephone business.

 

Competition also exists for some of the HickoryTech services providedto interexchange carriers, such as customer billing services, dedicated privatelines, network switching and network routing. This competition comes primarilyfrom the interexchange carriers themselves, in that carriers may decide thatthe services provided by HickoryTech may be redirected or handled on their ownnetwork or on other networks. The provision of these services is primarilymonth-to-month service out of a general tariff, which is a schedule ofterms, rates and conditions that is approved by the appropriate state orfederal agency. The use of these services is primarily controlled by theinterexchange carriers. As interexchange carriers make these service decisions,they have the potential to reduce the Company’s revenue in the Telecom Sector.Other services, such as the provision of broadband, long distance service,directory advertising and end user equipment, are open to competition.

 

HickoryTech companies are sometimes engaged in negotiation orrenegotiation of arrangements for network interconnection with other carriersand contracts with various wireless service providers. MCTC has recentlyconcluded negotiations and other HickoryTech companies are presently involvedin interconnection negotiations with another service provider thatmay compete with HickoryTech companies. Although such negotiations mayresult in reduced revenue, HickoryTech cannot, at this time, estimate the potentialrevenue impact related to these negotiations.

 

Future decisions regarding the regulation of Voice over InternetProtocol (VoIP) may result in a change in the business relationship betweenHickoryTech companies and interexchange carriers. These relationships and regulationconcerning them are discussed further in the regulated industry section ofthis Form 10-Q.

 

Crystal began operations in January 1998 as a new CLEC. Crystaloffers local service, long distance, dial-up and broadband Internet accessservices, and digital TV on a competitive basis to customers in southernMinnesota and Iowa, which were not previously served by HickoryTech’s TelecomSector service area. These service offerings provide customers alternatives tothe incumbent communication providers in various communities and are offeredunder the brand name HickoryTech service. These services are currently beingoffered to customers in ten rural communities, encompassing eight exchanges, inMinnesota, as well as three communities, encompassing two exchanges, in Iowa.Crystal also provides the long distance service, dial-up and broadband Internetaccess services to HickoryTech’s ILEC subscribers and is providing digital TVin one community served by Mid-Comm.

 

CLEC activities require Crystal to file for authority to operate withthe appropriate public utilities commission in each state it serves. Crystalcompetes directly against existing incumbent LECs in the areas in which itoperates. Crystal competes directly with incumbent cable TV providers and satellitefor its digital TV services. Crystal is presently providing these servicesunder franchise agreements with the local communities. Crystal is not dependentupon any single customer or small group of customers. No single customer inCrystal accounts for ten percent or more of HickoryTech’s consolidatedrevenues.

 

There is currently a multi-state incumbent LEC industry dispute with alarge RBOC (Regional Bell Operating Company) regarding certain access charges.Following a formal complaint process with the Minnesota Public UtilitiesCommission, the Minnesota ILEC industry and Qwest have negotiated an interimarrangement, which placed the complaint process in a “continuance” while theyconduct a trial of a proposed resolution.

 

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

 

REGULATED INDUSTRY

 

ILEC Minnesota - HickoryTech’s two Minnesota ILEC subsidiaries continueto operate under an alternative form of regulation as defined in MinnesotaChapter 237, whereby companies with less than 50,000 customers are regulated onprice and service level rather than profit.

 

The Minnesota Public Utilities Commission (PUC) has been consideringintrastate access reform and universal service for several years. In June 2004,the Minnesota PUC issued an order to refer the carrier common line (CCL)component of the access reform issue to a contested case hearing. In September 2004,the Minnesota PUC also referred the local switching and transport (LST)component of the access reform issue for a separate contested case hearing. Theprocess on both of these dockets was suspended in December 2004 subsequentto concerns expressed by state agencies regarding increases in local rates andthe potential that federal activity may also address this issue. HickoryTechcannot estimate the impact, if any, of future potential state access revenuechanges.

 

In December, 2004, the Federal Court of Appeals, 8th Circuit upheld an October 2003ruling by the United States District Court, District of Minnesota, in issuingan injunction providing relief from regulation of any service provider of VoIPbased services in Minnesota. The issue of regulation of VoIP is also underconsideration at the FCC.  In March, 2005a Petition of Forbearance from requirements for payment of access charges by aVoIP provider was withdrawn by the initiator. Future decisions regarding theregulation of VoIP may result in a change in the business relationship betweenHickoryTech companies and the interexchange carriers, as interconnections withcertain VoIP providers may not be governed by tariffed access charges.HickoryTech cannot, at this time, estimate the revenue impact, if any, relatedto these events.

 

On June 27, 2005, the United States Supreme Court reversed a priorruling that required cable operators to open up their high-speed Internet linesto competition. The FCC has recently released regulations intended to spur thedevelopment of broadband services HickoryTech cannot, at this time, estimatethe revenue impact, if any, related to these events.

 

ILEC Iowa – In 2005, rate deregulation was granted to all Iowacompanies for all services other than single line services. Previously, onlycompanies with fewer than 15,000 access lines were unregulated. HickoryTech’sIowa ILEC subsidiary has maintained less than 15,000 access lines so it hasbeen and will remain unregulated.

 

Wireline Interstate – The HickoryTech ILEC companies do not participatein the NECA traffic sensitive pool and set access rates according to either anationwide average cost of providing access, or in the case of Heartland,according to its own interstate costs. This biannual rate process was completedin June 2005, and established traffic sensitive interstate rates for theperiod from July 1, 2005 through June 30, 2007. HickoryTech ILECcompanies participate in the NECA common line pool. End User Common Line (EUCL)funds collected are pooled, and some of HickoryTech revenues are based onsettlements distributed from the pool. Pool settlements are adjustedperiodically. The July 1, 2005 change does not materially affect the levelof access revenues recorded.

 

CLEC – HickoryTech’s CLEC Company provides local exchange services inMinnesota and Iowa with less regulatory oversight than the HickoryTech ILECcompanies. Crystal also offers long distance services. In-state services inMinnesota are regulated by the PUC with respect to uniform pricing statewide.In-state long distance service in Iowa is unregulated. Long distance servicesare also deregulated at the federal level (for interstate services), but aresubject to annual certification of geographical rate averaging and rateintegration. Dial-up and broadband Internet access are unregulated at both thestate and federal levels.

 

In addition to the deregulation granted by new Iowa law, the IowaUtilities Board has opened another docket investigating effective competitionfor several additional communities and may authorize additional deregulationfor those communities. This docket includes one community served by Crystal.

 

15

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Crystal offers digital TV service in the St. Peter, Waseca, EllendaleNew Richland and St. Clair, Minnesota markets under franchises negotiated withthe local municipality.

 

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

 

The FCC has an open docket on intercarrier compensation as well asseveral dockets on VoIP. In February 2005, the FCC issued a Further Noticeof Public Rule Making (FNPRM) and has received voluminous commentsreflecting diverse opinions for intercarrier compensation reform. HickoryTechcannot predict the outcome of such proceedings nor can it estimate the impact,if any, on HickoryTech.

 

Local Number Portability (LNP) – On November 10, 2003, the FCCreleased a decision providing guidance on porting between wireline and wirelessnetworks (intermodal porting). Most of the Company’s wireline operations weresubject to a May 24, 2004 implementation date for intermodal porting,however, Heartland Telecommunications Company of Iowa received a suspensionorder from the Iowa Utilities Board allowing additional time and implementedLNP on January 25, 2005. The effects of intermodal porting on the Company’sMinnesota wireline operations have been minimal as of September 30, 2005.Given the short history for which intermodal porting has been available,however, the Company cannot fully quantify the long-term effects ofimplementing intermodal porting on its wireline operations. It is possible thatthese requirements could adversely affect the Company’s wireline operatingcosts and customer growth rates. HickoryTech is also unable to quantify therevenue impact of wireline customers that may switch to wireless or otherwireline alternatives.

 

Triennial Review Order – In August 2003, the FCC published areview order proposing changes in rules developed under the provisions ofthe Telecommunications Act of 1996 Section 251(c)(3) which requiresincumbent LECs to make elements of their networks available on an unbundledbasis to new entrants at model-based rates. The FCC adopted final rules onDecember 15, 2004 eliminating portions of these requirements. HickoryTech’sCLEC, Crystal Communications, predominately uses its own network and has notmade extensive use of the type of network elements addressed in the ruling.While HickoryTech cannot fully quantify the impact of this issue, the FCCorders are not expected to have a material impact on Crystal’s business.

 

*INFORMATION SOLUTIONS SECTOR*

 

Through NIBI, HickoryTech’sInformation Solutions Sector provides data processing and related services,principally for HickoryTech, other local exchange telephone companies, CLECs,interexchange network carriers and wireless companies. The InformationSolutions Sector’s principal activity is the provision of monthly batchprocessing of computerized data for HickoryTech as well as non-affiliatedcompanies. Services for telephone company customers include the processing oflong distance telephone calls from data sources and telephone switches, thepreparation of the subscriber telephone bills, customer record keeping andcarrier access bills. There are a number of companies engaged in supplying dataprocessing services comparable to those furnished by the Information SolutionsSector. Competition is based primarily on price and service. HickoryTech’sInformation Solutions Sector has developed an integrated billing and managementsystem called SuiteSolution. SuiteSolution can provide wireline and wirelesscarriers the individual benefits of a billing platform or a total systemsolution.

 

*ENTERPRISESOLUTIONS SECTOR*

 

Through Collins, HickoryTech’sEnterprise Solutions Sector provides telephone, data and VoIP business systemsequipment sales and services to companies primarily based in metropolitanMinneapolis/St. Paul, Minnesota. This sector also supports the businesstelephone system service for HickoryTech ILEC and CLEC operations in southernMinnesota and in Iowa. The customers in the Enterprise Solutions Sector’smarket are the individual business end users of telecommunications service withongoing service requirement offerings. Products consist of communicationplatforms such as Nortel, Cisco and Bay Networks (Nortel) equipment. EnterpriseSolutions specializes in complex design, installation and maintenance of voice,data or Internet Protocol products. Enterprise Solutions continues itscommitment to service and support its core products, Nortel and Cisco, whileidentifying new opportunities such as call centers, computer telephoneintegration voice mail and interactive voice response systems.

 

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Revenues are primarily earned bythe sales, installation and service of business telephone and IP data systems.HickoryTech’s Enterprise Solutions Sector is not dependent upon any singlecustomer or small group of customers. No single customer in the EnterpriseSolutions Sector accounts for ten percent or more of HickoryTech’s consolidatedrevenues.

 

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

 

**RESULTS OF OPERATIONS**

 

CONSOLIDATED OPERATING RESULTS:

 

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

 

##### OPERATING REVENUES:

 

Consolidated operating revenueswere $22,304,000, which is $127,000 or 0.6% higher in the three months ended September 30,2005 compared to the three months ended September 30, 2004.****Consolidated operating revenues were $70,680,000, which is$2,952,000 or 4.4% higher in the nine months ended September 30, 2005compared to the nine months ended September 30, 2004. The increase for thenine months ended September 30, 2005 compared to the nine months ended September 30,2004 can be primarily attributed to a higher volume of business in theEnterprise Solutions Sector service, offset by decreased revenue in theInformation Solutions and Telecom Sectors.

 

COSTOF SALES, ENTERPRISE SOLUTIONS:

 

Cost of sales increased $365,000 or 19.7% in the third quarter of 2005compared to the third quarter of 2004.****Cost of salesincreased $2,600,000 or 45.9% in the nine months ended September 30, 2005compared to the nine months ended September 30, 2004. The increase in costof sales in the three and nine months ended September 30, 2005 compared tothe three and nine months ended September 30, 2004 corresponds with theincrease in sales in both periods.****EnterpriseSolutions received a $211,000 rebate in the third quarter from one of itssuppliers, which is recorded in cost of sales.

 

COSTOF SERVICES, excluding Depreciation and Amortization:

 

Costof services, excluding depreciation and amortization decreased $24,000 or 0.3%in third quarter 2005 compared to third quarter 2004. Decreases****in****the****Telecom and Information Solution Sectors’ cost of servicesfor the third quarter of 2005 compared to the third quarter of 2004 werepartially offset****by an increase in the inventoryvaluation reserve in the Enterprise Solutions Sector.****Costof services, excluding depreciation and amortization decreased $161,000 or 0.6%in the nine months ended September 30, 2005 compared to the nine monthsended September 30, 2004.****This decreasefor the nine months ended September 30, 2005 compared to the nine monthsended September 30, 2004 was primarily due to cost reduction actions andlower costs from outsourced contractors in the Information Solutions Sector**,**lower leased fiber expenses, lower Internet expense due tocustomers who have switched from dial-up Internet to broadband Internet andlower bad debt expense, all in the Telecom Sector. The decrease was partiallyoffset by increased wages, transport costs, consulting fees and originatingaccess fees, in the Telecom Sector and an increase in the Enterprise Solutionsinventory valuation reserve. The decrease in bad debt expense for the three andnine months ended September 30, 2005 relates to $410,000 of bad debtrecoveries associated with a carrier bankruptcy.

 

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES,excluding Depreciation and Amortization:

 

Selling, general and administrative expenses, excluding depreciationand amortization increased $5,000 or 0.1% in third quarter 2005 compared tothird quarter 2004. Selling, general and administrative expenses, excludingdepreciation and amortization increased $837,000 or 7.8% in the nine monthsended September 30, 2005 compared to the nine months ended September 30,2004. The primary reasons for this increase were the one-time fees associatedwith the termination of leases in the Information Solutions Sector, increased salesexpenses associated with the customer premise equipment (CPE) phone systemsales, regulatory fees and property taxes in the Telecom Sector, partially offset by decreasedwages and bad debt expense in the Enterprise Solutions Sector.

 

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DEPRECIATION AND AMORTIZATION:

 

Depreciation expense was $3,544,000,which is $368,000 or 9.4% lower in the three months ended September 30,2005 compared to the three months ended September 30, 2004. The decreasein depreciation expense can be largely attributed to central office switchingequipment becoming fully depreciated in the third quarter of 2005. Depreciationexpense was $11,588,000, which is $81,000 or 0.7% lower in the nine monthsended September 30, 2005 compared to the nine months ended September 30,2004.****The decrease in depreciation expensecan be largely attributed to central office switching equipment becoming fullydepreciated in the third quarter of 2005, partially offset by the depreciationassociated with an increase in Telecom Sector’s network assets. Amortizationexpense was $26,000, which is $211,000 or 89.0% lower in the three months endedSeptember 30, 2005 compared to the three months ended September 30,2004.****Amortization expense was $467,000,which is $243,000 or 34.2% lower in the nine months ended September 30,2005 compared to the nine months ended September 30, 2004. The decrease inamortization expense in the three and nine months ended September 30, 2005was due to the SuiteSolution asset (capitalized software development) in theInformation Solutions Sector becoming fully amortized in the second quarter of2005.

 

OPERATING INCOME:

 

Operating income was $4,666,000, which is $361,000 or 8.4% higher inthe three months ended September 30, 2005 compared to the three monthsended September 30, 2004.****The increasein operating income was primarily due to the****$368,000decrease in depreciation, $211,000 decrease in amortization expense****and $127,000 increase in operating revenues, all of whichare explained above,****partiallyoffset by a $364,000 increase in cost of sales, which is described above.Operating income was $14,061,000, which is $1,000 higher in the nine monthsended September 30, 2005 compared to the nine months ended September 30,2004. The increase in operating income was driven by the $2,952,000 increase inoperating revenues,****the $243,000decrease in amortization expense, the $161,000 decrease in cost of services andthe $81,000 decrease in depreciation, all of which are explained above,****partially offset by a $2,599,000 increase in cost of salesand $837,000 increase in selling, general and administrative expenses, all ofwhich were described above. 

 

INTEREST EXPENSE:

 

Interest expense increased $3,000 or 0.3% to $1,124,000 in the threemonths ended September 30, 2005 compared to the three months ended September 30,2004.****Interest expense decreased $320,000 or9.3% to $3,128,000 in the nine months ended September 30, 2005 compared tothe nine months ended September 30, 2004.****Thedecrease in interest expense for the period was primarily due to a decrease intotal debt outstanding. The outstanding balance of the revolving creditfacility was $94,750,000 at September 30, 2005 and $105,250,000 at September 30,2004.

 

INCOME TAXES:

 

The effective income tax rate of approximately 40.5% for third quarter2005 and third quarter 2004 exceeds the federal statutory rate primarily due tostate income taxes. The effective income tax rate of approximately 40.5% forthe nine months ended September 30, 2005 and approximately 40.4% for thenine months ended September 30, 2004 exceeds the federal statutory rateprimarily due to state income taxes.

 

INCOME FROM CONTINUING OPERATIONS:

 

Consolidated income from continuing operations was $2,130,000, which is$228,000 or 12.0% higher in the three months ended September 30, 2005compared to the three months ended September 30, 2004.****Theincrease in income from continuing operations was driven by the****$368,000 decrease in depreciation, $211,000 decrease inamortization expense****and $127,000increase in operating revenues, all of which are explained above,****partially offset by a $364,000 increase in cost of sales,which is described above. Consolidated income from continuing operations was$6,555,000, which is $209,000 or 3.3% higher in the nine months ended September 30,2005 compared to the nine months ended September 30, 2004. The increase inincome from continuing operations was driven by the $2,952,000 increase inoperating revenues,****the $320,000decrease in interest expense,****the $243,000decrease in amortization expense, the $161,000 decrease in cost of services andthe $81,000 decrease in depreciation, all of which are explained above,****partially offset by a $2,599,000 increase in cost of salesand $837,000 increase in selling, general and administrative expenses, all ofwhich were described above. 

 

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SECTOR RESULTS OF OPERATIONS FROM CONTINUINGOPERATIONS

 

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

 

**TELECOM SECTOR**

 
| ** **                                                                              | ** ** | **For Three Months Ended** | ** ** | **For Nine Months Ended** | ** ** |
|-----------------------------------------------------------------------------------------|------------|----------------------------|------------|---------------------------|------------|
| **(Dollars in Thousands)**                                                              | ** ** | **9/30/2005**              | ** ** | **9/30/2004**             | ** ** | **9/30/2005** | ** ** | **9/30/2004** | ** ** |
|                                                                                    |       |                       |       |                      |       |   |   |   |   |
| Revenues Before Intersegment Eliminations                                               |       |                       |       |                      |       |   |   |   |   |
| ILEC                                                                                    |       |                       |       |                      |       |   |   |   |   |
| Local Service                                                                           | ** ** | **$**                      | **3,720**  |                      | $          | 3,847 | ** ** | **$** | **11,198** |   | $ | 11,396 |   |
| Network Access                                                                          | ** ** | **7,317**                  |       | 8,062                     | ** ** | **24,175** |   | 25,011 |   |
| Data                                                                                    | ** ** | **606**                    |       | 524                       | ** ** | **1,766** |   | 1,593 |   |
| Intersegment                                                                            | ** ** | **51**                     |       | 68                        | ** ** | **154** |   | 206 |   |
| Other                                                                                   | ** ** | **1,738**                  |       | 1,635                     | ** ** | **4,962** |   | 4,978 |   |
| Total ILEC                                                                              | ** ** | **13,432**                 |       | 14,136                    | ** ** | **42,255** |   | 43,184 |   |
|                                                                                    |       |                       |       |                      |       |   |   |   |   |
| CLEC                                                                                    |       |                       |       |                      |       |   |   |   |   |
| Local Service                                                                           | ** ** | **886**                    |       | 912                       | ** ** | **2,658** |   | 2,766 |   |
| Network Access                                                                          | ** ** | **474**                    |       | 652                       | ** ** | **1,486** |   | 1,953 |   |
| Data                                                                                    | ** ** | **647**                    |       | 521                       | ** ** | **1,895** |   | 1,301 |   |
| Other                                                                                   | ** ** | **441**                    |       | 443                       | ** ** | **1,336** |   | 1,323 |   |
| Total CLEC                                                                              | ** ** | **2,448**                  |       | 2,528                     | ** ** | **7,375** |   | 7,343 |   |
|                                                                                    |       |                       |       |                      |       |   |   |   |   |
| Long Distance                                                                           | ** ** | **1,244**                  |       | 1,165                     | ** ** | **3,605** |   | 3,499 |   |
|                                                                                    |       |                       |       |                      |       |   |   |   |   |
| Internet                                                                                | ** ** | **1,076**                  |       | 1,011                     | ** ** | **3,247** |   | 3,000 |   |
|                                                                                    |       |                       |       |                      |       |   |   |   |   |
| Digital TV                                                                              | ** ** | **234**                    |       | 146                       | ** ** | **686** |   | 371 |   |
|                                                                                    |       |                       |       |                      |       |   |   |   |   |
| Total Telecom Revenues                                                                  | ** ** | **$**                      | **18,434** |                      | $          | 18,986 | ** ** | **$** | **57,168** |   | $ | 57,397 |   |
|                                                                                    |       |                       |       |                      |       |   |   |   |   |
| Total Telecom Revenues Before Intersegment  Eliminations                                |       |                       |       |                      |       |   |   |   |   |
| Unaffiliated Customers                                                                  | ** ** | **$**                      | **18,383** |                      | $          | 18,918 | ** ** | **$** | **57,014** |   | $ | 57,191 |   |
| Intersegment                                                                            | ** ** | **51**                     |       | 68                        | ** ** | **154** |   | 206 |   |
| ** **                                                                              |       | **18,434**                 |       | 18,986                    | ** ** | **57,168** |   | 57,397 |   |
|                                                                                    |       |                       |       |                      |       |   |   |   |   |
| Cost of Services, excluding Depreciation  and Amortization                              | ** ** | **7,431**                  |       | 7,554                     | ** ** | **22,389** |   | 22,216 |   |
| Selling, General, and Administrative  Expenses, excluding Depreciation and Amortization | ** ** | **2,892**                  |       | 2,586                     | ** ** | **8,340** |   | 7,664 |   |
| Depreciation and Amortization                                                           | ** ** | **3,123**                  |       | 3,459                     | ** ** | **10,223** |   | 10,273 |   |
| Operating Income                                                                        | ** ** | **$**                      | **4,988**  |                      | $          | 5,387 | ** ** | **$** | **16,216** |   | $ | 17,244 |   |
|                                                                                    |       |                       |       |                      |       |   |   |   |   |
| Income from Continuing Operations, Net of  Tax                                          | ** ** | **$**                      | **2,970**  |                      | $          | 3,207 | ** ** | **$** | **9,654** |   | $ | 10,266 |   |
| Income/(Loss) from Discontinued Operations                                              | ** ** | **22**                     |       | (15                       | )          | **123** |   | (74 | ) |
| Net Income                                                                              | ** ** | **$**                      | **2,992**  |                      | $          | 3,192 | ** ** | **$** | **9,777** |   | $ | 10,192 |   |
|                                                                                    |       |                       |       |                      |       |   |   |   |   |
| Capital Expenditures                                                                    | ** ** | **$**                      | **4,603**  |                      | $          | 2,869 | ** ** | **$** | **8,653** |   | $ | 9,086 |   |

 

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| ** **                      | ** ** | **For Nine Months Ended** | ** ** |
|---------------------------------|------------|---------------------------|------------|
| **(Dollars in Thousands)**      | ** ** | **9/30/2005**             | ** ** | **9/30/2004** | ** ** |
|                            |       |                      |       |   |   |
| ILEC Access  Lines              | ** ** | **57,080**                |       | 61,085 |   |
|                            |       |                      |       |   |   |
| CLEC Access  Lines              |       |                      |       |   |   |
| Overbuild                       | ** ** | **11,094**                |       | 10,285 |   |
| Unbundled Network Element (UNE) | ** ** | **1,656**                 |       | 1,721 |   |
| Total Service Resale (TSR)      | ** ** | **1,592**                 |       | 2,160 |   |
| Total                           | ** ** | **14,342**                |       | 14,166 |   |
|                            |       |                      |       |   |   |
| Long  Distance Customers        | ** ** | **40,936**                |       | 41,763 |   |
|                            |       |                      |       |   |   |
| Internet Customers              | ** ** | **18,028**                |       | 17,090 |   |
|                            |       |                      |       |   |   |
| Total  Telecom Customers        | ** ** | **130,386**               |       | 134,104 |   |
|                            |       |                      |       |   |   |
| DSL  Customers                  | ** ** | **12,372**                |       | 9,745 |   |
|                            |       |                      |       |   |   |
| Digital TV  Customers           | ** ** | **2,573**                 |       | 1,732 |   |

 

Telecom Sector operating revenuesbefore intersegment eliminations were $18,434,000, which is $552,000 or 2.9%lower in the three months ended September 30, 2005 compared to the threemonths ended September 30, 2004.****The decreasein revenue in the third quarter of 2005 compared to the third quarter of 2004was due primarily to****declines inILEC and CLEC local service and network access, partially offset by increasesin ILEC and CLEC data revenue and increases in long distance, Internet anddigital TV revenues.****Telecom Sectoroperating revenues before intersegment eliminations were $57,168,000, which is$229,000 or 0.4% lower in the nine months ended September 30, 2005compared to the nine months ended September 30, 2004.****Forthe nine month period ended September 30, 2005 as compared to the sameperiod in 2004, the decrease in revenue was primarily due to****declines in ILEC and CLEC local service and network access,partially offset by increases in ILEC and CLEC data revenue and increases inlong distance, Internet and digital TV revenues.

 

ILEC local service revenue was $3,720,000, which is $127,000 or 3.3%lower in the three months ended September 30, 2005 compared to the threemonths ended September 30, 2004.****ILEC localservice revenue was $11,198,000, which is $198,000 or 1.7% lower in the ninemonths ended September 30, 2005 compared to the nine months ended September 30,2004.****The decrease is the result of 4,005fewer access lines at September 30, 2005 than at September 30, 2004.****Enterprise Solutions signed a large contract with a collegecampus in Minnesota to provide an Internet Protocol (IP) Telephony System. ThisSystem has already replaced over 2,000 ILEC access lines in the third quarterof 2005. The new System will eventually replace approximately 2,000 more ILECaccess lines and approximately $45,000 per month of local revenue when fullyimplemented by year-end 2005.

 

ILEC network access revenue was $7,317,000, which is $745,000 or 9.2%lower in the three months ended September 30, 2005 compared to the threemonths ended September 30, 2004. The decrease in network access revenue inthe three months ended September 30, 2005 compared to the three monthsended September 30, 2004 was primarily due to an interstate rate decreaseon July 1, 2005. ILEC network access revenue was $24,175,000, which is$836,000 or 3.3% lower in the nine months ended September 30, 2005compared to the nine months ended September 30, 2004. The decrease innetwork access revenue in the nine months ended September 30, 2005 wasprimarily due to an interstate rate decrease on July 1, 2005 and lowerMOUs (minutes of use). A combination of changing MOUs, carriers reroutingtraffic, and lower demand for dedicated lines may negatively impact futureaccess revenues. In addition, future access reform may provide further negativeinfluences. The Minnesota Public Utilities Commission (PUC) has beenconsidering intrastate access reform and universal service for several years(see regulatory section).

 

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ILEC data revenue was $606,000, which is $82,000 or 15.6% higher in thethree months ended September 30, 2005 compared to three months ended September 30,2004. ILEC data revenue was $1,766,000, which is $173,000 or 10.9% higher inthe nine months ended September 30, 2005 compared to the nine months endedSeptember 30, 2004. The increase is the result of 1,996 more digitalsubscriber line (DSL) customers at September 30, 2005 than at September 30,2004.

 

ILEC other revenue was $103,000 or 6.3% higher in third quarter 2005compared to third quarter 2004. This increase was primarily due to an increasein CPE phone system sales. ILEC other revenue was $16,000 or 0.3% lower in thenine months ended September 30, 2005 compared to the nine months ended September 30,2004.

 

CLEC local service revenue was $886,000, which is $26,000 or 2.9% lowerin the three months ended September 30, 2005 compared to the three monthsended September 30, 2004. CLEC local service revenue was $2,658,000, whichis $108,000 or 3.9% lower in the nine months ended September 30, 2005compared to the nine months ended September 30, 2004. Access linesincreased by 176 lines or 1.2% from September 30, 2004 to September 30,2005. Despite the increase in lines, an implementation of package pricing tomeet competitive pricing pressures by incumbent LEC’s in those markets resultedin the decreased revenue in the three and nine months ended September 30,2005 compared to September 30, 2004.

 

CLEC network access revenue was $178,000 or 27.3% lower in thirdquarter 2005 compared to third quarter 2004.****CLECnetwork access revenue was $467,000 or 23.9% lower in the nine months ended September 30,2005 compared to the nine months ended September 30, 2004.****This decrease in the three and nine months ended September 30,2005 compared to September 30, 2004 was primarily due to a mandated ratedecrease in June of 2004 and lower MOUs.

 

CLECdata revenue was $126,000 or 24.2% higher in third quarter 2005 compared tothird quarter 2004. CLEC data revenue was $594,000 or 45.7% higher in the ninemonths ended September 30, 2005 compared to the nine months ended September 30,2004. The increase in 2005 compared to 2004 was caused primarily by an increasein residential and business DSL penetration in CLEC communities as well as therollout of Ethernet services to large business customers in 2004.

 

Longdistance revenue was $79,000 or 6.8% higher in the three months ended September 30,2005 compared to the three months ended September 30, 2004. Long distancerevenue was $106,000 or 3.0% higher in the nine months ended September 30,2005 compared to the nine months ended September 30, 2004.****In June of 2005, a large Minnesota college campusended its contract for long distance services, which resulted in a loss ofapproximately 2,800 long distance customers. Despite the loss of this contract,the long distance customer base only decreased 1,125 lines or 2.7% in the thirdquarter of 2005 and decreased 827 lines or 2.0% between September 30, 2005and September 30, 2004 due to other new customer growth.****Higher long distance usage customer growth offset the lossof the lower long distance usage customers mentioned above in the three andnine months ended September 30, 2005 compared to the three and nine monthsended September 30, 2004.

 

Internetrevenue was $65,000, or 6.4% higher in the three months ended September 30,2005 compared to the three months ended September 30, 2004. Internetrevenue was $247,000, or 8.2% higher in the nine months ended September 30,2005 compared to the nine months ended September 30, 2004. The increase inrevenue was caused primarily by an increase in Internet customers of 938 or5.5% between September 30, 2004 and September 30, 2005.

 

DigitalTV was $88,000, or 60.3% higher in the three months ended September 30,2005 compared to the three months ended September 30, 2004. The increasein the three months ended September 30, 2005 compared to the three monthsended September 30, 2004 was the result of the offering of digital TV inNew Richland and Ellendale in June 2005, and St. Clair, Minnesota in September 2005.Digital TV was $315,000, or 84.9% higher in the nine months ended September 30,2005 compared to the nine months ended September 30, 2004. The increase inthe nine months ended September 30, 2005 compared to the nine months endedSeptember 30, 2004 was the result of the offering of digital TV in Wasecain July 2004, New Richland and Ellendale, Minnesota in June 2005, andSt. Clair, Minnesota in September 2005.

 

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Costof Services, excluding Depreciation and Amortization:

 

Costof services, excluding depreciation and amortization was $123,000 or 1.6% lowerin the third quarter of 2005 compared to the third quarter of 2004.****The decrease in the three months ended September 30,2005 compared to the three months ended September 30, 2004 is primarilydue to lower bad debt expense and lower Internet expense due to lower costsassociated with customers who have switched from dial-up Internet to broadbandInternet, partially offset by increased wages and consulting fees. Cost of services,excluding depreciation and amortization was $173,000 or 0.8% higher in the ninemonths ended September 30, 2005 compared to the nine months ended September 30,2004. The increase in nine months ending September 30, 2005 compared tothe nine months ended September 30, 2004 is primarily due to increasedwages, transport costs, consulting fees and originating access fees, partiallyoffset by lower leased fiber expenses, lower Internet expense due to lowercosts associated with customers who have switched from dial-up Internet tobroadband Internet and lower bad debt expense. The decrease in bad debt expensefor the three and nine months ended September 30, 2005 relates to $410,000of bad debt recoveries associated with a carrier bankruptcy.

 

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

 

Selling,general and administrative expenses, excluding depreciation and amortizationwere $306,000 or 11.8% higher in the third quarter of 2005 compared to thethird quarter of 2004.****Selling,general and administrative expenses, excluding depreciation and amortizationwere $676,000 or 8.8% higher in the nine months ended September 30, 2005compared to the nine months ended September 30, 2004.****Theincrease in three and nine months ended September 30, 2005 compared to thethree and nine months ended September 30, 2004 is primarily due toincreased sales expenses associated with the CPE phone system sales, regulatoryfees and property taxes.

 

Depreciationand Amortization:

 

Depreciationand amortization were $3,123,000, which is $336,000 or 9.7% lower in the threemonths ended September 30, 2005 compared to the same period in 2004.****The decrease in depreciation expense in the three monthsended September 30, 2005 can be largely attributed to central officeswitching equipment becoming fully depreciated in the third quarter of 2005.Depreciation and amortization were $10,223,000, which is $50,000 or 0.5% lowerin the nine months ended September 30, 2005 compared to the same period in2004.****The decrease in depreciation expensein the nine months ended September 30, 2005 compared to the nine monthsended September 30, 2004 can be largely attributed to central officeswitching equipment becoming fully depreciated in the third quarter of 2005,partially offset by an increase in Telecom Sector’snetwork assets.

 

Operatingand Net Income:

 

Operatingincome was $4,988,000, which is $399,000 or 7.4% lower in the three monthsended September 30, 2005 compared to the three months ended September 30,2004.****Net income was $2,992,000, which is$200,000 or 6.3% lower in the three months ended September 30, 2005compared to the three months ended September 30, 2004. These decreaseswere driven by the $552,000 decrease in revenues and $306,000 increase in selling,general and administrative expenses, partially****offsetby the $336,000 decrease in depreciation and amortization and $123,000 decreasein cost of services, all of which were mentioned above.****Operatingincome was $16,216,000, which is $1,028,000 or 6.0% lower in the nine monthsended September 30, 2005 compared to the nine months ended September 30,2004.****Net income was $9,777,000, which is$415,000 or 4.1% lower in the nine months ended September 30, 2005compared to the nine months ended September 30, 2004. These decreases weredriven by the $676,000 increase in selling, general and administrativeexpenses, $229,000 decrease in revenues, $173,000 increase in cost of services,partially offset by the $50,000 decrease in depreciation and amortization, allof which were mentioned above.

 

DiscontinuedOperations:

 

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

 

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

 

**INFORMATION SOLUTIONS SECTOR**

 
| ** **                                                                              | ** ** | **For Three Months Ended** | ** ** | **For Nine Months Ended** | ** ** |
|-----------------------------------------------------------------------------------------|------------|----------------------------|------------|---------------------------|------------|
| **(Dollars in Thousands)**                                                              | ** ** | **9/30/2005**              | ** ** | **9/30/2004**             | ** ** | **9/30/2005** | ** ** | **9/30/2004** | ** ** |
| Revenues Before Eliminations                                                            |       |                       |       |                      |       |   |   |   |   |
| Unaffiliated Customers                                                                  | ** ** | **$**                      | **519**    |                      | $          | 574 | ** ** | **$** | **1,921** |   | $ | 2,219 |   |
| Intersegment                                                                            | ** ** | **1,056**                  |       | 1,078                     | ** ** | **3,239** |   | 3,252 |   |
| ** **                                                                              |       | **1,575**                  |       | 1,652                     | ** ** | **5,160** |   | 5,471 |   |
| Cost of Services, excluding Depreciation  and Amortization                              | ** ** | **1,424**                  |       | 1,441                     | ** ** | **4,201** |   | 4,863 |   |
| Selling, General, and Administrative  Expenses, excluding Depreciation and Amortization | ** ** | **175**                    |       | 216                       | ** ** | **1,057** |   | 662 |   |
| Depreciation and Amortization                                                           | ** ** | **403**                    |       | 636                       | ** ** | **1,698** |   | 1,929 |   |
|                                                                                    |       |                       |       |                      |       |   |   |   |   |
| Operating Loss                                                                          | ** ** | **$**                      | **(427**   | **)**                     | $          | (641 | ) | **$** | **(1,796** | **)** | $ | (1,983 | ) |
| Net Loss                                                                                | ** ** | **$**                      | **(262**   | **)**                     | $          | (390 | ) | **$** | **(1,091** | **)** | $ | (1,198 | ) |
|                                                                                    |       |                       |       |                      |       |   |   |   |   |
| Capital Expenditures                                                                    | ** ** | **$**                      | **866**    |                      | $          | — | ** ** | **$** | **1,424** |   | $ | 1 |   |

 

The operations of the Information Solutions Sector include the internalInformation Technology functions for HickoryTech and its affiliates, as well asits external services to non-affiliated customers.

 

Revenues:

 

Operating revenues from unaffiliated customers decreased $55,000 or9.6% in the third quarter 2005 compared to the third quarter 2004.****The decrease was largely due to the loss of severalcustomers which was partially offset by increased billings to several othercustomers.****Operating revenues from unaffiliatedcustomers decreased $298,000 or 13.4% in the nine months ended September 30,2005 compared to the nine months ended September 30, 2004. In June 2005,the Company recognized $369,000 in license fees from the sale of SuiteSolutionto a customer. Despite this sale, the Company has lost several other customersincluding $456,000 over the first nine months of 2005 from a temporary customerrelationship that ended in 2004. This was partially offset by increasedbillings to several other customers.

 

Cost of Services, excluding Depreciation andAmortization:

 

Cost of services, excluding depreciation and amortization decreased$17,000 or 1.2% in the third quarter 2005 compared to the third quarter 2004.****Cost of services, excluding depreciation and amortizationdecreased $662,000 or 13.6% in the nine months ended September 30, 2005compared to the nine months ended September 30, 2004. The decrease isprimarily due to management cost reduction actions and lower costs recognizedfrom outsourced contractor work.

 

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

 

Selling, general and administrative expenses, excluding depreciationand amortization were $41,000 or 19.0% lower in the third quarter of 2005compared to the third quarter of 2004. The decrease was largely due to loweremployee benefits.****Selling,general and administrative expenses, excluding depreciation and amortizationwere $395,000 or 59.7% higher in the nine months ended September 30, 2005compared to the nine months ended September 30, 2004. The increase waslargely due to one-time fees associated with the termination of leases.

 

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Operating and Net Loss:

 

Operating loss decreased $214,000 or 33.4% in third quarter 2005compared to third quarter 2004.****Net lossdecreased $128,000 or 32.8% in third quarter 2005 compared to third quarter2004. The decrease in operating loss and net loss in third quarter 2005compared to third quarter 2004 was primarily attributable****to****the decrease in depreciation and amortization, the decreasein selling, general and administrative expenses, excluding depreciation andamortization, and the decrease in cost of services, excluding depreciation andamortization, partially offset by the decrease in revenues. Operating lossdecreased $187,000 or 9.4% in the nine months ended September 30, 2005compared to the nine months ended September 30, 2004.****Netloss decreased $107,000 or 8.9% in the nine months ended September 30,2005 compared to the nine months ended September 30, 2004.****The decrease in operating loss and net loss for the ninemonths ended September 30, 2005 compared to nine months ended September 30,2004 was primarily attributable to the decrease in cost of services, excludingdepreciation and amortization, the decrease in depreciation and amortization,partially offset by the increase in selling, general and administrativeexpenses, excluding depreciation and amortization and the decrease****in revenues. The operations of the Information SolutionsSector include the internal Information Technology functions for HickoryTechand its affiliates, as well as its external services to non-affiliatedcustomers.

 

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

 

**ENTERPRISE SOLUTIONS SECTOR**

 
| ** **                                                                             | ** ** | **For Three Months Ended** | ** ** | **For Nine Months Ended** | ** ** |
|----------------------------------------------------------------------------------------|------------|----------------------------|------------|---------------------------|------------|
| **(Dollars in Thousands)**                                                             | ** ** | **9/30/2005**              | ** ** | **9/30/2004**             | ** ** | **9/30/2005** | ** ** | **9/30/2004** | ** ** |
| Revenues Before Intersegment Eliminations                                              |       |                       |       |                      |       |   |   |   |   |
| Installation                                                                           | ** ** | **$**                      | **1,253**  | ** **                | $          | 961 | ** ** | **$** | **5,653** | ** ** | $ | 2,841 |   |
| Service                                                                                | ** ** | **2,149**                  | ** ** | 1,724                     | ** ** | **6,092** | ** ** | 5,477 |   |
| ** **                                                                             |       | **3,402**                  | ** ** | 2,685                     | ** ** | **11,745** | ** ** | 8,318 |   |
| Cost of Sales                                                                          | ** ** | **2,219**                  | ** ** | 1,854                     | ** ** | **8,259** | ** ** | 5,659 |   |
| Cost of Services, excluding Depreciation  And Amortization                             | ** ** | **573**                    | ** ** | 499                       | ** ** | **1,401** | ** ** | 1,141 |   |
| Selling, General and Administrative  Expenses, excluding Depreciation and Amortization | ** ** | **635**                    | ** ** | 774                       | ** ** | **2,201** | ** ** | 2,381 |   |
| Depreciation and Amortization                                                          | ** ** | **28**                     | ** ** | 40                        | ** ** | **91** | ** ** | 135 |   |
|                                                                                   |       |                       | ** ** |                      |       |   | ** ** |   |   |
| Operating Income/(Loss)                                                                | ** ** | **$**                      | **(53**    | **)**                     | $          | (482 | ) | **$** | **(207** | **)** | $ | (998 | ) |
| Net Income/(Loss)                                                                      | ** ** | **$**                      | **(31**    | **)**                     | $          | (287 | ) | **$** | **(123** | **)** | $ | (594 | ) |
|                                                                                   |       |                       | ** ** |                      |       |   | ** ** |   |   |
| Capital Expenditures                                                                   | ** ** | **$**                      | **—** | ** **                | $          | 2 | ** ** | **$** | **20** | ** ** | $ | 24 |   |

 

Revenues:

 

Operating revenues increased $717,000 or 26.7% in the third quarter of2005 compared to the third quarter of 2004.****Operatingrevenues increased $3,427,000 or 41.2% in the nine months ended September 30,2005 compared to the nine months ended September 30, 2004.****Installation revenue increased $292,000 or 30.4% in thethird quarter of 2005 compared to the third quarter of 2004. The increase ininstallation revenue in the third quarter of 2005 compared to the third quarterof 2004 was mainly the result of****increasedsales and installations of Private Branch Exchange (PBX) Systems of $163,000and an increase in Small Business Systems (SBS) installations of $159,000.Installation revenue increased $2,812,000 or 99% in the nine months ended September 30,2005 compared to the nine months ended September 30, 2004.****The increase in installation revenue in the nine monthsended September 30, 2005 compared to the nine months ended September 30,2004 was mainly the result of increased data revenue of $1,931,000, which wasprimarily the result of a large contract with a college campus in Minnesota.****Service revenue was $425,000****or24.7% higher in the third quarter of 2005 compared to the third quarter of2004. The increase in service revenue in the third quarter of 2005 compared tothe third quarter of 2004 was primarily a result of****a$445,000 or 52.7% increase in Move, Add and Change (MAC) revenues.****Service revenue was $615,000 or 11.2% higher in the ninemonths ended September 30, 2005 compared to the nine months ended September 30,2004.****The increase in service revenue in thenine months ended September 30, 2005 compared to the nine months ended September 30,2004 was largely the result of a $688,000 or 24.5% increase in MAC revenues.

 

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Cost of Sales:

 

Cost of sales increased $365,000 or 19.7% in the third quarter of 2005compared to the third quarter of 2004.****Cost of salesincreased $2,600,000 or 45.9% in the nine months ended September 30, 2005compared to the nine months ended September 30, 2004. The increase in costof sales in the three and nine months ended September 30, 2005 compared tothe three and nine months ended September 30, 2004 corresponds with theincrease in sales in both periods.****EnterpriseSolutions received a $211,000 rebate in the third quarter from one of its suppliers,which is recorded in cost of sales.

 

Cost of Services, excluding Depreciation andAmortization:

 

Cost of services excluding depreciation and amortization increased$74,000 or 14.8% in the third quarter 2005 compared to the third quarter 2004.****Cost of services excluding depreciation and amortizationincreased $260,000 or 22.8% in the nine months ended September 30, 2005compared to the nine months ended September 30, 2004.****Theincrease in both the three and nine months ended September 30, 2005 is mainlythe result of an increase in the inventory valuation reserve. Due to thesurplus of supplier inventory in the market and resultant decline in productprices in this line of business over recent quarters, the Company is makingsystematic inventory valuation adjustments. The Company cannot predict theimpact or timing, if any, of future inventory valuation changes.

 

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

 

Selling, general and administrative expenses, excluding depreciationand amortization were $139,000 or 18.0% lower in the third quarter of 2005compared to the third quarter of 2004. Selling, general and administrativeexpenses, excluding depreciation and amortization were $180,000 or 7.6% lowerin the nine months ended September 30, 2005 compared to the nine monthsended September 30, 2004. The decrease in selling, general andadministrative expenses, excluding depreciation and amortization for the threeand nine months ended September 30, 2005 compared to the three and ninemonths ended September 30, 2004 was largely due to decreased wages and baddebt expense.

 

Operating and Net Loss:

 

Operating loss decreased $429,000 in the third quarter 2005 compared tothe third quarter 2004. Net loss decreased $256,000 in the third quarter 2005compared to the third quarter 2004.****Operating lossdecreased $791,000 in the nine months ended September 30, 2005 compared tothe nine months ended September 30, 2004. Net loss decreased $471,000 inthe nine months ended September 30, 2005 compared to the nine months endedSeptember 30, 2004.****The decreasein operating and net loss for the three and nine months ended September 30,2005 resulted primarily from the increase in operating revenues and decrease inselling, general and administrative expenses, excluding depreciation andamortization, partially offset by the increase in cost of sales and cost ofservices, excluding depreciation and amortization, all of which are describedabove.

 

LIQUIDITY AND CAPITAL RESOURCES

 

CASH FLOWS – Cashprovided by operations was $22,358,000 in the first nine months of 2005compared to $25,485,000 in the first nine months of 2004. Cash flows fromoperations in the first nine months of 2005 were primarily attributable to netincome plus non-cash expenses for depreciation and amortization as well as adecrease in receivables. Cash flows from operations in the first nine months of2004 were primarily attributable to net income plus non-cash expenses fordepreciation and amortization and a decrease in receivables.

 

Cash flows used in investing activities were $7,990,000 in the firstnine months of 2005 compared to $6,467,000 for the same period in 2004. Capitalexpenditures were $10,136,000 during the first nine months of 2005 as comparedto $9,111,000 for the same period in 2004. 2005 capital expenditures wereincurred primarily to provide additional network facilities in the TelecomSector. Management expects capital expenditures in the remainder of 2005 to beapproximately $12,500,000. Management plans to use the current credit facilityto finance these capital expenditures that exceed available cash flow in theremainder of 2005. Pursuant to conditions of its debt agreement, which allowsthe Company to reduce its investment in one of its lenders by an amount equalto 10% of the annual principal payments of the term loan component of its debt,the Company received a refund of its investment in the amount of $2,100,000 inthe first nine months of 2005 and $2,600,000 in the first nine months of 2004.

 

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Cash flows used in financing activities were $14,079,000 for the firstnine months of 2005 compared to $18,698,000 for the first nine months of 2004.Included in cash flows used in financing activities are debt repayments anddividend payments. HickoryTech made payments on its revolving credit facilityof $12,750,000 during the first nine months of 2005, and $15,250,000 during thefirst nine months of 2004. HickoryTech borrowed $5,000,000 on its revolving creditfacility during the first nine months of 2005, and $2,000,000 during the firstnine months of 2004. Dividend payments for the first nine months of 2005 were$4,704,000 compared to $4,281,000 for the same period in 2004.

 

WORKING CAPITAL –Working capital (i.e. current assets minus current liabilities) was $3,637,000as of September 30, 2005, compared to working capital of $787,000 as of December 31,2004. The ratio of current assets to current liabilities was 1.2 to 1.0 as of September 30,2005 and 1.0 to 1.0 as of December 31, 2004.

 

LONG-TERM OBLIGATIONS- HickoryTech’s long-term obligations as of September 30, 2005 were$94,035,000, excluding current maturities of $1,451,000. As of September 30,2005, HickoryTech had a $113,375,000 credit facility with a syndicate of banks.The credit facility is collateralized by certain property, plant and equipmentand contains covenants relating to cash flow and capitalization. As of September 30,2005, there were no covenant violations. The credit facility is comprised of a$103,125,000 revolving credit component and a $10,250,000 term loan component.The available line of credit on the $103,125,000 revolving credit componentbegan decreasing in increments in March 2004, and has a final maturitydate in September 2007, at which time the $84,500,000 borrowed on therevolving credit component is due to be paid, pursuant to the Fifth Amendmentto the credit facility, which was effective June 23, 2005. The term loancomponent requires equal quarterly principal payments of $250,000 during theperiod of March 2001 to December 2008, and $7,000,000 in the firstquarter of 2009. The weighted average interest rate associated with this creditfacility varies with LIBOR and certain other rates. The weighted averageinterest rate was 4.7% at September 30, 2005 and 4.1% at September 30,2004. HickoryTech has utilized interest rate swap agreements to implement fixedinterest terms on various portions of the overall debt outstanding. The currentagreements result in fixed interest terms on $70,000,000 of the outstandingdebt until June 2008. As of September 30, 2005, HickoryTech had drawn$94,750,000 on this credit facility and had $18,625,000 of available credit.The Fifth Amendment to the credit facility dated June 23, 2005 also establishedaccessibility for HickoryTech to $25,000,000 in incremental term loans inaddition to the revolver and term loan credit facility. Management believes theremaining available credit is sufficient to cover future cash requirements.

 

HickoryTech’s Information Solutions Sector leases certain computerequipment under capital lease arrangements. During the nine months ended September 30,2005 and 2004, this sector recorded additions to property, plant and equipmentof $666,000 and $81,000, respectively, related to these capital leasearrangements.

 

CONSTRUCTION PLANS -Beginning in 2004, HickoryTech embarked on a five-year network enhancementprogram in its core telephone property in Mankato in support of its broadbandservice strategy. The Company has been upgrading its Mankato network since 2004and will continue to do so through 2007. Management believes that theenhancement will support the broadband product deployment strategies of thefuture, as well as serving as defense against competition in its core market.These upgrades to an already state of the art network will give HickoryTech thecapability to offer more diversified services to its core customer base. Thetotal capital expenditure program in 2005 is estimated to be between$22,000,000 and $23,000,000.

 

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.

 

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CRITICAL ACCOUNTING POLICIES

 

Management’s discussion and analysis of financial condition and resultsof operations stated in this Form 10-Q are based upon HickoryTech’s consolidatedfinancial statements, which have been prepared in accordance with accountingprinciples generally accepted in the United States of America and, whereapplicable, conform to the accounting principles as prescribed by federal andstate telephone utility regulatory authorities. HickoryTech presently givesaccounting recognition to the actions of regulators where appropriate, asprescribed by Statement of Financial Accounting Standards (SFAS) No. 71, “Accountingfor the Effects of Certain Types of Regulation.” The preparation of thesefinancial statements requires management to make estimates and judgments thataffect the reported amounts of assets, liabilities, revenues, and expenses andrelated disclosure of contingent assets and liabilities. Management believesthat the application of the accounting policies, which are important toHickoryTech’s financial position and results of operations, requiressignificant judgments and estimates on the part of management.  A description of the critical accountingpolicies adhered to by HickoryTech is contained in the Management’s Discussionand Analysis of Financial Condition and Results of Operations in HickoryTech’sAnnual Report on Form 10-K for the year ended December 31, 2004.There were no significant changes to these critical accounting policies duringthe quarter ended September 30, 2005.

 

RECENT ACCOUNTING DEVELOPMENTS

 

In December 2004, the Financial Accounting Standards Board (“FASB”)issued SFAS No. 123(R), “Share-Based Payment,” which is a revision of SFASNo. 123 and supersedes APB Opinion No. 25. SFAS No. 123(R)requires all share-based payments to employees, including grants of employeestock options, to be valued at fair value on the date of grant, and to beexpensed over the applicable vesting period. Companies must recognizecompensation expense related to any awards that are not fully vested as of theeffective date. Compensation expense for the unvested awards will be measuredbased on the fair value of the awards previously calculated in developing thepro forma disclosures in accordance with the provisions of SFAS No. 123.Originally, SFAS No. 123(R) was effective for all stock-based awardsgranted beginning with the first annual or interim period after June 15,2005. On April 14, 2005, The Securities and Exchange Commission (SEC)approved a new rule that changed the effective date of SFAS No. 123(R)for public companies to the first annual or interim period in the first fiscalyear beginning after June 15, 2005. HickoryTech is currently assessing theimpact of adopting SFAS 123(R), which may be material in future periods, to itsconsolidated results of operations. Reference is made to the disclosures underSFAS No. 123 in Note 10 of the Notes to Consolidated Financial Statements.

 

ITEM 3. QUANTATIVE AND QUALITATIVEDISCLOSURES ABOUT MARKET RISK

 

HickoryTech does not have operations subject to risks of foreigncurrency fluctuations. HickoryTech does, however, use derivative financialinstruments to manage exposure to interest rate fluctuations. HickoryTech’sobjectives for holding derivatives are to minimize interest rate risks usingthe most effective methods to eliminate or reduce the impact of theseexposures. Variable rate debt instruments are subject to interest rate risk.HickoryTech has entered into interest rate swap agreements with remainingmaturities of thirty-three months to manage its exposure to interest ratemovements on a portion of its variable rate debt obligations. The effectiveportion of the cumulative gain or loss on these derivative instruments isreported as a component of accumulated other comprehensive income/loss inshareholders’ equity and is recognized in earnings when the term of the swapagreement is concluded. HickoryTech’s earnings are affected by changes ininterest rates as a portion of its long-term debt has variable interest ratesbased on LIBOR. If interest rates for the portion of HickoryTech’s long-termdebt not protected by interest rate swap agreements had averaged 10% more forthe quarter ended September 30, 2005, HickoryTech’s interest expense wouldhave increased $39,000. If interest rates for the portion of HickoryTech’slong-term debt based on variable rates had averaged 10% more for the ninemonths ended September 30, 2005, HickoryTech’s interest expense would haveincreased $94,000.

 

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ITEM 4.  CONTROLS AND PROCEDURES

 

Evaluation of Disclosure Controls andProcedures. An evaluation was performed under thesupervision and with the participation of the Company’s management, includingthe chief executive officer and chief financial officer, regarding theeffectiveness of the design and operation of the Company’s disclosure controlsand procedures (as defined in Rule 13a-15(e) promulgated under theSecurities and Exchange Act of 1934, as amended (the “Exchange Act”)). Based onthat evaluation, the chief executive officer and chief financial officerconcluded that, as of the end of the period covered by this report, the Company’sdisclosure controls and procedures were effective.

 

Changes in Internal Controls.During our third quarter of 2005, there have not been any changes in theCompany’s internal control over financial reporting (as defined in Rule 13(a)-15(f) underthe Exchange Act) that have materially affected, or are reasonably likely tomaterially affect, our internal control over financial reporting.

 

PART II. OTHER INFORMATION

 

Item 1.    Legal Proceedings.

 

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.    Unregistered Sales ofEquity Securities and Use of Proceeds.

 

None.

 

Item 3.    Defaults Upon SeniorSecurities.

 

None.

 

Item 4.    Submission of Matters to aVote of Security Holders.

 

None.

 

Item 5.    Other Information.

 

None.

 

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Item 6.    Exhibits.

 

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

 

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

 

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

 

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

 

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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: | November 1, 2005 |                                           | 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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