**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,DC 20549**

 

**FORM 10-Q**

** **

**(Mark One)**

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

 

**Commissionfile number   0-13721**

 

**HICKORYTECH CORPORATION**

(Exact name of registrant as specified in itscharter)

 

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

 

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

 

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

 

The total number of shares of the registrant’s common stock outstandingas of September 30, 2003: 13,997,543.

 

 

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**HICKORY TECH CORPORATION**September 30, 2003PART I. FINANCIAL INFORMATION

ITEM 1.   FINANCIAL STATEMENTS.

CONSOLIDATED STATEMENTS OF OPERATIONS(UNAUDITED)

 
|                                                                                                        |   | **For Quarter Ended** |    | **For Nine Months Ended** |   |
|-------------------------------------------------------------------------------------------------------------|--------|-----------------------|---------|---------------------------|--------|
| **(In Thousands Except Per Share Amounts)**                                                                 |   | **9/30/2003**         |    | **9/30/2002**             |   | **9/30/2003** |   | **9/30/2002** |   |
| OPERATING REVENUES:                                                                                         |   |                  |    |                      |   |   |   |   |   |
| Telecom Sector                                                                                              |   | $                     | 18,810  |                      | $      | 18,100 |   | $ | 56,058 |   | $ | 52,857 |   |
| Information Solutions Sector                                                                                |   | 702                   |    | 981                       |   | 2,609 |   | 3,064 |   |
| Enterprise Solutions Sector                                                                                 |   | 3,565                 |    | 5,257                     |   | 10,859 |   | 11,655 |   |
| TOTAL OPERATING REVENUES                                                                                    |   | 23,077                |    | 24,338                    |   | 69,526 |   | 67,576 |   |
| COSTS AND EXPENSES:                                                                                         |   |                  |    |                      |   |   |   |   |   |
| Cost of Sales, Enterprise Solutions                                                                         |   | 2,606                 |    | 3,688                     |   | 7,675 |   | 7,905 |   |
| Operating Expenses, excluding Depreciation and Amortization                                                 |   | 11,475                |    | 12,557                    |   | 35,242 |   | 35,651 |   |
| Depreciation                                                                                                |   | 3,780                 |    | 3,448                     |   | 11,013 |   | 10,085 |   |
| Amortization of Intangibles                                                                                 |   | 236                   |    | 336                       |   | 761 |   | 989 |   |
| TOTAL COSTS AND EXPENSES                                                                                    |   | 18,097                |    | 20,029                    |   | 54,691 |   | 54,630 |   |
| OPERATING INCOME                                                                                            |   | 4,980                 |    | 4,309                     |   | 14,835 |   | 12,946 |   |
| OTHER INCOME (EXPENSE):                                                                                     |   |                  |    |                      |   |   |   |   |   |
| Equity in Net Income/(Loss) of Investees                                                                    |   | 1                     |    | (29                       | )      | (4 | ) | (27 | ) |
| Interest and Other Income                                                                                   |   | 10                    |    | 66                        |   | 35 |   | 138 |   |
| Interest Expense                                                                                            |   | (1,579                | )       | (1,752                    | )      | (4,624 | ) | (5,566 | ) |
| TOTAL OTHER INCOME (EXPENSE)                                                                                |   | (1,568                | )       | (1,715                    | )      | (4,593 | ) | (5,455 | ) |
|                                                                                                        |   |                  |    |                      |   |   |   |   |   |
| INCOME BEFORE INCOME TAXES                                                                                  |   | 3,412                 |    | 2,594                     |   | 10,242 |   | 7,491 |   |
| INCOME TAXES                                                                                                |   | 1,395                 |    | 1,060                     |   | 4,186 |   | 3,061 |   |
| INCOME FROM CONTINUING OPERATIONS                                                                           |   | 2,017                 |    | 1,534                     |   | 6,056 |   | 4,430 |   |
| DISCONTINUED OPERATIONS (Note 4)                                                                            |   |                  |    |                      |   |   |   |   |   |
| Income (Loss) from operations of discont. component, including loss  of the disposal of $25,345,000 in 2003 |   | (24,873               | )       | 949                       |   | (23,487 | ) | 2,637 |   |
| Income Taxes (Benefit)                                                                                      |   | (10,198               | )       | 389                       |   | (9,630 | ) | 1,081 |   |
| INCOME (LOSS) ON DISCONT. OPERATIONS                                                                        |   | (14,675               | )       | 560                       |   | (13,857 | ) | 1,556 |   |
| NET INCOME (LOSS)                                                                                           |   | $                     | (12,658 | )                         | $      | 2,094 |   | $ | (7,801 | ) | $ | 5,986 |   |
|                                                                                                        |   |                  |    |                      |   |   |   |   |   |
| Basic Earnings Per Share - Continuing Operations                                                            |   | $                     | 0.14    |                      | $      | 0.11 |   | $ | 0.43 |   | $ | 0.32 |   |
| Basic Earnings Per Share - Discontinued Operations                                                          |   | (1.05                 | )       | 0.04                      |   | (0.99 | ) | 0.11 |   |
|                                                                                                        |   | $                     | (0.91   | )                         | $      | 0.15 |   | $ | (0.56 | ) | $ | 0.43 |   |
| Dividends Per Share                                                                                         |   | $                     | 0.11    |                      | $      | 0.11 |   | $ | 0.33 |   | $ | 0.33 |   |
| Weighted Average Common Shares Outstanding                                                                  |   | 13,974                |    | 14,059                    |   | 13,973 |   | 14,009 |   |
|                                                                                                        |   |                  |    |                      |   |   |   |   |   |
| Diluted Earnings Per Share - Continuing Operations                                                          |   | $                     | 0.14    |                      | $      | 0.11 |   | $ | 0.43 |   | $ | 0.32 |   |
| Diluted Earnings Per Share - Discontinued Operations                                                        |   | (1.05                 | )       | 0.04                      |   | (0.99 | ) | 0.11 |   |
|                                                                                                        |   | $                     | (0.91   | )                         | $      | 0.15 |   | $ | (0.56 | ) | $ | 0.43 |   |
| Weighted Average Common and Equivalent Shares Outstanding                                                   |   | 14,024                |    | 14,117                    |   | 14,031 |   | 14,093 |   |

 

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

 

1

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**HICKORY TECH CORPORATION**September 30, 2003CONSOLIDATED BALANCE SHEETS(UNAUDITED)

 
| **(In Thousands Except   Share and Per Share Amounts)**                                                                                   |   | **9/30/2003** |        | **12/31/2002** |   |
|------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------|-------------|----------------|--------|
| ASSETS                                                                                                                                         |   |          |        |           |   |
| CURRENT ASSETS:                                                                                                                                |   |          |        |           |   |
| Cash and Cash Equivalents                                                                                                                      |   | **$**         | **880**     |           | $      | 1,874 |   |
| Receivables, Net of Allowance for Doubtful Accounts of $1,201 and  $1,358                                                                      |   | **10,343**    |        | 11,056         |   |
| Income Taxes Receivable                                                                                                                        |   | **—**    |        | 3,222          |   |
| Costs in Excess of Billings on Contracts                                                                                                       |   | **839**       |        | 2,107          |   |
| Inventories                                                                                                                                    |   | **4,825**     |        | 5,059          |   |
| Deferred Income Taxes                                                                                                                          |   | **951**       |        | 951            |   |
| Other                                                                                                                                          |   | **2,534**     |        | 2,840          |   |
| Assets Held for Sale                                                                                                                           |   | **2,181**     |        | —         |   |
| TOTAL CURRENT ASSETS                                                                                                                           |   | **22,553**    |        | 27,109         |   |
| INVESTMENTS                                                                                                                                    |   | **6,741**     |        | 10,517         |   |
| PROPERTY, PLANT AND EQUIPMENT                                                                                                                  |   | **224,482**   |        | 247,375        |   |
| Less ACCUMULATED DEPRECIATION                                                                                                                  |   | **112,807**   |        | 111,101        |   |
| PROPERTY, PLANT AND EQUIPMENT, NET                                                                                                             |   | **111,675**   |        | 136,274        |   |
| OTHER ASSETS:                                                                                                                                  |   |          |        |           |   |
| Goodwill                                                                                                                                       |   | **25,086**    |        | 25,086         |   |
| Intangible Assets, Net                                                                                                                         |   | **507**       |        | 34,669         |   |
| Financial Derivative Instrument                                                                                                                |   | **1,961**     |        | —         |   |
| Deferred Income Taxes                                                                                                                          |   | **5,211**     |        | —         |   |
| Deferred Costs and Other                                                                                                                       |   | **4,945**     |        | 6,556          |   |
| Assets Held for Sale                                                                                                                           |   | **27,481**    |        | —         |   |
| TOTAL OTHER ASSETS                                                                                                                             |   | **65,191**    |        | 66,311         |   |
| TOTAL ASSETS                                                                                                                                   |   | **$**         | **206,160** |           | $      | 240,211 |   |
| LIABILITIES & SHAREHOLDERS’ EQUITY                                                                                                    |   |          |        |           |   |
| CURRENT LIABILITIES:                                                                                                                           |   |          |        |           |   |
| Accounts Payable                                                                                                                               |   | **$**         | **2,608**   |           | $      | 4,543 |   |
| Accrued Expenses                                                                                                                               |   | **2,495**     |        | 3,719          |   |
| Accrued Interest                                                                                                                               |   | **60**        |        | 512            |   |
| Accrued Income Taxes                                                                                                                           |   | **1,576**     |        | —         |   |
| Billings in Excess of Costs on Contracts                                                                                                       |   | **275**       |        | 80             |   |
| Advanced Billings and Deposits                                                                                                                 |   | **2,846**     |        | 3,741          |   |
| Liabilities Held for Sale                                                                                                                      |   | **1,568**     |        | —         |   |
| Current Maturities of Long-Term Obligations                                                                                                    |   | **1,482**     |        | 1,441          |   |
| TOTAL CURRENT LIABILITIES                                                                                                                      |   | **12,910**    |        | 14,036         |   |
| LONG-TERM OBLIGATIONS, Net of Current Maturities                                                                                               |   | **140,096**   |        | 157,599        |   |
| LONG-TERM LIABILITIES HELD FOR SALE                                                                                                            |   | **31**        |        | —         |   |
| DEFERRED INCOME TAXES                                                                                                                          |   | **—**    |        | 4,377          |   |
| DEFERRED REVENUE AND BENEFITS                                                                                                                  |   | **5,766**     |        | 5,604          |   |
| TOTAL LIABILITIES                                                                                                                              |   | **158,803**   |        | 181,616        |   |
| COMMITMENTS AND CONTINGENCIES (Note 9)                                                                                                         |   | **—**    |        | —         |   |
| SHAREHOLDERS’ EQUITY:                                                                                                                     |   |          |        |           |   |
| Common Stock, no par value, $.10 stated value   Shares authorized: 100,000,000   Shares outstanding: 13,997,543 in 2003 and 13,983,929 in 2002 |   | **1,400**     |        | 1,398          |   |
| Additional Paid-In Capital                                                                                                                     |   | **8,519**     |        | 7,885          |   |
| Retained Earnings                                                                                                                              |   | **36,281**    |        | 49,312         |   |
| Accumulated Other Comprehensive Income                                                                                                         |   | **1,157**     |        | —         |   |
| TOTAL SHAREHOLDERS’ EQUITY                                                                                                                |   | **47,357**    |        | 58,595         |   |
| TOTAL LIABILITIES & SHAREHOLDERS’ EQUITY                                                                                              |   | **$**         | **206,160** |           | $      | 240,211 |   |

 

Theaccompanying notes are an integral part of the consolidated financialstatements.

 

2

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**HICKORY TECH CORPORATION**September 30, 2003CONSOLIDATED STATEMENTS OF CASH FLOWS(UNAUDITED)

 
|                                                              |   | **For Nine Months Ended** |       |
|-------------------------------------------------------------------|--------|---------------------------|------------|
| **(Dollars In Thousands)**                                        |   | **9/30/2003**             |       | **9/30/2002** |   |
| CASH FLOWS FROM OPERATING ACTIVITIES:                             |   |                      | ** ** |   |   |
| Net Income (Loss)                                                 |   | **$**                     | **(7,801** | **)** | $ | 5,986 |   |
| Adjustments to Reconcile Net Income (Loss) to Net                 |   |                      | ** ** |   |   |
| Cash Provided by Operating Activities:                            |   |                      | ** ** |   |   |
| Depreciation and Amortization                                     |   | **13,545**                | ** ** | 12,918 |   |
| Intangible Asset Impairment                                       |   | **21,000**                | ** ** | — |   |
| Long-Lived Asset Impairment                                       |   | **4,345**                 | ** ** | — |   |
| (Gain) on Sale of Assets                                          |   | **(2**                    | **)**      | — |   |
| Loss on Disposal of Assets                                        |   | **632**                   | ** ** | — |   |
| Deferred Income Taxes                                             |   | **(10,391**               | **)**      | — |   |
| Stock-Based Compensation                                          |   | **234**                   | ** ** | 701 |   |
| Employee Retirement Benefits and Deferred Compensation            |   | **242**                   | ** ** | 460 |   |
| Accrued Patronage Refunds                                         |   | **(443**                  | **)**      | (589 | ) |
| Equity in Net (Income) Loss of Investees                          |   | **4**                     | ** ** | 27 |   |
| Provision for Losses on Accounts Receivable                       |   | **601**                   | ** ** | 2,218 |   |
| Changes in Operating Assets and Liabilities:                      |   |                      | ** ** |   |   |
| Receivables                                                       |   | **3,180**                 | ** ** | 1,365 |   |
| Inventories                                                       |   | **(69**                   | **)**      | (124 | ) |
| Billings and Costs on Contracts                                   |   | **1,462**                 | ** ** | (53 | ) |
| Accounts Payable and Accrued Expenses                             |   | **(2,787**                | **)**      | (116 | ) |
| Advance Billings and Deposits                                     |   | **(152**                  | **)**      | 230 |   |
| Deferred Revenue and Benefits                                     |   | **(49**                   | **)**      | 28 |   |
| Other                                                             |   | **1,253**                 | ** ** | (226 | ) |
| Net Cash Provided By Operating Activities                         |   | **24,804**                | ** ** | 22,825 |   |
|                                                              |   |                      | ** ** |   |   |
| CASH FLOWS FROM INVESTING ACTIVITIES:                             |   |                      | ** ** |   |   |
| Additions to Property, Plant and Equipment                        |   | **(7,532**                | **)**      | (12,222 | ) |
| Redemption of Investments                                         |   | **4,100**                 | ** ** | 100 |   |
| Proceeds from Sale of Assets                                      |   | **97**                    | ** ** | 243 |   |
| Net Cash Used In Investing Activities                             |   | **(3,335**                | **)**      | (11,879 | ) |
|                                                              |   |                      | ** ** |   |   |
| CASH FLOWS FROM FINANCING ACTIVITIES:                             |   |                      | ** ** |   |   |
| Payments of Capital Lease Obligations                             |   | **(385**                  | **)**      | (329 | ) |
| Repayments on Credit Facility                                     |   | **(18,500**               | **)**      | (10,950 | ) |
| Borrowings on Credit Facility                                     |   | **1,250**                 | ** ** | 2,200 |   |
| Proceeds from Issuance of Common Stock                            |   | **628**                   | ** ** | 952 |   |
| Dividends Paid                                                    |   | **(4,610**                | **)**      | (4,438 | ) |
| Stock Repurchase                                                  |   | **(846**                  | **)**      | — |   |
| Net Cash Used In Financing Activities                             |   | **(22,463**               | **)**      | (12,565 | ) |
|                                                              |   |                      | ** ** |   |   |
| NET DECREASE IN CASH AND CASH EQUIVALENTS                         |   | **(994**                  | **)**      | (1,619 | ) |
|                                                              |   |                      | ** ** |   |   |
| CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD                  |   | **1,874**                 | ** ** | 2,008 |   |
|                                                              |   |                      | ** ** |   |   |
| CASH AND CASH EQUIVALENTS AT END OF PERIOD                        |   | **$**                     | **880**    | ** ** | $ | 389 |   |
|                                                              |   |                      | ** ** |   |   |
| SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:                 |   |                      | ** ** |   |   |
| Cash Paid for Interest                                            |   | **$**                     | **5,355**  | ** ** | $ | 5,845 |   |
| Cash Paid for Income Taxes, Net of Tax Refunds of $1,600 and $307 |   | **$**                     | **150**    | ** ** | $ | (47 | ) |
| NON-CASH INVESTING ACTIVITIES:                                    |   |                      | ** ** |   |   |
| Property, Plant and Equipment Acquired with Capital Leases        |   | **$**                     | **173**    | ** ** | $ | 492 |   |

 

Theaccompanying notes are an integral part of the consolidated financialstatements.

 

3

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**HICKORY TECH CORPORATIONSEPTEMBER 30, 2003PART 1. FINANCIAL INFORMATION**

 

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

 

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 presentation of results of operations, financial position,and cash flows in conformity with accounting principles generally accepted inthe United States of America. In the opinion of management, the condensedconsolidated financial statements reflect all adjustments (consisting only ofnormal recurring adjustments) considered necessary for a fair presentation ofHickory Tech Corporation’s (HickoryTech) results for the periods presented.Operating results for interim periods are not necessarily indicative of resultsthat may be expected for the fiscal year as a whole. The preparation offinancial statements in conformity with accounting principles generallyaccepted in the United States of America requires management to make estimatesand assumptions that affect the reported amounts of assets, liabilities,revenues, expenses, and related disclosures at the date of the financialstatements and during the reporting period. Actual results could differ fromthese estimates. These unaudited interim condensed consolidated financialstatements should be read in conjunction with HickoryTech’s Annual Report onForm 10-K for the year ended December 31, 2002.

 

The consolidatedfinancial statements of HickoryTech include Hickory Tech Corporation and itssubsidiaries in the following three business segments: (i) Telecom Sector, (ii)Information Solutions Sector and (iii) Enterprise Solutions Sector. Aninvestment in an unconsolidated partnership for the Information SolutionsSector is accounted for using the equity method. The operations of thispartnership ended during the second quarter of 2003 with dissolution to followlater in 2003. No material wind-down costs are anticipated. All inter-companytransactions have been eliminated from the consolidated financial statements.

 

Certainreclassifications were made to the financial statements as of and for the threeand nine months ended September 30, 2002 to conform to the 2003presentation. These reclassifications did not change previously reported netincome (loss), shareholders’ equity or cash flows.

 

Operating expensesinclude all costs related to delivery of HickoryTech’s communications servicesand products. These costs include all selling, general and administrative costsand all costs of performing services and providing related products, except forcosts associated with the depreciation and amortization of property, plant andequipment and intangible assets, and cost of sales for the Enterprise SolutionsSector.

 

OnSeptember 18, 2003, HickoryTech executed a definitive agreement to sellthe stock of its wireless business, Minnesota Southern Wireless Company (MSWC),to Western Wireless Corporation (WWC). The wireless operations are reported aspart of the Telecom Sector. The results of operations of the wireless businessare reported as discontinued operations for all periods presented (see Note 4).

 

NOTE 2. EARNINGS AND CASH DIVIDENDS PER COMMON SHARE

 

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

 

4

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|                                          |   | **For Three Months Ended** |   | **For Nine Months Ended** |   |
|-----------------------------------------------|--------|----------------------------|--------|---------------------------|--------|
|                                          |   | **9/30/2003**              |   | **9/30/2002**             |   | **9/30/2003** |   | **9/30/2002** |   |
| Weighted  Average Shares Outstanding          |   | 13,973,920                 |   | 14,058,750                |   | 13,972,741 |   | 14,008,985 |   |
| Stock  Options (dilutive only)                |   | 32,952                     |   | 42,885                    |   | 41,236 |   | 68,996 |   |
| Weighted Average Stock  Subscribed (ESPP)     |   | 17,347                     |   | 15,692                    |   | 16,885 |   | 14,951 |   |
| Weighted  Average Dilutive Shares Outstanding |   | 14,024,219                 |   | 14,117,327                |   | 14,030,862 |   | 14,092,932 |   |

 

Options topurchase 408,883 and 117,150 shares for the three months endedSeptember 30, 2003 and 2002, respectively and 112,950 and 76,650 sharesfor the nine months ended September 30, 2003 and 2002, respectively, werenot included in the computation of earnings per share assuming dilutioncalculation because their effect on earnings per share would have beenantidilutive.

 

Cash dividends arebased on the number of common shares outstanding at the respective recorddates. Listed below is the number of shares outstanding as of the record datefor the first three quarters of 2003 and 2002.

 
| **Shares  Outstanding on Record Date** |   | **2003**   |   | **2002**   |
|----------------------------------------|--------|------------|--------|------------|
| First Quarter (Feb. 15)                |   | 14,003,335 |   | 13,971,484 |
| Second Quarter  (May 15)          |   | 13,942,662 |   | 14,007,250 |
| Third Quarter  (August 15)        |   | 13,962,261 |   | 14,049,776 |

 

Dividends pershare are based on the quarterly dividend per share as declared by theHickoryTech Board of Directors.

 

During the firstnine months of 2003 and 2002, shareholders have elected to reinvest $202,000and $185,000, respectively, of dividends into HickoryTech common stock pursuantto the HickoryTech Dividend Reinvestment Plan.

 

NOTE 3. COMPREHENSIVE INCOME

 

HickoryTechfollows the provisions of SFAS No. 130, “Reporting Comprehensive Income.” Thisstatement established rules for the reporting of comprehensive income and itscomponents. In addition to net income (loss), HickoryTech’s comprehensive incomeincludes changes in unrealized gains and losses on derivative instrumentsqualifying and designated as cash flow hedges. Comprehensive income (loss) forthe three months ended September 30, 2003 and September 30, 2002 was($12,082,000) and $2,094,000, respectively. Comprehensive income (loss) for thenine months ended September 30, 2003 and September 30, 2002 was($6,644,000) and $5,986,000, respectively.

 

NOTE 4. DISCONTINUED OPERATIONS

 

OnSeptember 18, 2003, HickoryTech executed a definitive agreement to sellthe stock of its wireless business, Minnesota Southern Wireless Company (MSWC),to Western Wireless Corporation (WWC), for $25,000,000, subject to workingcapital and construction in progress adjustments to be determined at closing.The selling price is comprised of approximately one million shares ofHickoryTech common stock to be returned to HickoryTech by WWC, and  $12,800,000 in cash. The market value ofthese shares was approximately $12,200,000 as of September 30, 2003.  The final fair market value of this stockconsideration will be measured by the Company on the closing date of thesale.  HickoryTech will retire theshares of HickoryTech stock currently owned by WWC.  The transaction is expected to close in the fourth quarter of2003, subject to approval of the Federal Communications Commission andsatisfaction of various other closing conditions. The wireless operations arereported as part of the Telecom Sector. The condensed consolidated statementsof operations for all periods presented have been restated to reflect wirelessoperations as discontinued operations.

 

5

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In connection with thedetermination by management in the third quarter of 2003 that it would pursuethe sale of its wireless operations and that the purchase price would likely beless than the current carrying value of the wireless net assets, the Companycompleted an impairment test in the third quarter of 2003 for the FCC licensespursuant to the requirements of SFAS No. 142, “Goodwill and Other IntangibleAssets.” Management estimated the fair value of the FCC licenses using adiscounted cash flow technique consistent with the method used by the Companyin performing its most recent impairment analysis at December 31, 2002. Asa result of this assessment, management determined that the FCC licenses wereimpaired and recorded an impairment charge of approximately $21 million($12,390,000 after-tax), in the third quarter of 2003. This impairment chargeis recorded as a component of the loss on discontinued operations onHickoryTech’s condensed consolidated statement of operations for the quarterended September 30, 2003. HickoryTech believes that the decline in thefair value of its FCC licenses is due principally to the rapid pace oftechnological change being undertaken by the major wireless service providersto adopt new protocols (i.e. GSM or CDMA) and potentially move away fromHickoryTech’s current primary protocol called TDMA, which has greatly hinderedHickoryTech’s position in finding a future roaming partner. Other factorsinclude declining roaming revenues, increasing price competition, and theprotracted downturn in the telecommunications market. The FCC licenses weretested for impairment on an aggregate basis, which is consistent withHickoryTech’s management of the wireless business.

 

As a result of theCompany’s commitment to sell the wireless business, the Company made adetermination during the third quarter of 2003 that the remaining assets of thewireless operations should be considered “held for sale” pursuant to SFAS No.144, “Accounting for Impairment or Disposal of Long-Lived Assets,” (SFAS No.144). Pursuant to SFAS No. 144 the Company recorded an impairment charge duringthe third quarter of 2003 related to the other long-lived assets of thewireless business of $4,345,000 ($2,564,000 after tax). This charge is alsorecorded as a component of the loss on discontinued operations on HickoryTech’scondensed consolidated statement of operations for the quarter endedSeptember 30, 2003. As of September 30, 2003, the carrying value ofthe remaining net assets of the wireless business is equal to its estimatedselling price less the costs to sell it. The carrying value of the wirelessassets and the related loss on discontinued operations is subject to adjustmentto the extent that the fair market value of the HickoryTech shares to bereceived upon closing of the sale is higher or lower than theSeptember 30, 2003 fair market value of the shares, or to the extent thatactual costs to sell the wireless business are higher or lower than estimated.

 

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)**        |   | **9/30/2003**              |    | **9/30/2002**             |   | **9/30/2003** |   | **9/30/2002** |   |
| Revenues                           |   | $                          | 4,009   |                      | $      | 4,374 |   | $ | 11,370 |   | $ | 11,739 |   |
|                               |   |                       |    |                      |   |   |   |   |   |
| Income  (Loss) Before Income Taxes |   | $                          | (24,873 | )                         | $      | 949 |   | $ | (23,487 | ) | $ | 2,637 |   |

 

6

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The carrying amounts and majorclasses of the assets and liabilities, which are presented as assets andliabilities held for sale in the accompanying balance sheet as ofSeptember 30, 2003 are as follow:

 
| **(Dollars  in Thousands)**            |   |   |   |
|----------------------------------------|--------|--------|--------|
|                                   |   |   |   |
| Current  Assets Held for Sale:         |   |   |   |
| Accounts  Receivable                   |   | $      | 1,729  |   |
| Inventories                            |   | 304    |   |
| Other                                  |   | 148    |   |
| Total                                  |   | $      | 2,181  |   |
|                                   |   |   |   |
| Long-Term  Assets Held for Sale:       |   |   |   |
| Property,  Plant and Equipment         |   | $      | 14,449 |   |
| Intangible  Assets FCC Licenses, (Net) |   | 13,000 |   |
| Other                                  |   | 32     |   |
| Total                                  |   | $      | 27,481 |   |
|                                   |   |   |   |
| Current Liabilities Held  for Sale:    |   |   |   |
| Accounts  Payable                      |   | $      | 615    |   |
| Accrued  Expenses                      |   | 209    |   |
| Other                                  |   | 744    |   |
| Total                                  |   | $      | 1,568  |   |
|                                   |   |   |   |
| Long-Term Liabilities Held  for Sale:  |   |   |   |
| Deferred  Revenue                      |   | $      | 31     |   |

 

NOTE 5. INVENTORIES

 

Inventories, whichconsist of equipment for resale, materials and supplies, are stated at thelower of average cost or market.

 

NOTE 6. INTANGIBLE ASSETS

 

EffectiveJanuary 1, 2002, HickoryTech adopted SFAS No. 142, “Goodwill and OtherIntangible Assets.” SFAS No. 142 established new standards related to howacquired goodwill and other intangible assets are to be recorded upon theiracquisition as well as how they are to be accounted for after they have beeninitially recognized in the financial statements.

 

Effective with theadoption of this standard, HickoryTech is no longer amortizing acquiredgoodwill. Instead, SFAS No. 142 requires acquired goodwill to be evaluated forimpairment using a two-step test based upon a fair value approach. The firststep is used to identify potential impairment, while the second step calculatesthe amount of impairment, if any. Upon adoption of this standard, HickoryTechcompleted a transitional impairment test for its acquired goodwill, determiningthe fair value using primarily a discounted cash flow model. The determinedfair value was sufficient to pass the first step impairment test, and thereforeno impairment was recorded. On a prospective basis, HickoryTech is required totest acquired goodwill for impairment on an annual basis based upon a fairvalue approach. Additionally, goodwill shall be tested for impairment betweenannual tests if an event occurs or circumstances change that would more likelythan not reduce the fair value of an entity below its carrying value.

 

Additionally, uponadoption of SFAS No. 142, HickoryTech was required to reassess the usefullives of its other intangible assets. HickoryTech’s other intangible assetsprimarily consist of wireless FCC licenses (FCC licenses). The renewal of FCClicenses is a routine matter involving a nominal fee and HickoryTech hasdetermined that no legal, regulatory, contractual, competitive, economic orother factors currently exist that limit the useful life of its FCC licenses.As such, effective with the adoption of SFAS No. 142, HickoryTech is nolonger amortizing FCC licenses as they are deemed to be intangible assets thathave indefinite lives. SFAS No. 142 requires that indefinite livedintangible assets be tested for impairment by comparing the fair value of theassets to their carrying amount. Due to the pending sale of Minnesota SouthernWireless Company, HickoryTech completed an impairment test in the third quarterof 2003 for the FCC licenses, as discussed in Note 4.

 

7

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The carrying valueof HickoryTech’s goodwill is $25,086,000 as of September 30, 2003 andDecember 31, 2002.

 

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

 
|                               |   | **As of September 30, 2003** |   | **As of December 31, 2002** |   |
|------------------------------------|--------|-----------------------------------|--------|----------------------------------|--------|
| **(Dollars in Thousands)**         |   | **Gross Carrying  Amount**        |   | **Accumulated  Amortization**    |   | **Gross Carrying  Amount** |   | **Accumulated  Amortization** |   |
|                               |   |                              |   |                             |   |   |   |   |   |
| Definite-Lived Intangible Assets   |   |                              |   |                             |   |   |   |   |   |
| Customers                          |   | $                                 | 821    |                             | $      | 314 |   | $ | 821 |   | $ | 237 |   |
| Other Intangibles                  |   | 100                               |   | 100                              |   | 185 |   | 100 |   |
| Total                              |   | $                                 | 921    |                             | $      | 414 |   | $ | 1,006 |   | $ | 337 |   |
|                               |   |                              |   |                             |   |   |   |   |   |
| Indefinite-Lived Intangible Assets |   |                              |   |                             |   |   |   |   |   |
| FCC Licenses                       |   | $                                 | 13,000 |                             |   |   | $ | 34,000 |   |   |   |

 

Amortizationexpense related to the definite-lived intangible assets for the three monthsended September 30, 2003 and 2002 was $26,000 and $124,000, respectively.Amortization expense related to the definite-lived intangible assets for thenine months ended September 30, 2003 and 2002 was $77,000 and $351,000,respectively. Total estimated amortization expense for the remaining threemonths of 2003 and the five years subsequent to 2003 is as follows: 2003(October 1 through December 31) - $25,000; 2004 - $102,000; 2005 -$102,000; 2006 - $102,000; 2007 - $102,000 and 2008 - $74,000.

 

The FCC licenses are included in assets held for sale as ofSeptember 30, 2003.

 

NOTE 7. RECENT ACCOUNTING DEVELOPMENTS

 

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

 

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

 

HickoryTech’scompetitive local telephone companies (CLEC), Enterprise Solutions, andInformation Solutions, also adopted SFAS No. 143 effective January 1,2003. HickoryTech has determined that its competitive local telephone companiesalong with Enterprise Solutions and Information Solutions do not have amaterial legal obligation to remove long-lived assets as described by SFAS No.143, and accordingly, adoption of SFAS No. 143 did not impact HickoryTech’sfinancial position or results of operations.

 

8

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HickoryTech alsoadopted the provisions of SFAS No. 143 for its wireless operations as ofJanuary 1, 2003. HickoryTech performed an analysis to identify allpotential Asset Retirement Obligations. The legal obligations identifiedconsist of obligations to remediate leased property where cell sites arelocated. However, based upon HickoryTech’s experience and expectations, thereis significant uncertainty as to whether third parties that own these leased propertieswould enforce their remediation rights related to the sites. Furthermore,HickoryTech determined the amount of asset retirement obligations, if any,related to its wireless operations under the provisions of SFAS No. 143 werenot significant, and therefore the implementation of SFAS No. 143 onJanuary 1, 2003 did not impact HickoryTech’s financial position or resultsof operations. In addition, due to the pending sale of the wireless operations(see Note 4), HickoryTech does not expect to incur any asset retirementobligations related to its wireless operations.

 

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

 

In June 2002,the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit orDisposal Activities,” which replaces Emerging Issues Task Force (EITF) IssueNo. 94-3, “Liability Recognition for Certain Employee Termination Benefits andOther Costs to Exit an Activity (including Certain Costs Incurred in aRestructuring).” SFAS No. 146 requires companies to recognize costs associatedwith exit or disposal activities when they are incurred rather than at the dateof a commitment to an exit or disposal plan. HickoryTech has engaged in no activities in the three or nine monthsended September 30, 2003 that are subject to the provisions of SFAS No.146. Accordingly, the adoption of SFAS No. 146 did not impact HickoryTech’sfinancial position or results of operations.

 

InDecember 2002, the FASB issued SFAS No. 148, “Accounting for Stock-BasedCompensation – Transition Disclosure – an amendment of SFAS No. 123” (SFAS No.148). This Statement amends SFAS No. 123, “Accounting for Stock-BasedCompensation,” to provide alternative methods of transition for a voluntarychange to the fair value based method of accounting for stock-based employeecompensation. In addition, this Statement amends the disclosure requirements ofSFAS No. 123 to require prominent disclosures in both annual and interimfinancial statements about the method of accounting for stock-based employeecompensation and the effect of the method used on reported results. Theprovisions of SFAS No. 148 are effective for financial statements for fiscalyears ending after December 15, 2002, and disclosure requirements shall beeffective for interim periods beginning after December 15, 2002. TheCompany will continue to account for stock-based compensation to its employeesand directors using the intrinsic value method prescribed by APB Opinion No.25, and related interpretations. The Company adopted the provisions of SFAS No.148 and has made certain disclosures required by SFAS No. 148 in theconsolidated financial statements presented in this report. The adoption ofSFAS No. 148 did not impact HickoryTech’s financial position or results ofoperations.

 

InNovember 2002, the FASB issued Interpretation No. 45, “Guarantor’sAccounting and Disclosure Requirements for Guarantees, Including IndirectGuarantees of Indebtedness of Others.” This interpretation elaborates on thedisclosures required in financial statements concerning obligations undercertain guarantees. It also clarifies the requirements related to therecognition of liabilities by a guarantor at the inception of certainguarantees. The disclosure requirements of this interpretation were effectivefor HickoryTech on December 31, 2002 but did not require any additionaldisclosures. The recognition provisions of the interpretation are effective forHickoryTech in 2003 and are applicable only to guarantees issued or modifiedafter December 31, 2002. The adoption of Interpretation No. 45 did notimpact the financial position, results of operations, or cash flows of HickoryTech.

 

9

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InApril 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 onDerivative Instruments and Hedging Activities.” This statement amends andclarifies financial accounting and reporting for derivative instruments,including certain derivative instruments embedded in other contracts and forhedging activities under SFAS No. 133, “Accounting for Derivative Instrumentsand Hedging Activities.” SFAS No. 149 is effective for certain contracts enteredinto or modified after June 30, 2003. This standard did not change theaccounting for HickoryTech’s interest rate swap contract and therefore had noimpact on HickoryTech’s consolidated financial position, results of operationsor cash flows (see Note 11).

 

10

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NOTE 8. QUARTERLY SECTOR FINANCIAL SUMMARY

 

Business segmentinformation for the first three quarters of 2003 and 2002 is as follows.Certain amounts in 2002 have been reclassified to conform to the 2003presentation.

 
| **(In Thousands)**                                                        |   | **Telecom** |   | **Information  Solutions** |   | **Enterprise  Solutions** |   | **Corporate and  Eliminations** |   | **HickoryTech  Consolidated** |   |
|---------------------------------------------------------------------------|--------|-------------|--------|----------------------------|--------|---------------------------|--------|---------------------------------|--------|-------------------------------|--------|
| **Three Months Ended 9/30/03**                                            |   |        |   |                       |   |                      |   |                            |   |                          |   |
| Operating  Revenue from Unaffiliated Customers                            |   | $           | 18,810 |                       | $      | 702                       |   | $                               | 3,565  |                          | $      | — |   | $ | 23,077 |   |
| Intersegment  Revenues                                                    |   | 69          |   | 848                        |   | —                    |   | (917                            | )      | —                        |   |
| Total                                                                     |   | 18,879      |   | 1,550                      |   | 3,565                     |   | (917                            | )      | 23,077                        |   |
|                                                                      |   |        |   |                       |   |                      |   |                            |   |                          |   |
| Depreciation  and Amortization                                            |   | 3,319       |   | 618                        |   | 61                        |   | 18                              |   | 4,016                         |   |
| Operating  Income (Loss)                                                  |   | 5,803       |   | (826                       | )      | (369                      | )      | 372                             |   | 4,980                         |   |
| Interest  Expense                                                         |   | 3           |   | 15                         |   | —                    |   | 1,561                           |   | 1,579                         |   |
| Income  Taxes (Benefit)                                                   |   | 2,409       |   | (376                       | )      | (154                      | )      | (484                            | )      | 1,395                         |   |
|                                                                      |   |        |   |                       |   |                      |   |                            |   |                          |   |
| Income  (Loss) from Continuing Operations                                 |   | 3,475       |   | (540                       | )      | (221                      | )      | (697                            | )      | 2,017                         |   |
| Income  (Loss) from Discont. Operations   Including Intersegment Revenues |   | (14,871     | )      | 139                        |   | —                    |   | 57                              |   | (14,675                       | )      |
| Net  Income (Loss)                                                        |   | (11,396     | )      | (401                       | )      | (221                      | )      | (640                            | )      | (12,658                       | )      |
|                                                                      |   |        |   |                       |   |                      |   |                            |   |                          |   |
| Identifiable  Assets                                                      |   | 143,121     |   | 7,346                      |   | 9,627                     |   | 16,404                          |   | 176,498                       |   |
| Property,  Plant and Equip., Net                                          |   | 105,722     |   | 5,219                      |   | 524                       |   | 210                             |   | 111,675                       |   |
| Capital  Expenditures                                                     |   | 1,935       |   | 7                          |   | 12                        |   | 3                               |   | 1,957                         |   |
|                                                                      |   |        |   |                       |   |                      |   |                            |   |                          |   |
| **Three Months Ended 9/30/02**                                            |   |        |   |                       |   |                      |   |                            |   |                          |   |
| Operating  Revenue from Unaffiliated Customers                            |   | $           | 18,100 |                       | $      | 981                       |   | $                               | 5,257  |                          | $      | — |   | $ | 24,338 |   |
| Intersegment  Revenues                                                    |   | 68          |   | 841                        |   | —                    |   | (909                            | )      | —                        |   |
| Total                                                                     |   | 18,168      |   | 1,822                      |   | 5,257                     |   | (909                            | )      | 24,338                        |   |
|                                                                      |   |        |   |                       |   |                      |   |                            |   |                          |   |
| Depreciation  and Amortization                                            |   | 3,144       |   | 519                        |   | 65                        |   | 56                              |   | 3,784                         |   |
| Operating  Income (Loss)                                                  |   | 5,757       |   | (821                       | )      | 282                       |   | (909                            | )      | 4,309                         |   |
| Interest  Expense                                                         |   | 9           |   | 14                         |   | —                    |   | 1,729                           |   | 1,752                         |   |
| Income  Taxes (Benefit)                                                   |   | 2,386       |   | (383                       | )      | 109                       |   | (1,052                          | )      | 1,060                         |   |
|                                                                      |   |        |   |                       |   |                      |   |                            |   |                          |   |
| Income  (Loss) from   Continuing Operations                               |   | 3,446       |   | (552                       | )      | 157                       |   | (1,517                          | )      | 1,534                         |   |
| Income  (Loss) from Discont. Operations Including Intersegment Revenues   |   | 371         |   | 131                        |   | —                    |   | 58                              |   | 560                           |   |
| Net  Income (Loss)                                                        |   | 3,817       |   | (421                       | )      | 157                       |   | (1,459                          | )      | 2,094                         |   |
|                                                                      |   |        |   |                       |   |                      |   |                            |   |                          |   |
| Identifiable  Assets                                                      |   | 152,953     |   | 7,086                      |   | 9,603                     |   | 12,877                          |   | 182,519                       |   |
| Property,  Plant and Equip., Net                                          |   | 112,266     |   | 5,820                      |   | 527                       |   | 180                             |   | 118,793                       |   |
| Capital  Expenditures                                                     |   | 1,110       |   | 658                        |   | —                    |   | 72                              |   | 1,840                         |   |

 

11

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| **(In Thousands)**                                                      |   | **Telecom** |   | **Information  Solutions** |   | **Enterprise  Solutions** |   | **Corporate and  Eliminations** |   | **HickoryTech  Consolidated** |   |
|-------------------------------------------------------------------------|--------|-------------|--------|----------------------------|--------|---------------------------|--------|---------------------------------|--------|-------------------------------|--------|
| **Nine Months Ended 9/30/03**                                           |   |        |   |                       |   |                      |   |                            |   |                          |   |
| Operating  Revenue from Unaffiliated Customers                          |   | $           | 56,058 |                       | $      | 2,609                     |   | $                               | 10,859 |                          | $      | — |   | $ | 69,526 |   |
| Intersegment  Revenues                                                  |   | 206         |   | 2,379                      |   | —                    |   | (2,585                          | )      | —                        |   |
| Total                                                                   |   | 56,264      |   | 4,988                      |   | 10,859                    |   | (2,585                          | )      | 69,526                        |   |
|                                                                    |   |        |   |                       |   |                      |   |                            |   |                          |   |
| Depreciation  and Amortization                                          |   | 9,779       |   | 1,743                      |   | 182                       |   | 70                              |   | 11,774                        |   |
| Operating  Income (Loss)                                                |   | 18,654      |   | (2,510                     | )      | (853                      | )      | (456                            | )      | 14,835                        |   |
| Interest  Expense                                                       |   | 10          |   | 53                         |   | —                    |   | 4,561                           |   | 4,624                         |   |
| Income  Taxes (Benefit)                                                 |   | 7,675       |   | (1,142                     | )      | (359                      | )      | (1,988                          | )      | 4,186                         |   |
|                                                                    |   |        |   |                       |   |                      |   |                            |   |                          |   |
| Income  (Loss) from Continuing Operations                               |   | 11,076      |   | (1,643                     | )      | (516                      | )      | (2,861                          | )      | 6,056                         |   |
| Income  (Loss) from Discont. Operations Including Intersegment Revenues |   | (14,387     | )      | 386                        |   | —                    |   | 144                             |   | (13,857                       | )      |
| Net  Income (Loss)                                                      |   | (3,311      | )      | (1,257                     | )      | (516                      | )      | (2,717                          | )      | (7,801                        | )      |
| Identifiable  Assets                                                    |   | 143,121     |   | 7,346                      |   | 9,627                     |   | 16,404                          |   | 176,498                       |   |
| Property,  Plant and Equip., Net                                        |   | 105,722     |   | 5,219                      |   | 524                       |   | 210                             |   | 111,675                       |   |
| Capital  Expenditures                                                   |   | 5,091       |   | 151                        |   | 201                       |   | 156                             |   | 5,599                         |   |
|                                                                    |   |        |   |                       |   |                      |   |                            |   |                          |   |
| **Nine Months Ended 9/30/02**                                           |   |        |   |                       |   |                      |   |                            |   |                          |   |
| Operating  Revenue from Unaffiliated Customers                          |   | $           | 52,857 |                       | $      | 3,064                     |   | $                               | 11,655 |                          | $      | — |   | $ | 67,576 |   |
| Intersegment  Revenues                                                  |   | 205         |   | 2,325                      |   | —                    |   | (2,530                          | )      | —                        |   |
| Total                                                                   |   | 53,062      |   | 5,389                      |   | 11,655                    |   | (2,530                          | )      | 67,576                        |   |
|                                                                    |   |        |   |                       |   |                      |   |                            |   |                          |   |
| Depreciation  and Amortization                                          |   | 9,156       |   | 1,548                      |   | 201                       |   | 169                             |   | 11,074                        |   |
| Operating  Income (Loss)                                                |   | 17,027      |   | (2,289                     | )      | (169                      | )      | (1,623                          | )      | 12,946                        |   |
| Interest  Expense                                                       |   | 18          |   | 44                         |   | —                    |   | 5,504                           |   | 5,566                         |   |
| Income  Taxes (Benefit)                                                 |   | 7,008       |   | (1,038                     | )      | (90                       | )      | (2,819                          | )      | 3,061                         |   |
|                                                                    |   |        |   |                       |   |                      |   |                            |   |                          |   |
| Income  (Loss) from Continuing Operations                               |   | 10,111      |   | (1,495                     | )      | (129                      | )      | (4,057                          | )      | 4,430                         |   |
| Income  (Loss) from Discont. Operations Including Intersegment Revenues |   | 1,060       |   | 352                        |   | —                    |   | 144                             |   | 1,556                         |   |
| Net  Income (Loss)                                                      |   | 11,171      |   | (1,143                     | )      | (129                      | )      | (3,913                          | )      | 5,986                         |   |
|                                                                    |   |        |   |                       |   |                      |   |                            |   |                          |   |
| Identifiable  Assets                                                    |   | 152,953     |   | 7,086                      |   | 9,603                     |   | 12,877                          |   | 182,519                       |   |
| Property,  Plant and Equip., Net                                        |   | 112,266     |   | 5,820                      |   | 527                       |   | 180                             |   | 118,793                       |   |
| Capital  Expenditures                                                   |   | 6,462       |   | 1,866                      |   | 55                        |   | 211                             |   | 8,594                         |   |

 

12

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The TelecomSegment Identifiable Assets, Property Plant and Equipment and CapitalExpenditures presented above, exclude the following amounts related to thewireless business which is reported as a discontinued operation:

 
|                             |   | **Three Months Ended** |   | **Nine Months Ended** |   |
|----------------------------------|--------|------------------------|--------|-----------------------|--------|
| **(Dollars  in Thousands)**      |   | **9/30/2003**          |   | **9/30/2002**         |   | **9/30/2003** |   | **9/30/2002** |   |
| Identifiable  Assets             |   | $                      | 29,662 |                  | $      | 95,887 |   | $ | 29,662 |   | $ | 95,887 |   |
| Property,  Plant and Equip., Net |   | 14,449                 |   | 17,526                |   | 14,449 |   | 17,526 |   |
| Capital  Expenditures            |   | 1,116                  |   | 1,057                 |   | 1,934 |   | 3,628 |   |
|                                  |        |                        |        |                       |        |  |  |  |  |  |  |  |  |

 

NOTE 9. CONTINGENCIES

 

HickoryTech isinvolved in certain contractual disputes in the ordinary course of business.HickoryTech does not believe the ultimate resolution of any of these existingmatters will have a material adverse effect on its financial position, resultsof operations or cash flows.

 

NOTE 10. STOCK COMPENSATION

 

AtSeptember 30, 2003, HickoryTech has four stock-based employee and directorcompensation plans, which are described more fully in the HickoryTech AnnualReport on Form 10-K for the year ended December 31, 2002. HickoryTech haselected to account for these employee and director stock compensation plansusing the intrinsic value method as permitted by Accounting Principles BoardOpinion No. 25 and related interpretations.

 

In 2002,HickoryTech’s Board of Directors modified the terms of the stock options of aretiring officer. The modification extended the period after retirement duringwhich the officer can exercise his vested options. This modification resultedin HickoryTech recognizing $173,000 of compensation expense during the firstquarter of 2003. During the third quarter of 2003, the Board of Directorsextended the period during which this option holder can exercise his vestedoptions to December 31, 2004. This extension will not result in anyadditional compensation charges.

 

If HickoryTech hadelected to recognize compensation cost based on the fair value of the optionsand other stock compensation as prescribed by SFAS No. 123, the followingoperating results would have occurred using the Black-Scholes option-pricingmodel to determine the fair value of the options: 

 
|                                                                                                             |   | **For Three Months Ended** |        | **For Nine Months Ended** |       |
|------------------------------------------------------------------------------------------------------------------|--------|----------------------------|-------------|---------------------------|------------|
| **(Dollars  in Thousands)**                                                                                      |   | **9/30/2003**              |        | **9/30/2002**             |       | **9/30/2003** |   | **9/30/2002** |   |
|                                                                                                             |   |                       | ** **  |                      |       |   | ** ** |   |   |
| Reported Net Income (Loss)                                                                                       |   | **$**                      | **(12,658** | **)**                     | $          | 2,094 | ** ** | **$** | **(7,801** | **)** | $ | 5,986 |   |
| Add: Stock-based employee compensation expense included in reported  net income (loss)                           |   | **(168**                   | **)**       | 358                       | ** ** | **234** | ** ** | 701 |   |
| Deduct: Total stock-based employee compensation expense determined  under fair value based method for all awards |   | **72**                     | ** **  | (451                      | **)**      | **(531** | **)** | (1,035 | ) |
|                                                                                                             |   |                       | ** **  |                      |       |   | ** ** |   |   |
| Pro Forma Net Income (Loss)                                                                                      |   | **$**                      | **(12,754** | **)**                     | $          | 2,001 | ** ** | **$** | **(8,098** | **)** | $ | 5,652 |   |
|                                                                                                             |   |                       | ** **  |                      |       |   | ** ** |   |   |
| Earnings (Loss) per share:                                                                                       |   |                       | ** **  |                      |       |   | ** ** |   |   |
| Basic - as reported                                                                                              |   | **$**                      | **(0.91**   | **)**                     | $          | 0.15 | ** ** | **$** | **(0.56** | **)** | $ | 0.43 |   |
| Basic - pro forma                                                                                                |   | **$**                      | **(0.91**   | **)**                     | $          | 0.14 | ** ** | **$** | **(0.58** | **)** | $ | 0.40 |   |
|                                                                                                             |   |                       | ** **  |                      |       |   | ** ** |   |   |
| Diluted - as reported                                                                                            |   | **$**                      | **(0.91**   | **)**                     | $          | 0.15 | ** ** | **$** | **(0.56** | **)** | $ | 0.43 |   |
| Diluted - pro forma                                                                                              |   | **$**                      | **(0.91**   | **)**                     | $          | 0.14 | ** ** | **$** | **(0.58** | **)** | $ | 0.40 |   |

 

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NOTE 11. FINANCIAL DERIVATIVE INSTRUMENTS

 

HickoryTechaccounts for derivative instruments in accordance with SFAS No. 133, as amendedby SFAS No. 149, “Accounting for Derivative Instruments and HedgingActivities,” which requires derivative instruments to be recorded on thebalance sheet at fair value. Changes in fair value of derivative instrumentsmust be recognized in earnings unless specific hedge accounting criteria aremet, in which case the gains and losses are included in other comprehensiveincome rather than in earnings.

 
| **(Dollars in Thousands)**                                                  |   | **Interest Rate  Swap Agreement** |   |
|-----------------------------------------------------------------------------|--------|-----------------------------------|--------|
|                                                                        |   |                              |   |
| Accumulated other comprehensive income balance at December 31,  2002.  |   | $                                 | — |   |
| Market value increase on interest rate swap agreement                       |   | 1,157                             |   |
| Accumulated other comprehensive income balance at September 30,  2003. |   | $                                 | 1,157  |   |

 

HickoryTech hasvariable rate debt instruments, which subject the company to interest raterisk. Beginning in the second quarter of 2003, HickoryTech entered intointerest rate swap agreements, with remaining maturities of nine months tofifty-seven months, to manage its exposure to interest rate movements on aportion of its variable rate debt obligations. The market value of thecumulative gain or loss on these derivative instruments is reported as acomponent of accumulated other comprehensive income in shareholders’ equity andis recognized in earnings when the term of the swap agreement is concluded.

 

The fair value ofthe HickoryTech’s derivatives at September 30, 2003 is a net asset of$1,961,000, which is included in other assets in the accompanying condensedconsolidated balance sheet.

 

NOTE 12.  ABANDONED INITIATIVE

 

InSeptember of 2003 HickoryTech abandoned a CLEC initiative. As a result,HickoryTech wrote off property, plant and equipment with a carrying value of$632,000. This $632,000 charge is included in the operating expenses of theTelecom Sector in the condensed consolidated statement of operations.

 

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

 

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

 

Statements in this Form 10-Q that are not historical fact areforward-looking statements that are based on management’s current expectations,estimates and projections about the industry in which HickoryTech operates andmanagement’s beliefs and assumptions. Such forward-looking statements aresubject to important risks and uncertainties that could cause HickoryTech’sfuture actual results to differ materially from such statements. Thesestatements are not guarantees of future performance and involve certain risks, uncertaintiesand probabilities, which are difficult to predict. Therefore, actual outcomesand results 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 Exhibit 99 (Cautionary Statement for Purposes of the“Safe Harbor” Provision of the Private Securities Litigation Reform Act of1995) to HickoryTech’s Annual Report on Form 10-K for the year endedDecember 31, 2002, which is incorporated herein by reference. You arecautioned not to place undue reliance on these forward looking statements, whichspeak only as of the date on which they were made. Except as otherwise requiredby federal securities law, HickoryTech undertakes no obligation to update anyof its forward-looking statements for any reason.

 

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* *

**BUSINESSES**

 

HickoryTechoperates in three business segments: the Telecom, Information Solutions andEnterprise Solutions Sectors. Its largest and oldest business (since 1898) hasbeen the operation of incumbent local exchange carriers (ILECs) or traditionalwireline telephone service. The ILEC business is in HickoryTech’s TelecomSector. In 1998, HickoryTech began its competitive local exchange carrier(CLEC) line of business, competing for the telephone dial tone, data and longdistance calling business in other ILECs’ territories. The CLEC business is inHickoryTech’s Telecom Sector. Since 1964, HickoryTech’s Information SolutionsSector has provided computer data processing and software, predominantly forHickoryTech’s Telecom Sector operations and also to other telecommunicationscompanies.  HickoryTech acquired itsEnterprise Solutions Sector in 1990 and it has operated as a leadingtelecommunications and data equipment distributor from a base in Minneapolis/St.Paul, Minnesota. HickoryTech also began its wireless operations in 1998 byacquiring its first wholly owned wireless service license, an additionalwireless service license in 1999 and two PCS licenses in 2001. In the thirdquarter of 2003, HickoryTech entered into a definitive agreement to sell itswireless operations.  Management expectsto complete the sale of its wireless business in the fourth quarter of 2003,subject to the approval of the Federal Communications Commission. The wirelessoperations are reported as part of the Telecom Sector. All financial statementsand schedules have been restated to reflect wireless operations as discontinuedoperations.

 

**THE COMPANY**

 

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

 
| **TELECOM SECTOR**                                                        |
|---------------------------------------------------------------------------|
| Mankato 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 Operation |
| **INFORMATION SOLUTIONS SECTOR**                                          |
| National Independent Billing, Inc. (NIBI)                                 |
| **ENTERPRISE SOLUTIONS SECTOR**                                           |
| Collins Communications Systems Co. (Collins)                              |

 

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

 

The materials andsupplies that are necessary for the operation of the businesses of HickoryTechand its subsidiaries are available from a variety of sources, and no futuresupply problems are anticipated. All of HickoryTech’s central office switches,as well as a majority of HickoryTech’s equipment sold in its EnterpriseSolutions Sector, are supplied by Nortel. Nortel is a leading supplier ofcommunications equipment, and HickoryTech’s dependence on this brand is notviewed as a significant risk. An additional layer of network infrastructureequipment for broadband services is provided by Nextlevel. Nextlevel is a newersupplier of communications equipment and the Company is monitoring the risklevel of maintaining Nextlevel as a supplier in light of its status as a whollyowned subsidiary of Motorola.

 

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**INDUSTRY SEGMENTS**

 

*TELECOM SECTOR*

 

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

 

The Telecom Sectoralso includes Crystal, a competitive local exchange carrier (CLEC). Crystalprovides local telephone service, long distance and dial-up Internet access ona competitive basis. Crystal has customers in eight rural communities inMinnesota and two communities in Iowa that are not in HickoryTech’s ILECservice areas.

 

HickoryTech alsoowns and operates fiber optic cable facilities (CNI) in Minnesota, which are usedto transport interexchange communications as a service to telephone industrycustomers. HickoryTech’s Minnesota ILECs and its CLEC are the primary users ofthe fiber optic cable facilities.

 

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

 

MCTC and Mid-Commare Minnesota public utilities operating pursuant to indeterminate permitsissued by the Minnesota Public Utilities Commission. Heartland is also a publicutility, which operates pursuant to a certificate of public convenience andnecessity issued by the Iowa Utilities Board. These state agencies regulate theservices provided by MCTC, Mid-Comm and Heartland. CNI’s operations are notsubject to regulation by the state regulatory authority.  Neither the Minnesota Public UtilitiesCommission nor the Iowa Utilities Board regulates the rate of return or profitsof each of HickoryTech’s ILEC operations due to the size of these companiesrelative to state regulation. In Minnesota, MCTC and Mid-Comm’s price andservice levels are monitored by regulators. MCTC’s and Mid-Comm’s local servicerates are below those of most Minnesota ILECs. Regardless of whether aparticular rate is subject to regulatory review, the ability of HickoryTech andits subsidiaries to change rates will be determined by various factors,including economic and competitive circumstances.

 

As local exchangetelephone companies, MCTC, Mid-Comm and Heartland provide end office switchingand dedicated circuits to long distance interexchange carriers. Theserelationships allow HickoryTech’s telephone subscribers to place long distancetelephone calls and gain access to the telephone network. HickoryTech provideslong distance access for all of the individual customers who select analternative long distance carrier. The long distance interexchange carriers aresignificant customers of HickoryTech, but no carrier represents more than tenpercent of HickoryTech’s consolidated revenues.

 

Alternatives toHickoryTech service include customers leasing private line switched voice anddata services in or adjacent to the territories served by HickoryTech, whichpermits the bypassing of local telephone switching facilities. In addition,microwave transmission services, wireless communications, fiber optic andcoaxial cable deployment and other services provided by other companies 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.

 

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

 

Competition alsoexists for some of the services provided to interexchange carriers, such ascustomer billing services, dedicated private lines, network switching andnetwork routing. This competition comes primarily from the interexchangecarriers themselves. The provision of these services is either of a contractualnature or is month-to-month service out of a general tariff, but in either caseis primarily controlled by the interexchange carriers. As interexchangecarriers make these service decisions, changes have the potential of changingthe Company’s revenue in the Telecom Sector. Other services, such as directoryadvertising and wireless communications, are open to competition. Competitionis based primarily on service and experience.

 

InSeptember 2003, a potential competitor filed a request to negotiateinterconnection arrangements with HickoryTech’s Minnesota ILECS, MCTC &Mid-Comm. This potential competitor is an experienced company with the abilityto offer bundled services. MCTC and Mid-Comm have made a filing with theMinnesota Public Utilities commission exerting their rural exemption fromcertain components of this request. The potential competitor has not, as yet,followed through with its competitive filings in any other jurisdiction. Atthis time, HickoryTech is unable to predict the outcome of this proceeding.

 

The passage of the1996 Telecommunications Act created the opportunity for HickoryTech to offercommunications service in territories served by other telephone companies, andCrystal began operations in January 1998 as a new competitive localexchange carrier (CLEC). Crystal offers local service, long distance anddial-up Internet access services on a competitive basis to customers in southernMinnesota and Iowa, which are not served by HickoryTech’s Telecom Sectorservice area. These service offerings provide customers alternatives to theincumbent telephone carrier in various communities and are offered under thebrand name HickoryTech wireline service. These services are currently offeredto customers in eight rural communities in Minnesota, as well as twocommunities in Iowa. Crystal’s primary strategy is to provide service byoverbuilding with new telecommunications switching networks and telephonelines. Crystal also provides the long distance service and dial-up Internetaccess services to HickoryTech’s subscribers in both ILEC and CLEC markets.

 

CLEC activitiesrequire Crystal to file for authority to operate with the appropriate publicutilities commission in each state it serves. Crystal competes directly againstexisting ILECs in the areas in which Crystal operates. 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.

 

OnSeptember 18, 2003, HickoryTech executed a definitive agreement to sellthe stock of its wireless business, Minnesota Southern Wireless Company (MSWC),to Western Wireless Corporation (WWC), for $25,000,000, subject to workingcapital and construction in progress adjustments to be determined at closing.The selling price is comprised of approximately one million shares ofHickoryTech common stock to be returned to HickoryTech by WWC, and  $12,800,000 in cash. The market value ofthese shares was approximately $12,200,000 as of September 30, 2003.  The final fair market value of this stockconsideration will be measured by the Company on the closing date of thesale.  HickoryTech will retire theshares of HickoryTech stock currently owned by WWC. The transaction is expectedto close in the fourth quarter of 2003, subject to approval of the FederalCommunications Commission and satisfaction of various other closing conditions.The wireless operations are reported as part of the Telecom Sector. Allstatements of operations data and schedules included herein have been restatedto reflect wireless operations as discontinued operations.

 

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In connection withthe determination by management in the third quarter of 2003 that it wouldpursue the sale of its wireless operations and that the purchase price wouldlikely be less than the current carrying value of the wireless net assets, theCompany completed an impairment test in the third quarter of 2003 for the FCClicenses pursuant to the requirements of SFAS No. 142, “Goodwill and OtherIntangible Assets.” Management estimated the fair value of the FCC licensesusing a discounted cash flow technique consistent with the method used by theCompany in performing its most recent impairment analysis at December 31,2002. As a result of this assessment, management determined that the FCClicenses were impaired and recorded an impairment charge of approximately $21million ($12,390,000 after-tax), in the third quarter of 2003. This impairmentcharge is recorded as a component of the loss on discontinued operations onHickoryTech’s condensed consolidated statement of operations for the quarterended September 30, 2003. HickoryTech believes that the decline in thefair value of its FCC licenses is due principally to the rapid pace oftechnological change being undertaken by the major wireless service providersto adopt new protocols (i.e. GSM or CDMA) and potentially move away fromHickoryTech’s current primary protocol called TDMA, which has greatly hinderedHickoryTech’s position in finding a future roaming partner. Other factorsinclude declining roaming revenues, increasing price competition, and theprotracted downturn in the telecommunications market. The FCC licenses weretested for impairment on an aggregate basis, which is consistent withHickoryTech’s management of the wireless business.

 

As a result of theCompany’s commitment to sell the wireless business, the Company made adetermination during the third quarter of 2003 that the remaining assets of thewireless operations should be considered “held for sale” pursuant to SFAS No.144, “Accounting for Impairment or Disposal of Long-Lived Assets,” (SFAS No. 144).Pursuant to SFAS No. 144 the Company recorded an impairment charge during thethird quarter of 2003 related to the other long-lived assets of the wirelessbusiness of $4,345,000 ($2,564,000 after tax). This charge is also recorded asa component of the loss on discontinued operations on HickoryTech’s condensedconsolidated statement of operations for the quarter ended September 30,2003. As of September 30, 2003, the carrying value of the remaining netassets of the wireless business is equal to its estimated selling price lessthe costs to sell it. This carrying value of the wireless assets and therelated loss on discontinued operations is subject to adjustment to the extentthat the fair market value of the HickoryTech shares to be received upon closingof the sale is higher or lower than the September 30, 2003 fair marketvalue of the shares, or to the extent that actual costs to sell the wirelessbusiness are higher or lower than estimated.

 

The wirelesstelephone business consists of the “A-side” FCC wireless license to operate inMinnesota’s Rural Service Area 10 (RSA 10), the Minneapolis/St. Paul Metro A-2(Metro A-2) wireless license and two digital personal communications services(PCS) licenses covering the Minnesota Basic Trading Areas (BTAs) ofMankato-Fairmont and Rochester-Austin-Albert Lea.

 

In south centralMinnesota, MSWC provides wireless service for Minnesota’s Rural Service Area 10(RSA 10), under the brand name of HickoryTech Wireless. MSWC owns 100% ofthe  “A-side” FCC wireless license tooperate in seven counties in south central Minnesota. The area overlaps and islarger than HickoryTech’s Minnesota ILEC and CLEC service areas and serves apopulation of approximately 240,000. This business also owns theMinneapolis/St. Paul Metro A-2 (Metro A-2) wireless license, which was acquiredon June 1, 1999. The Metro A-2 property surrounds the metropolitanMinneapolis/St. Paul area and is located in five Minnesota counties and in oneWisconsin county. Metro A-2 provides service to an area with a population ofapproximately 185,000. In addition, this business also owns the PCS licensesfor the Minnesota BTAs of Mankato-Fairmont and Rochester-Austin-Albert Lea. Thetwo BTAs are located in 16 Minnesota counties and one Iowa county and provide serviceto an area with a population of approximately 500,000, some of which coincidewith the previously mentioned wireless RSA 10 population of 240,000.

 

MSWC, which ownsall four of the Company’s FCC wireless licenses, derives its principal revenuesand income from providing wireless telephone service to the retail customers inseven counties in south central Minnesota and from wireless roaming traffic.MSWC also derives roaming revenue from the six counties surrounding themetropolitan Minneapolis/St. Paul Metro A-2 area and roaming revenues from thePCS service territory that is comprised of 17 counties. MSWC directly competesagainst local wireless and PCS companies in southern Minnesota.

 

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REGULATED INDUSTRY

 

ILEC Minnesota -HickoryTech’s two Minnesota ILEC subsidiaries continue to operate under analternative form of regulation as defined in Minnesota Chapter 237, wherebycompanies with less than 50,000 customers are regulated on price and servicelevel rather than profit. The Minnesota PUC has been considering intrastateaccess reform for several years. While no formal action has been concluded, theMinnesota PUC recently issued a Statement of Proposed Inquiry regarding stateAccess Reform and state Universal Service. Minnesota process in matters such asthese, usually involve outcomes that may not by realized until the end of 2004.HickoryTech cannot estimate the impact, if any, of future potential stateaccess revenue changes.

 

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

 

CLEC -HickoryTech’s CLEC companies operate in Minnesota and Iowa with less regulatoryoversight than the HickoryTech ILEC companies.

 

WirelineInterState -The HickoryTech ILEC companies do not participatein the NECA traffic sensitive pool and set access rates according to anationwide average cost of providing access. This biannual rate process wasrecently completed and established traffic sensitive interstate rates for theperiod from July 1, 2003 through June 30, 2005. HickoryTech ILECcompanies participate in the NECA common line pool. In July of 2003,common line rates charged to interexchange carriers were reduced (to zero), andcommon line charges to end users were increased in accordance with an FCCOctober 2001 order (a/k/a MAG Plan). Funds collected are pooled, andHickoryTech revenues are based on settlements distributed from the pool. Poolsettlements are adjusted from time to time. HickoryTech’s CLEC access rates areestablished in accordance with the FCC’s April 2001 order and no furtherchanges are known at the present time.

 

Wireless– HickoryTech’s wireless business is subject to regulation by the FCC includingrules governing the construction and operation of wireless communicationsystems and licensing and technical standards for provision of wirelesscommunication services. The FCC has refrained from rate regulation of wirelesscommunications services, but retains its statutory authority to impose suchregulation. The FCC ordered wireless carriers to be able to pool telephonenumbers by November 2002. Further, the FCC has ordered that wirelesscarriers implement Local Number Portability (LNP) by November 24, 2003.HickoryTech expects to comply with the FCC’s wireless LNP mandate. The Companyexpects the cost of implementing wireless LNP to be approximately $50,000 forsystem implementation costs and approximately $2,500 per month for ongoingmaintenance.

 

*INFORMATION SOLUTIONS SECTOR*

 

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

 

There are a numberof companies engaged in supplying data processing services comparable to thosefurnished by the Information Solutions Sector. Competition is based primarilyon price and service. HickoryTech’s Information Solutions Sector has developedan integrated billing and management system called SuiteSolution. SuiteSolutioncan provide wireline and wireless carriers the individual benefits of a billingplatform or a total system solution. Management is unable to quantify whateffect, if any, the pending sale of the wireless business may have on themarketplace for this product.

 

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*ENTERPRISE SOLUTIONS SECTOR*

### ** **

Through Collins,HickoryTech’s Enterprise Solutions Sector provides telephone and data equipmentsales and services as well as the sale, installation and service of voice overInternet Protocol business systems 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 Iowa. The customers in the Enterprise Solutions Sector’s marketare the individual business end users of telecommunications service withongoing service requirement offerings. Products consist of telecommunicationplatforms such as Nortel on the voice side of the Enterprise Solutions’business, and Cisco and Bay Networks (Nortel) equipment on the data side of itsbusiness. Enterprise Solutions specializes in the quality custom installationand maintenance of data wide area networking solutions.

 

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

 

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

 

Companies competein equipment sales and service and voice over Internet Protocol communicationsproducts market in which Enterprise Solutions operates. Competition is basedprimarily on price and service. No one company is dominant in this field.Enterprise Solutions offers customer premises telephone and data equipmentthrough well-trained and experienced market representatives with long-termcustomer relationships. The Enterprise Solutions Sector’s activities arefocused on the sale, installation and service of business telephone systems anddata communications equipment to companies based in metropolitanMinneapolis/St. Paul, Minnesota. This sector also supports the businesstelephone system service for HickoryTech’s ILEC and CLEC operations in Minnesotaand Iowa.

 

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**RESULTS OF OPERATIONS**

 

CONSOLIDATED OPERATING RESULTS FROM CONTINUING OPERATIONS

 

The following is asummarized discussion of consolidated results of operations from continuingoperations. More detailed discussion of operating results by segment followsthis discussion.

 

OPERATING REVENUES FROM CONTINUING OPERATIONS- Consolidated operating revenues from continuing operations were $23,077,000,which is $1,261,000 or 5.2% lower in the three months ended September 30,2003 compared to the three months ended September 30, 2002. Consolidatedoperating revenues from continuing operations were $69,526,000, which is$1,950,000 or 2.9% higher in the nine months ended September 30, 2003compared to the nine months ended September 30, 2002. The decrease inrevenues from continuing operations in the three months endedSeptember 30, 2003 compared to the three months ended September 30,2002 can be primarily attributed to a decrease in revenue in the InformationSolutions Sector and a lower volume of business in the Enterprise SolutionsSector. The decrease in revenues in the Information Solutions sector can belargely attributed to a few customers who have experienced a significantdecrease in volumes processed. In the third quarter of 2002, the EnterpriseSolutions sector experienced an increase in installation revenues due torevenues related to a significant voice over Internet Protocol networkHickoryTech was installing in the corporate offices of a large specialtyretailer. This project was substantially completed by the third quarter of2003, which resulted in the revenue decline between quarters. The increase inrevenues from continuing operations in the nine months ended September 30,2003 compared to the nine months ended September 30, 2002 was largely dueto increases in revenues in the Telecom Sector resulting from increases innetwork access revenues, the CLEC customer base and increased broadband dataservice lines installed. This increase was partially offset by decreases inrevenues in the Information Solutions Sector and the Enterprise SolutionsSector. The decrease in revenues in the Information Solutions sector can belargely attributed to a few customers who have experienced a significant decreasein volumes processed. In the third quarter of 2002, the Enterprise Solutionssector experienced an increase in installation revenues due to revenues relatedto a significant voice over Internet Protocol network HickoryTech wasinstalling in the corporate offices of a large specialty retailer. This projecthas been substantially completed by the third quarter of 2003, which resultedin the revenue decline between quarters.

 

COST OF SALES, ENTERPRISESOLUTIONS - Cost of sales, which is related to the EnterpriseSolutions Sector was $2,606,000 which is $1,082,000 or 29.3% lower in the threemonths ended September 30, 2003 compared to the three months endedSeptember 30, 2002. Cost of sales was $7,675,000, which is $230,000 or2.9% lower in the nine months ended September 30, 2003 compared to thenine months ended September 30, 2002. Gross profit margin for this sectorin the three and nine months ended September 30, 2003 was 26.9% and 29.3%,respectively, compared to 29.8% and 32.2% for the three and nine months endedSeptember 30, 2002, respectively. The decrease in the cost of sales is theresult of lower costs associated with volume of business in the EnterpriseSolutions Sector and the decrease in the gross profit margin is the result oflower margins associated with a couple large system installations, whichEnterprise Solutions performed in 2003.

 

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OPERATING EXPENSES FROM CONTINUING OPERATIONS(excluding Depreciation and Amortization) - Operatingexpenses from continuing operations excluding depreciation and amortization was$11,475,000, which is $1,082,000 or 8.6% lower in the three months endedSeptember 30, 2003 compared to the three months ended September 30,2002. Operating expenses from continuing operations excluding depreciation andamortization was $35,242,000, which is $409,000 or 1.1 % lower in the ninemonths ended September 30, 2003 compared to the nine months endedSeptember 30, 2002. In September of 2003, HickoryTech abandoned aCLEC initiative in a specific market. As a result of this operating decision,HickoryTech abandoned approximately $632,000 of property, plant and equipmentwhich was written down to a carrying value of zero in the third quarter of2003. The remaining decrease in operating expenses from continuing operationsis primarily due to lower bad debt expense in the Telecom Sector of $499,000for the three months ended September 30, 2003 compared to three monthsended September 30, 2002. The higher bad debt expense in 2002 was due inlarge part to bankruptcies of interexchange carriers in the telecommunicationsindustry. Another factor contributing to the decrease in expenses in the thirdquarter of 2003 compared to the third quarter of 2002 was a $859,000 reductionin compensation accruals associated with management incentives, which are tiedto financial metrics and are not expected to be achieved as a result of theloss from discontinued operations recorded in the third quarter of 2003. Thedecrease in bad debt expense and the incentive compensation in 2003 werepartially offset by increased expenses in the Telecom Sector related to thegrowth in CLEC customers. The Company’s initiative to maintain low operatingexpenses have also contributed to keeping labor and network expenses fromrising significantly in 2003. Without the CLEC initiative write-off, operatingexpenses excluding depreciation and amortization would have been $34,610,000,which is $1,041,000 or 2.9% lower in the nine months ended September 30,2003 compared to nine months ended September 30, 2002. The decrease in baddebt expense in 2003 was partially offset by increased expenses in the TelecomSector related to the growth in CLEC customers. The Company’s initiative tomaintain low operating expenses have also contributed to keeping labor andnetwork expenses from rising significantly in 2003.

 

DEPRECIATION ANDAMORTIZATION FROM CONTINUING OPERATIONS - Depreciationexpense from continuing operations was $3,780,000, which is $332,000 or 9.6%higher in the three months ended September 30, 2003 compared to the threemonths ended September 30, 2002. Depreciation expense from continuingoperations was $11,013,000, which is $928,000 or 9.2% higher in the nine monthsended September 30, 2003 compared to the nine months endedSeptember 30, 2002. Increases in the Telecom Sector’s network assets,specifically the assets associated with the CLEC business, and amortization ofnew billing software primarily account for the increase in depreciation expensefrom continuing operations. Amortization expense from continuing operations was$236,000, which is $100,000 or 29.8% lower in the three months endedSeptember 30, 2003 compared to the three months ended September 30,2002. Amortization expense from continuing operations was $761,000, which is$228,000 or 23.1% lower in the nine months ended September 30, 2003compared to the nine months ended September 30, 2002. The decrease inamortization expense from continuing operations was largely due to anintangible asset in the Information Solutions Sector becoming fully amortizedin the second quarter of 2003 and no amortization expense recorded for an intangible asset that waswritten off at the end of 2002.

 

OPERATING INCOME FROM CONTINUING OPERATIONS- Operating income from continuing operations was $4,980,000, which is $671,000or 15.6% higher in the three months ended September 30, 2003 compared tothe three months ended September 30, 2002. Operating income fromcontinuing operations was $14,835,000, which is $1,889,000 or 14.6% higher inthe nine months ended September 30, 2003 compared to the nine months endedSeptember 30, 2002. The increase in operating income from continuingoperations for the three and nine months ended September 30, 2003 waslargely due to increased network access revenues, increased CLEC revenues,decreased bad debts in the Telecom Sector and the incentive compensationreversal, which were partially offset by the increase in operating expenses inthe Telecom Sector and the decrease in the Information Solutions and EnterpriseSolutions Sectors’ revenues, all of which are described above.

 

INTEREST EXPENSE FROM CONTINUING OPERATIONS- Interest expense from continuing operations decreased $173,000 or 9.9% to$1,579,000 in the three months ended September 30, 2003 compared to thethree months ended September 30, 2002. Interest expense from continuingoperations decreased $942,000 or 16.9% to $4,624,000 in the nine months endedSeptember 30, 2003 compared to the nine months ended September 30,2002. The decrease in interest expense from continuing operations for theperiod was primarily due to a decrease in total debt outstanding. Theoutstanding balance of the revolving credit facility was $140,750,000 atSeptember 30, 2003 and $161,250,000 at September 30, 2002.

 

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

 

INCOME FROM CONTINUING OPERATIONS- Consolidated income from continuing operations was $2,017,000, which is$483,000 or 31.5% higher in the three months ended September 30, 2003compared to the three months ended September 30, 2002. Consolidated incomefrom continuing operations was $6,056,000, which is $1,626,000 or 36.7% higherin the nine months ended September 30, 2003 compared to the nine monthsended September 30, 2002. The increase in operating income from continuingoperations was largely due to increased network access revenues, increased CLECrevenues, and decreased bad debts in the Telecom Sector, which were partiallyoffset by the increase in operating expenses in the Telecom Sector and thedecrease in the Information Solutions and Enterprise Solutions Sectors’revenues, as described above.

 

SECTOR RESULTS OF OPERATIONS FROM CONTINUING OPERATIONS

 

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

 
|                                                              |   | **For Three Months Ended** |        | **For Nine Months Ended** |       |
|-------------------------------------------------------------------|--------|----------------------------|-------------|---------------------------|------------|
| **(Dollars in Thousands)**                                        |   | **9/30/2003**              |        | **9/30/2002**             |       | **9/30/2003** |   | **9/30/2002** |   |
|                                                              |   |                       |        |                      |       |   |   |   |   |
| Revenues Before Intersegment Eliminations                         |   |                       |        |                      |       |   |   |   |   |
| ILEC                                                              |   |                       |        |                      |       |   |   |   |   |
| Local Service                                                     |   | **$**                      | **3,780**   |                      | $          | 3,760 | ** ** | **$** | **11,349** |   | $ | 11,319 |   |
| Network Access                                                    |   | **8,370**                  |        | 8,096                     | ** ** | **25,101** |   | 24,154 |   |
| Intersegment                                                      |   | **69**                     |        | 68                        | ** ** | **206** |   | 205 |   |
| Other                                                             |   | **2,355**                  |        | 2,231                     | ** ** | **6,745** |   | 6,889 |   |
| Total ILEC                                                        |   | **14,574**                 |        | 14,155                    | ** ** | **43,401** |   | 42,567 |   |
|                                                              |   |                       |        |                      |       |   |   |   |   |
| CLEC                                                              |   |                       |        |                      |       |   |   |   |   |
| Local Service                                                     |   | **926**                    |        | 820                       | ** ** | **2,762** |   | 2,216 |   |
| Other                                                             |   | **1,440**                  |        | 1,247                     | ** ** | **4,242** |   | 2,703 |   |
| Total CLEC                                                        |   | **2,366**                  |        | 2,067                     | ** ** | **7,004** |   | 4,919 |   |
|                                                              |   |                       |        |                      |       |   |   |   |   |
| Long Distance                                                     |   | **995**                    |        | 1,028                     | ** ** | **3,024** |   | 2,928 |   |
|                                                              |   |                       |        |                      |       |   |   |   |   |
| Internet                                                          |   | **944**                    |        | 918                       | ** ** | **2,835** |   | 2,648 |   |
|                                                              |   |                       |        |                      |       |   |   |   |   |
| Total Telecom Revenues                                            |   | **$**                      | **18,879**  |                      | $          | 18,168 | ** ** | **$** | **56,264** |   | $ | 53,062 |   |
|                                                              |   |                       |        |                      |       |   |   |   |   |
|                                                              |   |                       |        |                      |       |   |   |   |   |
| Total Telecom Revenues Before Intersegment Eliminations           |   |                       |        |                      |       |   |   |   |   |
| Unaffiliated Customers                                            |   | **$**                      | **18,810**  |                      | $          | 18,100 | ** ** | **$** | **56,058** |   | $ | 52,857 |   |
| Intersegment                                                      |   | **69**                     |        | 68                        | ** ** | **206** |   | 205 |   |
|                                                              |   | **18,879**                 |        | 18,168                    | ** ** | **56,264** |   | 53,062 |   |
|                                                              |   |                       |        |                      |       |   |   |   |   |
| Operating Expenses, excluding Depr. and Amort.                    |   | **9,757**                  |        | 9,267                     | ** ** | **27,831** |   | 26,879 |   |
| Depreciation and Amortization                                     |   | **3,319**                  |        | 3,144                     | ** ** | **9,779** |   | 9,156 |   |
| Operating Income                                                  |   | **$**                      | **5,803**   |                      | $          | 5,757 | ** ** | **$** | **18,654** |   | $ | 17,027 |   |
|                                                              |   |                       |        |                      |       |   |   |   |   |
| Income from Continuing Operations                                 |   | **$**                      | **3,475**   | ** **                | $          | 3,446 | ** ** | **$** | **11,076** | ** ** | $ | 10,111 |   |
| Income (Loss) from Discontinued Operations                        |   | **(14,871**                | **)**       | 371                       | ** ** | **(14,387** | **)** | 1,060 |   |
| Net Income (Loss)                                                 |   | **$**                      | **(11,396** | **)**                     | $          | 3,817 | ** ** | **$** | **(3,311** | **)** | $ | 11,171 |   |
|                                                              |   |                       |        |                      |       |   | ** ** |   |   |
| Capital Expenditures, excluding discontinued wireless business    |   | **$**                      | **1,935**   |                      | $          | 1,110 | ** ** | **$** | **5,091** |   | $ | 6,462 |   |
|                                                              |   |                       |        |                      |       |   |   |   |   |
| ILEC Access Lines                                                 |   | **63,421**                 |        | 65,360                    |       |   |   |   |   |
|                                                              |   |                       |        |                      |       |   |   |   |   |
| CLEC Access Lines                                                 |   |                       |        |                      |       |   |   |   |   |
| Overbuild                                                         |   | **9,607**                  |        | 7,385                     |       |   |   |   |   |
| Unbundled Network Element (UNE)                                   |   | **1,492**                  |        | 1,311                     |       |   |   |   |   |
| Total Service Resale (TSR)                                        |   | **2,938**                  |        | 4,736                     |       |   |   |   |   |
| Total                                                             |   | **14,037**                 |        | 13,432                    |       |   |   |   |   |
|                                                              |   |                       |        |                      |       |   |   |   |   |
| Long Distance Customers                                           |   | **39,663**                 |        | 33,746                    |       |   |   |   |   |
|                                                              |   |                       |        |                      |       |   |   |   |   |
| Internet Customers                                                |   | **15,901**                 |        | 13,936                    |       |   |   |   |   |
|                                                              |   |                       |        |                      |       |   |   |   |   |
| Total Telecom Customers, excluding discontinued wireless business |   | **133,022**                |        | 126,474                   |       |   |   |   |   |
|                                                              |   |                       |        |                      |       |   |   |   |   |
| DSL Customers                                                     |   | **6,694**                  |        | 3,162                     |       |   |   |   |   |

 

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Telecom Sector operating revenuesbefore intersegment eliminations were $18,879,000, which is $711,000 or 3.9%higher in the three months ended September 30, 2003 compared to the threemonths ended September 30, 2002. Telecom Sector operating revenues beforeintersegment eliminations were $56,264,000, which is $3,202,000 or 6.0% higherin the nine months ended September 30, 2003 compared to the nine monthsended September 30, 2002. The increases in 2003 compared to 2002 wereprimarily due to increased ILEC network access, growth in the CLEC and Internetservice revenues.

 

ILEC network access revenue was $8,370,000, which is $274,000 or 3.4%higher in the three months ended September 30, 2003 compared to the threemonths ended September 30, 2002. ILEC network access revenue was$25,101,000, which is $947,000 or 3.9% higher in the nine months endedSeptember 30, 2003 compared to the nine months ended September 30,2002. The increase in network access revenue in 2003 compared to 2002 wasdriven by higher demand for dedicated lines and high-speed circuits.HickoryTech does not belong to any NECA traffic sensitive access revenuereimbursement pools, but instead, establishes access rates bi-annuallyfollowing nationwide averages of providing access. HickoryTech’s interstateaccess rates were adjusted as of July 2003 and HickoryTech expects anadditional revenue increase associated with transport components of access somewherein a range of $375,000 to $500,000 for the three months endingDecember 31, 2003. Long-term continuation of these revenues is uncertain,however, as changes in the industry occur.

 

CLEC local servicerevenue was $926,000, which is $106,000 or 12.9% higher in the three monthsended September 30, 2003 compared to the three months endedSeptember 30, 2002. CLEC local service revenue was $2,762,000, which is$546,000 or 24.6% higher in the nine months ended September 30, 2003compared to the nine months ended September 30, 2002. CLEC access linesincreased by 605 lines or 4.5%, between September 30, 2002 andSeptember 30, 2003, which was the primary reason for the increase. Inaddition, HickoryTech saw an increase in revenue of approximately $134,000generated by optional calling plans in the nine months ended September 30,2003 compared to the nine months ended September 30, 2002. In the secondquarter of 2003, HickoryTech decided to exit several exchanges in its Iowaterritories, which utilized a resale of services approach. As ofSeptember 30, 2003, HickoryTech has stopped providing service for 734customers. As a result, revenues have decreased approximately $47,000 in thethird quarter of 2003 compared to the second quarter of 2003. In addition, HickoryTechexpects revenues to decrease approximately $131,000 in the fourth quarter of2003 compared to the third quarter of 2003 due to this action of exiting CLECresale in Iowa.

 

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Other CLEC revenuewas $1,440,000, which is $193,000 or 15.5% higher in the three months endedSeptember 30, 2003 compared to the three months ended September 30,2002. Other CLEC revenue was $4,242,000, which is $1,539,000 or 56.9% higher inthe nine months ended September 30, 2003 compared to the nine months endedSeptember 30, 2002. Other revenue included network access, high-speed datarevenues and digital TV, which generally grew along with the increase in accesslines in 2003 compared to 2002. The increase in other CLEC revenue for the ninemonths ended September 30, 2003 compared to the nine months endedSeptember 30, 2002 was the additional $705,000 of revenue recognized as aresult of services provided under terms of a multi-year contract awarded toHickoryTech effective July 1, 2002 to provide Internet access and videoconferencing to schools and libraries in south central Minnesota served by theProject SOCRATES distance-learning network.

 

Long distance revenue was $995,000,which is $33,000 or 3.2 % lower in the three months ended September 30,2003 compared to the three months ended September 30, 2002. Long distancerevenue was $3,024,000, which is $96,000 or 3.3% higher in the nine monthsended September 30, 2003 compared to the nine months ended September 30,2002. HickoryTech experienced a 5,917 or 17.5% increase in its long distancecustomer base between September 30, 2002 and September 30, 2003.Although the customer base is increasing, revenue per customer is decreasing.The decrease in revenue per customer is primarily the result of optional longdistance services available to customers, the increased use of Internetservices and other alternatives to long distance services. Also, a competitorof HickoryTech recently received approval from the state of Minnesota to offer long-distanceservices in all HickoryTech territories. This competitor already offers localtelephone service in HickoryTech’s CLEC territories and with this approval, hasthe potential to create stronger competition with HickoryTech in these markets,which could result in a reduction in long distance revenue in future periods.

 

Internet revenue was $944,000, which is $26,000 or 2.8% higher in thethree months ended September 30, 2003 compared to the three months endedSeptember 30, 2002. Internet revenue was $2,835,000, which is $187,000 or7.1% higher in the nine months ended September 30, 2003 compared to thenine months ended September 30, 2002. The increase in revenue was causedprimarily by an increase in Internet customers of 1,965 or 14.1% between September 30,2002 and September 30, 2003.

 

Operating expensesexcluding depreciation and amortization were $9,757,000, which is $490,000 or5.3% higher in the three months ended September 30, 2003 compared to thethree months ended September 30, 2002. Operating expenses excludingdepreciation and amortization were $27,831,000, which is $952,000 or 3.5%higher in the nine months ended September 30, 2003 compared to the ninemonths ended September 30, 2002. In September of 2003, HickoryTech abandoneda CLEC initiative in a specific market. As a result of this operating decision,HickoryTech abandoned approximately $632,000 of property, plant and equipmentwhich was written down to a carrying value of zero in the third quarter of2003. This charge is included in the operating expenses of the Telecom Sectoron the condensed consolidated statement of operations. The remaining decreasein expenses is primarily due to lower bad debt expense of $499,000 and$1,507,000 recorded in the three and nine months ended September 30, 2003compared to the three and nine months ended September 30, 2002. The higherbad debt expense in 2002 was due in large part to bankruptcies of interexchangecarriers in the telecommunications industry. Another factor contributing to thedecrease in expenses in the third quarter of 2003 compared to the third quarterof 2002 was a $104,000 reduction in compensation accruals associated withmanagement incentives, which are tied to financial metrics and are not expectedto be achieved as a result of the loss from discontinued operations recorded inthe third quarter of 2003. The decrease in bad debt expense and incentivecompensation were partially offset by increased expenses related to customeroperations in the growing CLEC business. Without the CLEC initiative write-off,operating expenses excluding depreciation and amortization would have been$27,199,000, which is $320,000 or 1.2% higher in the nine months endedSeptember 30, 2003 compared to nine months ended September 30, 2002.The increase in operating expenses was due primarily to the costs associatedwith the growth in CLEC customers partially offset by the decrease in bad debtexpense mentioned above. In the second quarter of 2003 and in order to alignitself with the company strategy of being a facilities-based telecommunicationsprovider, HickoryTech decided to exit several exchanges in its Iowaterritories, which utilized a resale of services approach. As ofSeptember 30, 2003, HickoryTech has stopped providing service for 734customers. Expenses have decreased approximately $91,000 in the third quarterof 2003 compared to the second quarter of 2003. In addition, HickoryTechexpects expenses to decrease approximately $70,000 in the fourth quarter of2003 compared to the third quarter of 2003, due to this action of exiting CLECresale in Iowa.

 

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Depreciation andamortization were $3,319,000, which is $175,000 or 5.6% higher in the threemonths ended September 30, 2003 and $9,779,000, which is $623,000 or 6.8%higher in the nine months ended September 30, 2003 compared to the sameperiods in 2002. Depreciation expense was $3,293,000, which is $191,000 or 6.2%higher in the three months ended September 30, 2003 and $9,728,000, whichis $677,000 or 7.5% higher in the nine months ended September 30, 2003compared to the same periods in 2002. The increase in depreciation expense canbe largely attributed to increased network infrastructure. Amortization expensewas $26,000, which is $16,000 or 38.1% lower in the three months endedSeptember 30, 2003 compared to the three months ended September 30,2002. Amortization expense was $51,000, which is $54,000 or 51.4% lower in thenine months ended September 30, 2003 compared to the nine months endedSeptember 30, 2002. The decrease in amortization expense was largely dueto no amortization expense recorded for an intangible asset that was written off at the end of2002.

 

Total operatingexpenses were $13,076,000, which is $665,000 or 5.4% higher in the three monthsended September 30, 2003 compared to the three months endedSeptember 30, 2002. Total operating expenses were $37,610,000, which is$1,575,000 or 4.4% higher in the nine months ended September 30, 2003compared to the nine months ended September 30, 2002. These expensesincreased for the reasons described in the preceding two paragraphs.

 

Operating incomewas $5,803,000, which is $46,000 or 0.8% higher in the three months endedSeptember 30, 2003 compared to the three months ended September 30, 2002.Operating income was $18,654,000, which is $1,627,000 or 9.6% higher in thenine months ended September 30, 2003 compared to the nine months endedSeptember 30, 2002. Net income was $3,475,000, which is $29,000 or 0.8%higher in the three months ended September 30, 2003 compared to the threemonths ended September 30, 2002. Net income was $11,076,000, which is$965,000 or 9.5% higher in the nine months ended September 30, 2003compared to the nine months ended September 30, 2002. These increases werefor the reasons described above.

 

OnSeptember 18, 2003, HickoryTech executed a definitive agreement to sellthe stock of its wireless business, Minnesota Southern Wireless Company (MSWC),to Western Wireless Corporation (WWC), for $25,000,000, subject to workingcapital and construction in progress adjustments to be determined at closing.The selling price is comprised of approximately one million shares ofHickoryTech common stock to be returned to HickoryTech by WWC, and  $12,800,000 in cash. The market value ofthese shares was approximately $12,200,000 as of September 30, 2003.  The final fair market value of this stockconsideration will be measured by the Company on the closing date of the sale.  HickoryTech will retire the shares ofHickoryTech stock currently owned by WWC. The transaction is expected to closein the fourth quarter of 2003, subject to approval of the FederalCommunications Commission and satisfaction of various other closing conditions.The wireless operations are reported as part of the Telecom Sector. Allstatements of operations data included herein has been restated to reflectwireless operations as discontinued operations.

 

In connection withthe determination by management in the third quarter of 2003 that it wouldpursue the sale of its wireless operations and that the purchase price wouldlikely be less than the current carrying value of the wireless net assets, theCompany completed an impairment test in the third quarter of 2003 for the FCClicenses pursuant to the requirements of SFAS No. 142, “Goodwill and OtherIntangible Assets.” Management estimated the fair value of the FCC licensesusing a discounted cash flow technique consistent with the method used by theCompany in performing its most recent impairment analysis at December 31,2002. As a result of this assessment, management determined that the FCClicenses were impaired and recorded an impairment charge of approximately $21million ($12,390,000 after-tax), in the third quarter of 2003. This impairmentcharge is recorded as a component of the loss on discontinued operations onHickoryTech’s condensed consolidated statement of operations for the quarterended September 30, 2003. HickoryTech believes that the decline in thefair value of its FCC licenses is due principally to the rapid pace oftechnological change being undertaken by the major wireless service providersto adopt new protocols (i.e. GSM or CDMA) and potentially move away fromHickoryTech’s current primary protocol called TDMA, which has greatly hinderedHickoryTech’s position in finding a future roaming partner. Other factorsinclude declining roaming revenues, increasing price competition, and theprotracted downturn in the telecommunications market. The FCC licenses weretested for impairment on an aggregate basis, which is consistent withHickoryTech’s management of the wireless business.

 

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As a result of theCompany’s commitment to sell the wireless business, the Company made adetermination during the third quarter of 2003 that the remaining assets of thewireless operations should be considered “held for sale” pursuant to SFAS No.144, “Accounting for Impairment or Disposal of Long-Lived Assets,” (SFAS No.144). Pursuant to SFAS No. 144 the Company recorded an impairment charge duringthe third quarter of 2003 related to the other long-lived assets of thewireless business of $4,345,000 ($2,564,000 after tax). This charge is alsorecorded as a component of the loss on discontinued operations on HickoryTech’scondensed consolidated statement of operations for the quarter endedSeptember 30, 2003. As of September 30, 2003, the carrying value ofthe remaining net assets of the wireless business is equal to its estimatedselling price less the costs to sell it. This carrying value of the wirelessassets and the related loss on discontinued operations is subject to adjustmentto the extent that the fair market value of the HickoryTech shares to bereceived upon closing of the sale is higher or lower than the September 30,2003 fair market value of the shares, or to the extent that actual costs tosell the wireless business are higher or lower than estimated.

 

Revenue fromwireless discontinued operations was $4,009,000 for the three months endedSeptember 30, 2003, which is $365,000 or 8.3% lower than the three monthsended September 30, 2002. Revenue from wireless discontinued operationswas $11,370,000 for the nine months ended September 30, 2003, which is$369,000 or 3.1% lower than the nine months ended September 30, 2002. Thedecrease in revenue from wireless discontinued operations for the three monthsended September 30, 2003, compared to the three months endedSeptember 30, 2002 was the result of a decrease in roaming revenues.  The decrease in revenue from wirelessdiscontinued operations for the nine months ended September 30, 2003compared to the nine months ended September 30, 2002 was the result of adecrease in roaming revenues, partially offset by an increase in equipmentsales.

 

The loss beforetaxes from wireless discontinued operations was $24,873,000 for the threemonths ended September 30, 2003, compared to income of $949,000 for thethree months ended September 30, 2002. The loss before taxes from wirelessdiscontinued operations was $23,487,000 for the nine months endedSeptember 30, 2003 compared to income of $2,637,000 for the nine monthsended September 30, 2002. The decrease for the three and nine months endedSeptember 30, 2003 compared to the three and nine months ended September 30,2002 is mainly due to the $21,000,000 intangible asset impairment and the$4,345,000 long-lived asset impairment that was recorded in the third quarterof 2003, which are described above.

 

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)**                     |   | **9/30/2003**              |     | **9/30/2002**             |       | **9/30/2003** |   | **9/30/2002** |   |
| Revenues Before Eliminations                   |   |                       |     |                      |       |   |   |   |   |
| Unaffiliated Customers                         |   | **$**                      | **702**  |                      | $          | 981 | ** ** | **$** | **2,609** |   | $ | 3,064 |   |
| Intersegment                                   |   | **848**                    |     | 841                       | ** ** | **2,379** |   | 2,325 |   |
|                                           |   | **1,550**                  |     | 1,822                     | ** ** | **4,988** |   | 5,389 |   |
| Operating Expenses, excluding Depr. and Amort. |   | **1,758**                  |     | 2,124                     | ** ** | **5,755** |   | 6,130 |   |
| Depreciation and Amortization                  |   | **618**                    |     | 519                       | ** ** | **1,743** |   | 1,548 |   |
|                                           |   |                       |     |                      |       |   |   |   |   |
| Operating Loss                                 |   | **$**                      | **(826** | **)**                     | $          | (821 | ) | **$** | **(2,510** | **)** | $ | (2,289 | ) |
| Net Loss                                       |   | **$**                      | **(540** | **)**                     | $          | (552 | ) | **$** | **(1,643** | **)** | $ | (1,495 | ) |
|                                           |   |                       |     |                      |       |   |   |   |   |
| Capital Expenditures                           |   | **$**                      | **7**    |                      | $          | 658 | ** ** | **$** | **151** |   | $ | 1,866 |   |

 

27

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Operating revenuesfrom unaffiliated customers decreased $279,000 or 28.4% to $702,000 in thethree months ended September 30, 2003 compared to the three months endedSeptember 30, 2002. Operating revenues from unaffiliated customersdecreased $455,000 or 14.8% to $2,609,000 in the nine months endedSeptember 30, 2003 compared to the nine months ended September 30,2002. The decrease in operating revenues in the three and nine months endedSeptember 30, 2003 compared to the three and nine months ended September 30,2002 can be largely attributed to the loss of a couple customers in 2003.

 

Operating expensesexcluding depreciation and amortization decreased $366,000 or 17.2% to$1,758,000 in the three months ended September 30, 2003 compared to thethree months ended September 30, 2002. Operating expenses excludingdepreciation and amortization decreased $375,000 or 6.1% to $5,755,000 in thenine months ended September 30, 2003 compared to the nine months endedSeptember 30, 2002. The decreases in operating expenses primarily reflectcost control measures initiated by management. In addition, shipping and otherpass-through costs have declined due to the loss of a couple customers in 2003.

 

Depreciation andamortization expense increased $99,000 or 19.1% to $618,000 in the three monthsended September 30, 2003 compared to the three months endedSeptember 30, 2002. Depreciation and amortization expense increased$195,000 or 12.6% to $1,743,000 in the nine months ended September 30,2003 compared to the nine months ended September 30, 2002. These netincreases primarily relate to amortization of costs of new billing softwaredeveloped during 2002.

 

Total operatingexpenses decreased $267,000 to $2,376,000 in the three months endedSeptember 30, 2003 compared to the three months ended September 30,2002 and decreased $180,000 to $7,498,000 in the nine months endedSeptember 30, 2003 compared to the nine months ended September 30,2002. These decreases were for the reasons described in the preceding twoparagraphs.

 

Operating lossincreased $5,000 or 0.6% in the three months ended September 30, 2003compared to the three months ended September 30, 2002 and increased$221,000 or 9.7% in the nine months ended September 30, 2003 compared tothe nine months ended September 30, 2002. Net loss decreased $12,000 or2.2% in the three months ended September 30, 2003 compared to the threemonths ended September 30, 2002 and increased $148,000 or 9.9% in the ninemonths ended September 30, 2003 compared to the nine months ended September 30,2002. The decrease in operating loss and net loss for the three months endedSeptember 30, 2003 compared to the three months ended September 30,2002 was due to the decrease in operating expenses. The increase in operatingloss and net loss for the nine months ended September 30, 2003 compared tothe nine months ended September 30, 2002 was primarily attributable to thedecline in revenues combined with the increase in depreciation and amortizationdiscussed above.

 

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)**                     |   | **9/30/2003**              |      | **9/30/2002**             |       | **9/30/2003** |   | **9/30/2002** |   |
| Revenues Before Intersegment Eliminations      |   |                       |      |                      |       |   |   |   |   |
| Installation                                   |   | **$**                      | **1,698** |                      | $          | 3,352 | ** ** | **$** | **5,333** |   | $ | 6,008 |   |
| Service                                        |   | **1,867**                  |      | 1,905                     | ** ** | **5,526** |   | 5,647 |   |
|                                           |   | **3,565**                  |      | 5,257                     | ** ** | **10,859** |   | 11,655 |   |
| Cost of Sales                                  |   | **2,606**                  |      | 3,688                     | ** ** | **7,675** |   | 7,905 |   |
| Operating Expenses, excluding Depr. and Amort. |   | **1,267**                  |      | 1,222                     | ** ** | **3,855** |   | 3,718 |   |
| Depreciation and Amortization                  |   | **61**                     |      | 65                        | ** ** | **182** |   | 201 |   |
|                                           |   |                       |      |                      |       |   |   |   |   |
| Operating Income/(Loss)                        |   | **$**                      | **(369**  | **)**                     | $          | 282 | ** ** | **$** | **(853** | **)** | $ | (169 | ) |
| Net Income/(Loss)                              |   | **$**                      | **(221**  | **)**                     | $          | 157 | ** ** | **$** | **(516** | **)** | $ | (129 | ) |
|                                           |   |                       |      |                      |       |   |   |   |   |
| Capital Expenditures                           |   | **$**                      | **12**    |                      | $          | — | ** ** | **$** | **201** |   | $ | 55 |   |

 

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Operating revenuesdecreased $1,692,000 or 32.2% to $3,565,000 in the three months endedSeptember 30, 2003 compared to the three months ended September 30,2002 and decreased $796,000 or 6.8% to $10,859,000 in the nine months endedSeptember 30, 2003 compared to the nine months ended September 30,2002. Installation revenue was $1,654,000 or 49.3% lower in the three monthsended September 30, 2003 compared to the three months endedSeptember 30, 2002 and $675,000 or 11.2% lower in the nine months endedSeptember 30, 2003 compared the nine months ended September 30, 2002.The decrease in installation revenues in the three months endedSeptember 30, 2003 was****primarilya result of a decrease in sales and installations of PBX systems of $1,904,000while the decrease in installation revenues in the nine months endedSeptember 30, 2003 was also primarily a result of a decrease in sales andinstallations of PBX systems of $1,162,000. Installation of a voice overInternet Protocol network was being performed in a corporate office during thethree months ended September 30, 2002 and was substantially complete bythe three months ended September 30, 2003, thus the PBX sales and installationsare lower in that timeframe. Service revenue decreased****$38,000 or 2.0% to $1,867,000 in the threemonths ended September 30, 2003 compared to the three months endedSeptember 30, 2002 and $121,000 or 2.1% to $5,526,000 in the nine monthsended September 30, 2003 compared to the nine months endedSeptember 30, 2002.

 

Cost of salesdecreased $1,082,000 or 29.3% to $2,606,000 in the three months endedSeptember 30, 2003 compared to the three months ended September 30,2002 and decreased $230,000 or 2.9% to $7,675,000 in the nine months endedSeptember 30, 2003 compared to the nine months ended September 30,2002. Gross profit margin for this sector in the three and nine months endedSeptember 30, 2003 was 26.9% and 29.3%, respectively compared to 29.8% and32.2% for the three and nine months ended September 30, 2002,respectively. The decrease in cost of sales was the result of the decreasedinstallation work described above and the decrease in the gross profit marginis the result of lower margins associated with a couple large systeminstallations performed in 2003.

 

Operating expensesexcluding depreciation and amortization increased $45,000 or 3.7% to $1,267,000in the three months ended September 30, 2003 compared to the three monthsended September 30, 2002 and increased $137,000 or 3.7% to $3,855,000 inthe nine months ended September 30, 2003 compared to the nine months endedSeptember 30, 2002. Depreciation and amortization decreased $4,000 or 6.2%in the three months ended September 30, 2003 compared to the three monthsended September 30, 2003 and decreased $19,000 or 9.5% in the nine monthsended September 30, 2003 compared to the nine months endedSeptember 30, 2002.

 

Total operatingexpenses increased $41,000 to $1,328,000 in the three months endedSeptember 30, 2003 compared to the three months ended September 30,2002 and increased $118,000 to $4,037,000 in the nine months endedSeptember 30, 2003 compared to the nine months ended September 30,2002. The increases were for the reasons described in the preceding twoparagraphs.

 

Operating loss was$369,000 in the three months ended September 30, 2003 compared tooperating income of $282,000 in the three months ended September 30, 2002.****Operating loss was $853,000 in the ninemonths ended September 30, 2003 compared to an operating loss of $169,000in the nine months ended September 30, 2002. Net loss in the three monthsended September 30, 2003 was $221,000 compared to net income of $157,000in the three months ended September 30, 2002. Net loss in the nine monthsended September 30, 2003 was $516,000 compared to a net loss of $129,000in the nine months ended September 30, 2002. The operating and net lossesgenerated in the three and nine months ended September 30, 2003 comparedto the three and nine months ended September 30, 2002 occurred for thereasons described above.

 

LIQUIDITY AND CAPITAL RESOURCES

 

CASH FLOWS – Cashprovided by operations was $24,804,000 in the first nine months of 2003compared to $22,825,000 in the first nine months of 2002. Cash flows fromoperations in the first nine months of 2003 were primarily attributa5ble to netincome plus non-cash expenses for asset impairment, depreciation andamortization, partially offset by an increase in deferred income taxes receivableand the impact of the discontinued operations. Cash flows from operations in the first nine months of 2002 wereprimarily attributable to net income plus non-cash expenses for assetimpairment, depreciation and amortization and the provision for losses inaccounts receivable.

 

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Cash flows used ininvesting activities were $3,335,000 in the first nine months of 2003 comparedto cash flows used of $11,879,000 for the same period in 2002. Capital expendituresrelating to ongoing businesses were $7,532,000 during the first nine months of2003 as compared to $12,222,000 for the same period in 2002. In 2002, capitalexpenditures were incurred primarily to construct additional network facilitiesto provide CLEC services and continued buildout of the PCS network in theTelecom Sector. Management expects capital expenditures in the fourth quarterof 2003 to be approximately $6,500,000. There were $4,100,000 redemptions ofinvestments in the first nine months of 2003, compared to $100,000 in the firstnine months of 2002. The first nine months of 2003 redemption reflects theamount by which HickoryTech was permitted to reduce its equity investment inone of its lenders, through conditions of its debt agreements.

 

Cash flows used infinancing activities were $22,463,000 for the first nine months of 2003compared to $12,565,000 for the first nine months of 2002. Included in cashflows used in financing activities are debt repayments and dividend payments.HickoryTech made payments on its revolving credit facility of $18,500,000during the first nine months of 2003, and $10,950,000 during the first ninemonths of 2002. HickoryTech borrowed $1,250,000 on its revolving creditfacility during the first nine months of 2003, and $2,200,000 during the firstnine months of 2002. Dividend payments for the first nine months of 2003 were$4,610,000 compared to $4,438,000 for the same period in 2002. During the firstnine months of 2003, HickoryTech also repurchased 66,600 common shares for$661,000. In addition, HickoryTech used $185,000 of cash in connection of theretirement of 18,370 common shares from a stock compensation plan in the secondquarter of 2003.

 

WORKING CAPITAL– Working capital (i.e. current assets minus current liabilities) was$9,643,000 as of September 30, 2003, compared to working capital of$13,073,000 as of December 31, 2002. The ratio of current assets tocurrent liabilities was 1.7:1.0 as of September 30, 2003 and 1.9:1.0 as ofDecember 31, 2002. Management believes adequate internal and externalresources are available to finance ongoing operating requirements, includingcapital expenditures, business development, debt service and the payment ofdividends for at least the next twelve months.

 

LONG-TERM CONTRACTS,COMMITMENTS AND OFF-BALANCE SHEET OBLIGATIONS - HickoryTech’slong-term obligations as of September 30, 2003 were $140,096,000,excluding current maturities of $1,482,000. As of September 30, 2003,HickoryTech had a $182,250,000 credit facility with a syndicate of banks. Thecredit facility is comprised of a $125,000,000 revolving credit component and a$57,250,000 term loan component. The available line of credit on the$125,000,000 revolving credit component decreases in increments beginning in March 2004with a final maturity date in September 2008. The term loan componentrequires equal quarterly principal payments of $250,000 during the period ofMarch 2001 to December 2008, and $23,000,000 of principal paymentsper quarter for the first two quarters in 2009 and $6,000,000 in the thirdquarter of 2009. The weighted average interest rate associated with this creditfacility and related instruments, varies with LIBOR and certain other rates andwas 4.5% at September 30, 2003. HickoryTech has implemented fixed interestterms on various portions of the overall debt outstanding for varying terms.The longest fixed interest term, on $60,000,000 of the debt, is fixed untilJune 2008. As of September 30, 2003, HickoryTech had drawn$140,750,000 on this credit facility and had $41,500,000 of available credit.Management believes the remaining available credit is sufficient to coverfuture cash requirements.

 

HickoryTech’sInformation Solutions Sector leases certain computer equipment under capitallease arrangements. During the first three quarters of 2003, this sectorrecorded additions to property, plant and equipment of $173,000 related tothese capital lease arrangements.

 

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The followingtable sets forth HickoryTech’s contractual obligations, along with the cashpayments due each period. Interest on Long-term Debt is estimated using theinterest rate as of September 30, 2003.

 
|                                |   | **Payments Due by Year****(Dollars in Thousands)** |    |
|-------------------------------------|--------|----------------------------------------------------|---------|
|                                |   | **Total**                                          |    | **Remainder  of 2003** |   | **2004 to  2006** |   | **2007 to  2008** |   | **2009 and  after** |   |
| Contractual  Obligations            |   |                                               |    |   |   |   |   |   |   |   |   |
| Long-term  Debt                     |   | $                                                  | 140,750 |   | $ | 250 |   | $ | 25,563 |   | $ | 62,937 |   | $ | 52,000 |   |
| Interest  on Long-term Debt         |   | 31,653                                             |    | 1,631 |   | 19,042 |   | 9,749 |   | 1,231 |   |
| Capital  Lease Obligations          |   | 828                                                |    | 115 |   | 713 |   | — |   | — |   |
| Interest  on Capital Leases         |   | 50                                                 |    | 11 |   | 39 |   | — |   | — |   |
| Operating  Leases                   |   | 1,220                                              |    | 364 |   | 511 |   | 45 |   | 300 |   |
| Total  Contractual Cash Obligations |   | $                                                  | 174,501 |   | $ | 2,371 |   | $ | 45,868 |   | $ | 72,731 |   | $ | 53,531 |   |

 

The operatinglease obligations for the remainder of 2003 include $103,000 of leaseobligations related to the wireless operations.

 

The totalcommitment to HickoryTech on its revolving credit facility expires as follows:

 
|                        |   | **Amount of Commitment Expiration  per Year** |    |
|-----------------------------|--------|-----------------------------------------------|---------|
| **(Dollars in Thousands)**  |   | **Total**                                     |    | **Remainderof 2003** |   | **2004 to2006** |   | **2007 to2008** |   | **2009 andafter** | ** ** |
| Revolving  Credit Component |   | $                                             | 125,000 |   | $ | — |   | $ | 64,063 |   | $ | 60,937 |   | $ | — |   |
|                             |        |                                               |         |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

 

HickoryTech hasvariable rate debt instruments, which subject the company to interest raterisk. Beginning in the second quarter of 2003, HickoryTech entered intointerest rate swap agreements, with remaining maturities of nine months tofifty-seven months, to manage its exposure to interest rate movements on aportion of its variable rate debt obligations. The market value of thecumulative gain or loss on these derivative instruments is reported as acomponent of accumulated other comprehensive income in shareholders’ equity andis recognized in earnings when the term of the swap agreement is concluded.

 

HickoryTech accountsfor derivative instruments in accordance with SFAS No. 133, “Accounting forDerivative Instruments and Hedging Activities,” as amended by SFAS No. 149,which requires derivative instruments to be recorded on the balance sheet atfair value. Changes in fair value of derivative instruments must be recognizedin earnings unless specific hedge accounting criteria are met. HickoryTech hasmet those criteria with its cash flow hedge and SFAS. No. 133 states that theymust recognize gains and losses in other comprehensive income rather than inearnings. These interest rate swap contracts resulted in a reduction in incomeof $217,000, and $234,000, reported as interest expense for the three and ninemonths ended September 30, 2003, respectively. These interest rate swapsalso resulted in an increase in other comprehensive income of approximately$576,000, and $1,157,000, net of tax, for the three and nine months endedSeptember 30, 2003, respectively.

 

HickoryTech stillhas some variable interest rate debt as of September 30, 2003. HickoryTechcontinually monitors the interest rates on its bank loans and has implementedfixed interest terms on various portions of the overall debt outstanding forvarying terms. A lower level of interest expense is likely to occur because ofa trend of declining levels of debt.

 

OTHER- HickoryTech operates with original equity capital, retained earnings andrecent additions to indebtedness in the form of bank term and revolving linesof credit. HickoryTech believes its current level of debt to total capital isacceptable for ongoing operations.

 

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InNovember 2002, HickoryTech began repurchasing its stock inover-the-counter trading under a previously announced repurchase plan. HickoryTechfunds the repurchase of its stock from cash flows from operations. During thethree months ended September 30, 2003, HickoryTech purchased 13,300 commonshares for $142,000. During the nine months ended September 30, 2003,HickoryTech purchased 66,600 common shares for $661,000.

 

CRITICAL ACCOUNTING POLICIES

 

This Form 10-Q isbased upon HickoryTech’s consolidated financial statements, which have beenprepared in accordance with accounting principles generally accepted in theUnited States of America (see Note 1 of the notes to the financial statementsincluded in this Form 10-Q) and, where applicable, conform to the accountingprinciples as prescribed by federal and state telephone utility regulatoryauthorities. A description of the critical accounting policies adhered to byHickoryTech is contained in the Management’s Discussion and Analysis ofFinancial Condition and Results of Operations in HickoryTech’s Annual Report onForm 10-K for the year ended December 31, 2002. There were no significantchanges to these critical accounting policies during the quarter endedSeptember 30, 2003. During 2003, HickoryTech purchased an interest rateswap contract, which is accounted for pursuant to the provisions of SFAS No.133 as described in Note 11 of the notes to the accompanying financialstatements.

 

RECENT ACCOUNTING DEVELOPMENTS

 

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

 

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

 

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

 

HickoryTech alsoadopted the provisions of SFAS No. 143 for its wireless operations as ofJanuary 1, 2003. HickoryTech performed an analysis to identify allpotential Asset Retirement Obligations. The legal obligations identifiedconsist of obligations to remediate leased property where cell sites arelocated. However, based upon HickoryTech’s experience and expectations, thereis significant uncertainty as to whether third parties that own these leasedproperties would enforce their remediation rights related to the sites.Furthermore, HickoryTech determined the amount of asset retirement obligations,if any, related to its wireless operations under the provisions of SFAS No. 143were not significant, and therefore the implementation of SFAS No. 143 onJanuary 1, 2003 did not impact HickoryTech’s financial position or resultsof operations. In addition, due to the pending sale of the wireless operations(see Note 4), HickoryTech does not expect to incur any asset retirementobligations related to its wireless operations.

 

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

 

In June 2002,the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit orDisposal Activities,” which replaces Emerging Issues Task Force (EITF) IssueNo. 94-3, “Liability Recognition for Certain Employee Termination Benefits andOther Costs to Exit an Activity (including Certain Costs Incurred in aRestructuring).” SFAS No. 146 requires companies to recognize costs associatedwith exit or disposal activities when they are incurred rather than at the dateof a commitment to an exit or disposal plan. HickoryTech has engaged in no activities in the three or nine months endedSeptember 30, 2003 that are subject to the provisions of SFAS No. 146.Accordingly, the adoption of SFAS No. 146 did not impact HickoryTech’sfinancial position or results of operations.

 

InDecember 2002, the FASB issued SFAS No. 148, “Accounting for Stock-BasedCompensation – Transition Disclosure – an amendment of SFAS No. 123” (SFAS No.148). This Statement amends SFAS No. 123, “Accounting for Stock-BasedCompensation,” to provide alternative methods of transition for a voluntarychange to the fair value based method of accounting for stock-based employeecompensation. In addition, this Statement amends the disclosure requirements ofSFAS No. 123 to require prominent disclosures in both annual and interimfinancial statements about the method of accounting for stock-based employeecompensation and the effect of the method used on reported results. Theprovisions of SFAS No. 148 are effective for financial statements for fiscalyears ending after December 15, 2002, and disclosure requirements shall beeffective for interim periods beginning after December 15, 2002. TheCompany will continue to account for stock-based compensation to its employeesand directors using the intrinsic value method prescribed by APB Opinion No.25, and related interpretations. The Company adopted the provisions of SFAS No.148 and has made certain disclosures required by SFAS No. 148 in theconsolidated financial statements presented in this report. The adoption ofSFAS No. 148 did not impact HickoryTech’s financial position or results ofoperations.

 

InNovember 2002, the FASB issued Interpretation No. 45, “Guarantor’sAccounting and Disclosure Requirements for Guarantees, Including IndirectGuarantees of Indebtedness of Others.” This interpretation elaborates on thedisclosures required in financial statements concerning obligations undercertain guarantees. It also clarifies the requirements related to therecognition of liabilities by a guarantor at the inception of certainguarantees. The disclosure requirements of this interpretation were effectivefor HickoryTech on December 31, 2002 but did not require any additionaldisclosures. The recognition provisions of the interpretation are effective forHickoryTech in 2003 and are applicable only to guarantees issued or modifiedafter December 31, 2002. The adoption of Interpretation No. 45 did notimpact the financial position, results of operations or cash flows ofHickoryTech.

 

InApril 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 onDerivative Instruments and Hedging Activities.” This statement amends andclarifies financial accounting and reporting for derivative instruments,including certain derivative instruments embedded in other contracts and forhedging activities under SFAS No. 133, “Accounting for Derivative Instrumentsand Hedging Activities.” SFAS No. 149 is effective for certain contractsentered into or modified after June 30, 2003. This standard did not changethe accounting for HickoryTech’s interest rate swap contract and therefore hadno impact on HickoryTech’s consolidated financial position, results ofoperations or cash flows (see Note 11).

 

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ITEM 3. QUANTATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

HickoryTech doesnot have operations subject to risks of foreign currency fluctuations.HickoryTech does however, use derivative financial instruments to manageexposure to interest rate fluctuations. HickoryTech’s objectives for holdingderivatives are to minimize interest rate risks using the most effectivemethods to eliminate or reduce the impact of these exposures. Variable ratedebt instruments are subject to interest rate risk. HickoryTech has enteredinto interest rate swap agreements with remaining maturities ranging from ninemonths to fifty-seven months to manage its exposure to interest rate movementson a portion of its variable rate debt obligations. The effective portion ofthe cumulative gain or loss on these derivative instruments is reported as acomponent of accumulated other comprehensive income in shareholders’ equity andis recognized in earnings when the term of the swap agreement is concluded.HickoryTech’s earnings are affected by changes in interest rates as a portionof its long-term debt has variable interest rates based on LIBOR. If interestrates for the portion of HickoryTech’s long-term debt based on variable rateshad averaged 10% more for the quarter ended September 30, 2003,HickoryTech’s interest expense would have increased $80,000 for the three monthsended September 30, 2003. If interest rates for the portion ofHickoryTech’s long-term debt based on variable rates had averaged 10% more forthe nine months ended September 30, 2003, HickoryTech’s interest expensewould have increased $289,000 for the nine months ended September 30,2003.

 

ITEM 4.     CONTROLS AND PROCEDURES

 

HickoryTechcarried out an evaluation under the supervision and with the participation ofour management, including our Chief Executive Officer (“CEO”) and ChiefFinancial Officer (“CFO”), of the effectiveness of our disclosure controls andprocedures as of September 30, 2003, the end of the period covered by thisreport. Disclosure controls and procedures are procedures that are designedwith the objective of ensuring that information required to be disclosed in ourreports filed under the Securities Exchange Act of 1934, such as this Form10-Q, is recorded, processed, summarized and reported within the time periodsspecified in the Securities and Exchange Commission’s rules and forms. Based onthat evaluation, the CEO and CFO have concluded that the disclosure controlsand procedures are effective to satisfy the objectives for which they areintended. During the quarter ended September 30, 2003, there has been nochange in our internal control over financial reporting that has materiallyaffected or is reasonably likely to materially affect our internal control overfinancial reporting.

 

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PART II. OTHER INFORMATION

 

Item 1.             LegalProceedings.

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

 

Item 2.             Changesin Securities.

None.

 

Item 3.             DefaultUpon Senior Securities.

None.

 

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

None.

 

Item 5.             OtherInformation.

None.

 

Item 6.             Exhibitsand Reports of Form 8-K.

 
| (a)    |   | Exhibits                                                                                                                                                                         |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   | Exhibit 31(a) Certification pursuant to rule 13a-14(a) under the Exchange  Act, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of  2002                       |
|   |   | Exhibit 31(b) Certification pursuant to rule 13a-14(a) under the  Exchange Act, as adopted pursuant to Section 302 of the Sarbanes-Oxley  Act of 2002                       |
|   |   | Exhibit 32(a) Certification pursuant to 18 U.S.C. 1350, as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                                               |
|   |   | Exhibit 32(b) Certification pursuant to 18 U.S.C. 1350, as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                                               |
|   |   |                                                                                                                                                                             |
| (b)    |   | HickoryTech furnished a Form 8-K on July 28, 2003 containing a  press release announcing its second quarter consolidated operating results.                                 |
|   |   |                                                                                                                                                                             |
|   |   | HickoryTech filed a Form 8-K on September 18, 2003 announcing  that it signed a definitive agreement to sell all of its wireless business to  Western Wireless Corporation. |

 

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SIGNATURES

 

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

 
| Dated: | November 14, 2003 |                                          | HICKORY TECH CORPORATION |
|--------|------------------------|-----------------------------------------------|--------------------------|
|   |                   |
|   |                   |
|   | By:                    | /s/ John E. Duffy.                            |                     |
|   |                   | John E. Duffy, Chief Executive Officer        |
|   |                   |
|   |                   |
|   | By:                    | /s/ David A. Christensen                      |                     |
|   |                   | David A. Christensen, Chief Financial Officer |
|        |                        |                                               |                          |  |  |  |

 

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