**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**WASHINGTON, DC 20549**

 

**FORM10-Q**

 

**(Mark One)**
| **ý** | ** ** | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)  OF THE SECURITIES EXCHANGE ACT OF 1934**                                                                                                                                                                                                  |
|------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |       | **FOR THE  QUARTERLY PERIOD ENDED March 31, 2005**                                                                                                                                                                                                                                            |
| **OR**     |
| **o**      | ** ** | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**                                                                                                                                                                                                 |
|       |       | **FOR THE  TRANSITION PERIOD FROM                     TO                      ** |

 
| **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, Minnesota 56002-3248**                         |
| (Address of principal executive offices and zip code)     |
|                                                      |       |                |
| **(800) 326-5789**                                        |
| (Registrant’s telephone number, including area code) |

 

 

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

 

Indicate by check mark whetherthe Registrant (1) has filed all reports required to be filed by Section 13 or15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (orfor such shorter period that the registrant was required to file such reports),and (2) has been subject to such filing requirements for the past 90 days.   Yes  ý    No  o

 

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

 

The total number of shares ofthe registrant’s common stock outstanding as of March 31, 2005: 13,065,315.

 

 

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**HICKORY TECH CORPORATION**

March 31, 2005

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS.

CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED)

 
| ** **                                                                             | ** ** | **For Three Months Ended** | ** ** |
|----------------------------------------------------------------------------------------|------------|----------------------------|------------|
| **(In Thousands Except Per Share Amounts)**                                            | ** ** | **3/31/2005**              | ** ** | **3/31/2004** | ** ** |
| OPERATING REVENUES:                                                                    |       |                       |       |   |   |
| Telecom Sector                                                                         |       | $                          | 19,345     |   | $ | 19,426 |   |
| Information Solutions Sector                                                           |       | 488                        |       | 966 |   |
| Enterprise Solutions Sector                                                            |       | 3,275                      |       | 2,295 |   |
| TOTAL OPERATING REVENUES                                                               |       | 23,108                     |       | 22,687 |   |
| COSTS AND EXPENSES:                                                                    |       |                       |       |   |   |
| Cost of Sales, Enterprise Solutions                                                    |       | 2,268                      |       | 1,509 |   |
| Cost of Services, excluding Depreciation  and Amortization                             |       | 8,053                      |       | 8,608 |   |
| Selling, General and Administrative  Expenses, excluding Depreciation and Amortization |       | 4,027                      |       | 3,656 |   |
| Depreciation                                                                           |       | 4,001                      |       | 3,876 |   |
| Amortization of Intangibles                                                            |       | 237                        |       | 236 |   |
| TOTAL COSTS AND EXPENSES                                                               |       | 18,586                     |       | 17,885 |   |
| OPERATING INCOME                                                                       |       | 4,522                      |       | 4,802 |   |
| OTHER INCOME/(EXPENSE):                                                                |       |                       |       |   |   |
| Interest and Other Income                                                              |       | 8                          |       | 15 |   |
| Interest Expense                                                                       |       | (977                       | )          | (1,189 | ) |
| TOTAL OTHER INCOME/(EXPENSE)                                                           |       | (969                       | )          | (1,174 | ) |
|                                                                                   |       |                       |       |   |   |
| INCOME BEFORE INCOME TAXES                                                             |       | 3,553                      |       | 3,628 |   |
| INCOME TAX PROVISION                                                                   |       | 1,437                      |       | 1,467 |   |
| INCOME FROM CONTINUING OPERATIONS                                                      |       | 2,116                      |       | 2,161 |   |
| DISCONTINUED OPERATIONS (Note 4)                                                       |       |                       |       |   |   |
| Loss from Operations of Discontinued  Component                                        |       | —                     |       | (99 | ) |
| Income Tax Benefit                                                                     |       | —                     |       | (40 | ) |
| LOSS FROM DISCONTINUED OPERATIONS                                                      |       | —                     |       | (59 | ) |
| NET INCOME                                                                             |       | $                          | 2,116      |   | $ | 2,102 |   |
|                                                                                   |       |                       |       |   |   |
| Basic Earnings Per Share - Continuing  Operations:                                     |       | $                          | 0.16       |   | $ | 0.17 |   |
| Basic Loss Per Share - Discontinued  Operations:                                       |       | —                     |       | (0.01 | ) |
|                                                                                   |       | $                          | 0.16       |   | $ | 0.16 |   |
| Dividends Per Share                                                                    |       | $                          | 0.12       |   | $ | 0.11 |   |
| Weighted Average Common Shares Outstanding                                             |       | 13,059                     |       | 12,970 |   |
|                                                                                   |       |                       |       |   |   |
| Diluted Earnings Per Share - Continuing  Operations:                                   |       | $                          | 0.16       |   | $ | 0.17 |   |
| Diluted Loss Per Share - Discontinued  Operations:                                     |       | —                     |       | (0.01 | ) |
|                                                                                   |       | $                          | 0.16       |   | $ | 0.16 |   |
| Weighted Average Common and Equivalent  Shares Outstanding                             |       | 13,091                     |       | 13,020 |   |

 

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

 

1

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**HICKORY TECH CORPORATION**

March 31, 2005

CONSOLIDATED BALANCE SHEETS

(UNAUDITED)

 

 
| **(In Thousands Except Share and Per Share Amounts)**                                                                                         | ** ** | **3/31/2005** | ** **  | **12/31/2004** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------|-------------|----------------|------------|
| ASSETS                                                                                                                                        |       |          |        |           |       |
| CURRENT ASSETS:                                                                                                                               |       |          |        |           |       |
| Cash and Cash Equivalents                                                                                                                     | ** ** | **$**         | **1,258**   |           | $          | 257 |   |
| Receivables, Net of Allowance for Doubtful  Accounts of $1,294 and $1,283                                                                     | ** ** | **9,336**     |        | 9,892          |       |
| Income Taxes Receivable                                                                                                                       | ** ** | **—**    |        | 204            |       |
| Costs in Excess of Billings on Contracts                                                                                                      | ** ** | **217**       |        | 927            |       |
| Inventories                                                                                                                                   | ** ** | **3,163**     |        | 3,182          |       |
| Deferred Income Taxes                                                                                                                         | ** ** | **1,430**     |        | 1,430          |       |
| Prepaid Expenses                                                                                                                              | ** ** | **1,414**     |        | 1,185          |       |
| Other                                                                                                                                         | ** ** | **837**       |        | 1,214          |       |
| TOTAL CURRENT ASSETS                                                                                                                          | ** ** | **17,655**    |        | 18,291         |       |
| INVESTMENTS                                                                                                                                   | ** ** | **2,507**     |        | 4,371          |       |
| PROPERTY, PLANT AND EQUIPMENT                                                                                                                 | ** ** | **247,888**   |        | 246,341        |       |
| Less ACCUMULATED DEPRECIATION                                                                                                                 | ** ** | **135,432**   |        | 131,649        |       |
| PROPERTY, PLANT AND EQUIPMENT, NET                                                                                                            | ** ** | **112,456**   |        | 114,692        |       |
| OTHER ASSETS:                                                                                                                                 |       |          |        |           |       |
| Goodwill                                                                                                                                      | ** ** | **25,086**    |        | 25,086         |       |
| Intangible Assets, Net                                                                                                                        | ** ** | **361**       |        | 387            |       |
| Financial Derivative Instruments                                                                                                              | ** ** | **3,522**     |        | 2,501          |       |
| Deferred Costs and Other                                                                                                                      | ** ** | **2,852**     |        | 3,209          |       |
| TOTAL OTHER ASSETS                                                                                                                            | ** ** | **31,821**    |        | 31,183         |       |
| TOTAL ASSETS                                                                                                                                  | ** ** | **$**         | **164,439** |           | $          | 168,537 |   |
|                                                                                                                                          |       |          |        |           |       |
| LIABILITIES  & SHAREHOLDERS’ EQUITY                                                                                                  |       |          |        |           |       |
| CURRENT LIABILITIES:                                                                                                                          |       |          |        |           |       |
| Cash Overdraft                                                                                                                                | ** ** | **$**         | **—**  |           | $          | 1,680 |   |
| Accounts Payable                                                                                                                              | ** ** | **2,357**     |        | 4,065          |       |
| Accrued Expenses                                                                                                                              | ** ** | **3,462**     |        | 3,202          |       |
| Accrued Interest                                                                                                                              | ** ** | **75**        |        | 76             |       |
| Accrued Income Taxes                                                                                                                          | ** ** | **923**       |        | —         |       |
| Billings in Excess of Costs on Contracts                                                                                                      | ** ** | **202**       |        | 260            |       |
| Advanced Billings and Deposits                                                                                                                | ** ** | **2,806**     |        | 2,898          |       |
| Current Maturities of Long-Term Obligations                                                                                                   | ** ** | **8,171**     |        | 5,323          |       |
| TOTAL CURRENT LIABILITIES                                                                                                                     | ** ** | **17,996**    |        | 17,504         |       |
| LONG-TERM OBLIGATIONS, Net of Current  Maturities                                                                                             | ** ** | **91,256**    |        | 97,661         |       |
| DEFERRED INCOME TAXES                                                                                                                         | ** ** | **15,677**    |        | 15,270         |       |
| DEFERRED REVENUE AND EMPLOYEE BENEFITS                                                                                                        | ** ** | **6,606**     |        | 6,557          |       |
| TOTAL LIABILITIES                                                                                                                             | ** ** | **131,535**   |        | 136,992        |       |
| COMMITMENTS AND CONTINGENCIES (Note 9)                                                                                                        | ** ** | **—**    |        | —         |       |
| SHAREHOLDERS’ EQUITY:                                                                                                                    |       |          |        |           |       |
| Common Stock, no par value, $.10 stated  value  Shares authorized: 100,000,000  Shares outstanding: 13,065,315 in 2005 and 13,057,106 in 2004 | ** ** | **1,307**     |        | 1,306          |       |
| Additional Paid-In Capital                                                                                                                    | ** ** | **8,810**     |        | 8,615          |       |
| Retained Earnings                                                                                                                             | ** ** | **20,667**    |        | 20,119         |       |
| Accumulated Other Comprehensive Income                                                                                                        | ** ** | **2,120**     |        | 1,505          |       |
| TOTAL SHAREHOLDERS’ EQUITY                                                                                                               | ** ** | **32,904**    |        | 31,545         |       |
| TOTAL LIABILITIES & SHAREHOLDERS’  EQUITY                                                                                            | ** ** | **$**         | **164,439** |           | $          | 168,537 |   |

 

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

 

2

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**HICKORY TECH CORPORATION**

March 31, 2005

CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

 
| ** **                                                  | ** ** | **For Three Months Ended** | ** ** |
|-------------------------------------------------------------|------------|----------------------------|------------|
| **(Dollars In Thousands)**                                  | ** ** | **3/31/2005**              | ** ** | **3/31/2004** | ** ** |
| CASH FLOWS FROM OPERATING ACTIVITIES:                       |       |                       |       |   |   |
| Net Income                                                  | ** ** | **$**                      | **2,116**  | ** ** | $ | 2,102 |   |
| Adjustments to Reconcile Net Income to Net                  |       |                       | ** ** |   |   |
| Cash Provided by Operating Activities:                      |       |                       | ** ** |   |   |
| Depreciation and Amortization                               | ** ** | **4,238**                  | ** ** | 4,112 |   |
| Gain on Sale of Assets                                      | ** ** | **(4**                     | **)**      | — |   |
| Stock-Based Compensation                                    | ** ** | **22**                     | ** ** | 35 |   |
| Employee Retirement Benefits and Deferred  Compensation     | ** ** | **83**                     | ** ** | 166 |   |
| Accrued Patronage Refunds                                   | ** ** | **(136**                   | **)**      | (107 | ) |
| Provision for Losses on Accounts Receivable                 | ** ** | **224**                    | ** ** | 144 |   |
| Changes in Operating Assets and  Liabilities:               |       |                       | ** ** |   |   |
| Receivables                                                 | ** ** | **1,459**                  | ** ** | 3,208 |   |
| Inventories                                                 | ** ** | **20**                     | ** ** | 53 |   |
| Billings and Costs on Contracts                             | ** ** | **651**                    | ** ** | 729 |   |
| Accounts Payable and Accrued Expenses                       | ** ** | **(1,450**                 | **)**      | (764 | ) |
| Advance Billings and Deposits                               | ** ** | **(92**                    | **)**      | 36 |   |
| Deferred Revenue and Employee Benefits                      | ** ** | **(34**                    | **)**      | (38 | ) |
| Other                                                       | ** ** | **195**                    | ** ** | 443 |   |
| Net Cash Provided By Operating Activities                   | ** ** | **7,292**                  | ** ** | 10,119 |   |
|                                                        |       |                       | ** ** |   |   |
| CASH FLOWS FROM INVESTING ACTIVITIES:                       |       |                       | ** ** |   |   |
| Additions to Property, Plant and Equipment                  | ** ** | **(1,456**                 | **)**      | (2,122 | ) |
| Redemption of Investments                                   | ** ** | **2,100**                  | ** ** | 2,600 |   |
| Proceeds from Sale of Assets                                | ** ** | **11**                     | ** ** | 12 |   |
| Net Cash Provided By Investing Activities                   | ** ** | **655**                    | ** ** | 490 |   |
|                                                        |       |                       | ** ** |   |   |
| CASH FLOWS FROM FINANCING ACTIVITIES:                       |       |                       | ** ** |   |   |
| Change in Cash Overdraft                                    | ** ** | **(1,680**                 | **)**      | (973 | ) |
| Payments of Capital Lease Obligations                       | ** ** | **(123**                   | **)**      | (213 | ) |
| Repayments on Credit Facility                               | ** ** | **(4,750**                 | **)**      | (9,250 | ) |
| Borrowings on Credit Facility                               | ** ** | **1,000**                  | ** ** | 1,000 |   |
| Proceeds from Issuance of Common Stock                      | ** ** | **174**                    | ** ** | 118 |   |
| Dividends Paid                                              | ** ** | **(1,567**                 | **)**      | (1,426 | ) |
| Net Cash Used In Financing Activities                       | ** ** | **(6,946**                 | **)**      | (10,744 | ) |
|                                                        |       |                       | ** ** |   |   |
| NET INCREASE (DECREASE) IN CASH AND CASH  EQUIVALENTS       | ** ** | **1,001**                  | ** ** | (135 | ) |
|                                                        |       |                       | ** ** |   |   |
| CASH AND CASH EQUIVALENTS AT BEGINNING OF  PERIOD           | ** ** | **257**                    | ** ** | 278 |   |
|                                                        |       |                       | ** ** |   |   |
| CASH AND CASH EQUIVALENTS AT END OF PERIOD                  | ** ** | **$**                      | **1,258**  | ** ** | $ | 143 |   |
|                                                        |       |                       | ** ** |   |   |
| SUPPLEMENTAL DISCLOSURE OF CASH FLOW  INFORMATION:          |       |                       | ** ** |   |   |
| Cash Paid for Interest                                      | ** ** | **$**                      | **1,055**  | ** ** | $ | 1,236 |   |
| Net Cash Paid (Refunded) for Income Taxes                   | ** ** | **$**                      | **310**    | ** ** | $ | (1,745 | ) |
| NON-CASH INVESTING ACTIVITIES:                              |       |                       | ** ** |   |   |
| Property, Plant and Equipment Acquired with  Capital Leases | ** ** | **$**                      | **317**    | ** ** | $ | — |   |

 

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

 

3

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**HICKORY TECH CORPORATION**

**MARCH 31, 2005**

**PART 1. FINANCIAL INFORMATION**

 

**ITEM 1.  NOTES TO CONSOLIDATEDFINANCIAL STATEMENTS**

 

NOTE 1. BASIS OFPRESENTATION

 

The accompanyingunaudited condensed consolidated financial statements have been prepared inaccordance with generally accepted accounting principles for interim financialinformation and with the instructions to Form 10-Q and Article 10 of RegulationS-X. Accordingly, they do not include all of the information necessary for a fairpresentation of results of operations, financial position, and cash flows inconformity with accounting principles generally accepted in the United Statesof America. In the opinion of management, the condensed consolidated financialstatements reflect all adjustments (consisting only of normal recurringadjustments) considered necessary for a fair presentation of Hickory TechCorporation’s (HickoryTech) results for the periods presented. Operatingresults for interim periods are not necessarily indicative of results that maybe expected for the fiscal year as a whole. The preparation of financialstatements in conformity with accounting principles generally accepted in theUnited States of America requires management to make estimates and assumptionsthat affect the reported amounts of assets, liabilities, revenues, expenses,and related disclosures at the date of the financial statements and during thereporting period. Actual results could differ from these estimates. Theseunaudited interim condensed consolidated financial statements should be read inconjunction with HickoryTech’s Annual Report on Form 10-K for the year endedDecember 31, 2004.

 

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

 

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

 

On December 15, 2003, HickoryTech sold its wireless business, MinnesotaSouthern Wireless Company (MSWC), to Western Wireless Corporation (WWC). Thewireless operations are reported as part of the Telecom Sector. The results ofoperations of the wireless business are reported as discontinued operations forall periods presented (see Note 4).

 

NOTE 2. EARNINGS AND CASH DIVIDENDS PER COMMON SHARE

 

Basic earnings per share iscomputed by dividing net income by the weighted average number of shares ofcommon stock outstanding during the applicable period. Shares used in theearnings per share assuming dilution calculation are based on the weightedaverage number of shares of common stock outstanding during the periodincreased by potentially dilutive common shares. Potentially dilutive commonshares include stock options and stock subscribed under the employee stock purchaseplan (ESPP).

 
| ** **                          | ** ** | **For Three Months Ended** | ** ** |
|-------------------------------------|------------|----------------------------|------------|
| ** **                          | ** ** | **3/31/2005**              | ** ** | **3/31/2004** | ** ** |
| Weighted Average Shares Outstanding |       | 13,059,024                 |       | 12,969,590 |   |
| Stock Options (dilutive only)       |       | 17,691                     |       | 37,350 |   |
| Stock Subscribed (ESPP)             |       | 14,190                     |       | 12,958 |   |
| Total Dilutive Shares Outstanding   |       | 13,090,905                 |       | 13,019,898 |   |

 

4

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Options to purchase 476,000 and406,433 shares for the three months ended March 31, 2005 and 2004,respectively, were not included in the computation of earnings per shareassuming dilution because their effect on earnings per share would have beenantidilutive.

 

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

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

 

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

 

During the first three months of 2005 and 2004, shareholders haveelected to reinvest $66,000 and $67,000, respectively, of dividends intoHickoryTech common stock pursuant to the HickoryTech Dividend ReinvestmentPlan.

 

NOTE 3. COMPREHENSIVE INCOME

 

HickoryTech follows the provisions of SFAS No. 130, “ReportingComprehensive Income.” This statement established rules for the reporting ofcomprehensive income and its components. In addition to net income, HickoryTech’scomprehensive income includes changes in unrealized gains and losses onderivative instruments qualifying and designated as cash flow hedges.Comprehensive income for the three months ended March 31, 2005 and 2004 was$2,731,000 and $1,236,000, respectively.

 

NOTE 4. DISCONTINUED OPERATIONS

 

On December 15, 2003, HickoryTech sold its wirelessbusiness, Minnesota Southern Wireless Company (MSWC), to Western WirelessCorporation (WWC). The wireless operations are reported as part of the TelecomSector. The results of operations of the wireless business are reported asdiscontinued operations for all periods presented.

 

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

 
| ** **                 | ** ** | **For Three Months Ended** | ** ** |
|----------------------------|------------|----------------------------|------------|
| **(Dollars in Thousands)** | ** ** | **3/31/2005**              | ** ** | **3/31/2004** | ** ** |
| Revenues                   |       | $                          | —     |   | $ | — |   |
|                       |       |                       |       |   |   |
| Loss Before Income Taxes   |       | $                          | —     |   | $ | (99 | ) |

 

NOTE 5. INVENTORIES

 

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

 

5

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NOTE 6. INTANGIBLE ASSETS

 

Goodwill assets are subject to an impairment test annually as well asupon certain events that indicate that an impairment may be present. Thegoodwill impairment test includes two steps, the first of which requiresmanagement to determine the fair value of certain of the Company’s reportingunits (as defined by SFAS No. 142).  TheCompany determines the fair value of their reporting units by application of adiscounted cash flow analysis. Management makes estimates that are included intheir discounted cash flow analyses based upon the best available informationat the time that the determinations of fair value are made.  If circumstances change, HickoryTech’sestimates of fair value will also change and could result in a determination ofadditional impairment charges to reduce the carrying value of goodwill.

 

HickoryTech is required to test acquired goodwill for impairment on anannual basis based upon a fair value approach. Additionally, goodwill shall betested for impairment between annual tests if an event occurs or circumstanceschange that would more likely than not reduce the fair value of an entity belowits carrying value.

 

The carrying value of HickoryTech’s goodwill is $25,086,000 as of March31, 2005 and December 31, 2004.

 

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

 
| ** **                       | ** **   | **As of March 31, 2005** | ** ** | **As of December 31, 2004** | ** ** |
|----------------------------------|--------------|--------------------------|------------|-----------------------------|------------|
| *** ***                     | *** *** | **Gross Carrying**       | ** ** | **Accumulated**             | ** ** | **Gross Carrying** | ** ** | **Accumulated** | ** ** |
| **(Dollars in Thousands)**       | ** **   | **Amount**               | ** ** | **Amortization**            | ** ** | **Amount** | ** ** | **Amortization** | ** ** |
|                             |         |                     |       |                        |       |   |   |   |   |
| Definite-Lived Intangible Assets |         |                     |       |                        |       |   |   |   |   |
| Customers                        |         | $                        | 821        |                        | $          | 467 |   | $ | 821 |   | $ | 442 |   |
| Other Intangibles                |         | 109                      |       | 102                         |       | 109 |   | 101 |   |
| Total                            |         | $                        | 930        |                        | $          | 569 |   | $ | 930 |   | $ | 543 |   |

 

Amortization expense related to the definite-lived intangible assetsfor the three months ended March 31, 2005 and 2004 was $26,000 and $25,000,respectively. Total estimated amortization expense for the remaining ninemonths of 2005 and the five years subsequent to 2005 is as follows: 2005 (April1 through December 31) - $78,000; 2006 - $104,000; 2007 - $104,000; 2008 -$74,000; 2009 - $1,000 and 2010 - $0.

 

NOTE 7. RECENT ACCOUNTING DEVELOPMENTS

 

In December 2004, the Financial Accounting Standards Board (‘‘FASB’’)issued SFAS No. 123(R), “Share-Based Payment,” which is a revision of SFAS No. 123and supersedes APB Opinion No. 25. SFAS No. 123(R) requires all share-basedpayments to employees, including grants of employee stock options, to be valuedat fair value on the date of grant, and to be expensed over the applicablevesting period. Companies must recognize compensation expense related to anyawards that are not fully vested as of the effective date. Compensation expensefor the unvested awards will be measured based on the fair value of the awardspreviously calculated in developing the pro forma disclosures in accordancewith the provisions of SFAS No. 123. Originally, SFAS No. 123(R) was effectivefor all stock-based awards granted beginning with the first interim periodafter June 15, 2005. On April 14, 2005, The Securities and Exchange Commission(SEC) approved a new rule that changed the effective date of SFAS No. 123(R)for public companies to annual, rather than interim, periods that begin afterJune 15, 2005. HickoryTech is currently assessing the impact of adopting SFAS123(R), which may be material in future periods, to its consolidated results ofoperations and plans to comply with the regulations. For the historical impactof share-based payments to employees under APB No. 25, refer to the disclosuresin Note 10 of the Notes to Consolidated Financial Statements.

 

6

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NOTE 8. QUARTERLY SECTOR FINANCIAL SUMMARY

 
| *** ***                                                         | ** ** | *** *** | ** ** | **Information** | ** ** | **Enterprise** | ** ** | **Corporate and** | ** ** | **HickoryTech**  | ** ** |
|----------------------------------------------------------------------|------------|--------------|------------|-----------------|------------|----------------|------------|-------------------|------------|------------------|------------|
| **(Dollars In Thousands)**                                           | ** ** | **Telecom**  | ** ** | **Solutions**   | ** ** | **Solutions**  | ** ** | **Eliminations**  | ** ** | **Consolidated** | ** ** |
| **Three Months Ended 3/31/05**                                       |       |         |       |            |       |           |       |              |       |             |       |
| Operating Revenue from Unaffiliated  Customers                       |       | $            | 19,345     |            | $          | 488            |       | $                 | 3,275      |             | $          | — |   | $ | 23,108 |   |
| Intersegment Revenues                                                |       | 51           |       | 1,096           |       | —         |       | (1,147            | )          | —           |       |
| Total                                                                |       | 19,396       |       | 1,584           |       | 3,275          |       | (1,147            | )          | 23,108           |       |
|                                                                 |       |         |       |            |       |           |       |              |       |             |       |
| Depreciation and Amortization                                        |       | 3,536        |       | 656             |       | 32             |       | 14                |       | 4,238            |       |
| Operating Income (Loss)                                              |       | 5,764        |       | (752            | )          | (198           | )          | (292              | )          | 4,522            |       |
| Interest Expense                                                     |       | 1            |       | 13              |       | —         |       | 963               |       | 977              |       |
| Income Taxes (Benefit)                                               |       | 2,333        |       | (310            | )          | (80            | )          | (506              | )          | 1,437            |       |
| Income (Loss) from Continuing Operations                             |       | 3,432        |       | (455            | )          | (118           | )          | (743              | )          | 2,116            |       |
| Loss from Discontinued Operations Including  Intersegment Revenues   |       | —       |       | —          |       | —         |       | —            |       | —           |       |
| Net Income (Loss)                                                    |       | 3,432        |       | (455            | )          | (118           | )          | (743              | )          | 2,116            |       |
| Identifiable Assets                                                  |       | 143,818      |       | 4,742           |       | 7,159          |       | 8,720             |       | 164,439          |       |
| Property, Plant and Equip., Net                                      |       | 107,960      |       | 4,113           |       | 282            |       | 101               |       | 112,456          |       |
| Capital Expenditures                                                 |       | 1,372        |       | 84              |       | —         |       | —            |       | 1,456            |       |
|                                                                 |       |         |       |            |       |           |       |              |       |             |       |
| **Three Months Ended 3/31/04**                                       |       |         |       |            |       |           |       |              |       |             |       |
| Operating Revenue from Unaffiliated  Customers                       |       | $            | 19,426     |            | $          | 966            |       | $                 | 2,295      |             | $          | — |   | $ | 22,687 |   |
| Intersegment Revenues                                                |       | 69           |       | 1,047           |       | —         |       | (1,116            | )          | —           |       |
| Total                                                                |       | 19,495       |       | 2,013           |       | 2,295          |       | (1,116            | )          | 22,687           |       |
|                                                                 |       |         |       |            |       |           |       |              |       |             |       |
| Depreciation and Amortization                                        |       | 3,407        |       | 639             |       | 51             |       | 15                |       | 4,112            |       |
| Operating Income (Loss)                                              |       | 6,079        |       | (706            | )          | (376           | )          | (195              | )          | 4,802            |       |
| Interest Expense                                                     |       | 3            |       | 13              |       | —         |       | 1,173             |       | 1,189            |       |
| Income Taxes (Benefit)                                               |       | 2,460        |       | (290            | )          | (152           | )          | (551              | )          | 1,467            |       |
| Income (Loss) from Continuing Operations                             |       | 3,619        |       | (426            | )          | (224           | )          | (808              | )          | 2,161            |       |
| Income from Discontinued Operations Including  Intersegment Revenues |       | (59          | )          | —          |       | —         |       | —            |       | (59              | )          |
| Net Income (Loss)                                                    |       | 3,560        |       | (426            | )          | (224           | )          | (808              | )          | 2,102            |       |
| Identifiable Assets                                                  |       | 143,933      |       | 7,483           |       | 7,714          |       | 6,358             |       | 165,488          |       |
| Property, Plant and Equip., Net                                      |       | 106,782      |       | 4,865           |       | 409            |       | 180               |       | 112,236          |       |
| Capital Expenditures                                                 |       | 2,121        |       | 1               |       | —         |       | —            |       | 2,122            |       |

 

7

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NOTE 9. CONTINGENCIES

 

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

 

NOTE 10. STOCK COMPENSATION

 

At March 31, 2005, HickoryTech had four stock-based employee anddirector compensation plans, which are described more fully in the HickoryTechAnnual Report on Form 10-K for the year ended December 31, 2004. HickoryTechhas elected to account for these employee and director stock compensation plansusing the intrinsic value method as permitted by Accounting Principles BoardOpinion No. 25 and related interpretations.

 

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

 
| ** **                                                                                                                                   | ** ** | **For Three Months Ended** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------|------------|
| **(Dollars in Thousands)**                                                                                                                   | ** ** | **3/31/2005**              | ** ** | **3/31/2004** | ** ** |
|                                                                                                                                         |       |                       |       |   |   |
| Reported Net Income                                                                                                                          | ** ** | **$**                      | **2,116**  | ** ** | $ | 2,102 |   |
| Add: Stock-based employee compensation expense included in reported  net income, net of related tax effects                                  | ** ** | **13**                     | ** ** | 21 |   |
| Deduct: Total stock-based employee compensation expense determined  under fair value based method for all awards, net of related tax effects | ** ** | **(64**                    | **)**      | (88 | ) |
|                                                                                                                                         |       |                       | ** ** |   |   |
| Pro Forma Net Income                                                                                                                         | ** ** | **$**                      | **2,065**  | ** ** | $ | 2,035 |   |
|                                                                                                                                         |       |                       | ** ** |   |   |
| Earnings per share:                                                                                                                          |       |                       | ** ** |   |   |
| Basic - as reported                                                                                                                          | ** ** | **$**                      | **0.16**   | ** ** | $ | 0.16 |   |
| Basic - pro forma                                                                                                                            | ** ** | **$**                      | **0.16**   | ** ** | $ | 0.16 |   |
|                                                                                                                                         |       |                       | ** ** |   |   |
| Diluted - as reported                                                                                                                        | ** ** | **$**                      | **0.16**   | ** ** | $ | 0.16 |   |
| Diluted - pro forma                                                                                                                          | ** ** | **$**                      | **0.16**   | ** ** | $ | 0.16 |   |

 

NOTE 11. FINANCIAL DERIVATIVE INSTRUMENTS

 

HickoryTech accounts for derivative instruments in accordance with SFASNo. 133, as amended by SFAS No. 149, “Accounting for Derivative Instruments andHedging Activities,” which requires derivative instruments to be recorded onthe balance sheet at fair value. Changes in fair value of derivativeinstruments must be recognized in earnings unless specific hedge accountingcriteria are met, in which case the gains and losses are included in othercomprehensive income rather than in earnings.

 

8

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| ** **                                                           | ** ** | **Interest Rate**  | ** ** |
|----------------------------------------------------------------------|------------|--------------------|------------|
| **(Dollars in Thousands)**                                           | ** ** | **Swap Agreement** | ** ** |
|                                                                 |       |               |       |
| Accumulated other comprehensive income  balance at December 31, 2004 |       | $                  | 1,505      |   |
| Market value increase on interest rate swap  agreement               |       | 615                |       |
|                                                                 |       |               |       |
| Accumulated other comprehensive income  balance at March 31, 2005    |       | $                  | 2,120      |   |

 

HickoryTech has variable rate debt instruments, which subject theCompany to interest rate risk. Beginning in the second quarter of 2003,HickoryTech entered into interest rate swap agreements, with remainingmaturities of three months to thirty-nine months, to manage its exposure tointerest rate movements on a portion of its variable rate debt obligations. Themarket value of the cumulative gain or loss on these derivative instruments isreported as a component of accumulated other comprehensive income inshareholders’ equity and will be recognized in earnings when the term of theswap agreement is concluded.

 

The fair value of HickoryTech’s derivatives at March 31, 2005 andDecember 31, 2004 is a net asset of $3,522,000 and $2,501,000, respectively,which is included in other assets in the accompanying consolidated balancesheet.

 

NOTE 12. EMPLOYEE POST-RETIREMENT BENEFITS

 

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

 
| ** **                                                   | ** ** | **For Three Months Ended** | ** ** |
|--------------------------------------------------------------|------------|----------------------------|------------|
| **(Dollars in Thousands)**                                   | ** ** | **3/31/2005**              | ** ** | **3/31/2004** | ** ** |
| Components of Net Periodic Benefit Cost                      |       |                       |       |   |   |
| Service Cost                                                 | ** ** | **$**                      | **92**     | ** ** | $ | 93 |   |
| Interest Cost                                                | ** ** | **115**                    | ** ** | 131 |   |
| Expected Return on Plan Assets                               | ** ** | **—**                 | ** ** | — |   |
| Amortization of Transition Obligation                        | ** ** | **15**                     | ** ** | 15 |   |
| Amortization of Prior Service Cost                           | ** ** | **(3**                     | **)**      | (3 | ) |
| Recognized Net Actuarial Loss                                | ** ** | **44**                     | ** ** | 59 |   |
| Net Periodic Benefit Cost                                    | ** ** | **$**                      | **263**    | ** ** | $ | 295 |   |
|                                                         | ** ** | ** **                 | ** ** |   |   |
|                                                         | ** ** | **3/31/2005**              | ** ** |   |   |
| Employer’s Contributions                                | ** ** | ** **                 | ** ** |   |   |
| Contributions Made for the Three Months  Ended 03/31/05      | ** ** | **$**                      | **48**     | ** ** |   |   |
| Expected Contributions for Remainder of  2005                | ** ** | **150**                    | ** ** |   |   |
| Total Estimated Employer Contributions for  Fiscal Year 2005 | ** ** | **$**                      | **198**    | ** ** |   |   |

 

NOTE 13. REGULATORY ASSET ANDLIABILITY

 

Effective January 1, 2002, the Federal Communications Commission (FCC),in its “MAG (Multi Association Group) Order” on Access Charge Reform, directedall rate-of-return carriers to file revisions to their tariffs to eliminate thetransport interconnection charge (TIC) as a separate rate element. In effect,the costs previously recovered through the TIC were reallocated over all otheraccess categories, including carrier common line, transport, local switching,information surcharge and special access. The FCC made it clear that “thistariff filing should be a revenue neutral tariff filing.”

 

9

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The total revenues reallocated from the TIC to the remaining accesselements were limited to the total revenues recovered from the TIC for thetwelve-month period ended June 30, 2001. These revenues were calculated usingthe carrier’s traffic volumes and the TIC rate for the twelve-month periodended June 30, 2001. These calculations were prepared by an independentthird-party and approved by the National Exchange Carrier Association (NECA).TIC was eliminated by reallocating the costs to the other access billingcategories.

 

The FCC conducted an investigation of all tariff filings, includingNECA’s CCL (Carrier Common Line) tariff and Heartland’s Traffic Sensitive (TS)tariff, to determine if the filing parties had properly reallocated the TICcosts among the other access charge categories.

 

The FCC terminated its investigation of several tariff filings,concluding that “the carriers have substantially complied with theRate-of-Return Access Charge Reform Order and their tariffs no longer warrantinvestigation.” Despite this ruling by the FCC during the fourth quarter of2003, NECA informed HickoryTech’s Heartland subsidiary that it would not allowit to recover a portion of the TIC costs allocated to the CCL, because anincorrect TIC rate was used in the calculation.

 

As a result of this billing error, the Company recovered $611,000 ofexcess revenues from the NECA CCL pool. NECA required Heartland to repay the$611,000 in 2004.

 

The FCC approved a mid-course correction to Heartland’s TS tariff as asupportable method of recouping NECA’s CCL reduction. The revision corrects theTIC rate originally used, and factors recovery of the $611,000, into the TSrate elements. HickoryTech is recouping this revenue over the remainingeighteen months of the TS tariff, which began January 1, 2004. As of March 31,2005 HickoryTech has recognized a recovery of $509,000 of the revenue.

 

In accordance with SFAS No. 71, HickoryTech recorded a regulatory assetfor the revenue it would recoup with a balance of $102,000 at March 31, 2005and $204,000 at December 31, 2004.

 

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

 

**FORWARD-LOOKINGSTATEMENTS**

 

*Statements in this Form 10-Q that are nothistorical fact are forward-looking statements that are based on management’scurrent expectations, estimates and projections about the industry in whichHickoryTech operates and management’s beliefs and assumptions. Suchforward-looking statements are subject to important risks and uncertaintiesthat could cause HickoryTech’s future actual results to differ materially fromsuch statements. These statements are not guarantees of future performance andinvolve certain risks, uncertainties and probabilities, which are difficult topredict. Therefore, actual outcomes and results may differ materially from whatis expressed or forecasted in such forward-looking statements, whether as aresult of new information, future events or otherwise. Factors that might causesuch a difference include, but are not limited to, those contained in this “Management’sDiscussion and Analysis” (Item 2) and the Cautionary Statement for Purposes ofthe “Safe Harbor” Provision of the Private Securities Litigation Reform Act of1995 on pages 28-29 of HickoryTech’s Annual Report on Form 10-K for the year endedDecember 31, 2004, which is incorporated herein by reference. You are cautionednot to place undue reliance on these forward-looking statements, which speakonly as of the date on which they were made. Except as otherwise required byfederal securities law, HickoryTech undertakes no obligation to update any ofits forward-looking statements for any reason.*

 

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**BUSINESSES**

 

*HickoryTech operates in three businesssegments: the Telecom, Information Solutions and Enterprise Solutions Sectors.Its largest and oldest business (since 1898) has been the operation ofincumbent local exchange carriers (ILECs) or traditional wireline telephoneservice. The ILEC business is 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 incumbent LEC (local exchangecarrier) territories owned by others. The CLEC business is in HickoryTech’sTelecom Sector. Since 1964, HickoryTech’s Information Solutions Sector hasprovided computer data processing and software, predominantly for HickoryTech’sTelecom Sector operations and also to other telecommunications companies.HickoryTech acquired its Enterprise Solutions Sector in 1990 and it operates asa telecommunications, data and Internet Protocol equipment distributor from abase in Minneapolis/St. Paul, Minnesota. HickoryTech also began its wirelessoperations in 1998 by acquiring its first wholly owned wireless servicelicense, an additional wireless service license in 1999 and two PCS licenses in2001. HickoryTech sold the wireless operations on December 15, 2003. Thewireless operations are reported as part of the Telecom Sector. The results ofoperations of the wireless business are reported as discontinued operations forall periods presented.*

* *

*The eight subsidiaries of HickoryTech, allof which publicly operate and conduct business as HickoryTech, and the businesssegments in which they operate are:*

* *

**TELECOM SECTOR**

MankatoCitizens Telephone Company (MCTC)

Mid-Communications,Inc. (Mid-Comm)

HeartlandTelecommunications Company of Iowa, Inc. (Heartland)

Cable Network,Inc. (CNI)

CrystalCommunications, Inc. (Crystal)

MinnesotaSouthern Wireless Company (MSWC)-Discontinued Operations

**INFORMATION SOLUTIONS SECTOR**

NationalIndependent Billing, Inc. (NIBI)

**ENTERPRISE SOLUTIONS SECTOR**

CollinsCommunications Systems Co. (Collins)

* *

*HickoryTech and its subsidiaries areengaged in businesses that provide services to their customers for a fee. Manyof these services are recurring, and, as a result, backlog orders andseasonality are not significant factors. Working capital requirements primarilyinvolve financing the construction of networks involving switches and cable,and maintaining a high amount of fixed assets. Other working capitalrequirements include the payroll costs of highly skilled labor, the inventoryto service its capital projects and maintenance of the network and telephoneequipment customers, and the carrying value of trade accounts receivable, whichmay take several months to collect in the normal course of business.*

* *

*The materials and supplies that arenecessary for the operation of the businesses of HickoryTech and itssubsidiaries are available from a variety of sources. All of HickoryTech’scentral office switches, as well as a majority of HickoryTech’s equipment soldin its Enterprise Solutions Sector, are supplied by Nortel. Nortel is a leadingsupplier of communications equipment, and HickoryTech’s dependence on thisbrand is not viewed as a significant risk. An additional layer of networkinfrastructure equipment for broadband services is provided by Nextlevel. TheCompany also is a distributor of Cisco data equipment in its EnterpriseSolutions Sector.*

* *

**INDUSTRYSEGMENTS**

 

*HickoryTech reports the business operationsof Telephone, Communications Services, and Wireless Services as a singlesegment referred to as the Telecom Sector. The results of operations of thewireless business are reported as discontinued operations for all periodspresented. The other two business segments are the Information Solutions andEnterprise Solutions Sectors.*

 

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*TELECOMSECTOR*

 

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

 

The Telecom Sector also includes Crystal, a CLEC. Crystal provideslocal telephone service, long distance, dial-up and broadband Internet accessand digital television 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. In addition to the digital television service provided to customers inSt. Peter, Minnesota, HickoryTech began providing digital television service tocustomers in Waseca, Minnesota in July 2004.

 

HickoryTech also owns and operates fiber optic cable facilities inMinnesota in its subsidiary CNI.  Thesefacilities are used to transport interexchange communications as a service totelephone industry customers. HickoryTech’s Minnesota ILECs and CLEC are theprimary users of the fiber optic cable facilities.

 

The Telecom Sector included the operations of MSWC, which was soldDecember 15, 2003. None of the remaining companies in the Telecom Sectorexperienced major changes in operations during 2005 or 2004.

 

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

 

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

 

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

 

12

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

 

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

 

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

 

HickoryTech companies are sometimes engaged in negotiation orrenegotiation of arrangements for network interconnection with other carriersand contracts with various wireless service providers. Heartland and MCTC arepresently involved in interconnection negotiations with another serviceprovider.  Although such negotiations mayresult in reduced revenue, HickoryTech cannot, at this time, estimate the potentialrevenue impact related to these negotiations.

 

Future decisions regarding the regulation of VoIP may result in achange in the business relationship between HickoryTech companies andinterexchange carriers. These relationships and regulation concerning them arediscussed further in the regulated industry section of this Form 10-Q.

 

The passage of the 1996 Telecommunications Act created the opportunityfor HickoryTech to offer communications service in territories served by othertelephone companies, and Crystal began operations in January 1998 as a newCLEC. Crystal offers local service, long distance, dial-up and broadbandInternet access services, and digital television on a competitive basis tocustomers in southern Minnesota and Iowa, which were not previously served byHickoryTech’s Telecom Sector service area. These service offerings providecustomers alternatives to the incumbent communication providers in variouscommunities and are offered under the brand name HickoryTech service. Theseservices are currently being offered to customers in ten rural communities,encompassing eight exchanges, in Minnesota, as well as three communities,encompassing two exchanges, in Iowa. Crystal also provides the long distanceservice, dial-up and broadband Internet access services to HickoryTech’s ILECsubscribers.

 

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

 

There is currently a multi-state incumbent LEC industry dispute with alarge RBOC (Regional Bell Operating Company) regarding certain access charges.The incumbent LEC industry in Minnesota has jointly filed a formal complaintwith the Minnesota Public Utilities Commission regarding this dispute. Asrequested in the complaint, this matter was referred to the Office ofAdministrative Hearings for a contested case proceeding, which is currently inprocess. The parties have negotiated an interim arrangement which will placethe complaint process in a “continuance” while a trial of a proposed resolutionis conducted.

 

13

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On December 15, 2003, HickoryTechsold its wireless business, Minnesota Southern Wireless Company (MSWC), toWestern Wireless Corporation (WWC). The wireless operations are reported aspart of the Telecom Sector. The results of operations of the wireless businessare reported as discontinued operations for all periods presented.

 

REGULATED INDUSTRY

 

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

 

The Minnesota Public Utilities Commission (PUC) has been consideringintrastate access reform and universal service for several years. In June 2004,the Minnesota PUC issued an order to refer the carrier common line (CCL)component of the access reform issue to a contested case hearing. In September2004, the Minnesota PUC also referred the local switching and transport (LST)component of the access reform issue for a separate contested case hearing.Such hearings in Minnesota usually involve full development of a public recordand recommendation of an administrative law judge prior to final PUCdiscussion. The process on both of these dockets was suspended in December 2004subsequent to concerns expressed by state agencies regarding increases in localrates that might be instigated by mandated access reductions. The outcome ofany access reform process will not likely be known until the second quarter of2005 or later. HickoryTech cannot estimate the impact, if any, of futurepotential state access revenue changes.

 

In December, 2004, the Federal Court of Appeals, 8th Circuit upheld anOctober 2003 ruling by the United States District Court, District of Minnesota,in issuing an injunction providing relief from regulation of any serviceprovider of Voice over Internet Protocol (VoIP) based services in Minnesota.The issue of regulation of VoIP is also under consideration at the FCC.  In March, 2005 a Petition of Forbearance fromrequirements for payment of access charges by a VoIP provider was withdrawn bythe initiator. Future decisions regarding the regulation of VoIP may result ina change in the business relationship between HickoryTech companies and theinterexchange carriers, as interconnections with certain VoIP providers may notbe governed by tariffed access charges. HickoryTech cannot, at this time,estimate the revenue impact, if any, related to these events.

 

ILEC Iowa – In 2005, deregulation was granted to all Iowa companies forall services other than single line services with respect to rates. Previously,only companies with fewer than 15,000 access lines were unregulated.HickoryTech’s Iowa ILEC subsidiary has maintained less than 15,000 access linesso it has been and will remain unregulated.

 

Wireline Interstate – The HickoryTech ILEC companies do not participatein the NECA traffic sensitive pool and set access rates according to either anationwide average cost of providing access, or in the case of Heartland,according to its own interstate costs. This biannual rate process was completedin June 2003, and established traffic sensitive interstate rates for the periodfrom July 1, 2003 through June 30, 2005. HickoryTech ILEC companies participatein the NECA common line pool. In July of 2003, common line rates charged tointerexchange carriers were reduced (to zero), and common line charges to endusers were increased in accordance with an October 2001 FCC order (a/k/a MAGPlan). End User Common Line (EUCL) funds collected are pooled, and some of HickoryTechrevenues are based on settlements distributed from the pool. Pool settlementsare adjusted periodically. The rates will be adjusted in July, 2005 for theperiod of July 1, 2005 through June 30, 2006.

 

CLEC – HickoryTech’s CLEC Company provides local exchange services inMinnesota and Iowa with less regulatory oversight than the HickoryTech ILECcompanies. Additionally, Crystal offers digital television service in the St.Peter, Minnesota market under a franchise negotiated with the local municipality.Beginning in the third quarter 2004, Crystal began offering digital televisionin the Waseca, Minnesota market under a similar franchise agreement. Crystalalso offers long distance services. In-state services in Minnesota areregulated by the PUC with respect to uniform pricing statewide. In-state longdistance service in Iowa is unregulated. Long distance services are alsoderegulated at the federal level (for interstate services), but are subject toannual certification of geographical rate averaging and rate integration.Dial-up and broadband Internet access are unregulated at both the state andfederal levels.

 

14

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

 

The FCC has an open docket on intercarrier compensation as well asseveral dockets on VoIP. In February 2005, the FCC issued a Further Notice ofPublic Rule Making (FNPRM) requesting comments on various proposals forintercarrier compensation reform. HickoryTech cannot predict the outcome ofsuch proceedings nor can it estimate the impact, if any, on HickoryTech.

 

Local Number Portability (LNP) – On November 10, 2003, the FCC releaseda decision providing guidance on porting between wireline and wireless networks(intermodal porting). The FCC stated that intermodal number porting is requiredupon bona fide request where the coverage area of the wireless carrier (i.e.the area in which the wireless carrier provides service) overlaps thegeographic location in which the wireline number was provisioned. The FCC leftissues governing the payment of call routing costs to another pendingproceeding. The Company’s wireline operations were subject to a May 24, 2004implementation date for intermodal porting, however, HeartlandTelecommunications Company of Iowa joined in an industry action by the IowaTelecommunications Association to suspend the requirements for small ruralcarriers. After receiving an order from the Iowa Utilities Board allowingHeartland until April 6, 2005, to implement LNP, Heartland has proceeded and thisfunctionality was added as of January 25, 2005.

 

The effects of intermodal porting on the Company’s Minnesota wirelineoperations have been minimal as of March 31, 2005. Given the short history forwhich intermodal porting has been available, however, the Company cannot fullyquantify the long-term effects of implementing intermodal porting on itswireline operations. It is possible that these requirements could adverselyaffect the Company’s wireline operating costs and customer growth rates.  HickoryTech is also unable to quantify therevenue impact of wireline customers that may switch to wireless or otherwireline alternatives.

 

Triennial Review Order — In August 2003, the FCC published a revieworder proposing changes in rules developed under the provisions of theTelecommunications Act of 1996 Section 251(c)(3) which requires incumbent LECsto make elements of their networks available on an unbundled basis to newentrants at model-based rates. This order was immediately challenged by theUnited States Telecom Association (USTA) and several carriers. In April 2004,the Washington DC district court issued a ruling remanding the issue back tothe FCC so that, for specific unbundled network elements (UNEs), incumbent LECsface reduced mandates to make their network available and CLECs face reducedopportunities or increased costs in obtaining network from the incumbent withwhom they compete. Accordingly, in August 2004, the FCC released a Notice ofPublic Rule Making (NPRM) with transitional rules for elimination of UNEs andadopted final rules on December 15, 2004. HickoryTech’s CLEC, CrystalCommunications, predominately uses its own network and has not made extensiveuse of the type of network elements addressed in the ruling. While HickoryTechcannot fully quantify the impact of this issue, the FCC orders are not expectedto have a material impact on Crystal’s business.

 

*INFORMATION SOLUTIONS SECTOR*

 

Through NIBI, HickoryTech’sInformation Solutions Sector provides data processing and related services, principallyfor HickoryTech, 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 companiesengaged in supplying data processing services comparable to those furnished bythe Information Solutions Sector. Competition is based primarily on price andservice. HickoryTech’s Information Solutions Sector has developed an integratedbilling and management system called SuiteSolution. SuiteSolution can providewireline and wireless carriers the individual benefits of a billing platform ora total system solution.

 

15

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*ENTERPRISESOLUTIONS SECTOR*

 

Through Collins, HickoryTech’sEnterprise Solutions Sector provides telephone, data and Voice over InternetProtocol (VoIP) business systems equipment sales and services to companiesprimarily based in metropolitan Minneapolis/St. Paul, Minnesota. This sectoralso supports the business telephone system service for HickoryTech ILEC andCLEC operations in southern Minnesota and in Iowa. The customers in theEnterprise Solutions Sector’s market are the individual business end users oftelecommunications service with ongoing service requirement offerings. Productsconsist of communication platforms such as Nortel, Cisco and Bay Networks(Nortel) equipment. Enterprise Solutions specializes in complex design, installationand maintenance of voice, data or Internet Protocol products.

 

Revenues are primarily earned bythe sales, installation and service of business telephone and IP data systems.Enterprise Solutions continues its commitment to service and support its coreproduct, Nortel, while identifying new opportunities such as call centers,computer telephone integration voice mail and interactive voice responsesystems.

 

HickoryTech’s Enterprise SolutionsSector is not dependent upon any single customer or small group of customers.No single customer in the Enterprise Solutions Sector accounts for ten percentor more of HickoryTech’s consolidated revenues.

 

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

 

**RESULTS OF OPERATIONS**

 

CONSOLIDATED OPERATING RESULTS:

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

 

OPERATINGREVENUES:

Consolidated operating revenueswere $23,108,000, which is $421,000 or 1.9% higher in the three months endedMarch 31, 2005 compared to the three months ended March 31, 2004. The increasein revenues in the three months ended March 31, 2005 compared to the threemonths ended March 31, 2004 can be primarily attributed to a higher volume ofbusiness in the Enterprise Solutions Sector, as well as increased data servicerevenue in the Telecom Sector. These increases were partially offset by thedecreased revenue from unaffiliated customers in the Information SolutionsSector and the decreased network access revenues in the Telecom Sector.

 

COST OF SALES,ENTERPRISE SOLUTIONS:

Cost of sales, which is relatedto the Enterprise Solutions Sector, was $2,268,000, which is $759,000 or 50.3%higher in the three months ended March 31, 2005 compared to the three monthsended March 31, 2004. Gross profit margin was 30.7% in the first quarter of2005 compared to 34.2% in the first quarter of 2004. The decrease in grossprofit margin in the first quarter of 2005 compared to the first quarter of2004 is largely the result of the increase in installation work. These marginsare primarily affected by product mix sold.

 

COST OFSERVICES, excluding Depreciation and Amortization:

Cost of services, excludingdepreciation and amortization decreased $555,000 or 6.4% in first quarter 2005compared to first quarter 2004. This decrease was primarily due to greaterwages and benefits in the first quarter of 2004 in the Information SolutionsSector and decreased Internet expense and long distance wholesale expense inthe Telecom Sector. The wages and benefits in the Information Solutions Sectormentioned above were associated with a redeployment of personnel to selling,general and administrative cost centers in connection with management costreduction actions.

 

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

Selling, general andadministrative expenses, excluding depreciation and amortization increased$371,000 or 10.1% in first quarter 2005 compared to first quarter 2004. Theprimary reasons for the increase in first quarter 2005 compared to firstquarter 2004 was the increased wages and benefits resulting from a redeploymentof personnel from  cost of services costcenters in the Information Solutions Sector, as well as increased propertytaxes in the Telecom Sector.

 

DEPRECIATION AND AMORTIZATION:

Depreciation expense was $4,001,000, which is $125,000or 3.2% higher in the three months ended March 31, 2005 compared to the threemonths ended March 31, 2004. The increase in depreciation for the three monthsended March 31, 2005 compared to the three months ended March 31, 2004 was dueto an increase in the Telecom Sector’s network assets.

 

OPERATING INCOME:

Operating income was $4,522,000, which is $280,000 or 5.8% lower in thethree months ended March 31, 2005 compared to the three months ended March 31,2004. The decrease in income from continuing operations was driven by the$759,000 increase in cost of sales and the $371,000 increase in selling,general and administrative expenses, both of which were described above. Theseexpense increases were partially offset by the $555,000 decrease in cost ofservices and the $421,000 increase in operating revenues, both of which werealso described above.

 

INTEREST EXPENSE:

Interest expense decreased $212,000 or 17.8% to $977,000 in the threemonths ended March 31, 2005 compared to the three months ended March 31, 2004.The decrease in interest expense for the period was primarily due to a decreasein total debt outstanding. The outstanding balance of the revolving creditfacility was $98,750,000 at March 31, 2005 and $110,250,000 at March 31, 2004.

 

INCOME TAXES:

The effective income tax rate of approximately 40.4% for first quarter2005 and first quarter 2004 exceeds the federal statutory rate primarily due tostate income taxes.

 

INCOME FROM CONTINUING OPERATIONS:

Consolidated income from continuing operations was $2,116,000, which is$45,000 or 2.1% lower in the three months ended March 31, 2005 compared to thethree months ended March 31, 2004.  Thedecrease in income from continuing operations was driven by the $759,000increase in cost of sales, the $371,000 increase in selling, general andadministrative expenses and the $125,000 increase in depreciation, all of whichwere described above. These expense increases were partially offset by the$555,000 decrease in cost of services, $421,000 increase in operating revenuesand the $212,000 decrease in interest expense, all of which were also describedabove.

 

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SECTOR RESULTS OF OPERATIONS FROM CONTINUINGOPERATIONS

 

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

 

**TELECOMSECTOR**

 
| ** **                                                                              | ** ** | **For Three Months Ended** | ** ** |
|-----------------------------------------------------------------------------------------|------------|----------------------------|------------|
| **(Dollars in Thousands)**                                                              | ** ** | **3/31/2005**              | ** ** | **3/31/2004** | ** ** |
|                                                                                    |       |                       |       |   |   |
| Revenues  Before Intersegment Eliminations                                              |       |                       |       |   |   |
| ILEC                                                                                    |       |                       |       |   |   |
| Local  Service                                                                          | ** ** | **$**                      | **3,736**  |   | $ | 3,731 |   |
| Network  Access                                                                         | ** ** | **8,494**                  |       | 8,677 |   |
| Data                                                                                    | ** ** | **570**                    |       | 522 |   |
| Intersegment                                                                            | ** ** | **51**                     |       | 69 |   |
| Other                                                                                   | ** ** | **1,666**                  |       | 1,747 |   |
| Total ILEC                                                                              | ** ** | **14,517**                 |       | 14,746 |   |
|                                                                                    |       |                       |       |   |   |
| CLEC                                                                                    |       |                       |       |   |   |
| Local  Service                                                                          | ** ** | **889**                    |       | 929 |   |
| Network  Access                                                                         | ** ** | **518**                    |       | 680 |   |
| Data                                                                                    | ** ** | **618**                    |       | 381 |   |
| Other                                                                                   | ** ** | **433**                    |       | 430 |   |
| Total CLEC                                                                              | ** ** | **2,458**                  |       | 2,420 |   |
|                                                                                    |       |                       |       |   |   |
| Long  Distance                                                                          | ** ** | **1,142**                  |       | 1,228 |   |
|                                                                                    |       |                       |       |   |   |
| Internet                                                                                | ** ** | **1,071**                  |       | 995 |   |
|                                                                                    |       |                       |       |   |   |
| Digital TV                                                                              | ** ** | **208**                    |       | 106 |   |
|                                                                                    |       |                       |       |   |   |
| Total  Telecom Revenues                                                                 | ** ** | **$**                      | **19,396** |   | $ | 19,495 |   |
|                                                                                    |       |                       |       |   |   |
| Total  Telecom Revenues Before Intersegment Eliminations                                |       |                       |       |   |   |
| Unaffiliated  Customers                                                                 | ** ** | **$**                      | **19,345** |   | $ | 19,426 |   |
| Intersegment                                                                            | ** ** | **51**                     |       | 69 |   |
| ** **                                                                              |       | **19,396**                 |       | 19,495 |   |
|                                                                                    |       |                       |       |   |   |
| Cost of  Services, excluding Depreciation and Amortization                              | ** ** | **7,412**                  |       | 7,480 |   |
| Selling,  General, and Administrative Expenses, excluding Depreciation and Amortization | ** ** | **2,684**                  |       | 2,529 |   |
| Depreciation  and Amortization                                                          | ** ** | **3,536**                  |       | 3,407 |   |
| Operating  Income                                                                       | ** ** | **$**                      | **5,764**  |   | $ | 6,079 |   |
|                                                                                    |       |                       |       |   |   |
| Income from  Continuing Operations, Net of Tax                                          | ** ** | **$**                      | **3,432**  |   | $ | 3,619 |   |
| Loss from  Discontinued Operations                                                      | ** ** | **—**                 |       | (59 | ) |
| Net Income                                                                              | ** ** | **$**                      | **3,432**  |   | $ | 3,560 |   |
|                                                                                    |       |                       |       |   |   |
| Capital  Expenditures                                                                   | ** ** | **$**                      | **1,372**  |   | $ | 2,121 |   |
|                                                                                    |       |                       |       |   |   |
| ILEC Access  Lines                                                                      | ** ** | **59,612**                 |       | 62,242 |   |
|                                                                                    |       |                       |       |   |   |
| CLEC Access  Lines                                                                      |       |                       |       |   |   |
| Overbuild                                                                               | ** ** | **10,466**                 |       | 10,131 |   |
| Unbundled  Network Element (UNE)                                                        | ** ** | **1,760**                  |       | 1,694 |   |
| Total  Service Resale (TSR)                                                             | ** ** | **1,797**                  |       | 2,504 |   |
| Total                                                                                   | ** ** | **14,023**                 |       | 14,329 |   |
|                                                                                    |       |                       |       |   |   |
| Long  Distance Customers                                                                | ** ** | **44,423**                 |       | 41,695 |   |
|                                                                                    |       |                       |       |   |   |
| Internet  Customers                                                                     | ** ** | **17,718**                 |       | 16,453 |   |
|                                                                                    |       |                       |       |   |   |
| Total  Telecom Customers                                                                | ** ** | **135,776**                |       | 134,719 |   |
|                                                                                    |       |                       |       |   |   |
| DSL  Customers                                                                          | ** ** | **11,337**                 |       | 8,324 |   |
|                                                                                    |       |                       |       |   |   |
| Digital TV  Customers                                                                   | ** ** | **2,048**                  |       | 1,257 |   |

 

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Telecom Sector operating revenuesbefore intersegment eliminations were $19,396,000, which is $99,000 or 0.5%lower in the three months ended March 31, 2005 compared to the three monthsended March 31, 2004.  The decrease infirst quarter 2005 compared to first quarter 2004 was primarily due todecreased network access, offset by increased revenue from data and digital TV.

 

ILEC network access revenue was $8,494,000, which is $183,000 or 2.1%lower in the three months ended March 31, 2005 compared to the three monthsended March 31, 2004.  The decrease innetwork access revenue in 2005 compared to 2004 was driven by the impact ofcarriers rerouting traffic, carrier billing interpretations and lower minutesof use. A combination of access reform, changing minutes of use (MOU), carriersrerouting traffic, and lower demand for dedicated lines may negatively impactfuture access revenues. HickoryTech’s ILEC operations establish trafficsensitive access rates bi-annually in accordance with required regulation. TheCompany expects further declines in network access revenues when these ratesare adjusted in mid-2005. The Minnesota Public Utilities Commission (PUC)has been considering intrastate access reform and universal service for severalyears (see regulatory section).

 

ILEC data revenue was $48,000 or 9.2% higher in first quarter 2005compared to first quarter 2004. The increase is the result of 2,270 moreDigital Subscriber Line (DSL) customers at March 31, 2005 than at March 31,2004.

 

ILEC other revenue was $81,000 or 4.6% lower in first quarter 2005compared to first quarter 2004. 2005 is lower primarily because of a largepaystation settlement received in 2004.

 

CLEC network access revenue was $162,000 or 23.8% lower in firstquarter 2005 compared to first quarter 2004. This decrease was driven by amandated rate decrease in June, 2004 for interstate traffic. A combination ofaccess reform, changing MOUs, carriers rerouting traffic and lower demand fordedicated lines may negatively impact future access revenues.

 

CLEC data revenuewas $237,000 or 62.2% higher in first quarter 2005 compared to first quarter2004. The increase was caused primarily by an increase in residential andbusiness DSL penetration in CLEC communities, as well as the rollout ofEthernet services to large business customers in 2004.

 

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Long distancerevenue was $86,000 or 7.0% lower in the three months ended March 31, 2005compared to the three months ended March 31, 2004. The lower revenue in 2005was primarily due to the $125,000 of 2004 wholesale revenue received from awireless carrier that discontinued their use of our long distance services inthe second quarter of 2004. HickoryTech experienced a 2,728 or 6.5% increase inits long distance customer base between March 31, 2004 and March 31, 2005.

 

Internet revenuewas $76,000, or 7.6% higher in the three months ended March 31, 2005 comparedto the three months ended March 31, 2004. The increase in revenue was caused primarily by an increase in Internetcustomers of 1,265 or 7.7% between March 31, 2004 and March 31, 2005.

 

Digital TV was$102,000, or 96% higher in the three months ended March 31, 2005 compared tothe three months ended March 31, 2004. The increase was the result of theoffering of digital TV in an additional community in the latter half of 2004,as well as an increase in penetration in the existing community.

 

Cost of Services,excluding Depreciation and Amortization:

Cost of services,excluding depreciation and amortization was $68,000 or 0.9% lower in the firstquarter of 2005 compared to the first quarter of 2004. The decrease isprimarily due to lower Internet expense of $117,000 due to lower costsassociated with customers who have switched from dial-up Internet to broadbandInternet. Another cause of the decrease of cost of services in first quarter2005 compared to the first quarter 2004 was $107,000 of expense incurred in2004 received from a wireless carrier that discontinued their use of our long distanceservices in the second quarter of 2004. These reductions were offset byincreased long distance and commission expense.

 

Selling, Generaland Administrative Expenses, excluding Depreciation and Amortization:

Selling, generaland administrative expenses, excluding depreciation and amortization was$155,000 or 6.1% higher in the first quarter of 2005 compared to the firstquarter of 2004.  This increase isprimarily due to higher real estate tax expense as well as higher corporateallocations.

 

Depreciation andAmortization:

Depreciation andamortization were $3,536,000, which is $129,000 or 3.8% higher in the threemonths ended March 31, 2005 compared to the same period in 2004.  The increase in depreciation expense can belargely attributed to increased network infrastructure.

 

Operating and NetIncome:

Operating incomewas $5,764,000, which is $315,000 or 5.2% lower in the three months ended March31, 2005 compared to the three months ended March 31, 2004.  Net income was $3,432,000, which is $128,000or 3.6% lower in the three months ended March 31, 2005 compared to the threemonths ended March 31, 2004.  Thesedecreases were driven by the $155,000 increase in selling, general andadministrative expenses, $129,000 increase in depreciation and amortization and$99,000 decrease in revenue mentioned above, offset by the $68,000 decrease incost of services, also mentioned above.

 

DiscontinuedOperations:

On December 15, 2003, HickoryTechsold its wireless business, Minnesota Southern Wireless Company (MSWC), toWestern Wireless Corporation (WWC). The wireless operations are reported aspart of the Telecom sector. The results of operations of the wireless businessare reported as discontinued operations for all periods presented.

 

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

 

**INFORMATIONSOLUTIONS SECTOR**

 
| ** **                                                                              | ** ** | **For Three  Months Ended** | ** ** |
|-----------------------------------------------------------------------------------------|------------|-----------------------------|------------|
| **(Dollars in Thousands)**                                                              | ** ** | **3/31/2005**               | ** ** | **3/31/2004** | ** ** |
| Revenues  Before Eliminations                                                           |       |                        |       |   |   |
| Unaffiliated  Customers                                                                 | ** ** | **$**                       | **488**    | ** ** | $ | 966 |   |
| Intersegment                                                                            | ** ** | **1,096**                   | ** ** | 1,047 |   |
| ** **                                                                              |       | **1,584**                   | ** ** | 2,013 |   |
| Cost of  Services, excluding Depreciation and Amortization                              | ** ** | **1,381**                   | ** ** | 1,886 |   |
| Selling,  General, and Administrative Expenses, excluding Depreciation and Amortization | ** ** | **299**                     | ** ** | 194 |   |
| Depreciation  and Amortization                                                          | ** ** | **656**                     | ** ** | 639 |   |
|                                                                                    |       |                        | ** ** |   |   |
| Operating  Loss                                                                         | ** ** | **$**                       | **(752**   | **)** | $ | (706 | ) |
| Net Loss                                                                                | ** ** | **$**                       | **(455**   | **)** | $ | (426 | ) |
|                                                                                    |       |                        | ** ** |   |   |
| Capital  Expenditures                                                                   | ** ** | **$**                       | **84**     | ** ** | $ | 1 |   |

 

Revenues:

Operating revenues from unaffiliated customers decreased $478,000 or49.5% in the first quarter 2005 compared to the first quarter 2004. $365,000 or76.4% of this decrease was from a temporary customer that ended in secondquarter 2004. The remaining decrease in unaffiliated customer revenues wasprimarily due to the loss of several customers and a decline in volume for manyexisting customers.

 

Cost of Services, excluding Depreciation andAmortization:

Cost of services, excluding depreciation and amortization decreased$505,000 or 26.8% in the first quarter 2005 compared to the first quarter 2004.The decrease is primarily due to greater wages and benefits in the firstquarter of 2004 associated with a redeployment of personnel to selling, generaland administrative cost centers in connection with management cost reductionactions.

 

Selling, Generaland Administrative Expenses, excluding Depreciation and Amortization:

Selling, general and administrative expenses, excluding depreciationand amortization was $105,000 or 54.1% higher in the first quarter of 2005compared to the first quarter of 2004. The increase was largely due toincreased wages and benefits resulting from a redeployment of personnel fromcost of services cost centers.

 

Operating and Net Loss:

Operating loss increased $46,000 or 6.5% in first quarter 2005 comparedto first quarter 2004.  Net lossincreased $29,000 or 6.8% in first quarter 2005 compared to first quarter2004.  The increase in operating loss andnet loss in first quarter 2005 compared to first quarter 2004 was primarilyattributable to the decrease in revenues from unaffiliated customers and theincrease in selling, general, and administrative expenses excludingdepreciation and amortization, partially offset by the decrease in cost ofservices excluding depreciation and amortization.

 

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

 

**ENTERPRISESOLUTIONS SECTOR**

 
| ** **                                                                             | ** ** | **For Three Months Ended** | ** ** |
|----------------------------------------------------------------------------------------|------------|----------------------------|------------|
| **(Dollars in Thousands)**                                                             | ** ** | **3/31/2005**              | ** ** | **3/31/2004** | ** ** |
| Revenues  Before Intersegment Eliminations                                             |       |                       | ** ** |   |   |
| Installation                                                                           | ** ** | **$**                      | **1,387**  | ** ** | $ | 653 |   |
| Service                                                                                | ** ** | **1,888**                  | ** ** | 1,642 |   |
| ** **                                                                             |       | **3,275**                  | ** ** | 2,295 |   |
| Cost of  Sales                                                                         | ** ** | **2,268**                  | ** ** | 1,509 |   |
| Cost of  Services, excluding Depreciation And Amortization                             | ** ** | **375**                    | ** ** | 325 |   |
| Selling,  General and Administrative Expenses, excluding Depreciation and Amortization | ** ** | **798**                    | ** ** | 786 |   |
| Depreciation  and Amortization                                                         | ** ** | **32**                     | ** ** | 51 |   |
|                                                                                   |       |                       | ** ** |   |   |
| Operating  Loss                                                                        | ** ** | **$**                      | **(198**   | **)** | $ | (376 | ) |
| Net Loss                                                                               | ** ** | **$**                      | **(118**   | **)** | $ | (224 | ) |
|                                                                                   |       |                       | ** ** |   |   |
| Capital  Expenditures                                                                  | ** ** | **$**                      | **—** | ** ** | $ | — |   |

 

Revenues:

Operating revenues increased $980,000 or 42.7% in the first quarter of2005 compared to the first quarter of 2004. Installation revenue increased$734,000 or 112.4% in the first quarter of 2005 compared to the first quarterof 2004. The increase in installation revenue in the first quarter of 2005compared to the first quarter of 2004 was mainly the result of increased salesand installations in the small business system (SBS) and data product lines.SBS revenue increased by $281,000 and data revenue increased by $321,000 in thefirst quarter of 2005 compared to the first quarter of 2004. Sales in the SBSproduct line reflect an increased volume of small projects completed throughoutthe first quarter of 2005. Enterprise Solutions was awarded several largecontracts that increased data revenue in the first quarter of 2005. Servicerevenue was $246,000 or 15.0% higher in the first quarter of 2005 compared tothe first quarter of 2004. The increase in service revenue was primarily a resultof an increase in sales in the Move/Add/Change Contract product line.

 

Cost of Sales:

Cost of sales increased$759,000 or 50.3% in the first quarter of 2005 compared to the first quarter of2004. Gross profit margin was 30.7% in the first quarter of 2005 compared to34.2% in the first quarter of 2004. The decrease in gross profit margin in thefirst quarter of 2005 compared to the first quarter of 2004 is largely theresult of the increase in installation work. These margins are primarilyaffected by product mix sold.

 

Cost of Services, excluding Depreciation andAmortization:

Cost of services excluding depreciation and amortization increased$50,000 or 15.4% in the first quarter 2005 compared to the first quarter 2004.The increase is mainly the result of a $45,000 increase in the inventoryvaluation reserve in the first quarter of 2005. Due to the surplus of supplierinventory in the market and resultant decline in prices in this line ofbusiness over recent quarters, the Company recognizes that the value of itsinventory is declining. The Company cannot predict the impact or timing, ifany, of future inventory valuation changes.

 

Operating and Net Loss:

Operating loss decreased $178,000 in the first quarter 2005 compared tothe first quarter 2004. Net loss decreased $106,000 in the first quarter 2005compared to the first quarter 2004. The change between first quarter 2005 losscompared to the first quarter 2004 loss resulted primarily from the increase inoperating revenues described above, partially offset by the increase in cost ofproducts sold.

 

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LIQUIDITY AND CAPITAL RESOURCES

 

CASH FLOWS – Cashprovided by operations was $7,292,000 in the first three months of 2005compared to $10,119,000 in the first three months of 2004. Cash flows fromoperations in the first three months of 2005 were primarily attributable to netincome plus non-cash expenses for depreciation and amortization as well as adecrease in receivables offset by a decrease in accounts payable and accruedexpenses. Cash flows from operations in the first three months of 2004 wereprimarily attributable to net income plus non-cash expenses for depreciationand amortization and a decrease in receivables.

 

Cash flows provided by investing activities were $655,000 in the firstthree months of 2005 compared to $490,000 for the same period in 2004. Capitalexpenditures were $1,456,000 during the first three months of 2005 as comparedto $2,122,000 for the same period in 2004. First quarter 2005 capitalexpenditures were incurred primarily to provide additional network facilitiesin the Telecom Sector. Management expects capital expenditures in the remainderof 2005 to be approximately $22,000,000. Pursuant to conditions of its debtagreement, which allows the Company to reduce its equity investment in one ofits lenders by an amount equal to 10% of the annual principal payments of theterm loan component of its debt, the Company reduced its equity investment by$2,100,000 in the first three months of 2005 and $2,600,000 in the first threemonths of 2004.

 

Cash flows used in financing activities were $6,946,000 for the firstthree months of 2005 compared to $10,744,000 for the first three months of2004. Included in cash flows used in financing activities are debt repaymentsand dividend payments. HickoryTech made payments on its revolving creditfacility of $4,750,000 during the first three months of 2005, and $9,250,000during the first three months of 2004. HickoryTech borrowed $1,000,000 on itsrevolving credit facility during the first three months of 2005 and 2004.Dividend payments for the first three months of 2005 were $1,567,000 comparedto $1,426,000 for the same period in 2004.

 

WORKING CAPITAL –Working capital (i.e. current assets minus current liabilities) was ($341,000)as of March 31, 2005, compared to working capital of $787,000 as of December 31,2004. The ratio of current assets to current liabilities was 1.0 to 1.0 as of March31, 2005 and 1.0 to 1.0 as of December 31, 2004.

 

LONG-TERM OBLIGATIONS-HickoryTech’s long-term obligations as of March 31, 2005 were $91,256,000,excluding current maturities of $8,171,000. As of March 31, 2005, HickoryTechhad a $113,875,000 credit facility with a syndicate of banks. The creditfacility is comprised of a $103,125,000 revolving credit component and a$10,750,000 term loan component. The available line of credit on the$103,125,000 revolving credit component began decreasing in increments in March2004, and has a final maturity date in September 2008. However, since not allof the available revolving credit has been utilized as of March 31, 2005, thepayment schedule is as follows: December, 2005 - $500,000, 2006 - $26,562,000,2007 - $32,813,000 and 2008 - $28,125,000. The term loan component requiresequal quarterly principal payments of $250,000 during the period of March 2001to December 2008, and $7,000,000 in the first quarter of 2009. The weightedaverage interest rate associated with this credit facility varies with LIBORand certain other rates. The weighted average interest rate was 4.1% at March 31,2005 and 4.0% at March 31, 2004. HickoryTech has implemented fixed interestterms on various portions of the overall debt outstanding for varying terms.The longest fixed interest term, on $60,000,000 of the debt, is fixed until June2008. Another fixed interest term, on $20,000,000 of the debt, is fixed untilJune, 2005. As of March 31, 2005, HickoryTech had drawn $98,750,000 on thiscredit facility and had $15,125,000 of available credit. Management believesthe remaining available credit is sufficient to cover future cash requirements.

 

HickoryTech’s Information Solutions Sector leases certain computerequipment under capital lease arrangements. During the three months ended March31, 2005, this sector recorded additions to property, plant and equipment of$317,000 related to these capital lease arrangements.  No additions were recorded for the threemonths ended March 31, 2004 related to these capital lease arrangements.

 

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CONSTRUCTION PLANS -Beginning in 2004, HickoryTech embarked on a five-year network enhancementprogram in its core telephone property in Mankato in support of its broadbandservice strategy. The Company will add approximately $20,000,000 in total tothe network over the next four years, in addition to the historical levels ofcapital spending prior to 2004. Management believes that the enhancement willsupport the broadband product deployment strategies of the future, as well asserving as defense against competition in its core market. These upgrades to analready state of the art network will give HickoryTech the capability to offermore diversified services to its core customer base. The total capitalexpenditure program in 2005 is estimated to be $24,000,000.

 

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

 

CRITICAL ACCOUNTING POLICIES

 

Management’s discussion and analysis of financial condition and resultsof operations stated in this Form 10-Q are based upon HickoryTech’sconsolidated financial statements, which have been prepared in accordance withaccounting principles generally accepted in the United States of America and,where applicable, conform to the accounting principles as prescribed by federaland state telephone utility regulatory authorities. HickoryTech presently givesaccounting recognition to the actions of regulators where appropriate, asprescribed by Statement of Financial Accounting Standards (SFAS) No. 71,“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 of the critical accountingpolicies adhered to by HickoryTech is contained in the Management’s Discussionand Analysis of Financial Condition and Results of Operations in HickoryTech’sAnnual Report on Form 10-K for the year ended December 31, 2004. Therewere no significant changes to these critical accounting policies during thequarter ended March 31, 2005.

 

RECENT ACCOUNTING DEVELOPMENTS

 

In December 2004, the Financial Accounting Standards Board (‘‘FASB’’)issued SFAS No. 123(R), “Share-Based Payment,” which is a revision of SFAS No. 123and supersedes APB Opinion No. 25. SFAS No. 123(R) requires all share-basedpayments to employees, including grants of employee stock options, to be valuedat fair value on the date of grant, and to be expensed over the applicablevesting period. Companies must recognize compensation expense related to anyawards that are not fully vested as of the effective date. Compensation expensefor the unvested awards will be measured based on the fair value of the awardspreviously calculated in developing the pro forma disclosures in accordancewith the provisions of SFAS No. 123. Originally, SFAS No. 123(R) was effectivefor all stock-based awards granted beginning with the first interim periodafter June 15, 2005. On April 14, 2005, The Securities and Exchange Commission (SEC)approved a new rule that changed the effective date of SFAS No. 123(R) forpublic companies to annual, rather than interim, periods that begin after June 15,2005. HickoryTech is currently assessing the impact of adopting SFAS 123(R),which may be material in future periods, to its consolidated results ofoperations and plans to comply with the regulations. Reference is made to thedisclosures under APB No. 25 in Note 10 of the Notes to Consolidated FinancialStatements.

 

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ITEM 3. QUANTATIVE AND QUALITATIVEDISCLOSURES ABOUT MARKET RISK

 

HickoryTech does not have operations subject to risks of foreigncurrency fluctuations. HickoryTech does, however, use derivative financialinstruments to manage exposure to interest rate fluctuations. HickoryTech’sobjectives for holding derivatives are to minimize interest rate risks usingthe most effective methods to eliminate or reduce the impact of theseexposures. Variable rate debt instruments are subject to interest rate risk.HickoryTech has entered into interest rate swap agreements with remainingmaturities ranging from three months to thirty-nine months to manage itsexposure to interest rate movements on a portion of its variable rate debtobligations. The effective portion of the cumulative gain or loss on thesederivative instruments is reported as a component of accumulated othercomprehensive income/loss in shareholders’ equity and is recognized in earningswhen the term of the swap agreement is concluded. HickoryTech’s earnings areaffected by changes in interest rates as a portion of its long-term debt hasvariable interest rates based on LIBOR. If interest rates for the portion ofHickoryTech’s long-term debt based on variable rates had averaged 10% more forthe quarter ended March 31, 2005, HickoryTech’s interest expense would haveincreased $26,000.

 

ITEM 4.  CONTROLS AND PROCEDURES

 

Evaluation of Disclosure Controls andProcedures. An evaluation was performed under thesupervision and with the participation of the Company’s management, includingthe respective persons acting as chief executive officer and chief financialofficer, regarding the effectiveness of the design and operation of the Company’sdisclosure controls and procedures (as defined in Rule 13a-15(e) promulgatedunder the Securities and Exchange Act of 1934, as amended (the “Exchange Act”))as of March 31, 2005. Based on that evaluation, the respective persons actingas chief executive officer and chief financial officer concluded that theCompany’s disclosure controls and procedures were effective.

 

Changes in Internal Controls.During our first fiscal quarter, there have not been any changes in the Company’sinternal control over financial reporting (as defined in Rule 13(a)-15(f)under the Exchange Act) that have materially affected, or are reasonably likelyto materially affect, our internal control over financial reporting.

 

PART II. OTHER INFORMATION

 

Item 1.    Legal Proceedings.

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

 

Item 2.             UnregisteredSales of Equity Securities and Use of Proceeds.

None.

 

Item 3.             DefaultsUpon Senior Securities.

None.

 

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

None.

 

Item 5.             OtherInformation.

None.

 

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Item 6.             Exhibits.

 

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

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

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

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

 

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SIGNATURES

 

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

 
| Dated: | May 5, 2005                                    |                     | HICKORY TECH CORPORATION |
|--------|------------------------------------------------|--------------------------|--------------------------|
|   |                                           |
|   |                                           |
|   | By:                                            | /s/ John E. Duffy        |                     |
|   | John E.  Duffy, Chief Executive Officer        |
|   |                                           |
|   |                                           |
|   | By:                                            | /s/ David A. Christensen |                     |
|   | David A.  Christensen, Chief Financial Officer |
|        |                                                |                          |                          |  |  |  |

 

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