**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, DC 20549**

 

**FORM 10-Q**

 
| (Mark One) |                                                                                          |
|------------|-----------------------------------------------------------------------------------------------|
| **x**      | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF  THE SECURITIES EXCHANGE ACT OF 1934**  |
|       |                                                                                          |
|       | **For the quarterly  period ended September 30, 2006**                                        |
|       | **OR**                                                                                        |
| **o**      | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |

 

**For the transition periodfrom              to              .**

 

**Commission file number 0-13721**

 

**HICKORY TECH CORPORATION**

(Exact name of registrant as specified in its charter)

 

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

 

**221 East Hickory Street**

**Mankato, Minnesota56002-3248**

(Address of principal executive offices and zip code)

 

**(800) 326-5789**

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the Registrant (1) hasfiled all reports 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 x   No o

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer, or a non-accelerated filer. Seedefinition of “accelerated filer and large accelerated filer” in Rule 12b-2 ofthe Exchange Act. (Check one):

| Large accelerated  filer o |   | Accelerated  filer x |   | Non-accelerated  filer o. |
|---------------------------------|--------|---------------------------|--------|--------------------------------|

 

Indicate by check mark whether the registrant is ashell company (as defined in Rule 12b-2 of the Exchange Act).     Yes o   No x

Thetotal number of shares of the registrant's common stock outstanding as ofNovember 1, 2006: 13,192,745.

 

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**TABLE OF CONTENTS**

**PART I. FinancialInformation**
| Description | ** ** | ** **                                                                                                                 | ** ** | **Page** |
|-------------|------------|----------------------------------------------------------------------------------------------------------------------------|------------|----------|
|        |       |                                                                                                                       |       |     |
| Item 1.     |       | Financial Statements:                                                                                                      |       |     |
|        |       |                                                                                                                       |       |     |
|        |       | Consolidated  Statements of Operations (unaudited) for the Three Months and Nine Months  Ended September 30, 2006 and 2005 |       | 3        |
|        |       |                                                                                                                       |       |     |
|        |       | Consolidated  Balance Sheets (unaudited) as of September 30, 2006 and December 31, 2005                                    |       | 4        |
|        |       |                                                                                                                       |       |     |
|        |       | Consolidated  Statements of Cash Flows (unaudited) for the Nine Months Ended September 30,  2006 and 2005                  |       | 5        |
|        |       |                                                                                                                       |       |     |
|        |       | Condensed Notes to Consolidated Financial Statements  (unaudited)                                                          |       | 6 - 17   |
|        |       |                                                                                                                       |       |     |
| Item 2.     |       | Management’s  Discussion and Analysis of Results of Operations and Financial Condition                                |       | 17 - 40  |
|        |       |                                                                                                                       |       |     |
| Item 3.     |       | Quantitative  and Qualitative Disclosures About Market Risk                                                                |       | 40       |
|        |       |                                                                                                                       |       |     |
| Item 4.     |       | Controls and  Procedures                                                                                                   |       | 40 - 41  |

 

**PARTII. Other Information**
| Description | ** ** | ** **                                                   | ** ** | **Page** |
|-------------|------------|--------------------------------------------------------------|------------|----------|
|        |       |                                                         |       |     |
| Item 1.     |       | Legal Proceedings                                            |       | 41       |
|        |       |                                                         |       |     |
| Item  1A.   |       | Risk  Factors                                                |       | 41 - 42  |
|        |       |                                                         |       |     |
| Item 2.     |       | Unregistered  Sales of Equity Securities and Use of Proceeds |       | 42       |
|        |       |                                                         |       |     |
| Item 3.     |       | Defaults Upon  Senior Securities                             |       | 42       |
|        |       |                                                         |       |     |
| Item 4.     |       | Submission of  Matters to a Vote of Security Holders         |       | 42       |
|        |       |                                                         |       |     |
| Item 5.     |       | Other Information                                            |       | 42       |
|        |       |                                                         |       |     |
| Item  6.    |       | Exhibit  Listing                                             |       | 43       |
|        |       |                                                         |       |     |
|        |       | Signatures                                                   |       | 44       |
|        |       |                                                         |       |     |
|        |       | Exhibits                                                     |       |     |

 

2

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**HICKORY TECHCORPORATION**ConsolidatedStatements of Operations(Unaudited)
| ***(In Thousands Except Share and Per Share Amounts)*** | ** ** | **Three Months Ended  September 30** | ** ** | **Nine Months Ended  September 30** | ** ** |
|--------------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                                                                 | ** ** | **2006**                                            | ** ** | **2005**                                           | ** ** | **2006** | ** ** | **2005** | ** ** |
| Operating revenues:                                                                        |       |                                                |       |                                               |       |   |   |   |   |
| Telecom Sector                                                                             | ** ** | **$**                                               | **18,216** |                                               | $          | 18,383 | ** ** | **$** | **54,559** |   | $ | 57,014 |   |
| Information  Solutions Sector                                                              | ** ** | **482**                                             |       | 519                                                | ** ** | **1,705** |   | 1,921 |   |
| Enterprise  Solutions Sector                                                               | ** ** | **3,285**                                           |       | 3,402                                              | ** ** | **8,567** |   | 11,745 |   |
| Enventis Sector                                                                            | ** ** | **13,972**                                          |       | —                                             | ** ** | **43,234** |   | — |   |
| Total operating  revenues                                                                  | ** ** | **35,955**                                          |       | 22,304                                             | ** ** | **108,065** |   | 70,680 |   |
| Costs and expenses:                                                                        |       |                                                |       |                                               |       |   |   |   |   |
| Cost of sales,  Enterprise Solutions and Enventis                                          | ** ** | **9,493**                                           |       | 2,139                                              | ** ** | **28,990** |   | 7,844 |   |
| Cost of services  (excluding depreciation and amortization)                                | ** ** | **11,535**                                          |       | 8,354                                              | ** ** | **33,709** |   | 24,696 |   |
| Selling, general  and administrative expenses (excluding depreciation and amortization)    | ** ** | **6,452**                                           |       | 3,575                                              | ** ** | **19,968** |   | 12,024 |   |
| Depreciation                                                                               | ** ** | **4,260**                                           |       | 3,544                                              | ** ** | **12,569** |   | 11,588 |   |
| Amortization of  intangibles                                                               | ** ** | **293**                                             |       | 26                                                 | ** ** | **879** |   | 467 |   |
| Total costs and  expenses                                                                  | ** ** | **32,033**                                          |       | 17,638                                             | ** ** | **96,115** |   | 56,619 |   |
| Operating income                                                                           | ** ** | **3,922**                                           |       | 4,666                                              | ** ** | **11,950** |   | 14,061 |   |
| Other income/(expense):                                                                    |       |                                                |       |                                               |       |   |   |   |   |
| Interest and  other income                                                                 | ** ** | **40**                                              |       | 35                                                 | ** ** | **109** |   | 75 |   |
| Interest expense                                                                           | ** ** | **(1,913)**                                         |       | (1,124)                                            | ** ** | **(5,393)** |   | (3,128) |   |
| Total other  income/(expense)                                                              | ** ** | **(1,873)**                                         |       | (1,089)                                            | ** ** | **(5,284)** |   | (3,053) |   |
|                                                                                       |       |                                                |       |                                               |       |   |   |   |   |
| Income before income  taxes                                                                | ** ** | **2,049**                                           |       | 3,577                                              | ** ** | **6,666** |   | 11,008 |   |
| Income tax provision                                                                       | ** ** | **604**                                             |       | 1,447                                              | ** ** | **2,458** |   | 4,453 |   |
| Income from continuing  operations                                                         | ** ** | **1,445**                                           |       | 2,130                                              | ** ** | **4,208** |   | 6,555 |   |
| Discontinued  operations:                                                                  |       |                                                |       |                                               |       |   |   |   |   |
| Income from  operations of discontinued component                                          | ** ** | **—**                                          |       | 37                                                 | ** ** | **—** |   | 207 |   |
| Income tax  provision benefit                                                              | ** ** | **—**                                          |       | 15                                                 | ** ** | **—** |   | 84 |   |
| Income from  discontinued operations                                                       | ** ** | **—**                                          |       | 22                                                 | ** ** | **—** |   | 123 |   |
| Net income                                                                                 | ** ** | **$**                                               | **1,445**  |                                               | $          | 2,152 | ** ** | **$** | **4,208** |   | $ | 6,678 |   |
|                                                                                       |       |                                                |       |                                               |       |   |   |   |   |
| Basic earnings per  share—continuing operations                                       | ** ** | **$**                                               | **0.11**   |                                               | $          | 0.16 | ** ** | **$** | **0.32** |   | $ | 0.50 |   |
| Basic earnings per  share—discontinued operations                                     | ** ** | **—**                                          |       | —                                             | ** ** | **—** |   | 0.01 |   |
|                                                                                       | ** ** | **$**                                               | **0.11**   |                                               | $          | 0.16 | ** ** | **$** | **0.32** |   | $ | 0.51 |   |
| Dividends per share                                                                        | ** ** | **$**                                               | **0.12**   |                                               | $          | 0.12 | ** ** | **$** | **0.36** |   | $ | 0.36 |   |
| Basic weighted average  common shares outstanding                                          | ** ** | **13,172**                                          |       | 13,086                                             | ** ** | **13,152** |   | 13,073 |   |
|                                                                                       |       |                                                |       |                                               |       |   |   |   |   |
| Diluted earnings per  share—continuing operations                                     | ** ** | **$**                                               | **0.11**   |                                               | $          | 0.16 | ** ** | **$** | **0.32** |   | $ | 0.50 |   |
| Diluted earnings per  share—discontinued operations                                   | ** ** | **—**                                          |       | —                                             | ** ** | **—** |   | 0.01 |   |
|                                                                                       | ** ** | **$**                                               | **0.11**   | ** **                                         | **$**      | **0.16** | ** ** | **$** | **0.32** |   | $ | 0.51 |   |
| Diluted weighted average common and potential common shares  outstanding                   | ** ** | **13,172**                                          |       | 13,092                                             | ** ** | **13,155** |   | 13,084 |   |

 

The accompanying notes are an integral part of theconsolidated financial statements.

3

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**HICKORY TECHCORPORATIONConsolidated Balance Sheets(Unaudited)**
| ***(In Thousands Except Share and Per Share Amounts)*** | ** ** | **September 30,  2006** | ** **  | **December 31,  2005** | ** ** |
|--------------------------------------------------------------------------------------------|------------|------------------------------|-------------|-----------------------------|------------|
| ASSETS                                                                                     |       |                         |        |                        |       |
| Current assets:                                                                            |       |                         |        |                        |       |
| Cash and cash  equivalents                                                                 | ** ** | **$**                        | **1,119**   |                        | $          | 601 |   |
| Receivables, net  of allowance for doubtful accounts of $417 and $334                      | ** ** | **23,084**                   |        | 19,867                      |       |
| Costs in excess  of billings on contracts                                                  | ** ** | **597**                      |        | 462                         |       |
| Inventories                                                                                | ** ** | **9,611**                    |        | 4,577                       |       |
| Deferred income  taxes                                                                     | ** ** | **300**                      |        | 300                         |       |
| Prepaid expenses                                                                           | ** ** | **1,537**                    |        | 5,066                       |       |
| Other                                                                                      | ** ** | **1,406**                    |        | 1,155                       |       |
| Total current  assets                                                                      | ** ** | **37,654**                   |        | 32,028                      |       |
|                                                                                       |       |                         |        |                        |       |
| Investments                                                                                | ** ** | **3,554**                    |        | 3,407                       |       |
|                                                                                       |       |                         |        |                        |       |
| Property, plant and  equipment                                                             | ** ** | **306,785**                  |        | 290,499                     |       |
| Less accumulated  depreciation                                                             | ** ** | **153,722**                  |        | 141,157                     |       |
| Property, plant  and equipment, net                                                        | ** ** | **153,063**                  |        | 149,342                     |       |
|                                                                                       |       |                         |        |                        |       |
| Other assets:                                                                              |       |                         |        |                        |       |
| Goodwill                                                                                   | ** ** | **27,576**                   |        | 27,109                      |       |
| Intangible  assets, net                                                                    | ** ** | **3,432**                    |        | 4,312                       |       |
| Financial  derivative instruments                                                          | ** ** | **2,785**                    |        | 3,429                       |       |
| Deferred costs  and other                                                                  | ** ** | **3,188**                    |        | 3,640                       |       |
| Total other  assets                                                                        | ** ** | **36,981**                   |        | 38,490                      |       |
|                                                                                       |       |                         |        |                        |       |
| Total assets                                                                               | ** ** | **$**                        | **231,252** |                        | $          | 223,267 |   |
|                                                                                       |       |                         |        |                        |       |
| LIABILITIES AND  SHAREHOLDERS' EQUITY                                                      |       |                         |        |                        |       |
| Current liabilities:                                                                       |       |                         |        |                        |       |
| Cash overdraft                                                                             | ** ** | **$**                        | **—**  |                        | $          | 514 |   |
| Short-term  financing (Note 12)                                                            | ** ** | **5,734**                    |        | —                      |       |
| Accounts payable                                                                           | ** ** | **5,898**                    |        | 5,224                       |       |
| Accrued expenses                                                                           | ** ** | **5,845**                    |        | 6,809                       |       |
| Accrued interest                                                                           | ** ** | **414**                      |        | —                      |       |
| Accrued income  taxes                                                                      | ** ** | **5,769**                    |        | 4,765                       |       |
| Billings in  excess of costs on contracts                                                  | ** ** | **425**                      |        | 283                         |       |
| Advanced  billings and deposits                                                            | ** ** | **3,812**                    |        | 4,577                       |       |
| Current  maturities of long-term obligations                                               | ** ** | **1,639**                    |        | 1,778                       |       |
| Total current  liabilities:                                                                | ** ** | **29,536**                   |        | 23,950                      |       |
|                                                                                       |       |                         |        |                        |       |
| Long-term obligations,  net of current maturities                                          | ** ** | **141,898**                  |        | 140,980                     |       |
|                                                                                       |       |                         |        |                        |       |
| Deferred income taxes                                                                      | ** ** | **15,238**                   |        | 15,346                      |       |
|                                                                                       |       |                         |        |                        |       |
| Deferred revenue                                                                           | ** ** | **3,211**                    |        | 1,948                       |       |
| Accrued employee  benefits and deferred compensation                                       | ** ** | **6,644**                    |        | 6,034                       |       |
|                                                                                       |       |                         |        |                        |       |
| Total  liabilities                                                                         | ** ** | **196,527**                  |        | 188,258                     |       |
|                                                                                       |       |                         |        |                        |       |
| Commitments and  contingencies (Note 8)                                                    | ** ** | **—**                   |        | —                      |       |
|                                                                                       |       |                         |        |                        |       |
| Shareholders' equity:                                                                      |       |                         |        |                        |       |
| Common stock, no  par value, $.10 stated value                                             |       |                         |        |                        |       |
| shares  authorized: 100,000,000                                                            |       |                         |        |                        |       |
| shares  outstanding: 13,192,745 in 2006 and 13,124,928 in 2005                             | ** ** | **1,319**                    |        | 1,312                       |       |
| Additional  paid-in capital                                                                | ** ** | **9,883**                    |        | 9,262                       |       |
| Retained  earnings                                                                         | ** ** | **21,847**                   |        | 22,371                      |       |
| Accumulated  other comprehensive income                                                    | ** ** | **1,676**                    |        | 2,064                       |       |
| Total  shareholders' equity                                                                | ** ** | **34,725**                   |        | 35,009                      |       |
|                                                                                       |       |                         |        |                        |       |
| Total liabilities and shareholders' equity                                                 | ** ** | **$**                        | **231,252** |                        | $          | 223,267 |   |

 

The accompanying notes are an integral part of theconsolidated financial statements.

4

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**HICKORY TECHCORPORATION**ConsolidatedStatements of Cash Flows(Unaudited)
| ** **                                                  | ** ** | **Nine Months Ended  September 30** | ** ** |
|-------------------------------------------------------------|------------|----------------------------------------------------|------------|
| ***(Dollars In Thousands)***                      | ** ** | **2006**                                           | ** ** | **2005** | ** ** |
| Cash flows from  operating activities:                      | ** ** | ** **                                         |       |   |   |
| Net income                                                  | ** ** | **$**                                              | **4,208**  |   | $ | 6,678 |   |
| Adjustments to  reconcile net income to net                 | ** ** | ** **                                         |       |   |   |
| Cash provided by  operating activities:                     | ** ** | ** **                                         |       |   |   |
| Depreciation and  amortization                              | ** ** | **13,448**                                         |       | 12,055 |   |
| Gain on sale of  assets                                     | ** ** | **—**                                         |       | 12 |   |
| Stock-based  compensation                                   | ** ** | **158**                                            |       | 67 |   |
| Employee  retirement benefits and deferred compensation     | ** ** | **610**                                            |       | 462 |   |
| Accrued patronage  refunds                                  | ** ** | **(796)**                                          |       | (287) |   |
| Provision for  losses on accounts receivable                | ** ** | **425**                                            |       | 215 |   |
| Deferred income  taxes                                      | ** ** | **148**                                            |       | — |   |
| Changes in  operating assets and liabilities:               | ** ** | ** **                                         |       |   |   |
| Receivables                                                 | ** ** | **(2,637)**                                        |       | 4,741 |   |
| Inventories                                                 | ** ** | **(5,033)**                                        |       | 81 |   |
| Billings and  costs on contracts                            | ** ** | **7**                                              |       | (235) |   |
| Accounts payable  and accrued expenses                      | ** ** | **124**                                            |       | (1,283) |   |
| Advance billings  and deposits                              | ** ** | **(764)**                                          |       | (420) |   |
| Deferred revenue                                            | ** ** | **1,305**                                          |       | (82) |   |
| Prepaid assets                                              | ** ** | **3,529**                                          |       | (422) |   |
| Other                                                       | ** ** | **828**                                            |       | 776 |   |
| Net cash  provided by/(used in) operating activities        | ** ** | **15,560**                                         |       | 22,358 |   |
|                                                        | ** ** | ** **                                         |       |   |   |
| Cash flows from  investing activities:                      | ** ** | ** **                                         |       |   |   |
| Additions to  property, plant and equipment                 | ** ** | **(16,802)**                                       |       | (10,136) |   |
| Acquisitions,  adjustments to purchase price and allocation | ** ** | **125**                                            |       | — |   |
| Redemption of  investments                                  | ** ** | **21**                                             |       | 2,100 |   |
| Proceeds from  sale of assets                               | ** ** | **40**                                             |       | 46 |   |
| Net cash  provided by/(used in) investing activities        | ** ** | **(16,616)**                                       |       | (7,990) |   |
|                                                        | ** ** | ** **                                         |       |   |   |
| Cash flows from  financing activities:                      | ** ** | ** **                                         |       |   |   |
| Short-term  financing                                       | ** ** | **5,734**                                          |       | — |   |
| Change in cash  overdraft                                   | ** ** | **(514)**                                          |       | (1,680) |   |
| Payments of  capital lease obligations                      | ** ** | **(374)**                                          |       | (414) |   |
| Repayments on  credit facility                              | ** ** | **(19,510)**                                       |       | (12,750) |   |
| Borrowings on  credit facility                              | ** ** | **20,500**                                         |       | 5,000 |   |
| Proceeds from  issuance of common stock                     | ** ** | **470**                                            |       | 469 |   |
| Dividends paid                                              | ** ** | **(4,732)**                                        |       | (4,704) |   |
| Net cash  provided by/(used in) financing activities        | ** ** | **1,574**                                          |       | (14,079) |   |
|                                                        | ** ** | ** **                                         |       |   |   |
| Net increase in cash  and cash equivalents                  | ** ** | **518**                                            |       | 289 |   |
|                                                        | ** ** | ** **                                         |       |   |   |
| Cash and cash  equivalents at beginning of period           | ** ** | **601**                                            |       | 257 |   |
|                                                        | ** ** | ** **                                         |       |   |   |
| Cash and cash  equivalents at end of period                 | ** ** | **$**                                              | **1,119**  |   | $ | 546 |   |
|                                                        | ** ** | ** **                                         |       |   |   |
| Supplemental disclosure  of cash flow information:          | ** ** | ** **                                         |       |   |   |
| Cash paid for  interest                                     | ** ** | **$**                                              | **5,646**  |   | $ | 3,259 |   |
| Net cash  paid/(received) for income taxes                  | ** ** | **$**                                              | **1,290**  |   | $ | (332) |   |
| Non-cash investing  activities:                             | ** ** | ** **                                         |       |   |   |
| Property, plant and  equipment acquired with capital leases | ** ** | **$**                                              | **162**    |   | $ | 666 |   |

 

The accompanying notes are an integral part of theconsolidated financial statements.

5

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**HICKORY TECHCORPORATIONSEPTEMBER 30, 2006PART 1. FINANCIAL INFORMATION**

**ITEM1.**                    NOTESTO CONSOLIDATED FINANCIAL STATEMENTS

*NOTE 1. BASIS OF PRESENTATION*

The accompanying unaudited condensed consolidatedfinancial statements have been prepared in accordance with generally acceptedaccounting principles (GAAP) for interim financial information and with theinstructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, theydo not include all of the information necessary for a fair statement of resultsof operations, financial position, and cash flows in conformity with accountingprinciples generally accepted in the United States. In the opinion ofmanagement, the unaudited condensed consolidated financial statements reflectall adjustments (consisting only of normal recurring adjustments) considerednecessary for a fair statement of Hickory Tech Corporation’s (HickoryTech orthe Company) results for the periods presented. Operating results for interimperiods are not necessarily indicative of results that may be expected for thefiscal year as a whole. The preparation of financial statements in conformitywith accounting principles generally accepted in the United States requiresmanagement to make estimates and assumptions that affect the reported amountsof assets, liabilities, revenues, expenses, and related disclosures at the dateof the financial statements and during the reporting period. Actual resultscould 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, 2005.

The condensed consolidated financial statements ofHickoryTech include Hickory Tech Corporation and its subsidiaries in thefollowing four business segments: (i) Telecom Sector, (ii) InformationSolutions Sector, (iii) Enterprise Solutions Sector and (iv) Enventis Sector.All inter-company transactions have been eliminated from the consolidatedfinancial statements.

*Cost of Sales*

Cost of sales for the Enventis and EnterpriseSolutions Sectors includes the material and labor costs associated with theinstallation of products for customers.

*Cost of Services:*

Cost of services includes all costs related to thedelivery of communication services for all HickoryTech sectors. Those operatingcosts include engineering, customer service, billing and collections, networkmonitoring and transport costs.

*Selling, General and AdministrativeExpenses*

Selling, general and administrative expenses includedirect and indirect selling expenses, advertising, and all other general andadministrative costs associated with the operations of the business.

On December 30, 2005, HickoryTech purchased EnventisTelecom, Inc. (Enventis) from ALLETE, Inc. Enventis is a transport andenterprise Internet Protocol telephony equipment sales business whichspecializes in providing telecommunications and network solutions. In additionto its statewide SONET-based network, Enventis provides innovative InternetProtocol services that combine voice and data onto a single platform. Since1997, Enventis has provided network solutions for a broad spectrum of largecorporate, non-profit, government, and small business clients and has providednetwork capacity for other interexchange carriers on a wholesale basis. In2001, Enventis added the distribution of Cisco Internet Protocol equipment toend-users as another service. Enventis has offices located in Duluth, Plymouthand Rochester, Minnesota and Sioux Falls, South Dakota.

*Reclassifications*

Certain reclassifications of prior period data havebeen made to conform to the current period’s presentation.

6

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The most significant of these reclassifications is toreclassify approximately $1.6 million of transport costs for each of the prior twoquarters from cost of sales to cost of services. This reclassification resultsin reporting these costs for the Enventis Sector in a manner consistent withthe rest of the organization.

A similar reclassification was made to reclassifyselling commissions within the Enterprise Solutions Sector, previously includedin cost of sales, to selling, general and administrative expenses (excludingdepreciation and amortization). The amounts reclassified in EnterpriseSolutions were approximately $503,000 and $420,000 for the years endedDecember 31, 2005 and 2004 respectively, and $76,000 and $118,000 for thefirst and second quarters, respectively, of 2006. Reclassified amounts forthe three months and nine months ending September 30, 2005 wereapproximately $80,000 and $415,000, respectively. This reclassification resultsin reporting these costs for the Enterprise Solutions Sector in a mannerconsistent with the rest of the organization.

These reclassifications did not affect cash flows,financial position, or net income.

*Recently IssuedAccounting Pronouncements*

In July 2006, the Financial Accounting Standards Board(FASB) issued FASB Interpretation (FIN) No. 48, “Accounting forUncertainty in Income Taxes-an interpretation of FASB Statement No. 109.”Fin No. 48 provides guidance for recognizing and measuring uncertain taxpositions, as defined in Statement of Financial Accounting Standards (SFAS)No. 109, “Accounting for Income Taxes.” FIN No. 48 prescribes athreshold condition that a tax position must meet for any of the benefit of theuncertain tax position to be recognized in the financial statements. Guidanceis also provided regarding de-recognition, classification and disclosure ofthese uncertain tax positions. FIN No. 48 is effective for fiscal years beginningafter December 15, 2006. The Company does not expect that Fin No. 48 willhave a material impact on its financial position, results of operations, orcash flows.

On September 29, 2006, the FASB issued SFAS No. 158,“Employers’ Accounting for Defined Benefit Pension and Other PostretirementPlans – an amendment of FASB Statements No. 87, 88, 106 and 132(R).” SFAS No.158 requires employers to recognize in their balance sheet the over-funded orunder-funded status of defined benefit post-retirement plans, measured as thedifference between the fair value of plan assets and the benefit obligation(the projected benefit obligation for pension plans and the accumulatedpostretirement plans). Employers must also recognize the change in the fundedstatus of the plan in the year in which the change occurs through comprehensiveincome. SFAS No. 158 also requires plan assets and obligations to be measuredas of the employer’s balance sheet date. The recognition provisions of SFAS No.158 are effective for fiscal years ending after December 15, 2006. Themeasurement date provision of SFAS No. 158 will be effective for fiscal yearsbeginning after December 15, 2008. The company currently complies with themeasurement date provision. The Company estimates the impact of SFAS No. 158 onthe Company’s December 31, 2006 consolidated financial statements to be asfollows based on the most recent actuarial measurements of plan assets andobligations dated December 31, 2005. (*Dollars in thousands*)

 
| ** **                                                      | ** ** | ** ** | ** ** |
|-----------------------------------------------------------------|------------|------------|------------|
| Impact to Assets:                                               |       | $          | —     |   |
| Impact to  Liabilities:                                         |       | $          | 2,664      |   |
| Impact to  Shareholders' Equity: *(Shown gross of tax  effect)* |       | $          | (2,664     | ) |

 

The financial statement effects of complying with SFASNo. 158 do not cause the company to fail the financial covenants in its loanagreements nor do they expose the company to future such violation.

In September 2006, the SEC issued Staff AccountingBulletin No. 108 (SAB No. 108), “Considering the Effects of Prior YearMisstatements When Quantifying Misstatements in Current Year FinancialStatements.” SAB No. 108 provides interpretative guidance on how the effects ofthe carryover or reversal of prior year misstatements should be considered inquantifying a current year misstatement. The SEC staff believes that registrantsshould quantify errors using both a balance sheet and income statement approachand evaluate whether either approach results in quantifying a misstatementthat, when all relevant quantitative and qualitative factors are considered is,material. SAB No. 108 is effective for fiscal years ending on or after November15, 2006, with early application encouraged. The Company does not believe thatSAB No. 108 will have a material impact on the Company’s Consolidated FinancialStatements.

7

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In September 2006, the FASB issued SFAS No. 157, “FairValue Measurements.” SFAS No. 157, which defines fair value, establishes aframework for measuring fair value in GAAP, and expands disclosures about fairvalue measurements. SFAS No. 157 will apply whenever another standard requires(or permits) assets or liabilities to be measured at fair value. The standarddoes not expand the use of fair value to any new circumstances. SFAS No. 157 iseffective for the calendar year 2008. The Company is currently assessing theimpact of SFAS No. 157 on its results of operations, cash flows, and financialcondition.

*NOTE 2. EARNINGS AND CASH DIVIDENDSPER COMMON SHARE*

Basic earnings per share are computed by dividing netincome by the weighted average number of shares of common stock outstandingduring the applicable period. Shares used in the earnings per share assumingdilution calculation are based on the weighted average number of shares ofcommon stock outstanding during the period increased by potentially dilutivecommon shares. Potentially dilutive common shares include stock options andstock subscribed under the HickoryTech Corporation Amended and RestatedEmployee Stock Purchase Plan (ESPP).
| ** **                           | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|--------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                           | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| ** **                           | ** ** | **2006**                         | ** ** | **2005**                        | ** ** | **2006** | ** ** | **2005** | ** ** |
| Weighted average shares  outstanding |       | 13,171,658                       |       | 13,086,371                      |       | 13,152,435 |   | 13,072,656 |   |
| Stock options (dilutive  only)       |       |                             |       | 3,200                           |       |   |   | 8,964 |   |
| Stock subscribed (ESPP)              |       | 427                              |       | 1,948                           |       | 2,353 |   | 1,948 |   |
| Total dilutive shares outstanding    |       | 13,172,085                       |       | 13,091,519                      |       | 13,154,788 |   | 13,083,568 |   |

 

Options to purchase 565,251 shares and 564,850 sharesfor the three months ended September 30, 2006 and 2005, respectively, and502,161 shares and 517,950 shares for the nine months ended September 30, 2006and 2005, respectively, were not included in the computation of earnings pershare assuming dilution because their effect on earnings per share would havebeen anti-dilutive.

Cash dividends are based on the number of commonshares outstanding at the respective record dates. Listed below is the numberof shares outstanding as of the record date for the first, second, and thirdquarters of 2006 and 2005, respectively.

| Shares outstanding on record date | ** ** | **2006**   | ** ** | **2005**   | ** ** |
|-------------------------------------------------------|------------|------------|------------|------------|------------|
| First quarter (Feb. 15)                               |       | 13,133,928 |       | 13,057,106 |       |
| Second quarter (May 15)                               |       | 13,153,067 |       | 13,073,602 |       |
| Third Quarter (August 15)                             |       | 13,156,490 |       | 13,076,331 |       |

 

Dividends per share are based on the quarterlydividend per share as declared by the HickoryTech Board of Directors. HickoryTechpaid dividends of $0.12 per share for the third quarter of 2006 and 2005.

During the nine months ended September 30, 2006 and2005, shareholders have elected to reinvest $186,000 and $196,000,respectively, of dividends into HickoryTech common stock pursuant to the HickoryTechDividend Reinvestment Plan.

*NOTE 3. COMPREHENSIVE INCOME (LOSS)*

HickoryTech follows the provisions of SFAS No. 130,“Reporting Comprehensive Income.” This statement established rules for thereporting of comprehensive income (loss) and its components. In addition to netincome, HickoryTech’s comprehensive income (loss) includes changes inunrealized gains and losses on derivative instruments qualifying and designatedas cash flow hedges. Comprehensive income (loss) for the three months endedSeptember 30, 2006 and 2005 was ($594,000) and $2,597,000, respectively.Comprehensive income for the nine months ended September 30, 2006 and 2005 was$2,379,000 and $7,173,000, respectively.

8

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*NOTE 4. ACQUISITION OF ENVENTIS*

On December 30, 2005, HickoryTech purchased Enventis fromALLETE, Inc. Enventis was formerly a wholly owned subsidiary of ALLETE, Inc. Enventisis a network transport and an enterprise Internet Protocol telephony equipment salesbusiness. The acquisition of Enventis was made to expand the geographical regionwhich HickoryTech could serve with its business broadband service capabilities.Both Enventis and HickoryTech have similar business plans and use the concept ofcombined network service with equipment provisioning for end user customers.

The purchase price was cash of $35,500,000 in exchangefor the common stock of Enventis, with further purchase price adjustments andtransaction costs making the estimated total purchase consideration $38,602,000as of December 31, 2005. Enventis had no debt at the time of acquisition. Thepurchase agreement outlined certain purchase price adjustments which wereestimated as of December 31, 2005 and resulted in cash payments between ALLETEand HickoryTech in the first quarter of 2006. These adjustments were forworking capital, capital expenditures and employee benefits. These adjustmentsdecreased the estimated purchase price by $125,000, which reduced the amountsoriginally estimated for total purchase consideration and goodwill. In thesecond quarter of 2006 an adjustment was made to goodwill to accommodate achange in the fair value of acquired deferred revenue of $41,000. Goodwill wasalso adjusted in the amount of $633,000 as of September 30, 2006 due to anadjustment in the fair value assigned to property, plant, and equipment.

The financing for the adjusted $38,602,000 totalpurchase consideration for Enventis, plus an additional $8,500,000 for Enventisworking capital as of December 31, 2005, was entirely from HickoryTech’s creditagreement, as established on December 30, 2005. The credit facility is composedof a $30,000,000 revolving credit component, which expires on December 30,2011, and a $130,000,000 term loan component, which has partial maturitiesduring its term, with final maturity on June 30, 2013. In the first quarter of2006, an additional $10,000,000 credit facility with a vendor financeorganization was established for short-term inventory floor-plan financing ofaccounts payable for Enventis.

The Enventis acquisition was accounted for using thepurchase method of accounting. Accordingly, the purchase price was allocated tothe estimated fair value of assets acquired and liabilities assumed. Thepreliminary purchase price allocation resulted in goodwill of $2,023,000, whichhas been adjusted to $2,490,000 as of September 30, 2006, as noted in the tablebelow. For income tax purposes, ALLETE and HickoryTech have agreed to treat thetransaction as a purchase of assets. Accordingly, the tax basis of the acquiredassets and assumed liabilities will be the same for financial reporting.

A summary of the changes in the Enventis goodwill isas follows:
| ** **                                                                       | ** ** | **Enventis**         | ** ** |
|----------------------------------------------------------------------------------|------------|----------------------|------------|
| ** **                                                                       | ** ** | **Goodwill**         | ** ** |
| ** **                                                                       | ** ** | **(Dollars in** | ** ** |
| ** **                                                                       | ** ** | **Thousands)**       | ** ** |
| Balance at December 31,  2005                                                    |       | $                    | 2,023      |   |
| Purchase Price  Adjustments                                                      |       | (125                 | )          |
| Balance at March 31,  2006                                                       |       | 1,898                |       |
| Adjustments to  estimated fair values of assets acquired and liabilities assumed |       | (41                  | )          |
| Balance at June 30,  2006                                                        |       | 1,857                |       |
| Adjustments to  estimated fair values of assets acquired                         |       | 633                  |       |
| Balance as of September 30, 2006                                                 |       | $                    | 2,490      |   |

 

The purchase price allocation is still consideredpreliminary. Specific reasons causing the purchase price allocation to still bepreliminary are: 1) the liquidation of acquired accounts receivable, and 2)resolution of one litigation matter. With respect to the litigation matter,HickoryTech has received an indemnification from ALLETE which managementbelieves to be adequate to cover any loss. Both items are expected to beresolved by December 2006.

9

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*NOTE 5. INVENTORIES*

Inventories, which consist of equipment for resale,materials and supplies, are stated at the lower of average cost or market. Costis determined on a first-in, first-out (FIFO) basis. Reserves offset the costof inventory to arrive at the net realizable value of the inventory.Telecommunications equipment supply markets have changed in recent years andhave caused the Company to apply additional valuation methods, which estimatethe lower of cost or market principle in the Enterprise Solutions Sector. TheCompany has a regular process of evaluating its inventory and modifying itsvalue to its estimate of market prices and making the adjustments to lower ofcost or market on a consistent basis. The Company cannot predict the impact ortiming, if any, of future inventory valuation changes.

*NOTE 6. INTANGIBLE ASSETS*

Goodwill assets are subject to an impairment testannually as well as upon certain events that indicate that impairment may bepresent. The goodwill impairment test includes two steps, the first of whichrequires management to determine the fair value of certain of the Company’sreporting units (as defined by SFAS No. 142, “Goodwill and Other IntangibleAssets”). The Company determines the fair value of its reporting units byapplication of a discounted cash flow analysis. Management makes estimates thatare included in its discounted cash flow analysis based upon the best availableinformation at the time that the determinations of fair value are made. Ifcircumstances change, HickoryTech’s estimates of fair value will also changeand could result in a determination of additional impairment charges to reducethe carrying value of goodwill.

The carrying value of HickoryTech’s goodwill increasedfrom $27,109,000 as of December 31, 2005 to $27,576,000 as of September 30,2006 due to the working capital adjustment described above and the Enventispurchase price allocation adjustment associated with the acquisition ofEnventis (see Note 4).

The components of HickoryTech’s other intangibleassets are as follows:
| ** **                        | ** ** | ** **            | ** ** | **September 30, 2006**     | ** ** | **December 31, 2005** | ** ** |
|-----------------------------------|------------|-----------------------|------------|--------------------------------------|------------|---------------------------------|------------|
| ** **                        | ** ** | ** **            | ** ** | **Gross Carrying**              | ** ** | **Accumulated**                 | ** ** | **Gross Carrying** | ** ** | **Accumulated** | ** ** |
| ** **                        | ** ** | **Useful Lives** | ** ** | **Amount**                           | ** ** | **Amortization**                | ** ** | **Amount** | ** ** | **Amortization** | ** ** |
| ** **                        | ** ** | ** **            | ** ** | **(Dollars in Thousands)** | ** ** |
|                              |       |                  |       |                                 |       |                            |       |   |   |   |   |
| Definite-lived  intangible assets |       |                  |       |                                 |       |                            |       |   |   |   |   |
| Customers                         |       | 1 - 8 years           |       | $                                    | 4,229      |                            | $          | 1,264 |   | $ | 4,229 |   | $ | 544 |   |
| Other  intangibles                |       | 1 - 5 years           |       | 730                                  |       | 263                             |       | 730 |   | 103 |   |
| Total                             |       |                  |       | $                                    | 4,959      |                            | $          | 1,527 |   | $ | 4,959 |   | $ | 647 |   |

 

As required by SFAS No. 142, we periodically reassessthe carrying value, useful lives and classification of identifiable intangibleassets. Amortization expense related to the definite-lived intangible assetsfor the three months ended September 30, 2006 and 2005 was $293,000 and$26,000, respectively. Amortization expense related to the definite-livedintangible assets for the nine months ended September 30, 2006 and 2005 was$879,000 and $467,000, respectively. Total estimated amortization expense forthe remaining three months of 2006 and the five years subsequent to 2006 is asfollows: 2006 (October 1 through December 31) - $293,000; 2007 - $1,157,000;2008 - $1,127,000; 2009 - $853,000; 2010 - $2,000 and 2011 - $0.

10

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*NOTE 7. QUARTERLY SECTOR FINANCIALSUMMARY*

 

 
| ** **                                     | ** ** | ** **  | ** ** | **Information** | ** ** | **Enterprise** | ** ** | ** **   | ** ** | **Corporate and** | ** ** | **HickoryTech**  | ** ** |
|------------------------------------------------|------------|-------------|------------|-----------------|------------|----------------|------------|--------------|------------|------------------------|------------|------------------|------------|
| ** **                                     | ** ** | **Telecom** | ** ** | **Solutions**   | ** ** | **Solutions**  | ** ** | **Enventis** | ** ** | **Eliminations**       | ** ** | **Consolidated** | ** ** |
| **(Dollars In Thousands)**           | ** ** | ** **  | ** ** |
| Three Months Ended  September 30, 2006         | ** ** | ** **  | ** ** | ** **      | ** ** | ** **     | ** ** | ** **   | ** ** | ** **             | ** ** | ** **       | ** ** |
| Operating revenue from unaffiliated  customers |       | $           | 18,216     |            | $          | 482            |       | $            | 3,285      |                   | $          | 13,972           |       | $ | — |   | $ | 35,955 |   |
| Intersegment revenues                          |       | 77          |       | 972             |       | —         |       | —       |       | (1,049                 | )          | —           |       |
| Total                                          |       | 18,293      |       | 1,454           |       | 3,285          |       | 13,972       |       | (1,049                 | )          | 35,955           |       |
|                                           |       |        |       |            |       |           |       |         |       |                   |       |             |       |
| Depreciation and  amortization                 |       | 3,397       |       | 384             |       | 25             |       | 732          |       | 15                     |       | 4,553            |       |
| Operating income/(loss)                        |       | 4,354       |       | (644            | )          | (348           | )          | 680          |       | (120                   | )          | 3,922            |       |
| Interest and other  income                     |       | 1           |       | —          |       | —         |       | (3           | )          | 42                     |       | 40               |       |
| Interest expense                               |       | 1           |       | 11              |       | —         |       | —       |       | 1,901                  |       | 1,913            |       |
| Income taxes/(benefit)                         |       | 1,710       |       | (262            | )          | (139           | )          | 274          |       | (979                   | )          | 604              |       |
| Net income/(loss)                              |       | 2,567       |       | (393            | )          | (209           | )          | 403          |       | (923                   | )          | 1,445            |       |
|                                           |       |        |       |            |       |           |       |         |       |                   |       |             |       |
| Identifiable assets                            |       | 151,381     |       | 6,236           |       | 5,897          |       | 57,420       |       | 10,318                 |       | 231,252          |       |
| Property, plant and  equipment, net            |       | 115,295     |       | 5,687           |       | 173            |       | 31,828       |       | 80                     |       | 153,063          |       |
| Capital expenditures                           |       | 4,828       |       | 472             |       | —         |       | 1,240        |       | (35                    | )          | 6,505            |       |
|                                                |            |             |            |                 |            |                |            |              |            |                        |            |                  |            |  |  |  |  |  |  |

 
| ** **                                                         | ** ** | ** **  | ** ** | **Information** | ** ** | **Enterprise** | ** ** | ** **       | ** ** | **Corporate and** | ** ** | **HickoryTech**  | ** ** |
|--------------------------------------------------------------------|------------|-------------|------------|-----------------|------------|----------------|------------|------------------|------------|------------------------|------------|------------------|------------|
| ** **                                                         | ** ** | **Telecom** | ** ** | **Solutions**   | ** ** | **Solutions**  | ** ** | **Enventis (1)** | ** ** | **Eliminations**       | ** ** | **Consolidated** | ** ** |
| **(Dollars In Thousands)**                               | ** ** | ** **  | ** ** |
| Three Months Ended  September 30, 2005                             |       |        |       |            |       |           |       |             |       |                   |       |             |       |
| Operating revenue from unaffiliated  customers                     |       | $           | 18,383     |            | $          | 519            |       | $                | 3,402      |                   | $          | —           |       | $ | — |   | $ | 22,304 |   |
| Intersegment revenues                                              |       | 51          |       | 1,056           |       | —         |       | —           |       | (1,107                 | )          | —           |       |
| Total                                                              |       | 18,434      |       | 1,575           |       | 3,402          |       | —           |       | (1,107                 | )          | 22,304           |       |
|                                                               |       |        |       |            |       |           |       |             |       |                   |       |             |       |
| Depreciation and  amortization                                     |       | 3,123       |       | 403             |       | 28             |       | —           |       | 16                     |       | 3,570            |       |
| Operating income/(loss)                                            |       | 4,988       |       | (427            | )          | (53            | )          | —           |       | 158                    |       | 4,666            |       |
| Interest expense                                                   |       | 1           |       | 13              |       | —         |       | —           |       | 1,110                  |       | 1,124            |       |
| Income taxes/(benefit)                                             |       | 2,019       |       | (178            | )          | (22            | )          | —           |       | (372                   | )          | 1,447            |       |
| Income (loss)/from Continuing  operations                          |       | 2,970       |       | (262            | )          | (31            | )          | —           |       | (547                   | )          | 2,130            |       |
| Loss from discontinued  operations including intersegment revenues |       | 22          |       | —          |       | —         |       | —           |       | —                 |       | 22               |       |
| Net income/(loss)                                                  |       | 2,992       |       | (262            | )          | (31            | )          | —           |       | (547                   | )          | 2,152            |       |
|                                                               |       |        |       |            |       |           |       |             |       |                   |       |             |       |
| Identifiable assets                                                |       | 144,824     |       | 3,936           |       | 7,918          |       | —           |       | 9,340                  |       | 166,018          |       |
| Property, plant and  equipment, net                                |       | 108,575     |       | 4,936           |       | 227            |       | —           |       | 110                    |       | 113,848          |       |
| Capital expenditures                                               |       | 4,603       |       | 866             |       | —         |       | —           |       | 39                     |       | 5,508            |       |
|                                                                    |            |             |            |                 |            |                |            |                  |            |                        |            |                  |            |  |  |  |  |  |  |

 

11

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|                                           |   | ** **  | ** ** | **Information** | ** ** | **Enterprise** | ** ** | ** **   | ** ** | **Corporate and** | ** ** | **HickoryTech**  | ** ** |
|------------------------------------------------|--------|-------------|------------|-----------------|------------|----------------|------------|--------------|------------|------------------------|------------|------------------|------------|
|                                           |   | **Telecom** | ** ** | **Solutions**   | ** ** | **Solutions**  | ** ** | **Enventis** | ** ** | **Eliminations**       | ** ** | **Consolidated** | ** ** |
| **(Dollars In Thousands)**           |   | ** **  | ** ** |
| Nine Months Ended  September 30, 2006          |   |        |       |            |       |           |       |         |       |                   |       |             |       |
| Operating revenue from unaffiliated  customers |   | $           | 54,559     |            | $          | 1,705          |       | $            | 8,567      |                   | $          | 43,234           |       | $ | — |   | $ | 108,065 |   |
| Intersegment revenues                          |   | 180         |       | 3,249           |       | —         |       | —       |       | (3,429                 | )          | —           |       |
| Total                                          |   | 54,739      |       | 4,954           |       | 8,567          |       | 43,234       |       | (3,429                 | )          | 108,065          |       |
|                                           |   |        |       |            |       |           |       |         |       |                   |       |             |       |
| Depreciation and  amortization                 |   | 9,895       |       | 1,175           |       | 81             |       | 2,237        |       | 60                     |       | 13,448           |       |
| Operating income/(loss)                        |   | 13,539      |       | (1,464          | )          | (1,021         | )          | 1,978        |       | (1,082                 | )          | 11,950           |       |
| Interest and other  income                     |   | 6           |       | 6               |       | —         |       | 1            |       | 96                     |       | 109              |       |
| Interest  expense/(income)                     |   | (128        | )          | 37              |       | 1              |       | —       |       | 5,483                  |       | 5,393            |       |
| Income taxes/(benefit)                         |   | 5,398       |       | (598            | )          | (409           | )          | 801          |       | (2,734                 | )          | 2,458            |       |
| Net income/(loss)                              |   | 8,095       |       | (897            | )          | (613           | )          | 1,178        |       | (3,555                 | )          | 4,208            |       |
|                                           |   |        |       |            |       |           |       |         |       |                   |       |             |       |
| Identifiable assets                            |   | 151,381     |       | 6,236           |       | 5,897          |       | 57,420       |       | 10,318                 |       | 231,252          |       |
| Property, plant and  equipment, net            |   | 115,295     |       | 5,687           |       | 173            |       | 31,828       |       | 80                     |       | 153,063          |       |
| Capital expenditures                           |   | 11,399      |       | 976             |       | 29             |       | 4,340        |       | 58                     |       | 16,802           |       |
|                                                |        |             |            |                 |            |                |            |              |            |                        |            |                  |            |  |  |  |  |  |  |

 
|                                                                 |   | ** **  | ** ** | **Information** | ** ** | **Enterprise** | ** ** | ** **       | ** ** | **Corporate and** | ** ** | **HickoryTech**  | ** ** |
|----------------------------------------------------------------------|--------|-------------|------------|-----------------|------------|----------------|------------|------------------|------------|------------------------|------------|------------------|------------|
|                                                                 |   | **Telecom** | ** ** | **Solutions**   | ** ** | **Solutions**  | ** ** | **Enventis (1)** | ** ** | **Eliminations**       | ** ** | **Consolidated** | ** ** |
| **(Dollars In Thousands)**                                 |   | ** **  | ** ** |
| Nine Months Ended  September 30, 2005                                |   |        |       |            |       |           |       |             |       |                   |       |             |       |
| Operating revenue from unaffiliated  customers                       |   | $           | 57,014     |            | $          | 1,921          |       | $                | 11,745     |                   | $          | —           |       | $ | — |   | $ | 70,680 |   |
| Intersegment revenues                                                |   | 154         |       | 3,239           |       | —         |       | —           |       | (3,393                 | )          | —           |       |
| Total                                                                |   | 57,168      |       | 5,160           |       | 11,745         |       | —           |       | (3,393                 | )          | 70,680           |       |
|                                                                 |   |        |       |            |       |           |       |             |       |                   |       |             |       |
| Depreciation and  amortization                                       |   | 10,223      |       | 1,698           |       | 91             |       | —           |       | 43                     |       | 12,055           |       |
| Operating income/(loss)                                              |   | 16,216      |       | (1,796          | )          | (207           | )          | —           |       | (152                   | )          | 14,061           |       |
| Interest expense                                                     |   | 4           |       | 41              |       | —         |       | —           |       | 3,083                  |       | 3,128            |       |
| Income taxes/(benefit)                                               |   | 6,563       |       | (743            | )          | (84            | )          | —           |       | (1,283                 | )          | 4,453            |       |
| Income/(loss) from continuing  operations                            |   | 9,654       |       | (1,091          | )          | (123           | )          | —           |       | (1,885                 | )          | 6,555            |       |
| Income from  discontinued operations including intersegment revenues |   | 123         |       | —          |       | —         |       | —           |       | —                 |       | 123              |       |
| Net income/(loss)                                                    |   | 9,777       |       | (1,091          | )          | (123           | )          | —           |       | (1,885                 | )          | 6,678            |       |
|                                                                 |   |        |       |            |       |           |       |             |       |                   |       |             |       |
| Identifiable assets                                                  |   | 144,824     |       | 3,936           |       | 7,918          |       | —           |       | 9,340                  |       | 166,018          |       |
| Property, plant and  equipment, net                                  |   | 108,575     |       | 4,936           |       | 227            |       | —           |       | 110                    |       | 113,848          |       |
| Capital expenditures                                                 |   | 8,653       |       | 1,424           |       | 20             |       | —           |       | 39                     |       | 10,136           |       |
|                                                                      |        |             |            |                 |            |                |            |                  |            |                        |            |                  |            |  |  |  |  |  |  |

 

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(1)             Noinformation provided because the Enventis acquisition was not completed untilDecember 30, 2005.

*NOTE 8. CONTINGENCIES*

HickoryTech is involved in certain contractualdisputes in the ordinary course of business. HickoryTech does not believe theultimate resolution of any existing matters will have a material adverse effecton its financial position, results of operations or cash flows.

12

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*NOTE 9. STOCK COMPENSATION*

On January 1, 2006, the Company adopted SFAS No. 123(R)(revised 2004), “Share-Based Payment” (SFAS No. 123(R)), which requires themeasurement and recognition of compensation expense for all share-based paymentawards made to employees and directors, including employee stock options andemployee stock purchases related to the ESPP, based on estimated fair values.SFAS No. 123(R) supersedes the Company’s previous accounting under AccountingPrinciples Board Opinion No. 25, “Accounting for Stock Issued toEmployees” (APB No. 25) for periods beginning in fiscal 2006. InMarch 2005, the Securities and Exchange Commission issued SAB No. 107relating to SFAS No. 123(R). The Company has applied the provisions of SAB No.107 in its adoption of SFAS No. 123(R).

The Company adopted SFAS No. 123(R) using the modifiedprospective transition method, which requires the application of the accountingstandard as of January 1, 2006. The Company’s Consolidated FinancialStatements as of and for the nine months ended September 30, 2006 reflect theimpact of SFAS No. 123(R). In accordance with the modified prospectivetransition method, the Company’s Consolidated Financial Statements for priorperiods have not been restated to reflect, and do not include, the impact ofSFAS No. 123(R) or any modifications to outstanding stock options prior to theadoption of SFAS No. 123(R). Share-based compensation expense recognized underSFAS No. 123(R) for the three months ended September 30, 2006 was $42,000pre-tax and $26,000 after tax. In addition, share-based compensation expense recognizedunder SFAS No. 123(R) for the nine months ended September 30, 2006 was $128,000pre-tax and $78,000 after tax. The majority of this expense relates to theexpensing of stock options, and a small amount relates to the ESPP. Theadoption of SFAS No. 123(R) had minimal impact on earnings per share anddiluted earnings per share and for the three months ended September 30, 2006and nine months ended September 30, 2006. Also, adopting SFAS No. 123(R) hadminimal impact on cash flow from financing and operations.

Share-based compensation expense recognized during aperiod is based on the value of the portion of share-based payment awards thatare ultimately expected to vest during the period. Share-based compensationexpense recognized in the Company’s Consolidated Statements of Operations forthe nine months ended September 30, 2006 included compensation expense forshare-based payment awards granted prior to, but not yet vested as of December31, 2005, based on the grant date fair value estimated in accordance with thefair value provisions of SFAS No. 123(R). Because share-based compensationexpense recognized in the Consolidated Statements of Operations for the ninemonths ended September 30, 2006 is based on awards ultimately expected to vest,it has been reduced for estimated forfeitures. SFAS No. 123(R) requiresforfeitures to be estimated at the time of grant and revised, if necessary, insubsequent periods if actual forfeitures differ from those estimates. TheCompany accounted for forfeitures as they occurred for the periods prior to2006. The cumulative adjustment for the change in accounting principle wasimmaterial.

The fair value of each option award is estimated onthe date of grant using a Black-Scholes option valuation model. The Companyuses a seven-year period to calculate the historical volatility of its stockprice for use in the valuation model. The Company uses historical data toestimate option exercise and employee termination within the valuation model.The expected term of options granted is derived from historical experience andrepresents the period of time that options granted are expected to beoutstanding. The forfeiture rate is based upon a statistical computation ofremaining lives and exercise price in relationship to current stock price. Therisk-free rate for options is based on a U.S. Treasury rate commensurate withthe expected terms.

Mr. John W. Finke, current CEO, received a one-timegrant of 15,000 options associated with his acceptance of the CEO position. Otherthan the one-time stock award issued to John Finke, options were last grantedunder the Company’s Stock Award Plan in February 2005. The Stock Award Planprovides for the issuance of stock options, but no current compensationprograms have options as a component. The weighted average grant date fairvalue of options issued during the three months ending September 30, 2006 was$1.43.

Refer to the Company’s Annual Report on Form 10-K forthe year ended December 31, 2005 for a complete description of its stock-based compensationplans.

As of September 30, 2006, there was $135,000 of totalunrecognized compensation costs related to non-vested stock options grantedunder the Company’s Stock Award Plan. This expense is expected to be recognizedover a weighted average period of two years.

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A summary of stock option activity is as follows:
| ** **                         | ** ** | ** **                                                                           | ** ** | **Weighted Average** | ** ** | **Aggregate**            | ** ** |
|------------------------------------|------------|--------------------------------------------------------------------------------------|------------|---------------------------|------------|--------------------------|------------|
| ** **                         | ** ** | **Shares**                                                                           | ** ** | **Exercise Price**   | ** ** | **Intrinsic Value** | ** ** |
| ** **                         | ** ** | (In Thousands Except Share and Per Share Amounts) | ** ** |
| Outstanding at January  1, 2006    |       | 578,850                                                                              |       | $                         | 12.63      |                     | —     |   |
| Granted                            |       | 15,000                                                                               |       | 6.95                      |       | —                   |       |
| Exercised                          |       | —                                                                               |       | —                    |       | —                   |       |
| Forfeited                          |       | (26,199                                                                              | )          | 11.13                     |       | —                   |       |
| Expired                            |       | (2,400                                                                               | )          | 9.38                      |       | —                   |       |
| Outstanding at  September 30, 2006 |       | 565,251                                                                              |       | $                         | 12.56      |                     | $          | 1 |   |
| Exercisable at September 30, 2006  |       | 502,161                                                                              |       | $                         | 12.86      |                     | $          | — |   |

 

The following table provides certain information withrespect to stock options outstanding at September 30, 2006:

|                          | ** ** | **Stock**       | ** ** | **Average**  | ** ** | **Average**               | ** ** |
|--------------------------|------------|-----------------|------------|--------------|------------|---------------------------|------------|
| **Range of**        | ** ** | **Options**     | ** ** | **Exercise** | ** ** | **Remaining**             | ** ** |
| **Exercise Prices** | ** ** | **Outstanding** | ** ** | **Price**    | ** ** | **Contractual Life** | ** ** |
| $6.00 - $8.00            |       | 15,000          |       | $            | 6.95       |                      | 9.92 years |   |
| $8.00 - $12.00           |       | 244,201         |       | 10.24        |       | 6.68 years                |       |
| $12.00 - $16.00          |       | 245,550         |       | 13.83        |       | 4.35 years                |       |
| $16.00 - $21.00          |       | 60,500          |       | 18.17        |       | 4.51 years                |       |
|                     |       | 565,251         |       | $            | 12.56      |                      | 5.50 years |   |

 

The following table provides certain information withrespect to stock options exercisable at September 30, 2006:

|                          | ** ** | ** **      | ** ** | **Weighted** | ** ** | ** **                | ** ** |
|--------------------------|------------|-----------------|------------|--------------|------------|---------------------------|------------|
| ** **               | ** ** | **Stock**       | ** ** | **Average**  | ** ** | **Average**               | ** ** |
| **Range of**        | ** ** | **Options**     | ** ** | **Exercise** | ** ** | **Remaining**             | ** ** |
| **Exercise Prices** | ** ** | **Exercisable** | ** ** | **Price**    | ** ** | **Contractual Life** | ** ** |
| $8.00 - $12.00           |       | 196,111         |       | $            | 10.02      |                      | 6.30 years |   |
| $12.00 - $16.00          |       | 245,550         |       | 13.83        |       | 4.35 years                |       |
| $16.00 - $21.00          |       | 60,500          |       | 18.17        |       | 4.51 years                |       |
|                     |       | 502,161         |       | $            | 12.86      |                      | 5.13 years |   |

 

The following table provides the range of assumptionsused for valuing stock options:
| ** **               | ** ** | **Three Months Ended September 30** | ** ** | **Nine Months Ended September 30** | ** ** |
|--------------------------|------------|---------------------------------------------------------|------------|--------------------------------------------------------|------------|
| ** **               | ** ** | **2006**                                                | ** ** | **2005**                                               | ** ** | **2006** | ** ** | **2005** | ** ** |
| Expected volatility      |       | 37.03                                                   | %          | 34.34                                                  | %          | 37.03 | % | 34.34 | % |
| Expected dividends       |       | 6.80                                                    | %          | 5.40                                                   | %          | 6.20 | % | 5.00 | % |
| Expected term (in years) |       | 7                                                       |       | 7                                                      |       | 7 |   | 7 |   |
| Risk-free interest rate  |       | 4.79                                                    | %          | 4.07                                                   | %          | 4.79 | % | 4.07 | % |

 

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If HickoryTech had elected to recognize compensationcost based on the fair value of the options as prescribed by SFAS No. 123(R)for the three and nine month periods ended September 30, 2005, the followingoperating results would have resulted using the Black-Scholes option-pricingmodel to determine the fair value of the options:
| ** **                                                                                                                                    | ** ** | **Three Months Ended**          | ** ** | **Nine Months Ended**           | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                                                                                    | ** ** | **September 30, 2005 **(1) | ** ** | **September 30, 2005 **(1) | ** ** |
| Net income:                                                                                                                                   |       |                                      |       |                                      |       |
| As reported                                                                                                                                   |       | $                                         | 2,152      |                                      | $          | 6,678 |   |
| Add: Stock-based  employee compensation expense included in reported net income, net of related  tax effects                                  |       | 13                                        |       | 40                                        |       |
| Deduct: Total  stock-based employee compensation expense determined under fair value based method  for all awards, net of related tax effects |       | (44                                       | )          | (170                                      | )          |
| Pro forma net income                                                                                                                          |       | $                                         | 2,121      |                                      | $          | 6,548 |   |
|                                                                                                                                          |       |                                      |       |                                      |       |
| Earnings per share:                                                                                                                           |       |                                      |       |                                      |       |
| As reported:                                                                                                                                  |       |                                      |       |                                      |       |
| Basic                                                                                                                                         |       | $                                         | 0.16       |                                      | $          | 0.51 |   |
| Diluted                                                                                                                                       |       | $                                         | 0.16       |                                      | $          | 0.50 |   |
| Pro forma:                                                                                                                                    |       |                                      |       |                                      |       |
| Basic                                                                                                                                         |       | $                                         | 0.16       |                                      | $          | 0.51 |   |
| Diluted                                                                                                                                       |       | $                                         | 0.16       |                                      | $          | 0.50 |   |

----

(1)             2005 net income andnet income per share do not include share-based compensation expense inaccordance with SFAS No. 123(R).

As of September 30, 2006, the number of shares thatare available for future and/or existing grants under each of our stock-basedcompensation plans are as follows:

| Plan                                    | ** ** | ** ** | ** ** | **Shares Available** | ** ** |
|-----------------------------------------|------------|------------|------------|---------------------------|------------|
| Employee Stock Purchase  Plan           |       | 542,101    |       |
| Retainer Stock Plans  for Directors     |       | 240,327    |       |
| Non-Employee Directors'  Incentive Plan |       | 190,000    |       |
| Stock Award Plan                        |       | 946,946    |       |

 

Shares issued under other stock-based compensationplans are as follows:
| ** **                                | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended**  | ** ** |
|-------------------------------------------|------------|----------------------------------|------------|----------------------------------|------------|
| ** **                                | ** ** | **September 30, 2006** | ** ** | **September 30, 2006** | ** ** |
| Retainer Stock Plans  for Directors       |       | 2,315 shares                     |       | 6,694 shares                     |       |
| market  price/fair value at time of grant |       | $                                | 7.02/share |                             | $          | 7.02/share |   |
|                                      |       |                             |       |                             |       |
| Non-Employee Director's  Incentive Plan   |       | none                             |       | 10,000 shares                    |       |
| market  price/fair value at time of grant |       | NA                               |       | $                                | 8.03/share |   |
|                                      |       |                             |       |                             |       |
| Stock Award Plan                          |       | 1,312 shares                     |       | 2,932 shares                     |       |
| market price/fair value  at time of grant |       | $                                | 6.94/share |                             | $          | 6.94/share |   |

 

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NOTE 10. FINANCIAL DERIVATIVE INSTRUMENTS

HickoryTech accounts for derivative instruments inaccordance with SFAS No. 133, “Accounting for Derivative Instruments andHedging Activities,” as amended by SFAS No. 149, “Amendment of Statement 133Accounting for Derivative Instruments and Hedging Activities,” which requiresderivative instruments to be recorded on the balance sheet at fair value.Changes in fair value of derivative instruments must be recognized in earningsunless specific hedge accounting criteria are met, in which case the gains andlosses are included in other comprehensive income rather than in earnings.  The change in the fair value related toHickoryTech’s derivative instruments for the nine months ended September 30,2006 is as follows:

|                                                                                    | ** ** | **Interest Rate**  | ** ** |
|------------------------------------------------------------------------------------|------------|-------------------------|------------|
| **(***Dollars in Thousands)*                                             | ** ** | **Swap Agreement** | ** ** |
|                                                                               |       |                    |       |
| Accumulated other  comprehensive income balance at December 31, 2005               |       | $                       | 2,064      |   |
| Market value decrease  on interest rate swap agreement, net of related tax effects |       | (388)                   |       |
| Accumulated other comprehensive income balance at September 30, 2006               |       | $                       | 1,676      |   |

 

HickoryTech has variable rate debt instruments, whichsubject the Company to interest rate risk. Beginning in the second quarter of2003, HickoryTech entered into interest rate swap agreements, with remainingmaturities of twenty-one months, to manage its exposure to interest ratemovements on a portion of its variable rate debt obligations. The market valueof the cumulative gain or loss on these derivative instruments is reported as acomponent of accumulated other comprehensive income/loss in shareholders’equity and will be recognized in earnings when the term of the swap agreementis concluded.

The fair value of HickoryTech’s derivatives atSeptember 30, 2006 and December 31, 2005 is a net asset of $2,785,000 and$3,429,000, respectively, which is included in other assets in the accompanyingconsolidated balance sheet.

NOTE 11. EMPLOYEEPOST-RETIREMENT BENEFITS

HickoryTechprovides post-retirement health care and life insurance benefits for certainemployees. HickoryTech is not currently funding these post-retirement benefits,but has accrued these liabilities as of September 30, 2006 and 2005.
| ** **                                | ** ** | **Three Months Ended  September 30** | ** ** | **Nine Months Ended  September 30** | ** ** |
|-------------------------------------------|------------|-----------------------------------------------------|------------|----------------------------------------------------|------------|
| **(***Dollars in Thousands)*    | ** ** | **2006**                                            | ** ** | **2005**                                           | ** ** | **2006** | ** ** | **2005** | ** ** |
| Components of net  periodic benefit cost: |       |                                                |       |                                               |       |   |   |   |   |
| Service cost                              |       | $                                                   | 81         |                                               | $          | 91 |   | $ | 243 |   | $ | 275 |   |
| Interest cost                             |       | 107                                                 |       | 115                                                |       | 321 |   | 345 |   |
| Amortization of  transition obligation    |       | 15                                                  |       | 15                                                 |       | 45 |   | 45 |   |
| Amortization of prior  service cost       |       | (3                                                  | )          | (3                                                 | )          | (9 | ) | (9 | ) |
| Recognized net  actuarial loss            |       | 31                                                  |       | 44                                                 |       | 93 |   | 132 |   |
| Net periodic benefit  cost                |       | $                                                   | 231        |                                               | $          | 262 |   | $ | 693 |   | $ | 788 |   |

 
| ** **                                                       | ** ** | **September 30, 2006** | ** ** |
|------------------------------------------------------------------|------------|----------------------------------|------------|
| Employer's  contributions for current premiums:                  |       |                             |       |
| Contributions  made for the nine months ended September 30, 2006 |       | $                                | 149        |   |
| Expected  contributions for remainder of 2006                    |       | 51                               |       |
| Total estimated  employer contributions for fiscal year 2006     |       | $                                | 200        |   |

 

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NOTE 12. SHORT-TERM FINANCING ARRANGEMENT

Enventis has a $10million credit facility with a financing company to purchase inventories from certainapproved vendors. Advances under the financing arrangement are collateralizedby the accounts receivable and inventory of Enventis and a guaranty of theprincipal indebtedness by HickoryTech. The credit facility provides sixty-daypayment terms for working capital and can be terminated at any time by eitherparty. Borrowings outstanding under the credit facility at September 30, 2006totaled $5,734,000.

ITEM 2.MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION.

**FORWARD-LOOKINGSTATEMENTS**

This Quarterly Report on Form 10-Q contains certainforward-looking statements within the meaning of Section 27A of the SecuritiesAct of 1933, as amended, and Section 21E of the Securities Exchange Act of1934, as amended, which are subject to the “safe harbor” created by thosesections. Statements in this Quarterly Report on 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 whichHickory Tech Corporation (HickoryTech or the Company) operates and management’sbeliefs and assumptions. Forward-looking statements may be identified by theuse of terminology such as “may,” “will,” “believes,” “does not believe,” “no reasonto believe,” “expects,” “plans,” “intends,” “estimates,” “anticipated” or“anticipates,” and similar expressions, as they relate to HickoryTech or itsmanagement. Such forward-looking statements are subject to important risks anduncertainties that could cause HickoryTech’s future actual results to differmaterially from such statements. These statements are not guarantees of futureperformance and involve certain risks, uncertainties and probabilities, whichare difficult to predict. Therefore, actual outcomes and results may differmaterially from what is expressed or forecasted in such forward-lookingstatements, whether as a result of new information, future events or otherwise.Factors that might cause such a difference include, but are not limited to,those contained in this “Management’s Discussion and Analysis of Results ofOperations and Financial Condition” (Item 2) and Item 1A, “Risk Factors,” ofHickoryTech’s Annual Report on Form 10-K for the year ended December 31, 2005,as updated in this and previous quarterly reports on Form 10-Q which areincorporated herein by reference. You are cautioned not to place undue relianceon these forward-looking statements, which speak only as of the date on whichthey were made. Except as otherwise required by federal securities law,HickoryTech undertakes no obligation to update any of its forward-lookingstatements for any reason.

**BUSINESS**

HickoryTech operates in four business segments: theTelecom, Information Solutions, Enterprise Solutions and Enventis Sectors. Itslargest and oldest business (since 1898) has been the operation of incumbentlocal exchange carriers (ILECs) or traditional wireline telephone service. TheILEC business is included in HickoryTech’s Telecom Sector. In 1998, HickoryTechbegan its competitive local exchange carrier (CLEC) line of business, competingfor the telephone dial tone, dial-up and broadband Internet access, data,digital TV and long distance calling business in ILEC territories owned byothers. The CLEC business is in HickoryTech’s Telecom Sector. Since 1964,HickoryTech’s Information Solutions Sector has provided computer dataprocessing and software, predominantly for HickoryTech’s Telecom Sectoroperations and also for 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. On December 30, 2005, HickoryTechpurchased Enventis Telecom, Inc. (Enventis). Enventis is a Minnesota-basedregional provider of integrated fiber network, Internet Protocol telephony, anddata services, with 1,500 route miles of fiber network serving more than 300business customers in over 40 communities in the Upper Midwest.

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The eight current subsidiaries of HickoryTech and thebusiness segments in which they operate are:
| **TELECOM SECTOR**                                        |   |
|-----------------------------------------------------------|--------|
| Mankato Citizens  Telephone Company (MCTC)                |   |
| Mid-Communications,  Inc. (Mid-Comm)                      |   |
| Heartland  Telecommunications Company of Iowa (Heartland) |   |
| Cable Network,  Inc. (CNI)                                |   |
| Crystal  Communications, Inc. (Crystal)                   |   |
| **INFORMATION  SOLUTIONS SECTOR**                         |   |
| National  Independent Billing, Inc. (NIBI)                |   |
| **ENTERPRISE SOLUTIONS SECTOR**                           |   |
| Collins Communications  Systems Co. (Collins)             |   |
| **ENVENTIS SECTOR**                                       |   |
| Enventis Telecom, Inc. (Enventis)                         |   |

 

HickoryTech and its subsidiaries are engaged inbusinesses that provide services to their customers for a fee. Many of theseservices are recurring, and, as a result, backlog orders and seasonality arenot significant factors. Working capital requirements for the Telecom Sectorinvolve financing the construction of networks involving switches and cable,maintaining a high amount of fixed assets, paying payroll costs of highlyskilled labor, maintaining inventory to service its capital projects and itsnetwork and telephone equipment customers, and providing for the carrying valueof trade accounts receivable, which may take several months to collect in thenormal course of business. Working capital requirements for the InformationSolutions Sector involve capital for software development, operating losses,payroll costs of highly skilled labor and the carrying value of trade accountsreceivable. Working capital requirements for the Enterprise Solutions Sectorinvolve capital for payroll costs, inventory to service its customers, thecarrying value of trade accounts receivable, work-in-process and operatinglosses. Working capital requirements for the Enventis Sector involve capitalfor payroll costs, the carrying value of accounts receivable andwork-in-process.

The materials and supplies that are necessary for theoperation of the businesses of HickoryTech and its subsidiaries are availablefrom a variety of sources. All of HickoryTech’s central office switches, aswell as a majority of HickoryTech’s equipment sold in its Enterprise Solutionsand Enventis Sectors, are supplied by Nortel and Cisco. Nortel and Cisco areleading suppliers of communications and data equipment, and HickoryTech’sdependence on these brands is not viewed as a significant risk.

**INDUSTRY SEGMENTS**

HickoryTech reports the business operations ofTelephone and Communications Services as a single segment referred to as theTelecom Sector. The other three business segments are the Information Solutions,Enterprise Solutions and Enventis Sectors.

*TELECOM SECTOR*

HickoryTech’s Telecom Sector provides local exchangewireline telephone service, long distance, dial-up and broadband Internetaccess, and owns and operates fiber optic cable facilities. This sectorincludes three ILECs: MCTC, Mid-Comm and Heartland. MCTC and Mid-Comm providetelephone service in south central Minnesota, specifically Mankato (a regionalhub) and eleven rural communities surrounding Mankato. The third ILEC,Heartland, provides telephone service for eleven rural communities in northwestIowa. In total, there are twenty-three ILEC exchanges within the TelecomSector.

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The Telecom Sector also includes Crystal, a CLEC.Crystal provides local telephone service, long distance, dial-up and broadbandInternet access and digital TV on a competitive basis. Crystal also connectscommunication networks of interexchange and wireless carriers with theequipment and facilities of end users. Crystal has customers in ten ruralcommunities, encompassing eight exchanges, in Minnesota and three communities,encompassing two exchanges, in Iowa that are not in HickoryTech’s ILEC serviceareas. Crystal also provides digital TV service in eight Minnesota communitiesin addition to its telephone services described above. They include St. Peter,initiated in 2001, Waseca in 2004, New Richland, Ellendale and St. Clair in2005, and Faribault, Lake Crystal and Eagle Lake in 2006, all of which arecommunities where HickoryTech provides telephone service either as an ILEC orCLEC. In October 2006, the City Councils of both Mankato and North Mankatounanimously approved cable television franchise agreements, which will allowHickoryTech to offer digital TV services in those communities beginning in thesecond quarter of 2007.

HickoryTech also owns and operates fiber optic cablefacilities in Minnesota in its Telecom Sector, in addition to its EnventisSector. These facilities are used to transport interexchange communications asa service to telephone industry customers. HickoryTech’s Minnesota ILECs andCLEC are the primary users of the fiber optic cable facilities in the TelecomSector. None of the companies in the Telecom Sector experienced major changesin operations during the first three quarters of 2005 or 2006, other than thecumulative effect of repeated periodic declines in network access revenues,which has reduced profitability of this Sector.

MCTC derives its principal revenues and income fromlocal services charged to subscribers in its service area, access servicescharged to interexchange carriers and the operation of a toll tandem-switchingcenter in Mankato, Minnesota. Revenues and income for Mid-Comm are also derivedfrom local 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 are managedand maintained by a common workforce. Heartland derives its principal revenuesand income from local services charged to subscribers in its service area inIowa, as well as from providing interexchange access for its subscribers.Interexchange telephone access is provided by all three of HickoryTech’s ILECsubsidiaries by connecting the communications networks of interexchange andwireless carriers with the equipment and facilities of end users through itsswitched networks or private lines.

MCTC and Mid-Comm are Minnesota public utilitiesoperating pursuant to indeterminate permits issued by the Minnesota PublicUtilities Commission (MPUC). Heartland is also a public utility, which operatespursuant to a certificate of public convenience and necessity issued by theIowa Utilities Board (IUB). These state agencies regulate the services providedby MCTC, Mid-Comm and Heartland. CNI operations are not subject to regulationby the state regulatory authority. Neither the MPUC nor the IUB regulate therate of return or profits of each of HickoryTech’s ILEC operations due to thesize of these companies relative to state regulation. In Minnesota, regulatorsmonitor MCTC and Mid-Comm price and service levels. MCTC and Mid-Comm localservice rates are below those of most Minnesota ILEC’s. HickoryTech and itssubsidiaries can change its local rates by evaluating various factors,including economic and competitive circumstances.

As local exchange telephone companies, MCTC, Mid-Command Heartland provide end office switching and dedicated circuits to longdistance interexchange carriers. These relationships allow HickoryTech’stelephone subscribers to place long distance telephone calls to the telephonenetwork. HickoryTech provides interexchange access to its network forinterexchange carriers to conduct long distance business with individualcustomers who select a long distance carrier and for termination of calls toall customers. This interexchange access business is separate and distinct fromHickoryTech’s own long distance retail business, which is operated in itsCrystal subsidiary. The long distance interexchange carriers are significantcustomers of HickoryTech, but no carrier represents more than ten percent of HickoryTech’sconsolidated revenues.

Alternatives to HickoryTech service include customersleasing private lines in lieu of switched voice services and data services inor adjacent to the territories served by HickoryTech, which permits thebypassing of local telephone switching facilities. Additionally, servicesprovided by other companies utilizing various Internet, wireline or wirelesstechnologies permit bypass of the local exchange network. These alternatives tolocal exchange service represent a potential threat to HickoryTech’s long-termability to provide local exchange service at economical rates.

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Competition exists in several of HickoryTech’s ILECservice areas. A municipality has overbuilt Heartland’s network in onecommunity in Iowa and now serves over half of that market. Additionally, cableTV providers are offering voice services in several Heartland communities, twoMid-Comm communities and are also poised to do so in Mankato. MCTC, MidComm,Heartland and Crystal are also periodically engaged in negotiations orrenegotiations of arrangements for network interconnections and potential unitprice declines with other wireline carriers and contracts with various wirelessservice providers. Although competition from these various sources may result inreduced revenue, HickoryTech cannot, at this time, estimate the potentialimpact related to these events or negotiations.

Competition also exists for some of the HickoryTechservices provided to interexchange carriers, such as dedicated private lines, networkswitching and network routing. This competition comes primarily from theinterexchange carriers themselves, in that carriers may decide that theservices 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 ordered from a general tariff, which is a schedule ofterms, rates and conditions that is approved by the appropriate state orfederal agency. The interexchange carriers primarily control the procurement ofthese services. As interexchange carriers make these service decisions, theyhave the potential to reduce the Company’s revenue in the Telecom Sector. Otherservices, such as the provision of broadband, long distance service, directory advertising,end user equipment and customer billing services are open to competition.

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 customersalternatives to the incumbent communication providers in various communitiesand are offered under the brand name HickoryTech. These services are currentlybeing offered to customers in ten rural communities, encompassing eightexchanges, in Minnesota, as well as three communities, encompassing twoexchanges, in Iowa. Crystal has also been granted the necessary authority toprovide service in another ILEC community in Northwest Iowa. Crystal alsoprovides the long distance service, dial-up and broadband Internet accessservices to HickoryTech’s ILEC subscribers and is providing digital TV in onecommunity served by Mid-Comm, as well as seven CLEC communities.

CLEC activities require Crystal to file for authorityto operate with the appropriate public utilities commission in each state itserves. Crystal competes directly against existing ILEC’s in the areas in whichit operates. Crystal competes directly with incumbent cable TV providers andsatellite for its digital TV services. Crystal is presently providing theseservices under franchise agreements with the local communities. Crystal is notdependent upon any single customer or small group of customers. No singlecustomer in Crystal accounts for ten percent or more of HickoryTech’sconsolidated revenues.

REGULATED INDUSTRY

ILEC Minnesota - HickoryTech’s two Minnesota ILECsubsidiaries continue to operate under an alternative form of regulation asdefined in Minnesota Statutes, Chapter 237, whereby companies with less than50,000 customers are regulated on price and service level rather than profit.In 2005, the Minnesota legislature enacted a statute deregulating multi-linebusinesses in certain metropolitan markets.

The MPUC has been considering intrastate access reformand universal service for several years. In June 2004, the MPUC issued an orderto refer the carrier common line component of the access reform issue to acontested case hearing. In September 2004, the MPUC also referred the localswitching and transport component of the access reform issue for a separatecontested case hearing. The process on both of these dockets was suspended inDecember 2004 subsequent to concerns expressed by state agencies regardingincreases in local rates and the potential that federal activity may alsoaddress this issue. The MPUC officially closed the previous dockets in January2006, however, a similar docket has since been opened on the issue of stateaccess reform. HickoryTech cannot estimate the impact, if any, of futurepotential state access revenue changes.

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The U.S. 8th Circuit Court of Appeals, has upheld a rulingby the United States District Court, District of Minnesota, in issuing aninjunction providing relief from regulation of any service provider of Voiceover Internet Protocol (VoIP) based services in Minnesota. In July 2006, theFederal Communications Commission (FCC) ruled that VoIP services are subject toUniversal Service Fund contribution, however, any further regulation of VoIPunder consideration at the FCC is uncertain. 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 Courtreversed a prior ruling that required cable operators to open up theirhigh-speed Internet lines to competition. In October 2005, the FCC alsoreleased new regulations intended to spur the development of broadbandservices. HickoryTech cannot, at this time, estimate the revenue impact, ifany, related to these events.

ILEC Iowa – HickoryTech’s Iowa ILEC subsidiary isunregulated.

Wireline Interstate – The HickoryTech ILEC companiesdo not participate in the National Exchange Carrier Association (NECA) trafficsensitive pool. Instead, they set their own 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 the periodfrom July 1, 2005 through June 30, 2007. HickoryTech ILEC companies participatein the NECA common line pool. End User Common Line (EUCL) funds collected, arepooled and some of HickoryTech’s revenues are based on settlements distributedfrom the pool. Pool settlements are adjusted periodically.

CLEC – HickoryTech’s CLEC businesses provide servicesin Minnesota, Iowa and Wisconsin with less regulatory oversight than theHickoryTech ILEC companies. Crystal provides local exchange services inMinnesota and Iowa, and Enventis provides their own private line services inMinnesota and Wisconsin. Both Crystal and Enventis also offer long distanceservices. In-state services in Minnesota are regulated by the MPUC with respectto uniform pricing statewide. In-state long distance service in Iowa isunregulated. Long distance services are also deregulated at the federal level(for interstate services), but are subject to annual certification ofgeographical rate averaging and rate integration. Dial-up and broadbandInternet access are unregulated at both the state and federal levels.

In addition to the deregulation granted by Iowa law,the IUB has opened another docket investigating effective competition forseveral additional communities and may authorize additional deregulation forthose communities. This docket includes one community served by Crystal.

Crystal offers digital TV service in the eightMinnesota markets under franchises negotiated with these local municipalities.

Other – HickoryTech’s CLEC interstate access rates areestablished in accordance with an April 2001 FCC order. Under the final phaseof this order, interstate switched access rates for HickoryTech’s CLEC werereduced to levels comparable to those of the ILEC’s in June 2004.

The FCC has an open docket on intercarriercompensation as well as several dockets on VoIP. In February 2005, the FCCissued a Further Notice of Public Rule Making and has received voluminouscomments reflecting diverse opinions for intercarrier compensation reform. Thisprocess continues as an industry group has recently filed another plan (theMissoula Plan) with the FCC for its consideration. HickoryTech cannot predictthe outcome of such proceedings nor can it estimate the impact, if any, onHickoryTech.

HickoryTech companies have entered into a civilcomplaint against a large interexchange carrier related to an access avoidancescheme for prepaid calling card traffic. HickoryTech cannot predict the outcomeof such proceedings nor their impact, if any, on HickoryTech.

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Local Number Portability (LNP) – In 2003, the FCCreleased a decision providing guidance on porting between wireline and wirelessnetworks (inter-modal porting). All of the Company’s wireline operations haveoperated with LNP capabilities since early 2005. The effects of inter-modalporting on the Company’s wireline operations have been minimal to date. It ispossible that these requirements could adversely affect the Company’s wirelineoperating costs and customer growth rates. HickoryTech is unable to quantifythe long-term effects or revenue impact of wireline customers that may switchto wireless or other wireline alternatives.

*INFORMATION SOLUTIONS SECTOR*

Through NIBI, HickoryTech’s Information SolutionsSector provides data processing and related services, principally forHickoryTech, other local exchange telephone companies, CLECs, interexchangenetwork carriers and wireless companies. The Information Solutions Sector’sprincipal activity is the provision of monthly batch processing of computerizeddata for HickoryTech as well as non-affiliated companies. Services fortelephone company customers include the processing of long distance telephonecalls from data sources and telephone switches, the preparation of thesubscriber telephone bills, customer record keeping and carrier access bills.There are a number of companies engaged in supplying data processing servicescomparable to those furnished by the Information Solutions Sector. Competitionis based primarily on price and service. HickoryTech’s Information SolutionsSector has developed an integrated billing and management system calledSuiteSolution. SuiteSolution can provide wireline and wireless carriers theindividual benefits of a billing platform or a total system solution.SuiteSolution is comparable in the majority of functional elements to similarproducts/companies providing end-user billing services for small tomedium-sized independent wireline and wireless service providers in NorthAmerica. Certain features and functionality of SuiteSolution, which are basedon Request for Proposal (RFP) responses, are more highly rated than competingproducts, while other features and functionality may not be as highly rated ascompeting products. HickoryTech Information Solutions counts 18 to 20 companiesas its primary competitors in marketing to small to medium-sized independentwireline and wireless service providers in North America. SuiteSolution doesnot utilize uniquely patentable inventions or technological innovations in theconstruction of the product. Commercially available programming languages areutilized in the development of code that may, based on needs of a prospectiveuser, deliver solutions that are preferred over those of competing products.

*ENTERPRISE SOLUTIONS SECTOR*

Through Collins, HickoryTech’s Enterprise SolutionsSector provides telephone, data and VoIP business systems equipment sales andservices to companies primarily based in metropolitan Minneapolis/St. Paul,Minnesota. This sector also supports the business telephone system service forHickoryTech ILEC and CLEC operations in southern Minnesota and in Iowa. Thecustomers in the Enterprise Solutions Sector’s market are the individualbusiness end users of telecommunications service with ongoing servicerequirement offerings. Enterprise Solutions specializes in complex design,installation and maintenance of voice, data or Internet Protocol products.Enterprise Solutions continues its commitment to service and support its coreproduct line, Nortel, while identifying new opportunities such as call centers,computer telephone integration voice mail and interactive voice responsesystems.

Revenues in the Enterprise Solutions Sector areprimarily earned through the sales, installation and service of businesstelephone and Internet Protocol data systems. HickoryTech’s EnterpriseSolutions Sector is not dependent upon any single customer or small group ofcustomers. No single customer in the Enterprise Solutions Sector accounts forten percent or more of HickoryTech’s consolidated revenues.

Enterprise Solutions does business in a competitivemarket where a large number of companies compete for the sale, installation andservicing of telecommunications equipment and VoIP communications products.Competition is based primarily on price and service. No single company isdominant in this market.

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*ENVENTIS SECTOR*

On December 30, 2005, HickoryTech acquired Enventis.Through Enventis, HickoryTech provides integrated data services, offering fiberoptic-based communication and advanced data services to business communities inthe Upper Midwest. Enventis owns or has long-term leases to approximately 1,500route miles of fiber optic cable. Enventis also has extensive local fiber opticrings that directly connect the Enventis network with its larger clients (e.g.,health care, government and education). Other local fiber rings connect theEnventis network to the local telephone company’s central offices. This allowsEnventis to utilize the telephone company’s connections to access its smallerclients. Enventis serves customers through facilities that are primarily leasedfrom third parties. Enventis has business relationships with Cisco Systems, Inc.and is recognized as a Gold Partner. Enventis is a regional leader in deployingleading edge technologies such as Internet Protocol call centers. Enventis hasoffices located in Plymouth, Duluth and Rochester, Minnesota and Sioux Falls,South Dakota. Enventis provides converged Internet Protocol services that allowall communications (e.g., voice, video and data) to use the same fiberoptic-based delivery technology. Enventis’ product portfolio includes EncompassUnified Communications, which serves small- to medium-sized businesses.Encompass is a hosted or managed Internet Protocol communications serviceincluding local and long distance voice; business Internet Protocol telephonyvia hosted Internet Protocol private branch exchange; unified messaging (asingle inbox for voicemail, e-mail, and fax), and dedicated Internet access.Encompass leverages VoIP or Internet Protocol telephony over a privateconnection, minimizing upfront capital investment and information technologymanagement overhead. VoIP enables advanced functionality, voiceinteroperability with PCs, and scalability. Enventis has been granted authorityto operate from the Public Utility Commissions in Minnesota and Wisconsin forprivate line services that are subject to minimal regulation. Enventis has beengranted Minnesota authority to provide regulated local telephone (voice)services. Those services are provided primarily in a fashion that augments itsVoIP service. Services provided by Enventis compete directly with those fromILEC’s and other providers in the area in which it operates. Enventis is notdependent upon any single customer or small group of customers.

**RESULTS OFOPERATIONS**

CONSOLIDATEDOPERATING RESULTS:

The following is a summarized discussion ofconsolidated results of operations. A more detailed discussion of operatingresults by segment follows this discussion. The operating results of theEnventis Sector do not include a comparison to prior periods due to theacquisition date of December 30, 2005.

OPERATINGREVENUES:

Consolidated operating revenues were $35,955,000,which is $13,651,000 or 61.2% higher in the three months ended September 30,2006 compared to the three months ended September 30, 2005. Without the newEnventis Sector revenues, total consolidated operating revenues would havedecreased 1.4% in the third quarter of 2006 compared to the third quarter of2005. This decrease was primarily due to decreases in other revenues andnetwork access in the Telecom Sector, decreased installation revenue in theEnterprise Solutions Sector and decreased revenue from unaffiliated customersin the Information Solutions Sector, but was partially offset by increases indata revenue and digital TV revenue in the Telecom Sector and increases inservice revenue in the Enterprise Solutions Sector. The Enventis Sectorcontributed $13,972,000 of revenue to total HickoryTech consolidated operatingrevenues in the third quarter of 2006, compared to revenues of $14,084,000 and$15,178,000 in the first and second quarters, respectively, of 2006.

Consolidated operating revenues were $108,065,000,which is $37,385,000 or 52.9% higher in the nine months ended September 30,2006 compared to the nine months ended September 30, 2005. Without the newEnventis Sector revenues, total consolidated operating revenues would havedecreased 8.3% in the first nine months of 2006 compared to the first ninemonths of 2005. This decrease was primarily due to decreased installationrevenue in the Enterprise Solutions Sector, decreases in network access and otherrevenues in the Telecom Sector and decreased revenue from unaffiliatedcustomers in the Information Solutions Sector, but was partially offset byincreases in data revenue and digital TV revenue in the Telecom Sector, andincreased service revenue in the Enterprise Solutions Sector. The EnventisSector contributed $43,234,000 of revenue to total HickoryTech consolidatedoperating revenues in the first nine months of 2006.

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COST OF SALES,ENTERPRISE SOLUTIONS AND ENVENTIS:

Cost of sales, which isrelated to the Enterprise Solutions and Enventis Sectors, was $9,493,000, whichis $7,354,000 or 343.8% higher in the three months ended September 30, 2006compared to the three months ended September 30, 2005. Without the new EnventisSector costs of sales, cost of sales from the Enterprise Solutions Sector wouldhave been $2,310,000, which is $171,000 or 8.0% higher in the third quarter of2006 compared to the third quarter of 2005. This increase was primarily due toincreases in materials of $238,000 and warranty adjustments of $79,000, but waspartially offset by decreases in labor of $154,000. The portion of the cost of sales line item which is attributable to theEnventis Sector was $7,183,000 in the third quarter of 2006, compared to costof sales of $7,683,000 and $8,456,000 in the first and second quarters,respectively, of 2006.

Cost of sales was$28,990,000, which is $21,146,000 or 269.6% higher in the nine months endedSeptember 30, 2006 compared to the nine months ended September 30, 2005.Without the new Enventis Sector costs of sales, cost of sales from theEnterprise Solutions Sector would have been $5,668,000, which is $2,176,000 or27.7% lower in the first nine months of 2006 compared to the first nine monthsof 2005. This decrease was largely the result of the $2,155,000 decrease inmaterial costs due to lower installation work volume. The portion of the cost of sales line item which is attributable tothe Enventis Sector was $23,322,000 in the first nine months of 2006.

COST OF SERVICES (excluding Depreciation and Amortization):

Costof services (excluding depreciation and amortization) were $11,535,000, whichis $3,181,000 or 38.1% higher in the third quarter of 2006 compared to thethird quarter of 2005. Without the new Enventis cost of services, total cost ofservices would have been $8,215,000, which is $139,000 or 1.7% lower in thethird quarter of 2006 compared to the third quarter of 2005. This decrease wasprimarily due to the reassignment of support staff of $122,000 in wages andbenefits, which are now being reflected in the selling, general andadministrative expenses (excluding depreciation and amortization) in theInformation Solutions Sector, the decrease in inventory valuation expense of$111,000 and decreased operations staff and data engineering wages and benefitsof $77,000, both in the Enterprise Solutions Sector, offset by increased costof services in the Telecom Sector of $67,000. Cost of services, which wereattributable to the Enventis Sector, were $3,320,000 in the third quarter of2006, compared to cost of services of $2,687,000 and $2,932,000 in the first and second quarters, respectively, of2006.

Costof services (excluding depreciation and amortization) were $33,709,000, whichis $9,013,000 or 36.5% higher in the first nine months of 2006 compared to thefirst nine months of 2005. Without the new Enventis cost of services, totalcost of services would have been $24,770,000, which is $74,000 or 0.3% higherin the first nine months of 2006 compared to the first nine months of 2005.This increase was primarily due to the increased cost of services in theTelecom Sector of $487,000, which was the result of normal inflationary increases in labor and services such as transportcosts. In the Telecom Sector, even when revenues are declining, particularlywhen the revenue decrease is for network access service to interexchangecarrier customers, there is not a direct association between revenue trends andexpense levels. Consequently, the level of cost of service can still haveinflationary increases even when the volume of revenue has gone down. Alsocontributing to the increase in cost of services was increased maintenancecontract expense of $91,000 and the increase in costs recognized fromoutsourced contractor work of $72,000, both in the Information SolutionsSector, but this amount was offset by the $272,000 decrease in wages andbenefits due to the reassignment of support staff, which are now being reflectedin the selling, general and administrative expenses (excluding depreciation andamortization), decreased software expense of $155,000 and decreased bad debtexpense of $87,000, all in the Information Solutions Sector, and decreasedoperations staff and data engineering wages and benefits of $90,000 and adecrease in the inventory valuation expense of 52,000, both in the EnterpriseSolutions Sector. Cost of services, which were attributable to theEnventis Sector were $8,939,000 in the nine months ended September 30, 2006.

 

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SELLING, GENERALAND ADMINISTRATIVE EXPENSES (excluding Depreciation and Amortization):

Selling, generaland administrative expenses (excluding depreciation and amortization) were$6,452,000, which is $2,877,000 or 80.5% higher in the third quarter of 2006compared to the third quarter of 2005. Without the new Enventis Sector, totalselling, general and administrative expenses would have been $4,395,000, whichis $820,000 or 22.9% higher in the third quarter of 2006 compared to the thirdquarter of 2005. This increase was primarily due to the $190,000 increase inwages and benefits in the Telecom Sector and the increase in wages and benefitsof $190,000 in the Information Solutions Sector, which was the result of thereassignment of support staff of $122,000 in wages and benefits from costs ofservices (excluding depreciation and amortization) and normal inflationaryincreases in wages. Also contributing to the increase in selling, general andadministrative expenses was an increase in wages and benefits of $185,000 andan increase in outside accounting fees of $90,000, both of which are corporateexpenses, and the increase in staff technician and administration wages of$65,000, the increase in sales commissions of $62,000, and the increase in baddebt expense of $39,000, all in the Enterprise Solutions Sector. Selling,general and administrative expenses attributable to the Enventis Sector were$2,057,000, compared to selling, general and administrative expenses of$2,410,000 and $2,291,000 in the first and second quarters, respectively, of2006.

Selling, general andadministrative expenses (excluding depreciation and amortization) were$19,968,000, which is $7,944,000 or 66.1% higher in the first nine months of2006 compared to the first nine months of 2005. Without the new EnventisSector, total selling, general and administrative expenses would have been$13,210,000, which is $1,186,000 or 9.9% higher in the first nine months of2006 compared to the first nine months of 2005. This increase was primarily dueto the following: (1) in the Information Solutions Sector, (a) a $431,000increase in wages and benefits, which was the result of the reassignment ofsupport staff of $272,000 in wages and benefits from cost of services (excludingdepreciation and amortization) and normal inflationary increases in wages, and (b) a $72,000 increase in consultingfees; (2) corporate expenses including, (a) $254,000 of non-recurringseparation costs due to the departure of the Company’s former Chief ExecutiveOfficer, (b) an increase of $243,000 in consulting fees, (c) an increase of$158,000 in accounting fees, (d) an increase of $127,000 in post retirementbenefits, and a (e) a $119,000 increase in director’s fees; (3) in the Telecom Sector, an $89,000increase in expenses. The increase was partially offset by $329,000 of one-time fees associated with thetermination of leases in the second quarter of 2005 and the $56,000 decrease inpost-retirement benefits, both in the Information Solutions Sector and the$18,000 decrease in expenses in the Enterprise Solutions Sector. Selling,general and administrative expenses attributable to the Enventis Sector were$6,758,000 in the first nine months of 2006. Enventis selling, general andadministrative expenses of approximately $550,000, $1,100,000 and $1,650,000 inthe three, six and nine months ended September 30, 2006, respectively, were dueto acquisition integration costs, which are one-time costs incurred in thefirst year after the Enventis acquisition and are not expected to recur in2007.

DEPRECIATION ANDAMORTIZATION:

Depreciation expense was$4,260,000, which is $716,000 or 20.2% higher in the three months endedSeptember 30, 2006 compared to the three months ended September 30, 2005.Without the new Enventis Sector, total depreciation expense would have been$3,791,000, which is $247,000 or 7.0% higher in the third quarter of 2006compared to the third quarter of 2005. This increase was primarily due to anincrease in the Telecom Sector’s network assets. The increase in depreciationin the third quarter of 2006 reverses a trend of decreases initiated in thethird quarter of 2005 when central office equipment became fully depreciated inthe Telecom Sector. Depreciation expense attributable to the Enventis Sectorwas $469,000 in the third quarter of 2006, compared to depreciation expense of$476,000 and $505,000 in the first and second quarter, respectively, of 2006.

Depreciation expense was$12,569,000, which is $981,000 or 8.5% higher in the nine months endedSeptember 30, 2006 compared to the nine months ended September 30, 2005.Without the new Enventis Sector, total depreciation expense would have been$11,120,000, which is $469,000 or 4.0% lower in the first nine months of 2006compared to the first nine months of 2005. This decrease was primarily due tocentral office equipment becoming fully depreciated in the third quarter of2005 in the Telecom Sector. Depreciation expense attributable to the EnventisSector was $1,449,000 in the first nine months of 2006.

Amortization expense was$293,000, which is $267,000 or 1,026.9% higher in the three months endedSeptember 30, 2006 compared to the three months ended September 30, 2005.Without the new Enventis Sector, total amortization expense would have been$30,000 in the third quarter of 2006, compared to $26,000 in the third quarterof 2005.

 

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Amortization expense was$879,000, which is $412,000 or 88.2% higher in the nine months ended September30, 2006 compared to the nine months ended September 30, 2005. Without the newEnventis Sector, total amortization expense would have been $91,000, which is$376,000 or 80.5% lower in the first nine months of 2006 compared to the firstnine months of 2005. This decrease was primarily due to internally developed billingsoftware in the Information Solutions Sector becoming fully amortized in thesecond quarter of 2005. Amortization expense attributable to the EnventisSector was $788,000 in the first nine months of 2006.

OPERATING INCOME:

Operating income was $3,922,000,which is $744,000 or 15.9% lower in the three months ended September 30, 2006compared to the three months ended September 30, 2005. Without the new EnventisSector, operating income would have been $3,242,000, which is $1,424,000 or30.5% lower in the third quarter of 2006 compared to the third quarter of 2005.The decrease in total operating income was due to the $7,354,000 increase incost of sales, the $3,181,000 increase in cost of services (excludingdepreciation and amortization), $2,877,000 increase in selling, general andadministrative expenses (excluding depreciation and amortization), the $716,000increase in  depreciation and the$267,000 increase in amortization, described above. These expense increaseswere partially offset by the $13,651,000 increase in operating revenues alsodescribed above. The Enventis Sector contributed $680,000 of operating incomein the third quarter of 2006, compared to $567,000 and $731,000 in the firstand second quarters, respectively, of 2006.

Operating income was$11,950,000, which is $2,111,000 or 15.0% lower in the nine months endedSeptember 30, 2006 compared to the nine months ended September 30, 2005.Without the new Enventis Sector, operating income would have been $9,972,000,which is $4,089,000 or 29.1% lower in the nine months ended September 30, 2006compared to the nine months ended September 30, 2005. The decrease in totaloperating income was due to the $21,146,000 increase in cost of sales, the$9,013,000 increase in cost of services (excluding depreciation andamortization), the $7,944,000 increase in selling, general and administrativeexpenses (excluding depreciation and amortization), the $981,000 increase indepreciation and the $412,000 increase in amortization described above. Theseexpense increases were partially offset by the $37,385,000 increase inoperating revenues, also described above. The Enventis Sector contributed$1,978,000 of operating income in the first nine months of 2006.

INTEREST EXPENSE:

Interestexpense was $1,913,000, which is $789,000 or 70.2% higher in the threemonths ended September 30, 2006 compared to the three months ended September30, 2005. Interest expense increased$2,265,000 or 72.4% to $5,393,000 in the nine months ended September 30,2006 compared to the nine months ended September 30, 2005. The increase in interest expense for both thethree and nine month periods ended September 30, 2006 compared to thecorresponding periods ending September 30, 2005, was primarily due to anincrease in total debt outstanding and to an increase in the average effectiveinterest rate on outstanding debt of 0.10 percent to 5.85 percent. The proceedsfrom the increase in total debt outstanding were used to repay the outstandingobligations under the previous credit facility, pay fees and expensesassociated with the new credit facility and pay costs associated with theacquisition of Enventis. The outstanding balance of the revolving creditfacility was $143,025,000 at September 30, 2006 and $94,750,000 at September30, 2005.

INCOME TAXES:

The effective income taxrate of approximately 37.2% for the third quarter of 2006 and 40.5% for thethird quarter of 2005 exceeds the federal statutory rate primarily due to stateincome taxes.  The 2006 rate is significantlylower than the 2005 rate due to a $158,000 tax reserve that was reversed in thethird quarter in order to comply with Accounting Standards Statement 109.  This reversal was due to a tax reserverelated to a prior year federal audit period which was closed due to the expirationof the statute of limitations.

 

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INCOME FROM CONTINUING OPERATIONS:

Consolidatedincome from continuing operations was $1,445,000, which is $685,000 or 32.2%lower in the three months ended September 30, 2006 compared to the threemonths ended September 30, 2005. Without the new Enventis Sector, income fromcontinuing operations would have been $1,042,000, which is $1,088,000 or 51.1%lower in the third quarter of 2006 compared to the third quarter of 2005. Thedecrease in total income from continuing operations was primarily due to the$7,354,000 increase in cost of sales, the $3,181,000 increase in cost ofservices (excluding depreciation and amortization), the $2,877,000 increase inselling, general and administrative expenses (excluding depreciation andamortization), the $789,000 increase in interest expense, the $716,000 increasein depreciation and the $267,000 increase in amortization described above.These expense increases were partially offset by the $13,651,000 increase inoperating revenues also described above. The Enventis Sector contributed$403,000 of net income in the third quarter of 2006, compared to $338,000 and$437,000 in the first and second quarters, respectively, of 2006.

 

Consolidatedincome from continuing operations was $4,208,000, which is $2,347,000 or 35.8%lower in the nine months ended September 30, 2006 compared to the ninemonths ended September 30, 2005. Without the new Enventis Sector, income fromcontinuing operations would have been $3,030,000, which is $3,525,000 or 53.8%lower in the nine months ended September 30, 2006 compared to the nine monthsended September 30, 2005. The decrease in total income from continuingoperations was due to the $21,146,000 increase in cost of sales, the $9,013,000increase in cost of services (excluding depreciation and amortization), the$7,944,000 increase in selling, general and administrative expenses (excludingdepreciation and amortization), the $2,265,000 increase in interest expense,the $981,000 increase in depreciation and the $412,000 increase in amortizationdescribed above. These expense increases were partially offset by the$37,385,000 increase in operating revenues also described above. The EnventisSector contributed $1,178,000 of net income in the first nine months of 2006.

 

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SECTOR RESULTS OF OPERATIONS FROM CONTINUING OPERATIONS

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

**TELECOMSECTOR**
| ** **                                                                                     | ** ** | **Three Months Ended**     | ** ** | **Nine Months Ended** | ** ** |
|------------------------------------------------------------------------------------------------|------------|--------------------------------------|------------|---------------------------------|------------|
| ** **                                                                                     | ** ** | **September 30**                | ** ** | **September 30**           | ** ** |
| ** **                                                                                     | ** ** | **2006**                             | ** ** | **2005**                        | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                                                                     | ** ** | **(Dollars in Thousands)** | ** ** |
|                                                                                           |       |                                 |       |                            |       |   |   |   |   |
| Revenues before  intersegment eliminations:                                                    |       |                                 |       |                            |       |   |   |   |   |
| ILEC:                                                                                          |       |                                 |       |                            |       |   |   |   |   |
| Local service                                                                                  | ** ** | **$**                                | **3,678**  |                            | $          | 3,720 | ** ** | **$** | **11,077** |   | $ | 11,198 |   |
| Network access                                                                                 | ** ** | **7,086**                            |       | 7,317                           | ** ** | **20,851** |   | 24,175 |   |
| Data                                                                                           | ** ** | **806**                              |       | 606                             | ** ** | **2,150** |   | 1,766 |   |
| Intersegment                                                                                   | ** ** | **64**                               |       | 51                              | ** ** | **167** |   | 154 |   |
| Other                                                                                          | ** ** | **1,479**                            |       | 1,738                           | ** ** | **4,560** |   | 4,962 |   |
| Total ILEC                                                                                     | ** ** | **13,113**                           |       | 13,432                          | ** ** | **38,805** |   | 42,255 |   |
|                                                                                           |       |                                 |       |                            |       |   |   |   |   |
| CLEC:                                                                                          |       |                                 |       |                            |       |   |   |   |   |
| Local service                                                                                  | ** ** | **872**                              |       | 886                             | ** ** | **2,644** |   | 2,658 |   |
| Network access                                                                                 | ** ** | **476**                              |       | 474                             | ** ** | **1,467** |   | 1,486 |   |
| Data                                                                                           | ** ** | **839**                              |       | 647                             | ** ** | **2,371** |   | 1,895 |   |
| Intersegment                                                                                   | ** ** | **13**                               |       | 0                               | ** ** | **13** |   | 0 |   |
| Other                                                                                          | ** ** | **270**                              |       | 441                             | ** ** | **1,440** |   | 1,336 |   |
| Total CLEC                                                                                     | ** ** | **2,470**                            |       | 2,448                           | ** ** | **7,935** |   | 7,375 |   |
|                                                                                           |       |                                 |       |                            |       |   |   |   |   |
| Long distance                                                                                  | ** ** | **1,252**                            |       | 1,244                           | ** ** | **3,654** |   | 3,605 |   |
|                                                                                           |       |                                 |       |                            |       |   |   |   |   |
| Internet                                                                                       | ** ** | **1,072**                            |       | 1,076                           | ** ** | **3,355** |   | 3,247 |   |
|                                                                                           |       |                                 |       |                            |       |   |   |   |   |
| Digital TV                                                                                     | ** ** | **386**                              |       | 234                             | ** ** | **990** |   | 686 |   |
|                                                                                           |       |                                 |       |                            |       |   |   |   |   |
| Total Telecom revenues                                                                         | ** ** | **$**                                | **18,293** |                            | $          | 18,434 | ** ** | **$** | **54,739** |   | $ | 57,168 |   |
|                                                                                           |       |                                 |       |                            |       |   |   |   |   |
| Total Telecom revenues  before intersegment eliminations:                                      |       |                                 |       |                            |       |   |   |   |   |
| Unaffiliated  customers                                                                        | ** ** | **$**                                | **18,216** |                            | $          | 18,383 | ** ** | **$** | **54,559** |   | $ | 57,014 |   |
| Intersegment                                                                                   | ** ** | **77**                               |       | 51                              | ** ** | **180** |   | 154 |   |
|                                                                                           | ** ** | **18,293**                           |       | 18,434                          | ** ** | **54,739** |   | 57,168 |   |
|                                                                                           |       |                                 |       |                            |       |   |   |   |   |
| Cost of services  (excluding depreciation and amortization)                                    | ** ** | **7,498**                            |       | 7,431                           | ** ** | **22,876** |   | 22,389 |   |
|                                                                                           |       |                                 |       |                            |       |   |   |   |   |
|  Selling, general, and administrative  expenses (excluding depreciation and amortization) | ** ** | **3,044**                            |       | 2,892                           | ** ** | **8,429** |   | 8,340 |   |
| Depreciation and  amortization                                                                 | ** ** | **3,397**                            |       | 3,123                           | ** ** | **9,895** |   | 10,223 |   |
| Operating income                                                                               | ** ** | **$**                                | **4,354**  |                            | $          | 4,988 | ** ** | **$** | **13,539** |   | $ | 16,216 |   |
|                                                                                           |       |                                 |       |                            |       |   |   |   |   |
| Income from continuing  operations, net of tax                                                 | ** ** | **$**                                | **2,567**  |                            | $          | 2,970 | ** ** | **$** | **8,095** |   | $ | 9,654 |   |
| Income from  discontinued operations                                                           | ** ** | **—**                           |       | 22                              | ** ** | **—** |   | 123 |   |
| Net income                                                                                     | ** ** | **$**                                | **2,567**  |                            | $          | 2,992 | ** ** | **$** | **8,095** |   | $ | 9,777 |   |
|                                                                                           |       |                                 |       |                            |       |   |   |   |   |
| Capital expenditures                                                                           | ** ** | **$**                                | **4,828**  |                            | $          | 4,603 | ** ** | **$** | **11,399** |   | $ | 8,653 |   |

 

** **

28

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** **
| ** **                       | ** ** | **Nine Months Ended** | ** ** |
|----------------------------------|------------|---------------------------------|------------|
| ** **                       | ** ** | **September 30**           | ** ** |
| ** **                       | ** ** | **2006**                        | ** ** | **2005** | ** ** |
| ** **                       | ** ** | **(In Thousands)**         | ** ** |
|                             |       |                            |       |   |   |
| ILEC access lines                | ** ** | **54,568**                      |       | 57,080 |   |
|                             |       |                            |       |   |   |
| CLEC access lines                |       |                            |       |   |   |
| Overbuild                        | ** ** | **11,454**                      |       | 11,094 |   |
| Unbundled network  element (UNE) | ** ** | **1,467**                       |       | 1,656 |   |
| Total service resale  (TSR)      | ** ** | **1,340**                       |       | 1,592 |   |
| Total                            | ** ** | **14,261**                      |       | 14,342 |   |
|                             |       |                            |       |   |   |
| Long distance customers          | ** ** | **40,959**                      |       | 40,936 |   |
|                             |       |                            |       |   |   |
| Internet customers               | ** ** | **19,678**                      |       | 18,028 |   |
|                             |       |                            |       |   |   |
| Total Telecom customers          | ** ** | **129,466**                     |       | 130,386 |   |
|                             |       |                            |       |   |   |
| DSL customers                    | ** ** | **15,076**                      |       | 12,372 |   |
|                             |       |                            |       |   |   |
| Digital TV customers             | ** ** | **4,254**                       |       | 2,573 |   |

 

Revenues:

Telecom Sectoroperating revenues before intersegment eliminations were $18,293,000, which is$141,000 or 0.8% lower in the three months ended September 30, 2006 compared tothe three months ended September 30, 2005. The decrease was primarily due tothe $430,000 decrease in other revenue and $229,000 decrease in network accessrevenues, but was offset by increases in revenue from data of $392,000 anddigital TV of $152,000.

Telecom Sectoroperating revenues before intersegment eliminations were $54,739,000, which is$2,429,000 or 4.2% lower in the nine months ended September 30, 2006 comparedto the nine months ended September 30, 2005. The decrease was primarily due tothe $3,343,000 decrease in network access revenue and $298,000 decrease inother revenue, but was offset by increases in revenue from data of $860,000 anddigital TV of $304,000.

ILEC local servicerevenue was $3,678,000, which is $42,000 or 1.1% lower in the three monthsended September 30, 2006 compared to the three months ended September 30, 2005and $11,077,000, which is $121,000 or 1.1% lower in the nine months endedSeptember 30, 2006 compared to the nine months ended September 30, 2005. Thedecrease in ILEC local service revenue for both the three and nine monthperiods ended September 30, 2006 compared to September 30, 2005 was the resultof 2,512 fewer customer access lines at September 30, 2006 than at September30, 2005.

ILEC networkaccess revenue was $7,086,000, which is $231,000 or 3.2% lower in the threemonths ended September 30, 2006 compared to the three months ended September30, 2005. The decrease was primarily due to lower overall minutes of use andthe recognition of the impact of different treatment of traffic delivered viaQwest Communications. The level of the network access revenue decline is moremoderate than in preceding quarters because an interstate rate decrease institutedon July 1, 2005 has now been in place for a full year.

29

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ILEC networkaccess revenue was $20,851,000, which is $3,324,000 or 13.7% lower in the ninemonths ended September 30, 2006 compared to the nine months ended September 30,2005. The decrease was primarily due to interstate rate decreases on July 1,2005, lower overall minutes of use and the recognition of the impact ofdifferent treatment of traffic delivered via Qwest Communications, all of whichare expected to be lasting in nature. A combination of changing minutes of use,carriers optimizing their network costs and lower demand for dedicated linesmay negatively impact future access revenues. In addition, future federal orstate access reform may provide further negative influences.

ILEC data revenuewas $806,000, which is $200,000 or 33.0% higher in the three months endedSeptember 30, 2006 compared to the three months ended September 30, 2005 and$2,150,000, which is $384,000 or 21.7% higher in the nine months endedSeptember 30, 2006 compared to the nine months ended September 30, 2005. Theincrease in ILEC data revenue for both the three and nine month periods endedSeptember 30, 2006 compared to September 30, 2005 was primarily due toincreased broadband services to business customers, 2,704 more residentialDigital Subscriber Line (DSL) customers at September 30, 2006 than at September30, 2005 and DSL customers migrating from lower speed DSL products to higherspeed DSL products, which have the effect of increasing revenue per customer.

ILEC other revenuewas $1,479,000, which is $259,000 or 14.9% lower in the three months endedSeptember 30, 2006 compared to the three months ended September 30, 2005. Thedecrease was primarily due to decreases in sales of customer premise equipment(CPE) of $157,000, decreased add/move/change revenue of $66,000 and decreasedmiscellaneous revenue of $13,000.

ILEC other revenuewas $4,560,000, which is $402,000 or 8.1% lower in the nine months endedSeptember 30, 2006 compared to the nine months ended September 30, 2005. Thedecrease was primarily due to decreased add/move/change revenue of $109,000,decreased circuit private line revenue of $99,000, decreased features revenueof $89,000, decreased billing and collection revenue of $85,000, decreased CPEsales of $51,000 and decreased miscellaneous revenue of $44,000, but waspartially offset by a $103,000 increase in directory revenue.

CLEC local servicerevenue was $872,000, which is $14,000 or 1.6% lower in the three months endedSeptember 30, 2006 compared to the three months ended September 30, 2005 and$2,644,000, which is $14,000 or 0.5% lower in the nine months ended September30, 2006 compared to the nine months ended September 30, 2005. The decrease inCLEC local service revenue for both the three and nine month periods endedSeptember 30, 2006 compared to September 30, 2005 was the result of 81 fewercustomer access lines at September 30, 2006 than at September 30, 2005.Although total customer lines have decreased, the Company continues to replaceless profitable unbundled network element and total service resale customerswith more profitable network overbuild customers.

CLEC network access revenue was $476,000, which is $2,000 or 0.4%higher in the three months ended September 30, 2006 compared to the threemonths ended September 30, 2005 and $1,467,000, which is $19,000 or 1.3% lowerin the nine months ended September 30, 2006 compared to the nine months endedSeptember 30, 2005. The decrease in the nine months ended September 30, 2006compared to the nine months ended September 30, 2005 was primarily due to loweroverall minutes of use, but was partially offset by higher billings in June2006 for intrastate access. A combination of changing minutes of use,carriers optimizing their network costs, and lower demand for dedicated linesmay negatively impact future access revenues. In addition, future federal orstate access reform may provide further negative influences.

CLEC data revenue was $839,000, which is $192,000 or 29.7% higher inthe three months ended September 30, 2006 compared to the three months endedSeptember 30, 2005. CLEC data revenue was $2,371,000, which is $476,000 or25.1% higher in the nine months ended September 30, 2006 compared to the ninemonths ended September 30, 2005. The increase in CLEC data revenue forboth the three and nine month periods ended September 30, 2006 compared toSeptember 30, 2005 was primarily due to increased residential and business DSL penetration in CLEC communities, as wellas the rollout of Ethernet broadband services to large business customers in2005. Ethernet service revenues will continue to provide growth opportunitiesfor HickoryTech. Expanded networking opportunities among medium and largeenterprise customers are key drivers for this growth.

 

30

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CLEC other revenue was $270,000, which is $171,000 or 38.8% lower inthe three months ended September 30, 2006 compared to the three months endedSeptember 30, 2005. The decrease was primarily due to the loss of revenueassociated with the SOCRATES contract (see below) of $276,000, but waspartially offset by an increase in CPE sales of $117,000.

CLEC other revenue was $1,440,000, which is $104,000 or 7.8% higher inthe nine months ended September 30, 2006 compared to the nine months endedSeptember 30, 2005. The increase was primarily due to a $320,000 increase inCPE sales, a $29,000 increase in late fees, a $21,000 increase in miscellaneousrevenue and a $19,000 increase in installation revenue, but was partiallyoffset by a $301,000 decrease in SOCRATES revenue (see below), which began inthe third quarter of 2006.

In January 2006, HickoryTech was informed that its bid to renew itsmulti-year contract with Project SOCRATES (South Central Regional AreaTelecommunications System) was not accepted. HickoryTech had been providingInternet access and video conferencing for Project SOCRATES, which is adistance-learning network connecting schools and libraries in a 12-countyregion in south central Minnesota. HickoryTech’s contract with Project SOCRATESended on June 30, 2006. During the transition period to a new carrier in Julyand August 2006, HickoryTech continued to provide services to Project SOCRATESand recognized other revenues of $73,000 in the third quarter of 2006.HickoryTech expects CLEC’s other revenues will decrease by approximately$350,000 in the fourth quarter of 2006 associated with the loss of revenuesfrom this contract. There will be a smaller associated level of decrease incost of services associated with these revenue declines in the fourth quarterof 2006.

Long distance revenue was $1,252,000, which is $8,000 or 0.6% higher inthe three months ended September 30, 2006 compared to the three months endedSeptember 30, 2005. Long distance revenue was $3,654,000, which is $49,000 or1.4% higher in the nine months ended September 30, 2006 compared to the ninemonths ended September 30, 2005. The long distance customer base increased 23or 0.1% between September 30, 2005 and September 30, 2006. A combination of theslight increase in the customer base and higher long distance usage percustomer resulted in increased revenues in the three and nine months endedSeptember 30, 2006 compared to the three and nine months ended September 30,2005.

Internetrevenue was $1,072,000, which is $4,000 or 0.4% lower in the three months endedSeptember 30, 2006 compared to the three months ended September 30, 2005. Thedecrease was primarily due to a reallocation of service package revenue, whichis now being reflected in the data revenue.

Internet revenue was $3,355,000, which is $108,000 or 3.3% higher inthe nine months ended September 30, 2006 compared to the nine months endedSeptember 30, 2005. The increase in the nine months ended September 30, 2006compared to the nine months ended September 30, 2005 was primarily due to anincrease in Internet customers of 1,650 or 9.2% between September 30, 2005 andSeptember 30, 2006.

Digital TV revenue was $386,000, which is $152,000 or 65.0% higher inthe three months ended September 30, 2006 compared to the three months endedSeptember 30, 2005. Digital TV revenue was $990,000, which is $304,000 or 44.3%higher in the nine months ended September 30, 2006 compared to the nine monthsended September 30, 2005. The increase in digital TV revenue for boththe three and nine month periods ended September 30, 2006 compared to September30, 2005 was primarily the result of theoffering of digital TV in three additional communities in the latter half of2005 and three additional communities in 2006, which resulted in a 1,681 or65.3% increase in digital TV customers at September 30, 2006 compared toSeptember 30, 2005.

Cost of Services (excluding Depreciation and Amortization):

Cost of services (excluding depreciation and amortization) were$7,498,000, which is $67,000 or 0.9% higher in the three months ended September30, 2006 compared to the three months ended September 30, 2005. Decreases incosts associated with the Project SOCRATES, which ended in the third quarter of2006, enabled the costs of services in the third quarter of 2006 to remainrelatively static compared to the third quarter of 2005.

 

31

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Cost of services (excluding depreciation and amortization) was$22,876,000, which is $487,000 or 2.2% higher in the nine months endedSeptember 30, 2006 compared to the nine months ended June 30, 2005. Theincrease in cost of services in the nine months ended September 30, 2006compared to the nine months ended September 30, 2005 was primarily due tonormal inflationary increases in labor and services such as transport costs. Inthe Telecom Sector, even when revenues are declining, particularly when therevenue decrease is for network access service to interexchange carriercustomers, there is not a direct association between revenue trends and expenselevels. Consequently, the level of cost of service can still have inflationaryincreases even when the volume of revenue has gone down.

Selling, General and Administrative Expenses (excluding Depreciationand Amortization):

Selling, general and administrative expenses (excluding depreciationand amortization) were $3,044,000, which is $152,000 or 5.3% higher in thethree months ended September 30, 2006 compared to the three months endedSeptember 30, 2005. The increase was primarily due to a $190,000 increase inwages and benefits.

Selling, general and administrative expenses (excluding depreciationand amortization) were $8,429,000, which was $89,000 or 1.1% higher in the ninemonths ended September 30, 2006 compared to the nine months ended September 30,2005.

Depreciation and Amortization:

Depreciation and amortization were $3,397,000, which is $274,000 or8.8% higher in the three months ended September 30, 2006 compared to the threemonths ended September 30, 2005. The increase was primarily due to an increasein network assets. The increase in depreciation and amortization in the thirdquarter of 2006 changes a trend of decreases initiated in the third quarter of2005 when central office equipment became fully depreciated.

Depreciation and amortization were $9,895,000, which is $328,000 or3.2% lower in the nine months ended September 30, 2006 compared to the ninemonths ended September 30, 2005. The decrease in depreciation expense wasprimarily due to central office switching equipment becoming fully depreciatedin the third quarter of 2005.

Operating Income and Income from ContinuingOperations, net of tax:

Operating income was $4,354,000, which is $634,000 or 12.7% lower inthe three months ended September 30, 2006 compared to the three months endedSeptember 30, 2005. Income from continuing operations, net of tax was$2,567,000, which is $403,000 or 13.6% lower in the three months endedSeptember 30, 2006 compared to the three months ended September 30, 2005. Thedecreases in operating income and net income from continuing operations, net oftax were driven by the $274,000 increase in depreciation and amortization, the$152,000 increase in selling, general and administrative expenses (excludingdepreciation and amortization), the $141,000 decrease in revenue and the$67,000 increase in cost of services (excluding depreciation and amortization)described above.

Operating income was$13,539,000, which is $2,677,000 or 16.5% lower in the nine months endedSeptember 30, 2006 compared to the nine months ended September 30, 2005. Netincome from continuing operations, net of tax was $8,095,000, which is$1,559,000 or 16.1% lower in the nine months ended September 30, 2006 comparedto the nine months ended September 30, 2005. The decreases in operating incomeand net income from continuing operations, net of tax were driven by the$2,429,000 decrease in revenue, the $487,000 increase in cost of services(excluding depreciation and amortization) and the $89,000 increase in selling,general and administrative expenses (excluding depreciation and amortization)described above, but were partially offset by the $328,000 decrease indepreciation and amortization, also described above.

32

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INFORMATION SOLUTIONS — The following table provides a breakdown of the InformationSolutions Sector operating results.

**INFORMATIONSOLUTIONS SECTOR**
| ** **                                                                              | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-----------------------------------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                                              | ** ** | **September 30**            | ** ** | **September 30**           | ** ** |
| **(In Thousands)**                                                                 | ** ** | **2006**                         | ** ** | **2005**                        | ** ** | **2006** | ** ** | **2005** | ** ** |
| Revenues before  eliminations:                                                          |       |                             |       |                            |       |   |   |   |   |
| Unaffiliated  customers                                                                 | ** ** | **$**                            | **482**    |                            | $          | 519 | ** ** | **$** | **1,705** |   | $ | 1,921 |   |
| Intersegment                                                                            | ** ** | **972**                          |       | 1,056                           | ** ** | **3,249** |   | 3,239 |   |
| ** **                                                                              | ** ** | **1,454**                        |       | 1,575                           | ** ** | **4,954** |   | 5,160 |   |
| Cost of services  (excluding depr. and amort.)                                          | ** ** | **1,286**                        |       | 1,424                           | ** ** | **3,902** |   | 4,201 |   |
| Selling, general and  administrative expenses (excluding depreciation and amortization) | ** ** | **428**                          |       | 175                             | ** ** | **1,341** |   | 1,057 |   |
| Depreciation and  amortization                                                          | ** ** | **384**                          |       | 403                             | ** ** | **1,175** |   | 1,698 |   |
|                                                                                    |       |                             |       |                            |       |   |   |   |   |
| Operating loss                                                                          | ** ** | **$**                            | **(644**   | **)**                           | $          | (427 | ) | **$** | **(1,464** | **)** | $ | (1,796 | ) |
| Net loss                                                                                | ** ** | **$**                            | **(393**   | **)**                           | $          | (262 | ) | **$** | **(897** | **)** | $ | (1,091 | ) |
|                                                                                    |       |                             |       |                            |       |   |   |   |   |
| Capital expenditures                                                                    | ** ** | **$**                            | **472**    |                            | $          | 866 | ** ** | **$** | **976** |   | $ | 1,424 |   |

 

Revenues:

Operating revenues from unaffiliated customers were $482,000, which is$37,000 or 7.1% lower in the three months ended September 30, 2006 compared tothe three months ended September 30, 2005. The addition of several newcustomers helped offset decreased volumes for several existing customers in thethree months ended September 30, 2006 compared to the three months endedSeptember 30, 2005.

Operating revenues from unaffiliated customers were $1,705,000, whichis $216,000 or 11.2% lower in the nine months ended September 30, 2006 comparedto the nine months ended September 30, 2005. This is primarily due to the factthat in June 2005, the Company recognized $369,000 in non-recurring licensefees from the sale of SuiteSolutions to a customer. The addition of severalcustomers and increased volumes for several existing customers, helped offsetthe loss of the non-recurring license fee revenue in the nine months endedSeptember 30, 2006 compared to the nine months ended September 30, 2005.

Cost of Services (excludingDepreciation and Amortization):

Cost of services (excluding depreciation and amortization) were$1,286,000, which is $138,000 or 9.7% lower in the three months ended September30, 2006 compared to the three months ended September 30, 2005. The decreasewas primarily due to a $122,000 decrease in wages and benefits, which was theresult of a reassignment of support staff, which are now being reflected in theselling, general and administrative expenses (excluding depreciation andamortization).

Cost of services (excluding depreciation and amortization) were$3,902,000, which is $299,000 or 7.1% lower in the nine months ended September30, 2006 compared to the nine months ended September 30, 2005. The decrease wasprimarily due to a $272,000 decrease in wages and benefits, which was theresult of a reassignment of support staff, which are now being reflected in theselling, general and administrative expenses (excluding depreciation andamortization), decreased software expense of $155,000 and decreased bad debtexpense of $87,000, which was partially offset by increased maintenancecontract expense of $91,000 and an increase in costs recognized from outsourcedcontractor work of $72,000.

33

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

Selling, general and administrative expenses (excluding depreciationand amortization) were $428,000 which is $253,000 or 144.6% higher in the threemonths ended September 30, 2006 compared to the three months ended September30, 2005. The increase was largely due to an increase in wages and benefits of$190,000, which was the result of the reassignment of support staff of $122,000in wages and benefits from cost of services (excluding depreciation andamortization) and normal inflationary increases in wages. Also contributing tothe increase in selling, general and administrative expenses was a smallerpercentage of expenses billed out through inter-company charges of $69,000.

Selling, general and administrative expenses (excluding depreciationand amortization) were $1,341,000, which is $284,000 or 26.9% higher in thenine months ended September 30, 2006 compared to the nine months ended September30, 2005. The increase was largely due to an increase in wages and benefits of$431,000, which was the result of the reassignment of support staff of $272,000in wages and benefits from cost of services (excluding depreciation andamortization) and normal inflationary increases in wages. Also contributing tothe increase in selling, general and administrative expenses was a smallerpercentage of expenses billed out through inter-company charges of $239,000 anda $72,000 increase in consulting fees, which were partially offset by $329,000of one-time fees associated with the termination of leases in the secondquarter of 2005 and a $56,000 decrease in post-retirement benefits.

Depreciation and Amortization:

Depreciation and amortization was $384,000, which was $19,000 or 4.7%lower in the three months ended September 30, 2006 compared to the three monthsended September 30, 2005. The decrease was primarily due to several assetsbecoming fully amortized during the third quarter of 2006. The decrease indepreciation and amortization in the third quarter of 2006 compared to thethird quarter of 2005 is lower than the decrease in depreciation andamortization in the second quarter of 2006 compared to the second quarter of2005 due to billing software that became fully amortized in the second quarterof 2005.

Depreciation and amortization was $1,175,000, which was $523,000 or30.8% lower in the nine months ended September 30, 2006 compared to the ninemonths ended September 30, 2005. The decrease was primarily due to billingsoftware that became fully amortized in the second quarter of 2005.

Operating and Net Loss:

Operating loss was $644,000 in the three months ended September 30,2006 compared to operating loss of $427,000 in the three months ended September30, 2005. Net loss was $393,000 in the three months ended September 30, 2006compared to net loss of $262,000 in the three months ended September 30, 2005.The increases in operating loss and net loss were driven by the $253,000increase in selling, general and administrative expenses (excludingdepreciation and amortization) and the $37,000 decrease in operating revenuesfrom unaffiliated customers, described above, which were partially offset bythe $138,000 decrease in cost of services (excluding depreciation andamortization) and the $19,000 decrease in depreciation and amortization, alsodescribed above.

Operating loss was $1,464,000 in the nine months ended September 30,2006 compared to operating loss of $1,796,000 in the nine months ended September30, 2005. Net loss was $897,000 in the nine months ended September 30, 2006compared to net loss of $1,091,000 in the nine months ended September 30, 2005.The decreases in operating loss and net loss were primarily due to the $523,000decrease in depreciation and amortization and the $299,000 decrease in cost ofservices (excluding depreciation and amortization), described above, which werepartially offset by the $284,000 increase in selling, general andadministrative expenses (excluding depreciation and amortization) and the$216,000 decrease in revenues from unaffiliated customers, also describedabove.

34

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

**ENTERPRISESOLUTIONS SECTOR**
| ** **                                                                              | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-----------------------------------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                                              | ** ** | **September 30**            | ** ** | **September 30**           | ** ** |
| **(In Thousands)**                                                                 | ** ** | **2006**                         | ** ** | **2005**                        | ** ** | **2006** | ** ** | **2005** | ** ** |
| Revenues before  eliminations:                                                          |       |                             |       |                            |       |   |   |   |   |
| Installation                                                                            | ** ** | **$**                            | **844**    |                            | $          | 1,253 | ** ** | **$** | **1,999** |   | $ | 5,653 |   |
| Service                                                                                 | ** ** | **2,441**                        |       | 2,149                           | ** ** | **6,568** |   | 6,092 |   |
| ** **                                                                              | ** ** | **3,285**                        |       | 3,402                           | ** ** | **8,567** |   | 11,745 |   |
| Cost of sales                                                                           | ** ** | **2,310**                        |       | 2,139                           | ** ** | **5,668** |   | 7,844 |   |
| Cost of services  (excluding depr. and amort.)                                          | ** ** | **403**                          |       | 573                             | ** ** | **1,241** |   | 1,401 |   |
| Selling, general  and administrative expenses (excluding depreciation and amortization) | ** ** | **895**                          |       | 715                             | ** ** | **2,598** |   | 2,616 |   |
| Depreciation and  amortization                                                          | ** ** | **25**                           |       | 28                              | ** ** | **81** |   | 91 |   |
|                                                                                    |       |                             |       |                            |       |   |   |   |   |
| Operating loss                                                                          | ** ** | **$**                            | **(348**   | **)**                           | $          | (53 | ) | **$** | **(1,021** | **)** | $ | (207 | ) |
| Net loss                                                                                | ** ** | **$**                            | **(209**   | **)**                           | $          | (31 | ) | **$** | **(613** | **)** | $ | (123 | ) |
|                                                                                    |       |                             |       |                            |       |   |   |   |   |
| Capital expenditures                                                                    | ** ** | **$**                            | **—** |                            | $          | — | ** ** | **$** | **29** |   | $ | 20 |   |

 

Revenues:

EnterpriseSolutions Sector operating revenues were $3,285,000, which is $117,000 or 3.4%lower in the three months ended September 30, 2006 compared to the three monthsended September 30, 2005. Installation revenue was $844,000, which is $409,000or 32.6% lower in the three months ended September 30, 2006 compared to thethree months ended September 30, 2005. The decrease in installation revenue wasprimarily due to decreased sales and installations in the data product line of$448,000 and private branch exchange of $92,000, but was partially offset byincreased sales in the small business system line of $131,000. Service revenuewas $2,441,000, which was $292,000 or 13.6% higher in the three months endedSeptember 30, 2006 compared to the three months ended September 30, 2005. Theincrease in service revenue was primarily due to increases of $464,000 in themove/add/change contract product line and $74,000 in the maintenance contractlines, offset by a decrease of $246,000 in the move/add/change time andmaterial product lines.

EnterpriseSolutions Sector operating revenues were $8,567,000, which is $3,178,000 or27.1% lower in the nine months ended September 30, 2006 compared to the ninemonths ended September 30, 2005. Installation revenue was $1,999,000, which is$3,654,000 or 64.6% lower in the nine months ended September 30, 2006 comparedto the nine months ended September 30, 2005. The decrease in installationrevenue was primarily due to decreased sales and installations in the dataproduct line of $3,014,000 and private branch exchange product line of$654,000, but was partially offset by an increase in the small business systemproduct line of $14,000. In June 2005, the Enterprise Solutions Sectorrecognized a substantial installation contract with Minnesota State University—Mankato,Minnesota and South Central College in Mankato, Minnesota which is the primaryreason for the large decrease in the data product line in 2006. Service revenuewas $6,568,000, which is $476,000 or 7.8% higher in the nine months endedSeptember 30, 2006 compared to the nine months ended September 30, 2005. Theincrease in service revenue was primarily due to an increase in activity in themove/add/change product lines of $308,000 and maintenance product lines of$168,000.

Cost of Sales:

Cost of sales was$2,310,000, which is $171,000 or 8.0% higher in the three months endedSeptember 30, 2006 compared to the three months ended September 30, 2005. Thisincrease was primarily due to increases in materials of $238,000 and warrantyadjustments of $79,000, but was partially offset by decreases in labor of$154,000.

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Cost of sales was$5,668,000, which is $2,176,000 or 27.7% lower in the nine months endedSeptember 30, 2006 compared to the nine months ended September 30, 2005. Thisdecrease in the nine months ended September 30, 2006 compared to the ninemonths ended September 30, 2005, was largely the result of a $2,155,000decrease in material costs due to lower installation work volume.

Cost of Services (excludingDepreciation and Amortization):

Cost of services (excluding depreciation and amortization) was$403,000, which is $170,000 or 29.7% lower in the three months ended September30, 2006 compared to the three months ended September 30, 2005. The decreasewas primarily the result of a decrease in inventory valuation expense of$111,000, and decreased operations staff and data engineering wages andbenefits of $77,000, which was partially offset by an increase in miscellaneousexpense of $20,000.

Cost of services (excluding depreciation and amortization) was$1,241,000, which is $160,000 or 11.4% lower in the nine months ended September30, 2006 compared to the nine months ended September 30, 2005. The decrease wasprimarily the result of decreased operations staff and data engineering wagesand benefits of $90,000, a decrease in inventory valuation expense of $52,000and lower van leasing expenses of $19,000.

Telecommunications equipment supply markets have changed in recentyears and have caused the Company to apply additional valuation methods, whichestimate the lower of cost or market principle. The Company cannot predict theimpact or timing, if any, of future inventory valuation changes.

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

Selling, general and administrative expenses (excluding depreciationand amortization) were $895,000, which is $180,000 or 25.2% higher in the threemonths ended September 30, 2006 compared to the three months ended September30, 2005. The increase was primarily due to an increase in staff technician andadministration wages of $65,000, an increase in sales commissions of $62,000,an increase in an increase in bad debt expense of $39,000, and an increase incomputer expense of $8,000, but was partially offset by a decrease in incentivecompensation expense of $10,000.

Selling, general and administrative expenses (excluding depreciationand amortization) were $2,598,000, which is $18,000 or 0.7% lower in the ninemonths ended September 30, 2006 compared to the nine months ended September 30,2005.

Operating and Net Loss:

Operating loss was $348,000 in the three months ended September 30,2006 compared to operating loss of $53,000 in the three months ended September30, 2005. Net loss was $209,000 in the three months ended September 30, 2006compared to net loss of $31,000 in the three months ended September 30, 2005.The increases in operating loss and net loss were primarily due to the $180,000increase in selling, general and administrative expenses (excludingdepreciation and amortization), the $171,000 increase in the cost of sales andthe $117,000 decrease in operating revenues described above, which werepartially offset by the $170,000 decrease in the cost of services (excludingdepreciation and amortization).

Operating loss was $1,021,000 in the nine months ended September 30,2006 compared to operating loss of $207,000 in the nine months ended September30, 2005. Net loss was $613,000 in the nine months ended September 30, 2006compared to net loss of $123,000 in the nine months ended September 30, 2005.The increases in operating loss and net loss were primarily due to the$3,178,000 decrease in operating revenues, which was partially offset by the$2,176,000 decrease in cost of sales and the $160,000 decrease in the cost ofservices (excluding depreciation and amortization).

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ENVENTIS — Thefollowing table provides a breakdown of the Enventis operating results.

**ENVENTIS SECTOR**
| ** **                                                                                              | ** ** | ** **                       | ** ** | **Three Months Ended** | ** ** | ** **                   | ** ** | **Nine Months Ended**  | ** ** |
|---------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|----------------------------------|------------|------------------------------|------------|----------------------------------|------------|
| ** **                                                                                              | ** ** | **September 30, 2006** | ** ** | **June 30, 2006**      | ** ** | **March 31, 2006** | ** ** | **September 30, 2006** | ** ** |
| **(In Thousands)**                                                                                 | ** ** | ** **                       | ** ** | ** **                       | ** ** | ** **                   | ** ** | ** **                       | ** ** |
| Revenues before  eliminations:                                                                          |       |                             |       |                             |       |                         |       |                             |       |
| Enterprise Network Systems                                                                              | ** ** | **$**                            | **9,741**  |                             | $          | 11,144                       |       | $                                | 10,031     | ** ** | **$** | **30,916** | ** ** |
| Enterprise Transport Systems                                                                            | ** ** | **4,231**                        |       | 4,034                            |       | 4,053                        | ** ** | **12,318**                       | ** ** |
| ** **                                                                                              | ** ** | **13,972**                       |       | 15,178                           |       | 14,084                       | ** ** | **43,234**                       | ** ** |
| Cost of sales                                                                                           | ** ** | **7,183**                        |       | 8,456                            |       | 7,683                        | ** ** | **23,322**                       | ** ** |
| Cost of services  (excluding depreciation and amortization)                              | ** ** | **3,320**                        |       | 2,932                            |       | 2,687                        | ** ** | **8,939**                        | ** ** |
| Selling, general  and administrative expenses, (excluding depreciation and amortization) | ** ** | **2,057**                        |       | 2,291                            |       | 2,410                        | ** ** | **6,758**                        | ** ** |
| Depreciation and  amortization                                                                          | ** ** | **732**                          |       | 768                              |       | 737                          | ** ** | **2,237**                        | ** ** |
| ** **                                                                                              | ** ** | ** **                       | ** ** | ** **                       | ** ** | ** **                   | ** ** | ** **                       | ** ** |
| Operating income                                                                                        | ** ** | **$**                            | **680**    |                             | $          | 731                          |       | $                                | 567        | ** ** | **$** | **1,978** | ** ** |
| Net income                                                                                              | ** ** | **$**                            | **403**    |                             | $          | 437                          |       | $                                | 338        | ** ** | **$** | **1,178** | ** ** |
| ** **                                                                                              | ** ** | ** **                       | ** ** | ** **                       | ** ** | ** **                   | ** ** | ** **                       | ** ** |
| Capital expenditures                                                                                    | ** ** | **$**                            | **1,240**  |                             | $          | 2,593                        |       | $                                | 507        | ** ** | **$** | **4,340** | ** ** |

 

Revenues:

Enventis Sector operating revenues in the third quarter of 2006 were$13,972,000, which is $1,206,000 or 7.9% lower than in the second quarter of2006. The decrease was attributable to lower sales of Cisco equipment than inthe previous quarter. This decrease was offset by an increase in transport andInternet services revenue, which is more of a recurring revenue stream.

Cost of Sales:

Cost of sales in the third quarter of 2006, were $7,183,000, which is$1,273,000 or 15.1 % lower than in the second quarter of 2006. The decrease isdirectly related to the decreased sales of Cisco equipment described above.

Cost of Services (excludingDepreciation and Amortization):

Cost of services (excluding depreciation andamortization) increased to $3,320,000 in the third quarter of 2006 from$2,932,000 in the second quarter of 2006, an increase of $388,000 or 13.2%. Theincrease was primary due to increased circuit and co-location costs of$178,000, which are directly related to increased transport revenue of$197,000. Also contributing to the increase in cost of services was increasedstaffing, which impacted wages and benefits and totaled approximately $191,000.

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

Selling,general and administrative expenses (excluding depreciation and amortization)were $2,057,000 in the third quarter of 2006, which is $234,000 or 10.2% lowerthan in the second quarter of 2006. The decrease was primarily due to a $61,000decrease in wages and benefits, decreased equipment and repair costs of$33,000, decreased regulatory fees of $46,000 and a reduction in miscellaneousexpenses of $38,000. Enventis selling, general and administrative expenses ofapproximately $550,000, $1,100,000 and $1,650,000 in the three, six and ninemonths ended September 30, 2006, respectively, were due to acquisitionintegration costs, which are one-time costs incurred in the first year afterthe acquisition and are not expected to recur in 2007.

Operating and Net Income:

Operating income decreased $51,000 or 7.0% to $680,000 in the thirdquarter of 2006 compared to the second quarter of 2006. The decrease wasprimarily due to lower revenues of $1,206,000 and increased cost of services(excluding depreciation and amortization) of $388,000 described above, whichwere partially offset by the decrease in cost of sales of $1,273,000 anddecreased selling, general and administrative expenses (excluding depreciationand amortization) of $234,000, also described above.

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**LIQUIDITY AND CAPITAL RESOURCES**

CASH FLOWS

Cash provided by operations was $15,560,000 in the first nine months of2006 compared to $22,358,000 in the first nine months of 2005. Contributing tothe decrease in the cash provided by operations is an increase in theoutstanding accounts receivable balance of $2,637,000. This is primarily due toincreased outstanding accounts receivable balances in the Enventis Sector. Alsocontributing to the decrease is provided by operations is an increase ininventory of $5,033,000 due to seasonal projects in the Telecom sector alongwith increased projects in process in the Enventis sector. This was partiallyoffset by a decrease in prepaid inventory acquired in the Enventis acquisitionof $3,529,000.

Cash flows used by investing activities were $16,616,000 in the firstnine months of 2006 compared to $7,990,000 for the same period in 2005. Capitalexpenditures were $16,802,000 during the first nine months of 2006 as comparedto $10,136,000 for the same period in 2005. Second quarter 2006 capitalexpenditures were incurred primarily to provide network enhancements, broadbanddata and video growth, and for the installation of fiber networks to transportcustomers. Management expects capital expenditures in the remainder of 2006 tobe approximately $4,000,000.

Cash flows provided by financing activities were $1,574,000 for thefirst nine months of 2006 compared to cash flows used of $14,079,000 for thenine months of 2005. The increase in cash provided by financing activities wasprimarily due to the use of short-term financing in the Enventis Sector (seeshort-term financing arrangement below) of $5,734,000 and the increase in theHickoryTech credit facility of $990,000 in the nine months ended September 30,2006 compared to a decrease in the HickoryTech credit facility of $7,750,000 inthe nine months ended September 30, 2005.

WORKING CAPITAL

Working capital (i.e., current assets minus current liabilities) was$8,118,000 as of September 30, 2006, compared to working capital of $8,078,000as of December 31, 2005. The ratio of current assets to current liabilities was1.3 to 1.0 as of September 30, 2006 and 1.3 to 1.0 as of December 31, 2005.

SHORT-TERMFINANCING ARRANGEMENT

Enventishas a $10 million creditfacility with a financing company to purchase inventories from certain approvedvendors. Advances under the financing arrangement are collateralized by theaccounts receivable and inventory of Enventis and a guaranty of the principalindebtedness by HickoryTech. The credit facility provides sixty-day paymentterms for working capital and can be terminated at any time by either party.Borrowings outstanding under the credit facility at September 30, 2006 totaled$5,734,000 as compared to $4,546,000 at June 30, 2006.

LONG-TERMOBLIGATIONS

HickoryTech’s long-term obligations as of September 30, 2006 were$141,898,000, excluding current maturities of $1,300,000 on debt and $339,000 oncurrent maturities of capital leases. On December 30, 2005, HickoryTech enteredinto a $160,000,000 credit agreement with a syndicate of banks which amendedits previous credit facility. The credit facility is composed of a $30,000,000revolving credit component that expires on December 30, 2011 and a $130,000,000term loan component. The term loan component is composed of two componentswhich are defined as term loan B and term loan C. Under the terms of the creditfacility, HickoryTech is required to make quarterly payments on the outstandingprincipal of the term loans beginning March 31, 2006. The outstanding principalbalance of term loan B is $109,175,000 as of September 30, 2006, and is held invarying amounts by three of the lenders in the syndicate, U.S. Bank, GECommercial Distribution Finance Corporation and CoBank. Under the terms of termloan B, HickoryTech is required to make quarterly principal payments of $275,000from March 31, 2006 through December 31, 2011, with the remainder of theaggregate principal due in two payments on March 31, 2012 and June 30, 2012.The outstanding principal balance of term loan C is $19,850,000 as of September30, 2006, and is held entirely by Rural Telephone Finance Cooperative (RTFC).Under the terms of term loan C, HickoryTech is required to make quarterlyprincipal payments of $50,000 on the aggregate principal amount from March 31,2006 through December 31, 2012, with the remainder of the aggregate principaldue in two payments on March 31, 2013 and June 30, 2013. Under the terms of therevolving credit facility, any outstanding principal is payable in full onDecember 30, 2011.

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Under the credit facility, interest will be payableat an applicable margin in excess of a prevailing pricing level. The prevailingpricing level will be based on a Base Rate, LIBOR Rate Loans or RTFC ratetable. The prevailing rate for Base Rate Loans is the higher of Prime Rate orthe Federal Funds Rate plus 0.5%. The prevailing rate for LIBOR Rate Loans ispublicly available. The RTFC rate tables are established based on RTFCpolicies, are not publicly available, and change from time to time. Theapplicable margin for the revolving credit facility, term loan B, and term loanC will be determined quarterly based on the leverage ratio of HickoryTech. Thecredit facility also provides for an annual fee on any un-drawn commitment ofthe revolving credit facility, payable quarterly. The credit facility is collateralizedby certain property, plant and equipment and contains covenants relating tocash flow and capital expenditures. The credit facility requires HickoryTech toenter into or maintain in effect interest rate protection agreements on atleast 50% of the facility’s outstanding balance and to manage the Company’sexposure to interest rate fluctuations. The Company has complied by protectingapproximately 63% of its outstanding debt balance.

HickoryTech continually monitors the interest rates on its bank loansand has implemented interest rate protection agreements on various portions ofthe overall debt outstanding for varying terms. A higher level of interestexpense is occurring in 2006 because of the higher level of debt outstanding toaccommodate the purchase of Enventis.

HickoryTech is required to comply with specified financial ratios andtests applicable to the Company and its current subsidiaries, including maximumleverage ratio, minimum interest coverage ratio, and maximum capitalexpenditures. HickoryTech’s obligations under the credit facility are securedby a first-priority lien on all property and assets, tangible and intangible,of HickoryTech and its current subsidiaries, including, but not limited to,accounts receivable, inventory, equipment and intellectual property; generalintangibles, cash and proceeds of the foregoing; and a first-priority pledge ofthe capital stock of HickoryTech’s current subsidiaries.

HickoryTech’s Information Solutions Sector leases certain computerequipment under capital lease arrangements. During the nine months endedSeptember 30, 2006 and 2005, this sector recorded additions to property, plantand equipment of $162,000 and $666,000, respectively, related to these capitallease arrangements.

CONSTRUCTIONPLANS

Beginning in 2004, HickoryTech embarked on a five-year networkenhancement program in its core telephone property in Mankato in support of itsbroadband service strategy. Management believes that the enhancement willsupport the broadband product deployment strategies of the future, as well asserving as defense against competition. These upgrades will give HickoryTechthe capability to offer more diversified services to its core customer base. Inaddition, the Company continues to invest capital in the Enventis Sector toenhance its Internet Protocol backbone, to deploy Multi-protocol LabelSwitching services and for success-based new sales (directly related to revenueincreases). In addition, the Company has devoted capital expenditures todigital TV expansion in several new communities outside Mankato. The total capital expenditure program in 2006 for allHickoryTech companies is estimated to be $21,000,000.

OTHER

HickoryTech operates with original equity capital, retained earningsand recent additions to indebtedness in the form of bank term and revolvinglines of credit. HickoryTech believes its current level of debt to totalcapital and debt relative to its ability to generate operating cash flow isacceptable for ongoing operations.

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CRITICAL ACCOUNTING POLICIES

Management’sdiscussion and analysis of financial condition and results of operations statedin this Quarterly Report on Form 10-Q are based upon HickoryTech’s consolidatedfinancial statements, which have been prepared in accordance with accountingprinciples generally accepted in the United States and, where applicable,conform to the accounting principles as prescribed by federal and statetelephone utility regulatory authorities. HickoryTech presently givesaccounting recognition to the actions of regulators where appropriate, asprescribed by Statement of Financial Accounting Standards (SFAS) No. 71,“Accounting for the Effects of Certain Types of Regulation.” The preparation ofthese financial statements requires management to make estimates and judgmentsthat affect the reported amounts of assets, liabilities, revenues, and expensesand related disclosure of contingent assets and liabilities. Managementbelieves that the application of the accounting policies, which are importantto HickoryTech’s financial position and results of operations, requiressignificant judgments and estimates on the part of management. A description ofthe critical accounting policies adhered to by HickoryTech is contained in theManagement’s Discussion and Analysis of Financial Condition and Results ofOperations in HickoryTech’s Annual Report on Form 10-K for the year endedDecember 31, 2005. HickoryTech adopted SFAS No. 123(R), “Share-Based Payment,”as of January 1, 2006 and has chosen to use the modified prospective basis ofthe Black-Scholes option-pricing model to calculate future stock compensationexpense, using a fair value method as prescribed under SFAS No. 123(R). Thevaluation of equity instruments underlying stock-based compensation and theperiod during which the related stock compensation expense is recognized willbe based in part on various assumptions, including the estimated useful life ofequity instruments, stock volatility, interest rates and vesting terms. For thehistorical impact of share-based payments to employees under APB No. 25, referto the disclosures in Note 9 of the Notes to Consolidated Financial Statementscontained in this Quarterly Report on Form 10-Q.

 

ITEM3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

HickoryTechdoes not have operations subject to risks of foreign currency fluctuations.HickoryTech does, however, use derivative financial instruments to manageexposure to interest rate fluctuations. HickoryTech’s objectives for holdingderivatives are to minimize interest rate risks using the most effectivemethods to eliminate or reduce the impact of these exposures. Variable ratedebt instruments are subject to interest rate risk. HickoryTech has enteredinto interest rate protection agreements with remaining maturities oftwenty-one months to manage its exposure to interest rate movements on aportion of its variable rate debt obligations. The effective portion of thecumulative gain or loss on these derivative instruments is reported as a componentof accumulated other comprehensive income/loss in shareholders’ equity and isrecognized in earnings when the term of the protection agreement is concluded.HickoryTech’s earnings are affected by changes in interest rates as a portionof its long-term debt has variable interest rates based on LIBOR. If interestrates for the portion of HickoryTech’s long-term debt based on variable rateshad averaged 10% more for the quarter ended September 30, 2006, HickoryTech’sinterest expense would have increased by $281,000. There have not been anymaterial changes over the first nine months of 2006.

 

ITEM4. CONTROLS ANDPROCEDURES

 

Evaluation of Disclosure Controls and Procedures.

As of the end of the period covered by this Quarterly Report on Form10-Q (the Evaluation Date), the Company carried out an evaluation, 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 the SecuritiesExchange Act of 1934, as amended). Based upon that evaluation, the ChiefExecutive Officer and Chief Financial Officer have concluded that, as of theEvaluation Date, the Company’s disclosure controls and procedures wereeffective.

 

Changes in Internal Controls.

As disclosed in HickoryTech’s Annual Report on Form 10-K for the fiscalyear ended December 31, 2005, the Company was working to implement an internalcontrol structure at Enventis, a wholly owned subsidiary of the Companyacquired on December 30, 2005. The Company has fully implemented the internalcontrol structure at Enventis as of the third quarter of 2006. Testing of thesecontrols is currently underway, and the Company expects to have its Enventissubsidiary fully compliant with company-wide internal control policies byDecember 31, 2006.

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As disclosed in our Annual Report on Form 10-K for the fiscal yearended December 31, 2005, the Company was working to fully incorporate newenterprise resource planning (ERP) software into its procedures for internalcontrol over financial reporting. As of January 1, 2006, the Company beganusing the following modules located within the ERP software: general ledger,purchasing, accounts payable, billing, accounts receivable, inventory, assetmanagement, payroll, time and labor, and project costing. Two other modules,benefits administration and human resources, were implemented in 2005 and were beingused as of January 1, 2006. The Company has fully incorporated the internalcontrol structure surrounding this software as of the second quarter of 2006. Testing of these controls is currently underway.The Company expects its new ERP system will be fully tested for internalcontrol over financial reporting for the period ending December 31, 2006.

 

There have been noother changes in the Company’s internal control over financial reporting duringthe Company’s most recently completed fiscal quarter that have materiallyaffected, or are reasonably likely to materially affect, the Company’s internalcontrol over financial reporting.

 

PART II. OTHERINFORMATION

 

Item1.    Legal Proceedings.

Other than routine litigationincidental to HickoryTech’s business, there are no pending material legalproceedings to which HickoryTech is a party or to which any of its property issubject.

 

Item1A  Risk Factors.

The following risk factorspreviously disclosed in Item 1A, “Risk Factors,” to our Annual Report on Form10-K for the fiscal year ended December 31, 2005, have been updated to reflectnew information.

 

**We may not be able tosuccessfully introduce new products and services.**

Our success depends upon our ability to successfullyintroduce new products and services, such as the ability of our competitivelocal exchange carrier (CLEC) business to provide competitive local service innew markets, the ability of our Information Solutions Sector (which is abilling and data services company) to implement, market, and sell itsSuiteSolution billing system, our ability to offer bundled service packages onterms attractive to our customers, our ability to successfully expand our longdistance, Internet and digital TV offerings to new markets, our ability tointroduce and distribute the equipment and systems of manufacturers ofswitching equipment and the suppliers of communications technology compared tothe competitive alternatives of other suppliers and the ability of Enventis toprovide transport solutions and competitive Internet Protocol services,including telecommunications and network solutions.

 

We may not accurately predict technological trends orthe success of new products in these markets. New product development oftenrequires long-term forecasting of market trends, development and implementationof new technologies and processes and substantial capital investment. Inaddition, we do not know whether our products and services will meet withmarket acceptance or be profitable. Many of our competitors have greater resourcesthan we do. If we fail to anticipate or respond in a cost-effective and timelymanner to technological developments, changes in industry standards or customerrequirements, if we have any significant delays in product development orintroduction, or if any of our relationships with our vendors are negativelyimpacted, our business, operating results and financial condition could bematerially adversely affected.

 

**Some sectors of ourbusiness have experienced lower customer demand in recent years.**

Over the past several years, we have experienced lowercustomer demand for our billing services out of our Information SolutionsSector due to the reluctance of customers to spend capital dollars on billingsoftware and services offered by our Information Solutions Sector. We do notknow whether customer demand for these services will increase. Also, ourEnterprise Solutions Sector has experienced reduction of demand for itsproducts and services. During downturns in the economy and during periods oftechnology migration, customers are hesitant to spend capital dollars ontelephone and communications equipment offered by Enterprise Solutions as theyseek to retain the use of their existing systems. We cannot estimate whencustomer demand for Enterprise Solutions’ products and services will increase.

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**We may not be able tomanage our growth effectively.**

Our ability to manage our growth effectively,including our ability to integrate the operations of new businesses internallydeveloped or external businesses acquired into our operations, may adverselyaffect our business results of operations and financial condition. In addition,our ability to achieve projected economies of scale and cost savings, meet proforma cash flow projections in valuing newly acquired businesses, successfullyabsorb the impact of changes in accounting policies as required by GAAP, managethe working capital needs of our businesses and generate cash flow to serviceour debt, conform with existing debt covenants and negotiate new debt facilities,and identify future acquisition opportunities for growth may also adverselyaffect our business results of operations and financial condition.

 

**Customer payment defaults could have an adverseeffect on our financial condition and results of operations.**

As a result of adverse conditions in thecommunications market and non-communication market for Enventis Network Servicecustomers, some of our customers have experienced and may continue toexperience serious financial difficulties. In some cases these difficultieshave resulted or may result in bankruptcy filings or cessation of operations.If customers experiencing financial problems default on paying amounts owed tous, we may not be able to collect these amounts or recognize expected revenue.It is possible those customers from whom we expect to derive substantialrevenue will default or that the level of defaults will increase. Any materialpayment defaults by our customers would have an adverse affect on our resultsof operations and financial condition. We currently manage this exposurethrough an allowance for doubtful accounts. An unexpected bankruptcy or defaultfrom a customer may not be fully reserved in our allowance. In addition, someof our competitors engage in financing transactions with some of theircustomers for the purchase of equipment. To remain competitive, it may becomenecessary for us to offer similar financing arrangements. If such financingsoccur, it would be our intent to sell all or a portion of these commitments andoutstanding receivables to third parties. In the past, we have sold somereceivables with recourse and have had to compensate the purchaser for therelated losses.

 

Item2.    Unregistered Sales of EquitySecurities and Use of Proceeds.

None.

 

Item3.    Defaults Upon Senior Securities.

None.

 

Item4.    Submission of Matters to a Voteof Security Holders.

None. 

 

Item5.    Other Information.

None.

 

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Item 6.    Exhibits.

 

Exhibit10.1 Employment Agreementbetween the Company and John W. Finke, President and Chief Executive Officer of theCompany dated August 10, 2006 (incorporated by reference from the CurrentReport on Form 8-K of the Company filed August 16, 2006).

 

Exhibit 31.1 Certificationpursuant to Rule 13a-14(a) under the Exchange Act, as adopted pursuant toSection 302 of the Sarbanes-Oxley Act of 2002

 

Exhibit 31.2 Certificationpursuant to Rule 13a-14(a) under the Exchange Act, as adopted pursuant toSection 302 of the Sarbanes-Oxley Act of 2002

 

Exhibit 32.1 Certificationpursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of theSarbanes-Oxley Act of 2002

 

Exhibit 32.2 Certificationpursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of theSarbanes-Oxley Act of 2002

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SIGNATURES

 

Pursuant to the requirements ofthe Securities Exchange Act of 1934, the registrant has duly caused this reportto be signed on its behalf by the undersigned, thereunto duly authorized.

 
| Dated: November 9, 2006 | HICKORY TECH CORPORATION |
|-------------------------|--------------------------|
|                    |                     |   |
|                    |                     |   |
|                    |                     |   |
|                    | By:                      | /s/ John W. Finke |
|                    |                     | John W. Finke, President and Chief Executive Officer |
|                    |                     |   |
|                    |                     |   |
|                    |                     |   |
|                    | By:                      | /s/ David A. Christensen |
|                    |                     | David A. Christensen, Senior Vice President and |
|                    |                     | Chief Financial Officer |

 

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