**UNITED STATES**

**SECURITIESAND EXCHANGE COMMISSION**

**WASHINGTON,DC 20549**

 

**FORM 10-Q**

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

 

**Commissionfile number   0-13721**

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

 

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

 

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

 

The total number of shares of the registrant’s common stock outstandingas of June 30, 2005: 13,076,331.

 

 

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**HICKORY TECH CORPORATION**

June 30, 2005

PART I. FINANCIAL INFORMATION

ITEM 1.   FINANCIALSTATEMENTS.

CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED)

 
| **(In Thousands Except Per Share  Amounts)**                                           | ** ** | **For Three Months Ended** |       | **For Six Months Ended** | ** ** |
|----------------------------------------------------------------------------------------|------------|----------------------------|------------|--------------------------|------------|
| ** **                                                                             | ** ** | **6/30/2005**              | ** ** | **6/30/2004**            |       | **6/30/2005** | ** ** | **6/30/2004** | ** ** |
| OPERATING  REVENUES:                                                                   |       |                       | ** ** |                     |       |   | ** ** |   |   |
| Telecom  Sector                                                                        | ** ** | **$**                      | **19,286** | ** **               | $          | 18,847 |   | **$** | **38,631** | ** ** | $ | 38,273 |   |
| Information  Solutions Sector                                                          | ** ** | **914**                    | ** ** | 679                      |       | **1,402** | ** ** | 1,645 |   |
| Enterprise  Solutions Sector                                                           | ** ** | **5,068**                  | ** ** | 3,338                    |       | **8,343** | ** ** | 5,633 |   |
| TOTAL  OPERATING REVENUES                                                              | ** ** | **25,268**                 | ** ** | 22,864                   |       | **48,376** | ** ** | 45,551 |   |
| COSTS AND  EXPENSES:                                                                   |       |                       | ** ** |                     |       |   | ** ** |   |   |
| Cost of  Sales, Enterprise Solutions                                                   | ** ** | **3,772**                  | ** ** | 2,296                    |       | **6,040** | ** ** | 3,805 |   |
| Cost of  Services, excluding Depreciation and Amortization                             | ** ** | **8,289**                  | ** ** | 7,871                    |       | **16,342** | ** ** | 16,479 |   |
| Selling,  General and Administrative Expenses, excluding Depreciation and Amortization | ** ** | **4,087**                  | ** ** | 3,626                    |       | **8,114** | ** ** | 7,282 |   |
| Depreciation                                                                           | ** ** | **4,043**                  | ** ** | 3,881                    |       | **8,044** | ** ** | 7,757 |   |
| Amortization  of Intangibles                                                           | ** ** | **204**                    | ** ** | 237                      |       | **441** | ** ** | 473 |   |
| TOTAL COSTS  AND EXPENSES                                                              | ** ** | **20,395**                 | ** ** | 17,911                   |       | **38,981** | ** ** | 35,796 |   |
| OPERATING  INCOME                                                                      | ** ** | **4,873**                  | ** ** | 4,953                    |       | **9,395** | ** ** | 9,755 |   |
| OTHER  INCOME/(EXPENSE):                                                               |       |                       | ** ** |                     |       |   | ** ** |   |   |
| Interest and  Other Income                                                             | ** ** | **32**                     | ** ** | 19                       |       | **40** | ** ** | 34 |   |
| Interest  Expense                                                                      | ** ** | **(1,027**                 | **)**      | (1,138                   | )          | **(2,004** | **)** | (2,327 | ) |
| TOTAL OTHER  INCOME/(EXPENSE)                                                          | ** ** | **(995**                   | **)**      | (1,119                   | )          | **(1,964** | **)** | (2,293 | ) |
|                                                                                   |       |                       | ** ** |                     |       |   | ** ** |   |   |
| INCOME  BEFORE INCOME TAXES                                                            | ** ** | **3,878**                  | ** ** | 3,834                    |       | **7,431** | ** ** | 7,462 |   |
| INCOME TAX  PROVISION                                                                  | ** ** | **1,569**                  | ** ** | 1,551                    |       | **3,006** | ** ** | 3,018 |   |
| INCOME FROM  CONTINUING OPERATIONS                                                     | ** ** | **2,309**                  | ** ** | 2,283                    |       | **4,425** | ** ** | 4,444 |   |
| DISCONTINUED  OPERATIONS (Note 4)                                                      |       |                       | ** ** |                     |       |   | ** ** |   |   |
| Income/(Loss)  from Operations of Discontinued Component                               | ** ** | **170**                    | ** ** | —                   |       | **170** | ** ** | (99 | ) |
| Income Tax  (Benefit)/Provision                                                        | ** ** | **69**                     | ** ** | —                   |       | **69** | ** ** | (40 | ) |
| INCOME/(LOSS)  FROM DISCONTINUED OPERATIONS                                            | ** ** | **101**                    | ** ** | —                   |       | **101** | ** ** | (59 | ) |
| NET INCOME                                                                             | ** ** | **$**                      | **2,410**  | ** **               | $          | 2,283 |   | **$** | **4,526** | ** ** | $ | 4,385 |   |
|                                                                                   |       |                       | ** ** |                     |       |   | ** ** |   |   |
| Basic  Earnings Per Share - Continuing Operations:                                     | ** ** | **$**                      | **0.18**   | ** **               | $          | 0.18 |   | **$** | **0.34** | ** ** | $ | 0.34 |   |
| Basic  Earnings Per Share - Discontinued Operations:                                   | ** ** | **0.01**                   | ** ** | —                   |       | **0.01** | ** ** | — |   |
| ** **                                                                             |       | **$**                      | **0.19**   | ** **               | $          | 0.18 |   | **$** | **0.35** | ** ** | $ | 0.34 |   |
| Dividends  Per Share                                                                   | ** ** | **$**                      | **0.12**   | ** **               | $          | 0.11 |   | **$** | **0.24** | ** ** | $ | 0.22 |   |
| Basic  Weighted Average Common Shares Outstanding                                      | ** ** | **13,072**                 | ** ** | 12,975                   |       | **13,066** | ** ** | 12,972 |   |
|                                                                                   |       |                       | ** ** |                     |       |   | ** ** |   |   |
| Diluted  Earnings Per Share - Continuing Operations:                                   | ** ** | **$**                      | **0.18**   | ** **               | $          | 0.18 |   | **$** | **0.34** | ** ** | $ | 0.34 |   |
| Diluted  Earnings Per Share - Discontinued Operations:                                 | ** ** | **0.01**                   | ** ** | —                   |       | **0.01** | ** ** | — |   |
| ** **                                                                             |       | **$**                      | **0.19**   | ** **               | $          | 0.18 |   | **$** | **0.35** | ** ** | $ | 0.34 |   |
| Weighted  Average Common and Equivalent Shares Outstanding                             | ** ** | **13,102**                 | ** ** | 13,020                   |       | **13,102** | ** ** | 13,021 |   |

 

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

 

1

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**HICKORY TECH CORPORATION**

June 30, 2005

CONSOLIDATED BALANCE SHEETS

(UNAUDITED)

 
| **(In Thousands Except Share and  Per Share Amounts)**                    | ** ** | **6/30/2005** | ** **  | **12/31/2004** | ** ** |
|---------------------------------------------------------------------------|------------|---------------|-------------|----------------|------------|
| ASSETS                                                                    |       |          |        |           |       |
| CURRENT  ASSETS:                                                          |       |          |        |           |       |
| Cash and  Cash Equivalents                                                | ** ** | **$**         | **1,003**   |           | $          | 257 |   |
| Receivables,  Net of Allowance for Doubtful Accounts of $1,379 and $1,256 | ** ** | **9,628**     |        | 9,892          |       |
| Income Taxes  Receivable                                                  | ** ** | **—**    |        | 204            |       |
| Costs in  Excess of Billings on Contracts                                 | ** ** | **1,754**     |        | 927            |       |
| Inventories,  Net                                                         | ** ** | **3,579**     |        | 3,182          |       |
| Deferred  Income Taxes                                                    | ** ** | **1,430**     |        | 1,430          |       |
| Prepaid  Expenses                                                         | ** ** | **1,437**     |        | 1,185          |       |
| Other                                                                     | ** ** | **900**       |        | 1,214          |       |
| TOTAL  CURRENT ASSETS                                                     | ** ** | **19,731**    |        | 18,291         |       |
| INVESTMENTS                                                               |       | **2,507**     |        | 4,371          |       |
| PROPERTY,  PLANT AND EQUIPMENT                                            | ** ** | **250,428**   |        | 246,341        |       |
| Less  ACCUMULATED DEPRECIATION                                            | ** ** | **138,628**   |        | 131,649        |       |
| PROPERTY,  PLANT AND EQUIPMENT, NET                                       | ** ** | **111,800**   |        | 114,692        |       |
| OTHER  ASSETS:                                                            |       |          |        |           |       |
| Goodwill                                                                  | ** ** | **25,086**    |        | 25,086         |       |
| Intangible  Assets, Net                                                   | ** ** | **335**       |        | 387            |       |
| Financial  Derivative Instruments                                         | ** ** | **2,584**     |        | 2,501          |       |
| Deferred  Costs and Other                                                 | ** ** | **2,492**     |        | 3,209          |       |
| TOTAL OTHER  ASSETS                                                       | ** ** | **30,497**    |        | 31,183         |       |
| TOTAL ASSETS                                                              | ** ** | **$**         | **164,535** |           | $          | 168,537 |   |
|                                                                      |       |          |        |           |       |
| LIABILITIES &  SHAREHOLDERS’ EQUITY                         |       |          |        |           |       |
| CURRENT  LIABILITIES:                                                     |       |          |        |           |       |
| Cash  Overdraft                                                           | ** ** | **$**         | **—**  |           | $          | 1,680 |   |
| Accounts  Payable                                                         | ** ** | **2,327**     |        | 4,065          |       |
| Accrued  Expenses                                                         | ** ** | **4,090**     |        | 3,202          |       |
| Accrued  Interest                                                         | ** ** | **69**        |        | 76             |       |
| Accrued  Income Taxes                                                     | ** ** | **2,562**     |        | —         |       |
| Billings in  Excess of Costs on Contracts                                 | ** ** | **254**       |        | 260            |       |
| Advanced  Billings and Deposits                                           | ** ** | **2,572**     |        | 2,898          |       |
| Current  Maturities of Long-Term Obligations                              | ** ** | **4,424**     |        | 5,323          |       |
| TOTAL  CURRENT LIABILITIES                                                | ** ** | **16,298**    |        | 17,504         |       |
| LONG-TERM  OBLIGATIONS, Net of Current Maturities                         | ** ** | **92,804**    |        | 97,661         |       |
| DEFERRED  INCOME TAXES                                                    | ** ** | **15,303**    |        | 15,270         |       |
| DEFERRED  REVENUE AND EMPLOYEE BENEFITS                                   | ** ** | **6,772**     |        | 6,557          |       |
| TOTAL  LIABILITIES                                                        | ** ** | **131,177**   |        | 136,992        |       |
| COMMITMENTS  AND CONTINGENCIES (Note 9)                                   | ** ** | **—**    |        | —         |       |
| SHAREHOLDERS’  EQUITY:                                               |       |          |        |           |       |
| Common  Stock, no par value, $.10 stated value                            |       |          |        |           |       |
| Shares  authorized: 100,000,000                                           |       |          |        |           |       |
| Shares  outstanding: 13,076,331 in 2005 and 13,057,106 in 2004            | ** ** | **1,308**     |        | 1,306          |       |
| Additional  Paid-In Capital                                               | ** ** | **8,985**     |        | 8,615          |       |
| Retained  Earnings                                                        | ** ** | **21,510**    |        | 20,119         |       |
| Accumulated  Other Comprehensive Income                                   | ** ** | **1,555**     |        | 1,505          |       |
| TOTAL  SHAREHOLDERS’ EQUITY                                          | ** ** | **33,358**    |        | 31,545         |       |
| TOTAL  LIABILITIES & SHAREHOLDERS’ EQUITY                   | ** ** | **$**         | **164,535** |           | $          | 168,537 |   |

 

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

 

2

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**HICKORY TECH CORPORATION**

June 30, 2005

CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

 
| ** **                                                                         | ** ** | **For Six Months Ended** | ** ** |
|------------------------------------------------------------------------------------|------------|--------------------------|------------|
| **(Dollars In Thousands)**                                                         | ** ** | **6/30/2005**            | ** ** | **6/30/2004** | ** ** |
| CASH FLOWS  FROM OPERATING ACTIVITIES:                                             |       |                     | ** ** |   |   |
| Net Income                                                                         | ** ** | **$**                    | **4,526**  | ** ** | $ | 4,385 |   |
| Adjustments  to Reconcile Net Income to Net Cash Provided by Operating Activities: |       |                     | ** ** |   |   |
| Depreciation  and Amortization                                                     | ** ** | **8,485**                | ** ** | 8,230 |   |
| (Gain)/Loss  on Sale of Assets                                                     | ** ** | **(4**                   | **)**      | 4 |   |
| Stock-Based  Compensation                                                          | ** ** | **45**                   | ** ** | 56 |   |
| Employee  Retirement Benefits and Deferred Compensation                            | ** ** | **273**                  | ** ** | 434 |   |
| Accrued  Patronage Refunds                                                         | ** ** | **(211**                 | **)**      | (197 | ) |
| Provision  for Losses on Accounts Receivable                                       | ** ** | **477**                  | ** ** | 326 |   |
| Changes in  Operating Assets and Liabilities:                                      |       |                     | ** ** |   |   |
| Receivables                                                                        | ** ** | **2,553**                | ** ** | 4,158 |   |
| Inventories                                                                        | ** ** | **(396**                 | **)**      | (130 | ) |
| Billings and  Costs on Contracts                                                   | ** ** | **(834**                 | **)**      | 431 |   |
| Accounts  Payable and Accrued Expenses                                             | ** ** | **(857**                 | **)**      | (1,079 | ) |
| Advance  Billings and Deposits                                                     | ** ** | **(326**                 | **)**      | (76 | ) |
| Deferred  Revenue and Employee Benefits                                            | ** ** | **(58**                  | **)**      | (102 | ) |
| Other                                                                              | ** ** | **366**                  | ** ** | 747 |   |
| Net Cash  Provided By Operating Activities                                         | ** ** | **14,039**               | ** ** | 17,187 |   |
| CASH FLOWS  FROM INVESTING ACTIVITIES:                                             |       |                     | ** ** |   |   |
| Additions to  Property, Plant and Equipment                                        | ** ** | **(4,628**               | **)**      | (6,240 | ) |
| Redemption  of Investments                                                         | ** ** | **2,100**                | ** ** | 2,600 |   |
| Purchase of  Intangible Asset                                                      | ** ** | **—**               | ** ** | (9 | ) |
| Proceeds  from Sale of Assets                                                      | ** ** | **25**                   | ** ** | 56 |   |
| Net Cash  Used In Investing Activities                                             | ** ** | **(2,503**               | **)**      | (3,593 | ) |
| CASH FLOWS  FROM FINANCING ACTIVITIES:                                             |       |                     | ** ** |   |   |
| Change in  Cash Overdraft                                                          | ** ** | **(1,680**               | **)**      | (173 | ) |
| Payments of  Capital Lease Obligations                                             | ** ** | **(303**                 | **)**      | (314 | ) |
| Repayments  on Credit Facility                                                     | ** ** | **(9,500**               | **)**      | (12,000 | ) |
| Borrowings  on Credit Facility                                                     | ** ** | **3,500**                | ** ** | 1,500 |   |
| Proceeds  from Issuance of Common Stock                                            | ** ** | **328**                  | ** ** | 244 |   |
| Dividends  Paid                                                                    | ** ** | **(3,135**               | **)**      | (2,853 | ) |
| Stock  Repurchase/Retirement                                                       | ** ** | **—**               | ** ** | (43 | ) |
| Net Cash  Used In Financing Activities                                             | ** ** | **(10,790**              | **)**      | (13,639 | ) |
| NET INCREASE  (DECREASE) IN CASH AND CASH EQUIVALENTS                              | ** ** | **746**                  | ** ** | (45 | ) |
| CASH AND  CASH EQUIVALENTS AT BEGINNING OF PERIOD                                  | ** ** | **257**                  | ** ** | 278 |   |
| CASH AND  CASH EQUIVALENTS AT END OF PERIOD                                        | ** ** | **$**                    | **1,003**  | ** ** | $ | 233 |   |
| SUPPLEMENTAL  DISCLOSURE OF CASH FLOW INFORMATION:                                 |       |                     | ** ** |   |   |
| Cash Paid  for Interest                                                            | ** ** | **$**                    | **2,119**  | ** ** | $ | 2,374 |   |
| Cash Paid  (Refunded) for Income Taxes                                             | ** ** | **$**                    | **310**    | ** ** | $ | (1,745 | ) |
| NON-CASH  INVESTING ACTIVITIES:                                                    |       |                     | ** ** |   |   |
| Property,  Plant and Equipment Acquired with Capital Leases                        | ** ** | **$**                    | **547**    | ** ** | $ | 81 |   |

 

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

 

3

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**HICKORYTECH CORPORATION**

**JUNE 30,2005**

**PART 1.FINANCIAL INFORMATION**

 

**ITEM 1. NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

NOTE 1. BASIS OF PRESENTATION

 

The accompanying unaudited condensed consolidated financial statementshave been prepared in accordance with generally accepted accounting principlesfor interim financial information and with the instructions to Form 10-Qand Article 10 of Regulation S-X. Accordingly, they do not include all ofthe information necessary for a fair statement of results of operations,financial position, and cash flows in conformity with accounting principlesgenerally accepted in the United States of America. In the opinion ofmanagement, the condensed consolidated financial statements reflect alladjustments (consisting only of normal recurring adjustments) considerednecessary for a fair statement of Hickory Tech Corporation’s (HickoryTech)results for the periods presented. Operating results for interim periods arenot necessarily indicative of results that may be expected for the fiscal yearas a whole. The preparation of financial statements in conformity withaccounting principles generally accepted in the United States of Americarequires management to make estimates and assumptions that affect the reportedamounts of assets, liabilities, revenues, expenses, and related disclosures atthe date of the financial statements and during the reporting period. Actualresults could differ from these estimates. These unaudited interim condensedconsolidated financial statements should be read in conjunction withHickoryTech’s Annual Report on Form 10-K for the year ended December 31,2004.

 

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

 

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

 

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

 

NOTE 2. EARNINGS AND CASH DIVIDENDS PER COMMON SHARE

 

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

 
| ** **                           | ** ** | **For Three Months Ended** | ** ** | **For Six Months Ended** | ** ** |
|--------------------------------------|------------|----------------------------|------------|--------------------------|------------|
| ** **                           | ** ** | **6/30/2005**              | ** ** | **6/30/2004**            | ** ** | **6/30/2005** | ** ** | **6/30/2004** | ** ** |
| Weighted  Average Shares Outstanding | ** ** | **13,072,273**             |       | 12,974,669               | ** ** | **13,065,685** |   | 12,972,130 |   |
| Stock  Options (dilutive only)       | ** ** | **5,166**                  |       | 25,301                   | ** ** | **11,009** |   | 28,818 |   |
| Stock  Subscribed (ESPP)             | ** ** | **24,877**                 |       | 20,347                   | ** ** | **24,877** |   | 20,347 |   |
| Total  Dilutive Shares Outstanding   | ** ** | **13,102,316**             |       | 13,020,317               | ** ** | **13,101,571** |   | 13,021,295 |   |

 

4

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Options to purchase 524,850 and 449,283 shares for the three monthsended June 30, 2005 and 2004, respectively, and 517,950 and 449,283 sharesfor the six months ended June 30, 2005 and 2004, respectively, were notincluded in the computation of earnings per share assuming dilution becausetheir effect on earnings per share would have been antidilutive.

 

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

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

 

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

 

During the first six months of 2005 and 2004, shareholders have electedto reinvest $132,000 and $136,000, respectively, of dividends into HickoryTechcommon stock pursuant to the HickoryTech Dividend Reinvestment Plan.

 

NOTE 3. COMPREHENSIVE INCOME

 

HickoryTech follows the provisions of SFAS No. 130, “ReportingComprehensive Income.” This statement established rules for the reportingof comprehensive income and its components. In addition to net income,HickoryTech’s comprehensive income includes changes in unrealized gains andlosses on derivative instruments qualifying and designated as cash flow hedges.Comprehensive income for the three months ended June 30, 2005 and 2004 was$1,845,000 and $3,617,000, respectively. Comprehensive income for the sixmonths ended June 30, 2005 and 2004 was $4,576,000 and $4,853,000,respectively.

 

NOTE 4. DISCONTINUED OPERATIONS

 

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

 

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

 
| **(Dollars in Thousands)**         | ** ** | **For Three Months Ended** | ** ** | **For Six Months Ended** | ** ** |
|------------------------------------|------------|----------------------------|------------|--------------------------|------------|
| ** **                         | ** ** | **6/30/2005**              | ** ** | **6/30/2004**            | ** ** | **6/30/2005** | ** ** | **6/30/2004** | ** ** |
| Revenues                           | ** ** | **$**                      | **—** |                     | $          | — | ** ** | **$** | **—** |   | $ | — |   |
|                               |       |                       |       |                     |       |   |   |   |   |
| Income/(Loss)  Before Income Taxes | ** ** | **$**                      | **170**    |                     | $          | — | ** ** | **$** | **170** |   | $ | (99 | ) |

 

NOTE 5. INVENTORIES

 

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

 

5

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NOTE 6. INTANGIBLE ASSETS

 

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

 

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

 

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

 
| ** **                        | ** ** | **As of June 30, 2005** | ** ** | **As of December 31, 2004** | ** ** |
|-----------------------------------|------------|------------------------------|------------|----------------------------------|------------|
| **(Dollars in Thousands)**        | ** ** | **Gross Carrying  Amount**   | ** ** | **Accumulated  Amortization**    | ** ** | **Gross Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** |
|                              |       |                         |       |                             |       |   |   |   |   |
| Definite-Lived  Intangible Assets |       |                         |       |                             |       |   |   |   |   |
| Customers                         | ** ** | **$**                        | **821**    | ** **                       | **$**      | **493** |   | $ | 821 |   | $ | 442 |   |
| Other  Intangibles                | ** ** | **109**                      | ** ** | **102**                          |       | 109 |   | 101 |   |
| Total                             | ** ** | **$**                        | **930**    | ** **                       | **$**      | **595** |   | $ | 930 |   | $ | 543 |   |

 

Amortization expense related to the definite-lived intangible assetsfor both the three months ended June 30, 2005 and 2004 was $26,000.Amortization expense related to the definite-lived intangible assets for thesix months ended June 30, 2005 and 2004 was $52,000 and $51,000,respectively.  Total estimatedamortization expense for the remaining six months of 2005 and the five yearssubsequent to 2005 is as follows: 2005 (July 1 through December 31) -$52,000; 2006 - $104,000; 2007 - $104,000; 2008 - $74,000; 2009 - $1,000 and2010 - $0.

 

NOTE 7. RECENT ACCOUNTING DEVELOPMENTS

 

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

 

6

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NOTE 8. QUARTERLY SECTOR FINANCIAL SUMMARY

 
| **(Dollars In Thousands)**                                           | ** ** | **Telecom** | ** ** | **Information  Solutions** | ** ** | **Enterprise  Solutions** | ** ** | **Corporate and  Eliminations** | ** ** | **HickoryTech  Consolidated** | ** ** |
|----------------------------------------------------------------------|------------|-------------|------------|----------------------------|------------|---------------------------|------------|---------------------------------|------------|-------------------------------|------------|
| **Three  Months Ended 6/30/05**                                      |       |        |       |                       |       |                      |       |                            |       |                          |       |
| Operating Revenue from Unaffiliated  Customers                       |       | $           | 19,286     |                       | $          | 914                       |       | $                               | 5,068      |                          | $          | — |   | $ | 25,268 |   |
| Intersegment  Revenues                                               |       | 52          |       | 1,087                      |       | —                    |       | (1,139                          | )          | —                        |       |
| Total                                                                |       | 19,338      |       | 2,001                      |       | 5,068                     |       | (1,139                          | )          | 25,268                        |       |
|                                                                 |       |        |       |                       |       |                      |       |                            |       |                          |       |
| Depreciation  and Amortization                                       |       | 3,564       |       | 639                        |       | 31                        |       | 13                              |       | 4,247                         |       |
| Operating  Income/(Loss)                                             |       | 5,464       |       | (617                       | )          | 44                        |       | (18                             | )          | 4,873                         |       |
| Interest  Expense                                                    |       | 2           |       | 15                         |       | —                    |       | 1,010                           |       | 1,027                         |       |
| Income  Taxes/(Benefit)                                              |       | 2,211       |       | (255                       | )          | 18                        |       | (405                            | )          | 1,569                         |       |
|                                                                 |       |        |       |                       |       |                      |       |                            |       |                          |       |
| Income/(Loss)  from Continuing Operations                            |       | 3,252       |       | (374                       | )          | 26                        |       | (595                            | )          | 2,309                         |       |
| Income from  Discontinued Operations Including Intersegment Revenues |       | 101         |       | —                     |       | —                    |       | —                          |       | 101                           |       |
| Net  Income/(Loss)                                                   |       | 3,353       |       | (374                       | )          | 26                        |       | (595                            | )          | 2,410                         |       |
|                                                                 |       |        |       |                       |       |                      |       |                            |       |                          |       |
| Identifiable  Assets                                                 |       | 143,347     |       | 4,377                      |       | 8,965                     |       | 7,846                           |       | 164,535                       |       |
| Property,  Plant and Equip., Net                                     |       | 107,085     |       | 4,356                      |       | 271                       |       | 88                              |       | 111,800                       |       |
| Capital  Expenditures                                                |       | 2,678       |       | 474                        |       | 20                        |       | —                          |       | 3,172                         |       |
|                                                                 |       |        |       |                       |       |                      |       |                            |       |                          |       |
| **Three  Months Ended 6/30/04**                                      |       |        |       |                       |       |                      |       |                            |       |                          |       |
| Operating  Revenue from Unaffiliated Customers                       |       | $           | 18,847     |                       | $          | 679                       |       | $                               | 3,338      |                          | $          | — |   | $ | 22,864 |   |
| Intersegment  Revenues                                               |       | 69          |       | 1,127                      |       | —                    |       | (1,196                          | )          | —                        |       |
| Total                                                                |       | 18,916      |       | 1,806                      |       | 3,338                     |       | (1,196                          | )          | 22,864                        |       |
|                                                                 |       |        |       |                       |       |                      |       |                            |       |                          |       |
| Depreciation  and Amortization                                       |       | 3,407       |       | 654                        |       | 44                        |       | 13                              |       | 4,118                         |       |
| Operating  Income/(Loss)                                             |       | 5,778       |       | (636                       | )          | (140                      | )          | (49                             | )          | 4,953                         |       |
| Interest  Expense                                                    |       | 3           |       | 15                         |       | —                    |       | 1,120                           |       | 1,138                         |       |
| Income  Taxes/(Benefit)                                              |       | 2,338       |       | (260                       | )          | (57                       | )          | (470                            | )          | 1,551                         |       |
| Income/(Loss)  from Continuing Operations                            |       | 3,440       |       | (382                       | )          | (83                       | )          | (692                            | )          | 2,283                         |       |
| Income from  Discontinued Operations Including Intersegment Revenues |       | —      |       | —                     |       | —                    |       | —                          |       | —                        |       |
| Net  Income/(Loss)                                                   |       | 3,440       |       | (382                       | )          | (83                       | )          | (692                            | )          | 2,283                         |       |
|                                                                 |       |        |       |                       |       |                      |       |                            |       |                          |       |
| Identifiable  Assets                                                 |       | 145,126     |       | 6,776                      |       | 7,661                     |       | 8,708                           |       | 168,271                       |       |
| Property,  Plant and Equip., Net                                     |       | 107,198     |       | 4,514                      |       | 387                       |       | 140                             |       | 112,239                       |       |
| Capital  Expenditures                                                |       | 4,096       |       | —                     |       | 22                        |       | —                          |       | 4,118                         |       |

 

7

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| **(Dollars In Thousands)**                                           | ** ** | **Telecom** | ** ** | **Information  Solutions** | ** ** | **Enterprise  Solutions** | ** ** | **Corporate and  Eliminations** | ** ** | **HickoryTech  Consolidated** | ** ** |
|----------------------------------------------------------------------|------------|-------------|------------|----------------------------|------------|---------------------------|------------|---------------------------------|------------|-------------------------------|------------|
| **Six  Months Ended 6/30/05**                                        |       |        |       |                       |       |                      |       |                            |       |                          |       |
| Operating  Revenue from Unaffiliated Customers                       |       | $           | 38,631     |                       | $          | 1,402                     |       | $                               | 8,343      |                          | $          | — |   | $ | 48,376 |   |
| Intersegment  Revenues                                               |       | 103         |       | 2,183                      |       | —                    |       | (2,286                          | )          | —                        |       |
| Total                                                                |       | 38,734      |       | 3,585                      |       | 8,343                     |       | (2,286                          | )          | 48,376                        |       |
|                                                                 |       |        |       |                       |       |                      |       |                            |       |                          |       |
| Depreciation  and Amortization                                       |       | 7,100       |       | 1,295                      |       | 63                        |       | 27                              |       | 8,485                         |       |
| Operating  Income/(Loss)                                             |       | 11,228      |       | (1,369                     | )          | (154                      | )          | (310                            | )          | 9,395                         |       |
| Interest  Expense                                                    |       | 3           |       | 28                         |       | —                    |       | 1,973                           |       | 2,004                         |       |
| Income  Taxes/(Benefit)                                              |       | 4,544       |       | (565                       | )          | (62                       | )          | (911                            | )          | 3,006                         |       |
|                                                                 |       |        |       |                       |       |                      |       |                            |       |                          |       |
| Income/(Loss)  from Continuing Operations                            |       | 6,684       |       | (829                       | )          | (92                       | )          | (1,338                          | )          | 4,425                         |       |
| Income from  Discontinued Operations Including Intersegment Revenues |       | 101         |       | —                     |       | —                    |       | —                          |       | 101                           |       |
| Net Income/(Loss)                                                    |       | 6,785       |       | (829                       | )          | (92                       | )          | (1,338                          | )          | 4,526                         |       |
|                                                                 |       |        |       |                       |       |                      |       |                            |       |                          |       |
| Identifiable  Assets                                                 |       | 143,347     |       | 4,377                      |       | 8,965                     |       | 7,846                           |       | 164,535                       |       |
| Property,  Plant and Equip., Net                                     |       | 107,085     |       | 4,356                      |       | 271                       |       | 88                              |       | 111,800                       |       |
| Capital  Expenditures                                                |       | 4,050       |       | 558                        |       | 20                        |       | —                          |       | 4,628                         |       |
|                                                                 |       |        |       |                       |       |                      |       |                            |       |                          |       |
| **Six  Months Ended 6/30/04**                                        |       |        |       |                       |       |                      |       |                            |       |                          |       |
| Operating  Revenue from Unaffiliated Customers                       |       | $           | 38,273     |                       | $          | 1,645                     |       | $                               | 5,633      |                          | $          | — |   | $ | 45,551 |   |
| Intersegment  Revenues                                               |       | 138         |       | 2,174                      |       | —                    |       | (2,312                          | )          | —                        |       |
| Total                                                                |       | 38,411      |       | 3,819                      |       | 5,633                     |       | (2,312                          | )          | 45,551                        |       |
|                                                                 |       |        |       |                       |       |                      |       |                            |       |                          |       |
| Depreciation  and Amortization                                       |       | 6,814       |       | 1,293                      |       | 95                        |       | 28                              |       | 8,230                         |       |
| Operating  Income/(Loss)                                             |       | 11,857      |       | (1,342                     | )          | (516                      | )          | (244                            | )          | 9,755                         |       |
| Interest  Expense                                                    |       | 7           |       | 27                         |       | —                    |       | 2,293                           |       | 2,327                         |       |
| Income  Taxes/(Benefit)                                              |       | 4,798       |       | (550                       | )          | (209                      | )          | (1,021                          | )          | 3,018                         |       |
| Income/(Loss)  from Continuing Operations                            |       | 7,059       |       | (808                       | )          | (307                      | )          | (1,500                          | )          | 4,444                         |       |
| Loss from  Discontinued Operations Including Intersegment Revenues   |       | (59         | )          | —                     |       | —                    |       | —                          |       | (59                           | )          |
| Net  Income/(Loss)                                                   |       | 7,000       |       | (808                       | )          | (307                      | )          | (1,500                          | )          | 4,385                         |       |
|                                                                 |       |        |       |                       |       |                      |       |                            |       |                          |       |
| Identifiable  Assets                                                 |       | 145,126     |       | 6,776                      |       | 7,661                     |       | 8,708                           |       | 168,271                       |       |
| Property,  Plant and Equip., Net                                     |       | 107,198     |       | 4,514                      |       | 387                       |       | 140                             |       | 112,239                       |       |
| Capital  Expenditures                                                |       | 6,217       |       | 1                          |       | 22                        |       | —                          |       | 6,240                         |       |

 

8

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NOTE 9. CONTINGENCIES

 

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

 

NOTE 10. STOCK COMPENSATION

 

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

 

If HickoryTech had elected to recognize compensation cost based on thefair value of the options and other stock compensation as prescribed by SFAS No. 123,the following operating results would have occurred using the Black-Scholesoption-pricing model to determine the fair value of the options: 

 
| ** **                                                                                                                                         | ** **   | **For Three Months Ended** |       | **For Six Months Ended** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------|--------------|----------------------------|------------|--------------------------|------------|
| **(Dollars in Thousands)**                                                                                                                         | *** *** | **6/30/2005**              | ** ** | **6/30/2004**            |       | **6/30/2005** | ** ** | **6/30/2004** | ** ** |
|                                                                                                                                               |         |                       | ** ** |                     |       |   | ** ** |   |   |
| Reported Net  Income                                                                                                                               | ** **   | **$**                      | **2,410**  | ** **               | $          | 2,283 |   | **$** | **4,526** | ** ** | $ | 4,385 |   |
| Add:  Stock-based employee compensation expense included in reported net income,  net of related tax effects                                       | ** **   | **14**                     | ** ** | 12                       |       | **27** | ** ** | 33 |   |
| Deduct:  Total stock-based employee compensation expense determined under fair  value based method for all awards, net of related tax effects | ** **   | **(62**                    | **)**      | (65                      | )          | **(126** | **)** | (153 | ) |
| Pro Forma  Net Income                                                                                                                              | ** **   | **$**                      | **2,362**  | ** **               | $          | 2,230 |   | **$** | **4,427** | ** ** | $ | 4,265 |   |
|                                                                                                                                               |         |                       | ** ** |                     |       |   | ** ** |   |   |
| Earnings per  share:                                                                                                                               |         |                       | ** ** |                     |       |   | ** ** |   |   |
| Basic - as  reported                                                                                                                               | ** **   | **$**                      | **0.19**   | ** **               | $          | 0.18 |   | **$** | **0.35** | ** ** | $ | 0.34 |   |
| Basic - pro  forma                                                                                                                                 | ** **   | **$**                      | **0.18**   | ** **               | $          | 0.17 |   | **$** | **0.34** | ** ** | $ | 0.33 |   |
|                                                                                                                                               |         |                       | ** ** |                     |       |   | ** ** |   |   |
| Diluted - as  reported                                                                                                                             | ** **   | **$**                      | **0.19**   | ** **               | $          | 0.18 |   | **$** | **0.35** | ** ** | $ | 0.34 |   |
| Diluted -  pro forma                                                                                                                               | ** **   | **$**                      | **0.18**   | ** **               | $          | 0.17 |   | **$** | **0.34** | ** ** | $ | 0.33 |   |

 

NOTE 11. FINANCIAL DERIVATIVE INSTRUMENTS

 

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

 

9

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| **(Dollars in Thousands)**                                                | ** ** | **Interest Rate  Swap Agreement** | ** ** |
|---------------------------------------------------------------------------|------------|-----------------------------------|------------|
|                                                                      |       |                              |       |
| Accumulated  other comprehensive income balance at December 31, 2004 |       | $                                 | 1,505      |   |
| Market value  increase on interest rate swap agreement                    |       | 50                                |       |
| Accumulated  other comprehensive income balance at June 30, 2005     |       | $                                 | 1,555      |   |

 

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

 

The fair value of HickoryTech’s derivatives at June 30, 2005 and December 31,2004 is a net asset of $2,584,000 and $2,501,000, respectively, which isincluded in other assets in the accompanying consolidated balance sheet.

 

NOTE 12. EMPLOYEE POST-RETIREMENT BENEFITS

 

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

 
| ** **                               | ** **   | **For Three Months Ended** |       | **For Six Months Ended** |   |
|------------------------------------------|--------------|----------------------------|------------|--------------------------|--------|
| **(Dollars in Thousands)**               | *** *** | **6/30/2005**              | ** ** | **6/30/2004**            |   | **6/30/2005** | ** ** | **6/30/2004** |   |
| Components  of Net Periodic Benefit Cost |         |                       | ** ** |                     |   |   | ** ** |   |   |
| Service Cost                             | ** **   | **$**                      | **92**     | ** **               | $      | 93 |   | **$** | **184** | ** ** | $ | 186 |   |
| Interest  Cost                           | ** **   | **115**                    | ** ** | 131                      |   | **230** | ** ** | 262 |   |
| Expected  Return on Plan Assets          | ** **   | **—**                 | ** ** | —                   |   | **—** | ** ** | — |   |
| Amortization  of Transition Obligation   | ** **   | **15**                     | ** ** | 15                       |   | **30** | ** ** | 30 |   |
| Amortization  of Prior Service Cost      | ** **   | **(3**                     | **)**      | (3                       | )      | **(6** | **)** | (6 | ) |
| Recognized  Net Actuarial Loss           | ** **   | **44**                     | ** ** | 59                       |   | **88** | ** ** | 118 |   |
| Net Periodic  Benefit Cost               | ** **   | **$**                      | **263**    | ** **               | $      | 295 |   | **$** | **526** | ** ** | $ | 590 |   |

 
|                                                         | ** ** | **2005**   | ** ** |
|--------------------------------------------------------------|------------|------------|------------|
| Employer’s  Contributions                               | ** ** | ** ** | ** ** |
| Contributions  Made For the Six Months Ended 06/30/05        | ** ** | **$**      | **97**     | ** ** |
| Expected Contributions  for Remainder of 2005                | ** ** | **98**     | ** ** |
| Total  Estimated Employer Contributions for Fiscal Year 2005 | ** ** | **$**      | **195**    | ** ** |

 

10

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NOTE 13. REGULATORY ASSET AND LIABILITY

 

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

 

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

 

**FORWARD-LOOKING STATEMENTS**

 

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

 

11

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**BUSINESSES**

 

HickoryTech operates in three business segments: the Telecom,Information Solutions and Enterprise Solutions Sectors. Its largest and oldestbusiness (since 1898) has been the operation of incumbent local exchangecarriers (ILECs) or traditional wireline telephone service. The ILEC businessis in HickoryTech’s Telecom Sector. In 1998, HickoryTech began its competitivelocal exchange carrier (CLEC) line of business, competing for the telephonedial tone, dial-up and broadband Internet access, data, digital TV and longdistance calling business in incumbent LEC (local exchange carrier) territoriesowned by others. The CLEC business is in HickoryTech’s Telecom Sector. Since1964, HickoryTech’s Information Solutions Sector has provided computer dataprocessing and software, predominantly for HickoryTech’s Telecom Sectoroperations and also to other telecommunications companies. HickoryTech acquiredits Enterprise Solutions Sector in 1990 and it operates as atelecommunications, data and Internet Protocol equipment distributor from abase in Minneapolis/St. Paul, Minnesota. HickoryTech also began its wirelessoperations in 1998 by acquiring its first wholly owned wireless servicelicense, an additional wireless service license in 1999 and two PCS licenses in2001. HickoryTech sold the wireless operations on December 15, 2003. Thewireless operations are reported as part of the Telecom Sector. The results ofoperations of the wireless business are reported as discontinued operations forall periods presented.

 

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

 

**TELECOM SECTOR**

Mankato Citizens Telephone Company (MCTC)

Mid-Communications, Inc. (Mid-Comm)

Heartland Telecommunications Company of Iowa, Inc.(Heartland)

Cable Network, Inc. (CNI)

Crystal Communications, Inc. (Crystal)

Minnesota Southern Wireless Company(MSWC)-Discontinued Operations

**INFORMATION SOLUTIONS SECTOR**

National Independent Billing, Inc.(NIBI)

**ENTERPRISE SOLUTIONS SECTOR**

Collins Communications Systems Co. (Collins)

 

HickoryTech and its subsidiaries are engaged in businesses that provideservices to their customers for a fee. Many of these services are recurring,and, as a result, backlog orders and seasonality are not significant factors.Working capital requirements primarily involve financing the construction ofnetworks involving switches and cable, and maintaining a high amount of fixedassets. Other working capital requirements include the payroll costs of highlyskilled labor, the inventory to service its capital projects and maintenance ofthe network and telephone equipment customers, and the carrying value of tradeaccounts receivable, which may take several months to collect in the normalcourse of business.

 

The materials and supplies that are necessary for the operation of thebusinesses of HickoryTech and its subsidiaries are available from a variety ofsources. All of HickoryTech’s central office switches, as well as a majority ofHickoryTech’s equipment sold in its Enterprise Solutions Sector, are suppliedby Nortel. Nortel is a leading supplier of communications equipment, andHickoryTech’s dependence on this brand is not viewed as a significant risk. Anadditional layer of network infrastructure equipment for broadband services isprovided by Nextlevel. The Company also is a distributor of Cisco dataequipment in its Enterprise Solutions Sector.

 

**INDUSTRY SEGMENTS**

 

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

 

12

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*TELECOM SECTOR*

 

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

 

The Telecom Sector also includes Crystal, a CLEC. Crystal provideslocal telephone service, long distance, dial-up and broadband Internet accessand digital TV on a competitive basis. Crystal also connects communicationnetworks of interexchange and wireless carriers with the equipment andfacilities of end users. Crystal has customers in ten rural communities,encompassing eight exchanges, in Minnesota and three communities, encompassingtwo exchanges, in Iowa that are not in HickoryTech’s ILEC service areas. Inaddition to the digital TV service provided to customers in St. Peter,Minnesota, HickoryTech began providing digital TV service to customers inWaseca, Minnesota in July 2004 and New Richland and Ellendale, Minnesotain June 2005.

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

HickoryTech companies are sometimes engaged in negotiation orrenegotiation of arrangements for network interconnection with other carriersand contracts with various wireless service providers. MCTC is presentlyinvolved in interconnection negotiations with another serviceprovider. Although such negotiations may result in reduced revenue,HickoryTech cannot, at this time, estimate the potential revenue impactrelated to these negotiations.

 

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

 

The passage of the 1996 Telecommunications Act created the opportunityfor HickoryTech to offer communications service in territories served by othertelephone companies, and Crystal began operations in January 1998 as a newCLEC. Crystal offers local service, long distance, dial-up and broadbandInternet access services, and digital TV on a competitive basis to customers insouthern Minnesota and Iowa, which were not previously served by HickoryTech’sTelecom Sector service area. These service offerings provide customers alternativesto the incumbent communication providers in various communities and are offeredunder the brand name HickoryTech service. These services are currently beingoffered to customers in ten rural communities, encompassing eight exchanges, inMinnesota, as well as three communities, encompassing two exchanges, in Iowa.Crystal also provides the long distance service, dial-up and broadband Internetaccess services to HickoryTech’s ILEC subscribers.

 

CLEC activities require Crystal to file for authority to operate withthe appropriate public utilities commission in each state it serves. Crystalcompetes directly against existing incumbent LECs in the areas in which itoperates. Crystal is not dependent upon any single customer or small group ofcustomers. No single customer in Crystal accounts for ten percent or more ofHickoryTech’s consolidated revenues.

 

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

 

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

 

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REGULATED INDUSTRY

 

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

 

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

 

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

 

On June 27, 2005, the United States Supreme Court reversed a priorruling that required cable operators to open up their high-speed Internet linesto competition. The FCC Chairman immediately announced an intention to “moveforward quickly to finalize regulations that will spur the development ofbroadband services for all Americans.” HickoryTech cannot, at this time,estimate the revenue impact, if any, related to these events.

 

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

 

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

 

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

 

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

 

Crystal offers digital TV service in the St. Peter, Waseca, Ellendaleand New Richland, Minnesota markets under franchises negotiated with the localmunicipality. Offering of digital TV services in the community of St. Clair isplanned for August 2005.

 

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

 

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

 

Local Number Portability (LNP) – On November 10, 2003, the FCCreleased a decision providing guidance on porting between wireline and wirelessnetworks (intermodal porting). Most of the Company’s wireline operations weresubject to a May 24, 2004 implementation date for intermodal porting,however, Heartland Telecommunications Company of Iowa received a suspensionorder from the Iowa Utilities Board allowing additional time and implementedLNP on January 25, 2005. The effects of intermodal porting on the Company’sMinnesota wireline operations have been minimal as of June 30, 2005. Giventhe short history for which intermodal porting has been available, however, theCompany cannot fully quantify the long-term effects of implementing intermodalporting on its wireline operations. It is possible that these requirementscould adversely affect the Company’s wireline operating costs and customergrowth rates.  HickoryTech is also unableto quantify the revenue impact of wireline customers that may switch towireless or other wireline alternatives.

 

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

 

*INFORMATION SOLUTIONS SECTOR*

 

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

 

*ENTERPRISESOLUTIONS SECTOR*

 

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

 

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

 

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

 

**RESULTS OF OPERATIONS**

 

CONSOLIDATED OPERATING RESULTS:

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

 

##### OPERATING REVENUES:

Consolidated operating revenueswere $25,268,000, which is $2,404,000 or 10.5% higher in the three months endedJune 30, 2005 compared to the three months ended June 30, 2004. The increase inrevenues can be primarily attributed to a higher volume of business in theEnterprise Solutions Sector, an increase in the Information Solutions revenuefrom unaffiliated customers as well as increased data, long distance, Internetand digital TV revenues all in the Telecom Sector. These increases werepartially offset by decreased revenue from local service in the Telecom Sector.Consolidated operating revenues were $48,376,000, which is $2,825,000 or 6.2%higher in the six months ended June 30, 2005 compared to the six months endedJune 30, 2004. The increase can be primarily attributed to a higher volume ofbusiness in the Enterprise Solutions Sector, as well as increased data,Internet and digital TV revenues all in the Telecom Sector. These increaseswere partially offset by the decreased revenue from unaffiliated customers inthe Information Solutions Sector and the decreased local service and networkaccess revenues in the Telecom Sector.

 

COSTOF SALES, ENTERPRISE SOLUTIONS:

Costof sales, which is related to the Enterprise Solutions Sector, was $3,772,000,which is $1,476,000 or 64.3% higher in the three months ended June 30,2005 compared to the three months ended June 30, 2004. Gross profit marginwas 25.6% in the second quarter of 2005 compared to 31.2% in the second quarterof 2004. Cost of sales was $6,040,000, which is $2,235,000 or 58.7% higher inthe six months ended June 30, 2005 compared to the six months ended June 30,2004. Gross profit margin was 27.6% in the six months ended June 30, 2005compared to 32.5% in the six months ended June 30, 2004. The increase incost of sales in the three and six months ended June 30, 2005 compared tothe three and six months ended June 30, 2004 corresponds with the increasein sales in both periods, while the decrease in gross profit margin in bothperiods is largely the result of the increase in lower margin installations oflarge complex systems. The margin in this sector is primarily affected by themix of various products and services sold.

 

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COSTOF SERVICES, excluding Depreciation and Amortization:

Costof services, excluding depreciation and amortization increased $418,000 or 5.3%in second quarter 2005 compared to second quarter 2004. This increase in thesecond quarter 2005 compared to the second quarter 2004 was primarily due toincreased wages and bad debt expense in the Telecom Sector. Also contributingto the increase was an increase in the Enterprise Solutions inventory valuationreserve. The increase was partially offset by the decreased wages and benefitsin the second quarter of 2005 in the Information Solutions Sector and decreasedInternet expense due to customers who have switched from dial-up Internet tobroadband Internet and lower billing and collection costs in the TelecomSector. The wages and benefits in the Information Solutions Sector mentionedabove were associated with a redeployment of personnel to selling, general andadministrative cost centers in connection with management cost reductionactions. Cost of services, excluding depreciation and amortization decreased$137,000 or 0.8% in the six months ended June 30, 2005 compared to the sixmonths ended June 30, 2004. This decrease for the six months ended June 30,2005 compared to the six months ended June 30, 2004 was primarily due tothe decreased wages and benefits in the second quarter of 2005 in theInformation Solutions Sector, decreased Internet expense due to customers whohave switched from dial-up Internet to broadband Internet, lower billing andcollection costs and lower wholesale costs associated with long distancecarriers, all in the Telecom Sector. The decrease was partially offset byincreased expenses in the Telecom digital TV product line to support salesgrowth, increased commissions, increased maintenance contracts and an increasein the Enterprise Solutions inventory valuation reserve.

 

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

Selling, general and administrative expenses, excluding depreciationand amortization increased $461,000 or 12.7% in second quarter 2005 compared tosecond quarter 2004. The primary reason for this increase was one-time feesassociated with the termination of leases for data processing equipment in theInformation Solutions Sector and increased regulatory fees in the TelecomSector. Selling, general and administrative expenses, excluding depreciationand amortization increased $832,000 or 11.4% in the six months ended June 30,2005 compared to the six months ended June 30, 2004. The primary reasonsfor this increase was the one-time fees associated with the termination ofleases and the redeployment of personnel from cost of services cost centers,both in the Information Solutions Sector as well as increased regulatory feesand property taxes in the Telecom Sector.

 

DEPRECIATIONAND AMORTIZATION:

Depreciationexpense was $4,043,000, which is $162,000 or 4.2% higher in the three monthsended June 30, 2005 compared to the three months ended June 30, 2004.Depreciation expense was $8,044,000, which is $287,000 or 3.7% higher in thesix months ended June 30, 2005 compared to the six months ended June 30,2004. The increase in depreciation was due to an increase in the Telecom Sector’snetwork assets. Amortization expense was $204,000, which is $33,000 or 13.9%lower in the three months ended June 30, 2005 compared to the three monthsended June 30, 2004. Amortization expense was $441,000, which is $32,000or 6.8% lower in the six months ended June 30, 2005 compared to the sixmonths ended June 30, 2004. The decrease in amortization expense was dueto the SuiteSolutions asset in the Information Solutions Sector becoming fullyamortized in the second quarter of 2005.

 

OPERATING INCOME:

Operating income was $4,873,000, which is $80,000 or 1.6% lower in thethree months ended June 30, 2005 compared to the three months ended June 30,2004. The decrease in operating income was driven by the $1,476,000 increase incost of sales, $418,000 increase in cost of services, $461,000 increase inselling, general and administrative expenses and $162,000 increase indepreciation, all of which were described above. These expense increases werepartially offset by the $2,404,000 increase in operating revenues, which wasalso described above. Operating income was $9,395,000, which is $360,000 or3.7% lower in the six months ended June 30, 2005 compared to the sixmonths ended June 30, 2004. The decrease in operating income was driven bythe $2,235,000 increase in cost of sales, $832,000 increase in selling, generaland administrative expenses and $287,000 increase in depreciation, all of whichwere described above. These expense increases were partially offset by the$2,825,000 increase in operating revenues and the $137,000 decrease in cost ofservices, which were also described above.

 

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INTEREST EXPENSE:

Interest expense decreased $111,000 or 9.8% to $1,027,000 in the threemonths ended June 30, 2005 compared to the three months ended June 30,2004. Interest expense decreased $323,000 or 13.9% to $2,004,000 in the sixmonths ended June 30, 2005 compared to the six months ended June 30,2004. The decrease in interest expense for the period was primarily due to adecrease in total debt outstanding. The outstanding balance of the revolvingcredit facility was $96,500,000 at June 30, 2005 and $108,000,000 at June 30,2004.

 

INCOME TAXES:

The effective income tax rate of approximately 40.4% for second quarter2005 and second quarter 2004 exceeds the federal statutory rate primarily dueto state income taxes. The effective income tax rate of approximately 40.4% forthe six months ended June 30, 2005 and the six months ended June 30,2004 exceeds the federal statutory rate primarily due to state income taxes.

 

INCOME FROM CONTINUING OPERATIONS:

Consolidated income from continuing operations was $2,309,000, which is$26,000 or 1.1% higher in the three months ended June 30, 2005 compared tothe three months ended June 30, 2004. The increase in income fromcontinuing operations was driven by the $2,404,000 increase in operatingrevenues, a $111,000 decrease in interest expense, both which are explainedabove, partially offset by a $1,476,000 increase in cost of sales, the $418,000increase in cost of services, the $461,000 increase in selling, general andadministrative expenses and the $162,000 increase in depreciation, all of whichwere described above. Consolidated income from continuing operations was$4,425,000, which is $19,000 or 0.4% lower in the six months ended June 30,2005 compared to the six months ended June 30, 2004. The decrease inincome from continuing operations was driven by the $2,235,000 increase in costof sales, the $832,000 increase in selling, general and administrative expensesand the $287,000 increase in depreciation, all of which are explained above,partially offset by a $2,825,000 increase in operating revenues, the $137,000decrease in cost of services and the $323,000 decrease in interest expense, allof which were described above. 

 

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SECTOR RESULTS OF OPERATIONS FROM CONTINUINGOPERATIONS

 

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

 

**TELECOMSECTOR**

 
| ** **                                                                              | ** ** | **For Three Months Ended** | ** ** | **For Six Months Ended** | ** ** |
|-----------------------------------------------------------------------------------------|------------|----------------------------|------------|--------------------------|------------|
| **(Dollars in Thousands)**                                                              | ** ** | **6/30/2005**              | ** ** | **6/30/2004**            | ** ** | **6/30/2005** | ** ** | **6/30/2004** | ** ** |
|                                                                                    |       |                       |       |                     |       |   |   |   |   |
| Revenues  Before Intersegment Eliminations                                              |       |                       |       |                     |       |   |   |   |   |
| ILEC                                                                                    |       |                       |       |                     |       |   |   |   |   |
| Local  Service                                                                          | ** ** | **$**                      | **3,742**  |                     | $          | 3,818 | ** ** | **$** | **7,478** |   | $ | 7,549 |   |
| Network  Access                                                                         | ** ** | **8,364**                  |       | 8,272                    | ** ** | **16,858** |   | 16,949 |   |
| Data                                                                                    | ** ** | **590**                    |       | 547                      | ** ** | **1,160** |   | 1,069 |   |
| Intersegment                                                                            | ** ** | **52**                     |       | 69                       | ** ** | **103** |   | 138 |   |
| Other                                                                                   | ** ** | **1,558**                  |       | 1,596                    | ** ** | **3,224** |   | 3,343 |   |
| Total ILEC                                                                              | ** ** | **14,306**                 |       | 14,302                   | ** ** | **28,823** |   | 29,048 |   |
|                                                                                    |       |                       |       |                     |       |   |   |   |   |
| CLEC                                                                                    |       |                       |       |                     |       |   |   |   |   |
| Local  Service                                                                          | ** ** | **883**                    |       | 925                      | ** ** | **1,772** |   | 1,854 |   |
| Network  Access                                                                         | ** ** | **494**                    |       | 621                      | ** ** | **1,012** |   | 1,301 |   |
| Data                                                                                    | ** ** | **630**                    |       | 399                      | ** ** | **1,248** |   | 780 |   |
| Other                                                                                   | ** ** | **462**                    |       | 450                      | ** ** | **895** |   | 880 |   |
| Total CLEC                                                                              | ** ** | **2,469**                  |       | 2,395                    | ** ** | **4,927** |   | 4,815 |   |
|                                                                                    |       |                       |       |                     |       |   |   |   |   |
| Long  Distance                                                                          | ** ** | **1,219**                  |       | 1,106                    | ** ** | **2,361** |   | 2,334 |   |
|                                                                                    |       |                       |       |                     |       |   |   |   |   |
| Internet                                                                                | ** ** | **1,100**                  |       | 994                      | ** ** | **2,171** |   | 1,989 |   |
|                                                                                    |       |                       |       |                     |       |   |   |   |   |
| Digital TV                                                                              | ** ** | **244**                    |       | 119                      | ** ** | **452** |   | 225 |   |
|                                                                                    |       |                       |       |                     |       |   |   |   |   |
| Total  Telecom Revenues                                                                 | ** ** | **$**                      | **19,338** |                     | $          | 18,916 | ** ** | **$** | **38,734** |   | $ | 38,411 |   |
|                                                                                    |       |                       |       |                     |       |   |   |   |   |
| Total  Telecom Revenues Before Intersegment Eliminations                                |       |                       |       |                     |       |   |   |   |   |
| Unaffiliated  Customers                                                                 | ** ** | **$**                      | **19,286** |                     | $          | 18,847 | ** ** | **$** | **38,631** |   | $ | 38,273 |   |
| Intersegment                                                                            | ** ** | **52**                     |       | 69                       | ** ** | **103** |   | 138 |   |
| ** **                                                                              |       | **19,338**                 |       | 18,916                   | ** ** | **38,734** |   | 38,411 |   |
|                                                                                    |       |                       |       |                     |       |   |   |   |   |
| Cost of  Services, excluding Depreciation and Amortization                              | ** ** | **7,546**                  |       | 7,182                    | ** ** | **14,958** |   | 14,662 |   |
| Selling,  General, and Administrative Expenses, excluding Depreciation and Amortization | ** ** | **2,764**                  |       | 2,549                    | ** ** | **5,448** |   | 5,078 |   |
| Depreciation  and Amortization                                                          | ** ** | **3,564**                  |       | 3,407                    | ** ** | **7,100** |   | 6,814 |   |
| Operating  Income                                                                       | ** ** | **$**                      | **5,464**  |                     | $          | 5,778 | ** ** | **$** | **11,228** |   | $ | 11,857 |   |
|                                                                                    |       |                       |       |                     |       |   |   |   |   |
| Income from  Continuing Operations, Net of Tax                                          | ** ** | **$**                      | **3,252**  |                     | $          | 3,440 | ** ** | **$** | **6,684** |   | $ | 7,059 |   |
| Income/(Loss)  from Discontinued Operations                                             | ** ** | **101**                    |       | —                   | ** ** | **101** |   | (59 | ) |
| Net Income                                                                              | ** ** | **$**                      | **3,353**  |                     | $          | 3,440 | ** ** | **$** | **6,785** |   | $ | 7,000 |   |
|                                                                                    |       |                       |       |                     |       |   |   |   |   |
| Capital  Expenditures                                                                   | ** ** | **$**                      | **2,678**  |                     | $          | 4,096 | ** ** | **$** | **4,050** |   | $ | 6,217 |   |

 

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| ** **                       | ** ** | **For Six Months Ended** | ** ** |
|----------------------------------|------------|--------------------------|------------|
| **(Dollars in Thousands)**       | ** ** | **6/30/2005**            | ** ** | **6/30/2004** | ** ** |
|                             |       |                     |       |   |   |
| ILEC Access  Lines               | ** ** | **57,995**               |       | 60,044 |   |
|                             |       |                     |       |   |   |
| CLEC Access  Lines               |       |                     |       |   |   |
| Overbuild                        | ** ** | **10,550**               |       | 10,406 |   |
| Unbundled  Network Element (UNE) | ** ** | **1,746**                |       | 1,699 |   |
| Total  Service Resale (TSR)      | ** ** | **1,757**                |       | 2,430 |   |
| Total                            | ** ** | **14,053**               |       | 14,535 |   |
|                             |       |                     |       |   |   |
| Long  Distance Customers         | ** ** | **42,061**               |       | 40,456 |   |
|                             |       |                     |       |   |   |
| Internet  Customers              | ** ** | **17,761**               |       | 16,707 |   |
|                             |       |                     |       |   |   |
| Total  Telecom Customers         | ** ** | **131,870**              |       | 131,742 |   |
|                             |       |                     |       |   |   |
| DSL  Customers                   | ** ** | **11,693**               |       | 8,946 |   |
|                             |       |                     |       |   |   |
| Digital TV  Customers            | ** ** | **2,141**                |       | 1,365 |   |

 

Telecom Sector operating revenuesbefore intersegment eliminations were $19,338,000, which is $422,000 or 2.2%higher in the three months ended June 30, 2005 compared to the threemonths ended June 30, 2004. The increase in revenue in the second quarterof 2005 compared to the second quarter of 2004 was due primarily to the growthin CLEC data, long distance, Internet and digital TV offset by declines in ILECand CLEC local service and CLEC network access. Telecom Sector operatingrevenues before intersegment eliminations were $38,734,000, which is $323,000or 0.8% higher in the six months ended June 30, 2005 compared to the sixmonths ended June 30, 2004. For the six month period ended June 30,2005 as compared to the same period in 2004, the increase in revenue wasprimarily due to increased CLEC data, long distance, Internet and digital TVoffset by declines in Total ILEC revenue and CLEC local service and networkaccess.

 

ILEC local service revenue was $3,742,000, which is $76,000 or 2.0%lower in the three months ended June 30, 2005 compared to the three monthsended June 30, 2004. ILEC local service revenue was $7,478,000, which is$71,000 or 0.9% lower in the six months ended June 30, 2005 compared tothe six months ended June 30, 2004. The decrease is the result of 2,049fewer access lines at June 30, 2005 than at June 30, 2004. EnterpriseSolutions has signed a large contract with a college campus in Minnesota toprovide an Internet Protocol (IP), Private Branch Exchange (PBX) System. ThisSystem will replace approximately 2,500 additional ILEC access lines andapproximately $45,000 per month of local revenue starting in the third quarterof 2005.

 

ILEC network access revenue was $8,364,000, which is $92,000 or 1.1%higher in the three months ended June 30, 2005 compared to the threemonths ended June 30, 2004. ILEC network access revenue was $16,858,000,which is $91,000 or 0.5% lower in the six months ended June 30, 2005compared to the six months ended June 30, 2004. The decrease in networkaccess revenue in the first six months of 2005 compared to the first six monthsof 2004 was driven by the impact of carriers rerouting traffic, carrier billinginterpretations and lower minutes of use. A combination of access reform,changing minutes of use (MOU), carriers rerouting traffic, and lower demand fordedicated lines may negatively impact future access revenues. The MinnesotaPublic Utilities Commission (PUC) has been considering intrastate access reformand universal service for several years (see regulatory section).

 

ILEC data revenue was $590,000, which is $43,000 or 7.9% higher in thethree months ended June 30, 2005 compared to three months ended June 30,2004. ILEC data revenue was $1,160,000, which is $91,000 or 8.5% higher in thesix months ended June 30, 2005 compared to the six months ended June 30,2004. The increase is the result of 2,137 more digital subscriber line (DSL)customers at June 30, 2005 than at June 30, 2004.

 

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ILEC other revenue was $38,000 or 2.4% lower in second quarter 2005compared to second quarter 2004. ILEC other revenue was $119,000 or 3.6% lowerin the six months ended June 30, 2005 compared to the six months ended June 30,2004. The decrease in the six months ended June 30, 2005 compared to thesix months ended June 30, 2004 is lower primarily because of a largepaystation settlement received in 2004.

 

CLEC local service revenue was $883,000, which is $42,000 or 4.5% lowerin the three months ended June 30, 2005 compared to the three months endedJune 30, 2004. CLEC local service revenue was $1,772,000, which is $82,000or 4.4% lower in the six months ended June 30, 2005 compared to the sixmonths ended June 30, 2004. The decrease is the result of 482 fewer accesslines at June 30, 2005 than at June 30, 2004.

 

CLEC network access revenue was $127,000 or 20.5% lower in secondquarter 2005 compared to second quarter 2004. CLEC network access revenue was$289,000 or 22.2% lower in the six months ended June 30, 2005 compared tothe six months ended June 30, 2004. This decrease in 2005 compared to 2004was driven by a mandated rate decrease in June of 2004. A combination ofaccess reform, changing MOUs, carriers rerouting traffic and lower demand fordedicated lines may negatively impact future access revenues.

 

CLECdata revenue was $231,000 or 57.9% higher in first quarter 2005 compared tofirst quarter 2004. CLEC data revenue was $468,000 or 60% higher in the sixmonths ended June 30, 2005 compared to the six months ended June 30,2004. The increase in 2005 compared to 2004 was caused primarily by an increasein residential and business DSL penetration in CLEC communities as well as therollout of Ethernet services to large business customers in 2004.

 

Longdistance revenue was $113,000 or 10.2% higher in the three months ended June 30,2005 compared to the three months ended June 30, 2004. Long distancerevenue was $27,000 or 1.2% higher in the six months ended June 30, 2005compared to the six months ended June 30, 2004. Despite the loss of$58,000 and $183,000 in the three and six months ended June 30, 2005,respectively, of wholesale revenue received from a wireless carrier thatdiscontinued their use of our long distance services in the second quarter of2004, HickoryTech’s long distance revenue increased in both the second quarterof 2005 and for the six months ended June 30, 2005 over 2004 due to a1,605 or 4.0% increase in its long distance customer base between June 30,2004 and June 30, 2005.

 

Internetrevenue was $106,000, or 10.7% higher in the three months ended June 30,2005 compared to the three months ended June 30, 2004. Internet revenuewas $182,000, or 9.2% higher in the six months ended June 30, 2005compared to the six months ended June 30, 2004. The increase in revenuewas caused primarily by an increase in Internet customers of 1,054 or 6.3%between June 30, 2004 and June 30, 2005.

 

DigitalTV was $125,000, or 105% higher in the three months ended June 30, 2005compared to the three months ended June 30, 2004. Digital TV was $227,000,or 100.9% higher in the six months ended June 30, 2005 compared to the sixmonths ended June 30, 2004. The increase in 2005 compared to 2004 was theresult of the offering of digital TV in Waseca, Minnesota in July 2004. InJune of 2005, HickoryTech began offering digital TV service in NewRichland and Ellendale, Minnesota. This should positively impact revenuesstarting in the third quarter of 2005.

 

Costof Services, excluding Depreciation and Amortization:

Costof services, excluding depreciation and amortization was $364,000 or 5.1%higher in the second quarter of 2005 compared to the second quarter of 2004.The increase in the second quarter of 2005 compared to the second quarter of2004 is primarily due to increased wages and bad debt expense offset by lowerInternet expense due to lower costs associated with customers who have switchedfrom dial-up Internet to broadband Internet and lower billing and collectioncosts. Cost of services, excluding depreciation and amortization was $296,000or 2.0% higher in the six months ended June 30, 2005 compared to the sixmonths ended June 30, 2004. The increase in six months ending June 30,2005 compared to the six months ended June 30, 2004 is primarily due toincreased wages and bad debt expense, offset by lower Internet expense due tolower costs associated with customers who have switched from dial-up Internetto broadband Internet, lower billing and collection costs and lower wholesalecosts associated with long distance carriers.

 

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

Selling,general and administrative expenses, excluding depreciation and amortizationwere $215,000 or 8.4% higher in the second quarter of 2005 compared to thesecond quarter of 2004. The increase is primarily due to increased regulatoryfees. Selling, general and administrative expenses, excluding depreciation andamortization were $370,000 or 7.3% higher in the six months ended June 30,2005 compared to the six months ended June 30, 2004. The increase isprimarily due to increased regulatory fees and property taxes.

 

Depreciationand Amortization:

Depreciationand amortization were $3,564,000, which is $157,000 or 4.6% higher in the threemonths ended June 30, 2005 compared to the same period in 2004.Depreciation and amortization were $7,100,000, which is $286,000 or 4.2% higherin the six months ended June 30, 2005 compared to the same period in 2004.The increase in depreciation expense can be largely attributed to increasednetwork infrastructure.

 

Operatingand Net Income:

Operatingincome was $5,464,000, which is $314,000 or 5.4% lower in the three monthsended June 30, 2005 compared to the three months ended June 30, 2004.Net income was $3,353,000, which is $87,000 or 2.5% lower in the three monthsended June 30, 2005 compared to the three months ended June 30, 2004.These decreases were driven by the $364,000 increase in cost of services,$215,000 increase in selling, general and administrative expenses and $157,000increase in depreciation and amortization, offset by the $422,000 increase inrevenues, all of which were mentioned above. Operating income was $11,228,000,which is $629,000 or 5.3% lower in the six months ended June 30, 2005compared to the six months ended June 30, 2004. Net income was $6,785,000,which is $215,000 or 3.1% lower in the six months ended June 30, 2005compared to the six months ended June 30, 2004. These decreases weredriven by the $296,000 increase in cost of services, $370,000 increase inselling, general and administrative expenses and $286,000 increase indepreciation and amortization, off set by the $323,000 increase in revenues,all of which were mentioned above.

 

DiscontinuedOperations:

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

 

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

 

**INFORMATIONSOLUTIONS SECTOR**

 
| *** ***                                                                            | ** ** | **For Three Months Ended** | ** ** | **For Six Months Ended** | ** ** |
|-----------------------------------------------------------------------------------------|------------|----------------------------|------------|--------------------------|------------|
| **(Dollars in Thousands)**                                                              | ** ** | **6/30/2005**              | ** ** | **6/30/2004**            | ** ** | **6/30/2005** | ** ** | **6/30/2004** | ** ** |
| Revenues  Before Eliminations                                                           |       |                       |       |                     |       |   |   |   |   |
| Unaffiliated  Customers                                                                 | ** ** | **$**                      | **914**    |                     | $          | 679 | ** ** | **$** | **1,402** |   | $ | 1,645 |   |
| Intersegment                                                                            | ** ** | **1,087**                  |       | 1,127                    | ** ** | **2,183** |   | 2,174 |   |
| ** **                                                                              |       | **2,001**                  |       | 1,806                    | ** ** | **3,585** |   | 3,819 |   |
| Cost of  Services, excluding Depreciation and Amortization                              | ** ** | **1,396**                  |       | 1,536                    | ** ** | **2,777** |   | 3,422 |   |
| Selling,  General, and Administrative Expenses, excluding Depreciation and Amortization | ** ** | **583**                    |       | 252                      | ** ** | **882** |   | 446 |   |
| Depreciation  and Amortization                                                          | ** ** | **639**                    |       | 654                      | ** ** | **1,295** |   | 1,293 |   |
|                                                                                    |       |                       |       |                     |       |   |   |   |   |
| Operating  Loss                                                                         | ** ** | **$**                      | **(617**   | **)**                    | $          | (636 | ) | **$** | **(1,369** | **)** | $ | (1,342 | ) |
| Net Loss                                                                                | ** ** | **$**                      | **(374**   | **)**                    | $          | (382 | ) | **$** | **(829** | **)** | $ | (808 | ) |
|                                                                                    |       |                       |       |                     |       |   |   |   |   |
| Capital  Expenditures                                                                   | ** ** | **$**                      | **474**    |                     | $          | — | ** ** | **$** | **558** |   | $ | 1 |   |

 

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Revenues:

Operating revenues from unaffiliated customers increased $235,000 or34.6% in the second quarter 2005 compared to the second quarter 2004. In June 2005,the Company recognized $369,000 in license fees from the sale of SuiteSolutionsto a customer. This helped offset the loss of several other customers.Operating revenues from unaffiliated customers decreased $243,000 or 14.8% inthe six months ended June 30, 2005 compared to the six months ended June 30,2004. Despite the sale of SuiteSolutions to a customer in the second quarter,the Company has lost several other customers including $438,000 over the firstsix months of 2005 from a temporary customer relationship that ended in secondquarter 2004.

 

Cost of Services, excluding Depreciation andAmortization:

Cost of services, excluding depreciation and amortization decreased$140,000 or 9.1% in the second quarter 2005 compared to the second quarter 2004.The decrease is primarily due to greater wages and benefits associated with aredeployment of personnel to selling, general and administrative cost centersin connection with management cost reduction actions. Cost of services,excluding depreciation and amortization decreased $645,000 or 18.8% in the sixmonths ended June 30, 2005 compared to the six months ended June 30,2004. The decrease is primarily due to higher wages and benefits associatedwith a redeployment of personnel to selling, general and administrative costcenters in connection with management cost reduction actions and lower costsrecognized from outsourced contractor work.

 

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

Selling, general and administrative expenses, excluding depreciationand amortization were $331,000 or 131.3% higher in the second quarter of 2005compared to the second quarter of 2004. The increase was largely due toone-time fees associated with the termination of leases. Selling, general andadministrative expenses, excluding depreciation and amortization were $436,000or 97.8% higher in the six months ended June 30, 2005 compared to the sixmonths ended June 30, 2004. The increase was largely due to one-time feesassociated with the termination of leases and increased wages and benefitsresulting from a redeployment of personnel from cost of services cost centers.

 

Operating and Net Loss:

Operating loss decreased $19,000 or 3.0% in second quarter 2005compared to second quarter 2004. Net loss decreased $8,000 or 2.1% in secondquarter 2005 compared to second quarter 2004. The decrease in operating lossand net loss in second quarter 2005 compared to second quarter 2004 wasprimarily attributable to the increase in revenues from unaffiliated customersand the decrease in cost of services excluding depreciation and amortization,partially offset by the increase in selling, general, and administrativeexpenses excluding depreciation and amortization. Operating loss increased$27,000 or 2.0% in the six months ended June 30, 2005 compared to the sixmonths ended June 30, 2004. Net loss increased $21,000 or 2.6% in the sixmonths ended June 30, 2005 compared to the six months ended June 30,2004. The increase in operating loss and net loss for the six months ended June 30,2005 compared to six months ended June 30, 2004 was primarily attributableto the decrease in revenues from unaffiliated customers and the increase inselling, general, and administrative expenses excluding depreciation andamortization, partially offset by the decrease in cost of services excludingdepreciation and amortization.

 

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

 

**ENTERPRISESOLUTIONS SECTOR**

 
| *** ***                                                                           | ** ** | **For Three Months Ended** | ** ** | **For Six Months Ended** | ** ** |
|----------------------------------------------------------------------------------------|------------|----------------------------|------------|--------------------------|------------|
| **(Dollars in Thousands)**                                                             | ** ** | **6/30/2005**              | ** ** | **6/30/2004**            | ** ** | **6/30/2005** | ** ** | **6/30/2004** | ** ** |
| Revenues  Before Intersegment Eliminations                                             |       |                       |       |                     |       |   |   |   |   |
| Installation                                                                           | ** ** | **$**                      | **3,013**  |                     | $          | 1,227 | ** ** | **$** | **4,400** |   | $ | 1,880 |   |
| Service                                                                                | ** ** | **2,055**                  |       | 2,111                    | ** ** | **3,943** |   | 3,753 |   |
| ** **                                                                             |       | **5,068**                  |       | 3,338                    | ** ** | **8,343** |   | 5,633 |   |
| Cost of  Sales                                                                         | ** ** | **3,772**                  |       | 2,296                    | ** ** | **6,040** |   | 3,805 |   |
| Cost of  Services, excluding Depreciation And Amortization                             | ** ** | **453**                    |       | 317                      | ** ** | **828** |   | 642 |   |
| Selling,  General and Administrative Expenses, excluding Depreciation and Amortization | ** ** | **768**                    |       | 821                      | ** ** | **1,566** |   | 1,607 |   |
| Depreciation  and Amortization                                                         | ** ** | **31**                     |       | 44                       | ** ** | **63** |   | 95 |   |
|                                                                                   |       |                       |       |                     |       |   |   |   |   |
| Operating  Income/(Loss)                                                               | ** ** | **$**                      | **44**     |                     | $          | (140 | ) | **$** | **(154** | **)** | $ | (516 | ) |
| Net  Income/(Loss)                                                                     | ** ** | **$**                      | **26**     |                     | $          | (83 | ) | **$** | **(92** | **)** | $ | (307 | ) |
|                                                                                   |       |                       |       |                     |       |   |   |   |   |
| Capital  Expenditures                                                                  | ** ** | **$**                      | **20**     |                     | $          | 22 | ** ** | **$** | **20** |   | $ | 22 |   |

 

Revenues:

Operating revenues increased $1,730,000 or 51.8% in the second quarterof 2005 compared to the second quarter of 2004. Operating revenues increased$2,710,000 or 48.1% in the six months ended June 30, 2005 compared to thesix months ended June 30, 2004. Installation revenue increased $1,786,000or 145.6% in the second quarter of 2005 compared to the second quarter of 2004.Installation revenue increased $2,520,000 or 134% in the six months ended June 30,2005 compared to the six months ended June 30, 2004. The increase ininstallation revenue in the second quarter of 2005 compared to the secondquarter of 2004 was mainly the result of increased sales and installations inthe data product lines. Data revenue increased by $1,639,000 in the secondquarter of 2005 compared to the second quarter of 2004, which was primarily theresult of a large contract with a college campus in Minnesota. Service revenuewas $56,000 or 2.7% lower in the second quarter of 2005 compared to the secondquarter of 2004. The decrease in service revenue was primarily a result of adecrease in sales maintenance work on customer systems. The increase ininstallation revenue in the six months ended June 30, 2005 compared to thesix months ended June 30, 2004 was mainly the result of increased salesand installations Private Branch Exchange (PBX) Systems of $253,000, anincrease in Small Business Systems (SBS) installations of $309,000 and an increasein the data product lines of $1,960,000. Service revenue was $190,000 or 5.1%higher in the six months ended June 30, 2005 compared to the six monthsended June 30, 2004. The increase in service revenue was a result of anincrease in Move, Add and Change (MAC) contracts offset by a decrease in salesof Maintenance Contracts.

 

Cost of Sales:

Cost of sales increased $1,476,000 or 64.3% in the second quarter of2005 compared to the second quarter of 2004. Gross profit margin was 25.6% inthe second quarter of 2005 compared to 31.2% in the second quarter of 2004.Cost of sales increased $2,235,000 or 58.7% in the six months ended June 30,2005 compared to the six months ended June 30, 2004. Gross profit marginwas 27.6% in the six months ended June 30, 2005 compared to 32.5% in thesix months ended June 30, 2004.The increase in cost of sales in the threeand six months ended June 30, 2005 compared to the three and six monthsended June 30, 2004 corresponds with the increase in sales in bothperiods, while the decrease in gross profit margin in both periods is largelythe result of the increase in lower margin installations of large complexsystems. The margin in this sector is primarily affected by the mix of variousproducts and services sold.

 

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Cost of Services, excluding Depreciation andAmortization:

Cost of services excluding depreciation and amortization increased$136,000 or 42.9% in the second quarter 2005 compared to the second quarter2004. Cost of services excluding depreciation and amortization increased$186,000 or 29% in the six months ended June 30, 2005 compared to the sixmonths ended June 30, 2004. The increase in both the three and six monthsended is mainly the result of an increase in the inventory valuation reserve.Due to the surplus of supplier inventory in the market and resultant decline inproduct prices in this line of business over recent quarters, the Company ismaking systematic inventory valuation adjustments. The Company cannot predictthe impact or timing, if any, of future inventory valuation changes.

 

Operating and Net Loss:

Operating income increased $184,000 in the second quarter 2005 comparedto the second quarter 2004. Net income increased $109,000 in the second quarter2005 compared to the second quarter 2004. The change between the second quarter2005 income compared to the second quarter 2004 loss resulted primarily fromthe increase in operating revenues described above, partially offset by theincrease in cost of products sold. Operating loss decreased $362,000 in the sixmonths ended June 30, 2005 compared to the six months ended June 30,2004. Net loss decreased $215,000 in the six months ended June 30, 2005compared to the six months ended June 30, 2004. The change between the sixmonths ended June 30, 2005 loss compared to the six months ended June 30,2004 loss resulted primarily from the increase in operating revenues describedabove, partially offset by the increase in cost of sales.

 

LIQUIDITY AND CAPITAL RESOURCES

 

CASH FLOWS – Cashprovided by operations was $14,039,000 in the first six months of 2005 comparedto $17,187,000 in the first six months of 2004. Cash flows from operations inthe first six months of 2005 were primarily attributable to net income plus non-cashexpenses for depreciation and amortization as well as a decrease inreceivables. Cash flows from operations in the first six months of 2004 wereprimarily attributable to net income plus non-cash expenses for depreciationand amortization and a decrease in receivables.

 

Cash flows provided by investing activities were $2,503,000 in thefirst six months of 2005 compared to $3,593,000 for the same period in 2004.Capital expenditures were $4,628,000 during the first six months of 2005 ascompared to $6,240,000 for the same period in 2004. 2005 capital expenditureswere incurred primarily to provide additional network facilities in the TelecomSector. Management expects capital expenditures in the remainder of 2005 to beapproximately $19,000,000. Pursuant to conditions of its debt agreement, whichallows the Company to reduce its investment in one of its lenders by an amountequal to 10% of the annual principal payments of the term loan component of itsdebt, the Company received a refund of its investment in the amount of$2,100,000 in the first six months of 2005 and $2,600,000 in the first sixmonths of 2004.

 

Cash flows used in financing activities were $10,790,000 for the firstsix months of 2005 compared to $13,639,000 for the first six months of 2004.Included in cash flows used in financing activities are debt repayments anddividend payments. HickoryTech made payments on its revolving credit facilityof $9,500,000 during the first six months of 2005, and $12,000,000 during thefirst six months of 2004. HickoryTech borrowed $3,500,000 on its revolvingcredit facility during the first six months of 2005, and $1,500,000 during thefirst six months of 2004. Dividend payments for the first six months of 2005were $3,135,000 compared to $2,853,000 for the same period in 2004.

 

WORKING CAPITAL –Working capital (i.e. current assets minus current liabilities) was $3,433,000as of June 30, 2005, compared to working capital of $787,000 as of December 31,2004. The ratio of current assets to current liabilities was 1.2 to 1.0 as of June 30,2005 and 1.0 to 1.0 as of December 31, 2004.

 

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LONG-TERM OBLIGATIONS- HickoryTech’s long-term obligations as of June 30, 2005 were$92,804,000, excluding current maturities of $4,424,000. As of June 30,2005, HickoryTech had a $113,625,000 credit facility with a syndicate of banks.The credit facility is collateralized by certain property, plant and equipmentand contains covenants relating to cash flow and capitalization. As of June 30,2005, there were no covenant violations. The credit facility is comprised of a$103,125,000 revolving credit component and a $10,500,000 term loan component.The available line of credit on the $103,125,000 revolving credit componentbegan decreasing in increments in March 2004, and has a final maturitydate in September 2007, pursuant to the Fifth Amendment to the creditfacility, which was effective June 23, 2005. Because not all of theavailable revolving credit has been utilized as of June 30, 2005, thepayment schedule is as follows pursuant to the Fifth Amendment to thecredit facility effective June 23, 2005: 2006 - $9,000,000, and 2007 -$77,000,000. The term loan component requires equal quarterly principalpayments of $250,000 during the period of March 2001 to December 2008,and $7,000,000 in the first quarter of 2009. The weighted average interest rateassociated with this credit facility varies with LIBOR and certain other rates.The weighted average interest rate was 4.7% at June 30, 2005 and 4.1% at June 30,2004. HickoryTech has utilized interest rate swap agreements to implement fixedinterest terms on various portions of the overall debt outstanding. The currentagreements result in fixed interest terms on $70,000,000 of the outstandingdebt until June 2008. As of June 30, 2005, HickoryTech had drawn$96,500,000 on this credit facility and had $17,125,000 of available credit.The Fifth Amendment to the credit facility dated June 23, 2005 alsoestablished accessibility for HickoryTech to $25,000,000 in incremental termloans in addition to the revolver and term loan credit facility. Managementbelieves the remaining available credit is sufficient to cover future cashrequirements.

 

HickoryTech’s Information Solutions Sector leases certain computerequipment under capital lease arrangements. During the six months ended June 30,2005 and 2004, this sector recorded additions to property, plant and equipmentof $547,000 and $81,000, respectively, related to these capital lease arrangements.

 

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

 

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

 

CRITICAL ACCOUNTING POLICIES

 

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

 

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RECENT ACCOUNTING DEVELOPMENTS

 

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

 

ITEM 3. QUANTATIVE AND QUALITATIVEDISCLOSURES ABOUT MARKET RISK

 

HickoryTech does not have operations subject to risks of foreigncurrency fluctuations. HickoryTech does, however, use derivative financialinstruments to manage exposure to interest rate fluctuations. HickoryTech’sobjectives for holding derivatives are to minimize interest rate risks usingthe most effective methods to eliminate or reduce the impact of theseexposures. Variable rate debt instruments are subject to interest rate risk.HickoryTech has entered into interest rate swap agreements with remainingmaturities of thirty-six months to manage its exposure to interest ratemovements on a portion of its variable rate debt obligations. The effectiveportion of the cumulative gain or loss on these derivative instruments isreported as a component of accumulated other comprehensive income/loss inshareholders’ equity and is recognized in earnings when the term of the swapagreement is concluded. HickoryTech’s earnings are affected by changes ininterest rates as a portion of its long-term debt has variable interest ratesbased on LIBOR. If interest rates for the portion of HickoryTech’s long-termdebt based on variable rates had averaged 10% more for the quarter ended June 30,2005, HickoryTech’s interest expense would have increased $29,000. If interestrates for the portion of HickoryTech’s long-term debt based on variable rateshad averaged 10% more for the six months ended June 30, 2005, HickoryTech’sinterest expense would have increased $55,000.

 

ITEM 4.     CONTROLS AND PROCEDURES

 

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

 

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

 

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PART II. OTHER INFORMATION

 

Item 1.   Legal Proceedings.

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

 

Item 2.   Unregistered Salesof Equity Securities and Use of Proceeds.

None.

 

Item 3.   Defaults Upon SeniorSecurities.

None.

 

Item 4.   Submission ofMatters to a Vote of Security Holders.

 

a.               The annualshareholders’ meeting was held on May 9, 2005.

b.              Four directors wereelected to serve three-year terms. The names of the directors elected at theannual meeting and the applicable votes were as follows:

 
| ** **                 | ** ** | ** ** | ** ** | ** **   | ** ** | **Broker**   | ** ** |
|----------------------------|------------|------------|------------|--------------|------------|--------------|------------|
| **Director**               | ** ** | **For**    | ** ** | **Withheld** | ** ** | **Nonvotes** | ** ** |
|                       |       |       |       |         |       |         |       |
| Robert D.  Alton, Jr. |       | 10,031,078 |       | 621,318      |       | None         |       |
| R. Wynn  Kearney, Jr. |       | 10,474,950 |       | 177,446      |       | None         |       |
| Robert E.  Switz           |       | 10,477,396 |       | 175,000      |       | None         |       |
| James W.  Bracke           |       | 10,499,622 |       | 152,774      |       | None         |       |

 

The following directors’ terms shall continueafter the meeting:

 

Lyle T. Bosacker

Myrita P. Craig

John E. Duffy

James H. Holdrege

Lyle G. Jacobson

Starr J. Kirklin

 

c.               The HickoryTechCorporation 2005 Directors’ Incentive Plan, which authorizes 200,000 shares forissuance pursuant to grants made under the Plan, was approved.  The votes were as follows:

 
| For              |   | 6,407,493 |   |
|------------------|--------|-----------|--------|
| Against          |   | 876,063   |   |
| Abstain          |   | 286,276   |   |
| Broker  Nonvotes |   | 3,082,564 |   |

 

Item 5.   Other Information.

None.

 

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Item 6.             Exhibits.

 

Exhibit 3(a) Restated Articles ofIncorporation (Incorporated by reference to Exhibit 3 to the registrant’s Form 10-Qdated May 6, 1999)

 

Exhibit 3(b) Amended and RestatedBy-Laws (Incorporated by reference to Exhibit 3(b) to the registrant’sForm 8-K filed February 22, 2005)

 

Exhibit 3(c) Certificate ofDesignations of Series A Junior Participating Preferred Stock of HickoryTech Corporation (Incorporated by reference to Exhibit 3(c) to theregistrant’s Form 10-K dated March 29, 2000)

 

Exhibit 4(a) Shareholder RightsAgreement (Incorporated by reference to Exhibit 1 to the registrant’s Form 8-Adated March 9, 1999)

 

Exhibit 4(b) Second Amended andRestated Credit Agreement dated as of September 21, 2000, by and amongHickory Tech Corporation, as Borrower, the Lenders referred to herein and FirstUnion National Bank, as Administrative Agent (Incorporated by reference to Exhibit 4to the registrant’s Form 10-Q dated November 10, 2000)

 

Exhibit 10(s) HickoryTech Corporation2005 Directors’ Incentive Plan (Incorporated by reference to the registrant’s Form 8-Kfiled May 12, 2005)

 

Exhibit 31(a)* Certification pursuant toRule 13a-14(a) under the Exchange Act, as adopted pursuant to Section 302of the Sarbanes-Oxley Act of 2002

 

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

 

Exhibit 32(a)* Certification pursuant to18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-OxleyAct of 2002

 

Exhibit 32(b)* Certification pursuant to18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-OxleyAct of 2002

 

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*Filed herewith

 

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SIGNATURES

 

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

 
| Dated: | August 4, 2005 |                                           | HICKORY TECH CORPORATION |
|--------|---------------------|------------------------------------------------|--------------------------|
|   |                |
|   |                |
|   | By:                 | /s/ John E. Duffy                              |                     |
|   |                | John E. Duffy, Chief Executive Officer         |
|   |                |
|   | By:                 | /s/ David A. Christensen                       |                     |
|   |                | David A. Christensen, Chief Financial  Officer |
|        |                     |                                                |                          |  |  |  |

 

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