UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549

FORM 10-Q

(Mark One)
x		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
		For the quarterly period ended June 30, 2006
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 address and former fiscal year, if changed since last report)

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for 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  x     No    o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

(Check one): Large accelerated filer o Accelerated filer x Non-accelerated filer o

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

The total number of shares of the registrant’s common stock outstanding as of July 28, 2006: 13,156,490.

TABLE OF CONTENTS

Description
		PART I. Financial Information
Item 1.		Financial Statements:
		Consolidated Statements of Operations (unaudited) for the Three Months and Six Months Ended June 30, 2006 and 2005
		Consolidated Balance Sheets (unaudited) as of June 30, 2006 and December 31, 2005
		Consolidated Statements of Cash Flows (unaudited) for the Six Months Ended June 30, 2006 and 2005
		Condensed Notes to Consolidated Financial Statements (unaudited)
Item 2.		Management’s Discussion and Analysis of Results of Operations and Financial Condition
Item 3.		Quantitative and Qualitative Disclosures About Market Risk
Item 4.		Controls and Procedures
		PART II. Other Information
Item 1.		Legal Proceedings
Item 1A.		Risk Factors
Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds
Item 3.		Defaults Upon Senior Securities
Item 4.		Submission of Matters to a Vote of Security Holders
Item 5.		Other Information
Item 6.		Exhibit Listing
		Signatures
		Exhibits

 

HICKORY TECH CORPORATION

Consolidated Statements of Operations

(Unaudited)

		Three Months Ended						Six Months Ended
		June 30,						June 30,
(In Thousands Except Share and Per Share Amounts)		2006			2005			2006			2005
Operating revenues:
Telecom Sector		$	18,378		$	19,286		$	36,346		$	38,631
Information Solutions Sector		534			914			1,222			1,402
Enterprise Solutions Sector		2,545			5,068			5,282			8,343
Enventis Sector		15,178			—			29,262			—
Total operating revenues		36,635			25,268			72,112			48,376
Costs and expenses:
Cost of sales, Enterprise Solutions and Enventis		11,828			3,772			22,855			6,040
Cost of services (excluding depreciation and amortization)		9,373			8,289			18,334			16,342
Selling, general and administrative expenses (excluding depreciation and amortization)		6,818			4,087			14,001			8,114
Depreciation		4,236			4,043			8,310			8,044
Amortization of intangibles		293			204			586			441
Total costs and expenses		32,548			20,395			64,086			38,981
Operating income		4,087			4,873			8,026			9,395
Other income/(expense):
Interest and other income		37			32			67			40
Interest expense		(1,830		)	(1,027		)	(3,479		)	(2,004		)
Total other income/(expense)		(1,793		)	(995		)	(3,412		)	(1,964		)
Income before income taxes		2,294			3,878			4,614			7,431
Income tax provision		920			1,569			1,851			3,006
Income from continuing operations		1,374			2,309			2,763			4,425
Discontinued operations:
Income/(loss) from operations of discontinued component		—			170			—			170
Income tax provision/(benefit)		—			69			—			69
Income/(loss) from discontinued operations		—			101			—			101
Net income		$	1,374		$	2,410		$	2,763		$	4,526
Basic earnings per share - continuing operations		$	0.10		$	0.18		$	0.21		$	0.34
Basic earnings per share - discontinued operations		—			0.01			—			0.01
		$	0.10		$	0.19		$	0.21		$	0.35
Dividends per share		$	0.12		$	0.12		$	0.24		$	0.24
Basic weighted average common shares outstanding		13,152			13,072			13,143			13,066
Diluted earnings per share - continuing operations		$	0.10		$	0.18		$	0.21		$	0.34
Diluted earnings per share - discontinued operations		—			0.01			—			0.01
		$	0.10		$	0.19		$	0.21		$	0.35
Diluted weighted average common and potential common shares outstanding		13,155			13,102			13,146			13,102

 

The accompanying notes are an integral part of the consolidated financial statements.

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HICKORY TECH CORPORATION
Consolidated Balance Sheets
(Unaudited)

		June 30,			December 31,
(In Thousands Except Share and Per Share Amounts)		2006			2005
ASSETS
Current assets:
Cash and cash equivalents		$	140		$	601
Receivables, net of allowance for doubtful accounts of $356 and $334		21,620			19,867
Costs in excess of billings on contracts		239			462
Inventories		7,303			4,577
Deferred income taxes		300			300
Prepaid expenses		1,739			5,066
Other		1,289			1,155
Total current assets		32,630			32,028
Investments		3,554			3,407
Property, plant and equipment		300,953			290,499
Less accumulated depreciation		149,471			141,157
Property, plant and equipment, net		151,482			149,342
Other assets:
Goodwill		26,943			27,109
Intangible assets, net		3,726			4,312
Financial derivative instruments		3,777			3,429
Deferred costs and other		2,921			3,640
Total other assets		37,367			38,490
Total assets		$	225,033		$	223,267
LIABILITIES AND SHAREHOLDERS EQUITY
Current liabilities:
Cash overdraft		$	—		$	514
Short-term financing (Note 12)		4,546			—
Accounts payable		3,740			5,224
Accrued expenses		5,260			6,809
Accrued interest		388			—
Accrued income taxes		5,803			4,765
Billings in excess of costs on contracts		300			283
Advanced billings and deposits		3,814			4,577
Current maturities of long-term obligations		1,693			1,778
Total current liabilities		25,544			23,950
Long-term obligations, net of current maturities		138,762			140,980
Deferred income taxes		15,592			15,346
Deferred revenue and employee benefits		9,850			7,982
Total liabilities		189,748			188,258
Commitments and contingencies (Note 8)		—			—
Shareholders’ equity:
Common stock, no par value, $.10 stated value shares authorized: 100,000,000  shares outstanding: 13,156,290 in 2006 and 13,124,928 in 2005		1,315			1,312
Additional paid-in capital		9,717			9,262
Retained earnings		21,980			22,371
Accumulated other comprehensive income		2,273			2,064
Total shareholders’ equity		35,285			35,009
Total liabilities and shareholders’ equity		$	225,033		$	223,267

 

The accompanying notes are an integral part of the consolidated financial statements.

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HICKORY TECH CORPORATION

Consolidated Statements of Cash Flows

(Unaudited)

		Six Months Ended
		June 30,
(Dollars In Thousands)		2006			2005
Cash flows from operating activities:
Net income		$	2,763		$	4,526
Adjustments to reconcile net income to net Cash provided by operating activities:
Depreciation and amortization		8,896			8,485
(Gain)/Loss on sale of assets		—			(4		)
Stock-based compensation		177			45
Employee retirement benefits and deferred compensation		353			273
Accrued patronage refunds		(543		)	(211		)
Provision for losses on accounts receivable		296			477
Deferred income taxes		108			—
Changes in operating assets and liabilities:
Receivables		(1,010		)	2,553
Inventories		(2,726		)	(396		)
Billings and costs on contracts		241			(834		)
Accounts payable and accrued expenses		(2,691		)	(857		)
Advance billings and deposits		(764		)	(326		)
Deferred revenue and employee benefits		1,514			(58		)
Prepaid assets		3,327			252
Other		960			114
Net cash provided by operating activities		10,901			14,039
Cash flows from investing activities:
Additions to property, plant and equipment		(10,297		)	(4,628		)
Acquisitions, adjustments to purchase price and allocation		166			—
Redemption of investments		21			2,100
Proceeds from sale of assets		5			25
Net cash provided by/(used in) investing activities		(10,105		)	(2,503		)
Cash flows from financing activities:
Short-term financing		4,546			—
Change in cash overdraft		(514		)	(1,680		)
New capital leases		(32		)	—
Payments of capital lease obligations		(244		)	(303		)
Repayments on credit facility		(12,685		)	(9,500		)
Borrowings on credit facility		10,500			3,500
Proceeds from issuance of common stock		200			328
Dividends paid		(3,028		)	(3,135		)
Net cash used in financing activities		(1,257		)	(10,790		)
Net increase (decrease) in cash and cash equivalents		(461		)	746
Cash and cash equivalents at beginning of period		601			257
Cash and cash equivalents at end of period		$	140		$	1,003
Supplemental disclosure of cash flow information:
Cash paid for interest		$	3,592		$	2,119
Net cash paid for income taxes		$	690		$	310
Non-cash investing activities:
Property, plant and equipment acquired with capital leases		$	158		$	547

 

The accompanying notes are an integral part of the consolidated financial statements.

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HICKORY TECH CORPORATION
JUNE 30, 2006
PART 1. FINANCIAL INFORMATION

ITEM 1.  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1. BASIS OF PRESENTATION

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information necessary for a fair statement of results of operations, financial position, and cash flows in conformity with accounting principles generally accepted in the United States of America. In the opinion of management, the unaudited condensed consolidated financial statements reflect all adjustments (consisting only of normal recurring adjustments) considered necessary for a fair statement of Hickory Tech Corporation’s (HickoryTech or the Company) results for the periods presented. Operating results for interim periods are not necessarily indicative of results that may be expected for the fiscal year as a whole. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, expenses, and related disclosures at the date of the financial statements and during the reporting period. Actual results could differ from these estimates. These unaudited interim condensed consolidated financial statements should be read in conjunction with HickoryTech’s Annual Report on Form 10-K for the year ended December 31, 2005.

Recently Issued Accounting Pronouncements

In July 2006, the FASB issued FASB Interpretation (FIN) No. 48, “Accounting for Uncertainty in Income Taxes-an interpretation of FASB Statement No. 109.” This Interpretation provides guidance for recognizing and measuring uncertain tax positions, as defined in SFAS No. 109, “Accounting for Income Taxes.” FIN No. 48 prescribes a threshold condition that a tax position must meet for any of the benefit of the uncertain tax position to be recognized in the financial statements. Guidance is also provided regarding derecognition, classification and disclosure of these uncertain tax positions. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company does not expect that this Interpretation will have a material impact on its financial position, results of operations, or cash flows.

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

Cost of services includes all costs related to delivery of HickoryTech’s communications services and products. These costs include all costs of performing services and providing related products. It does not include costs associated with selling, general and administrative, depreciation and amortization of property, plant and equipment and intangible assets, and cost of sales for the Enterprise Solutions and Enventis Sectors.

On December 30, 2005, HickoryTech purchased Enventis Telecom, Inc. (Enventis) from ALLETE, Inc. Enventis is a transport and enterprise Internet Protocol telephony equipment sales business which specializes in providing telecommunications and network solutions. In addition to its statewide SONET-based network, Enventis provides innovative Internet Protocol services that combine voice and data onto a single platform. Since 1997, Enventis has provided network solutions for a broad spectrum of large corporate, non-profit, government, and small business clients. Enventis has offices located in Duluth, Plymouth and Rochester, Minnesota and Sioux Falls, South Dakota.

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NOTE 2. EARNINGS AND CASH DIVIDENDS PER COMMON SHARE

Basic earnings per share are computed by dividing net income by the weighted average number of shares of common stock outstanding during the applicable period. Shares used in the earnings per share assuming dilution calculation are based on the weighted average number of shares of common stock outstanding during the period increased by potentially dilutive common shares. Potentially dilutive common shares include stock options and stock subscribed under the HickoryTech Corporation Amended and Restated Employee Stock Purchase Plan (ESPP).

		Three Months Ended				Six Months Ended
		June 30,				June 30,
		2006		2005		2006		2005
Weighted average shares outstanding		13,151,626		13,072,273		13,142,770		13,065,685
Stock options (dilutive only)		—		5,166		—		11,009
Stock subscribed (ESPP)		3,084		24,877		3,371		24,877
Total dilutive shares outstanding		13,154,710		13,102,316		13,146,141		13,101,571

 

Options to purchase 551,451 shares and 524,850 shares for the three months ended June 30, 2006 and 2005, respectively, and 502,161 shares and 517,950 shares for the six months ended June 30, 2006 and 2005, respectively, were not included in the computation of earnings per share assuming dilution because their effect on earnings per share would have been anti-dilutive.

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

 

Dividends per share are based on the quarterly dividend per share as declared by the HickoryTech Board of Directors.  HickoryTech paid dividends of $0.12 per share for the second quarter of 2006 and 2005.

During the first six months of 2006 and 2005, shareholders have elected to reinvest $125,000 and $132,000, respectively, of dividends into HickoryTech common stock pursuant to the HickoryTech Dividend Reinvestment Plan.

NOTE 3. COMPREHENSIVE INCOME

HickoryTech follows the provisions of Statement of Financial Accounting Standards (SFAS) No. 130, “Reporting Comprehensive Income.” This statement established rules for the reporting of comprehensive income and its components. In addition to net income, HickoryTech’s comprehensive income includes changes in unrealized gains and losses on derivative instruments qualifying and designated as cash flow hedges. Comprehensive income for the three months ended June 30, 2006 and 2005 was $1,409,000 and $1,845,000, respectively. Comprehensive income for the six months ended June 30, 2006 and 2005 was $2,972,000 and $4,576,000, respectively.

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NOTE 4. ACQUISITION OF ENVENTIS

On December 30, 2005, HickoryTech purchased Enventis from ALLETE, Inc. Enventis was formerly a wholly owned subsidiary of ALLETE, Inc. Enventis is a network transport and an enterprise Internet Protocol telephony equipment sales business. The acquisition of Enventis was made to expand the geographical region which HickoryTech could serve with its business broadband service capabilities. Both Enventis and HickoryTech have similarly bundled service business plans.

The purchase price was cash of $35,500,000 in exchange for the common stock of Enventis, with further purchase price adjustments and transaction costs making the estimated total purchase consideration $38,602,000 as of December 31, 2005. Enventis had no debt at the time of acquisition. The purchase agreement outlined certain purchase price adjustments which were estimated as of December 31, 2005 and resulted in cash payments between ALLETE and HickoryTech in the first quarter of 2006. These adjustments were for working capital, capital expenditures and employee benefits. These adjustments changed the estimated purchase price by $125,000, which reduced the amounts originally estimated for total purchase consideration and goodwill.

The financing for the adjusted $38,602,000 total purchase consideration for Enventis, plus an additional $8,500,000 for Enventis working capital as of December 31, 2005, was entirely from HickoryTech’s credit agreement, as established on December 30, 2005. The credit facility is comprised of a $30,000,000 revolving credit component, which expires on December 30, 2011, and a $130,000,000 term loan component, which has partial maturities during its term, with final maturity on June 30, 2013. In the first quarter of 2006, an additional $10,000,000 credit facility with a vendor finance organization was established for short-term inventory floor-plan financing of accounts payable for Enventis.

The Enventis acquisition was accounted for using the purchase method of accounting. Accordingly, the purchase price was allocated to the estimated fair value of assets acquired and liabilities assumed. The preliminary purchase price allocation resulted in goodwill of $2,023,000, which has been adjusted to $1,857,000 as of June 30, 2006, as noted in the table below. For income tax purposes ALLETE and HickoryTech have agreed to treat the transaction as a purchase of assets. Accordingly, the tax basis of the acquired assets and assumed liabilities will be the same for financial reporting.

A summary of the changes in the Enventis goodwill is as follows:

 

The purchase price allocation is still considered preliminary. Specific reasons causing the purchase price to still be preliminary are: 1) the liquidation of acquired accounts receivable, and 2) resolution of one litigation matter. On the litigation matter, HickoryTech has received an indemnification from ALLETE which management believes to be more than adequate to cover any loss. The first item is expected to be resolved by October 2006 and the last item by December 2006.

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NOTE 5. INVENTORIES

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

NOTE 6. INTANGIBLE ASSETS

Goodwill assets are subject to an impairment test annually as well as upon certain events that indicate that impairment may be present. The goodwill impairment test includes two steps, the first of which requires management to determine the fair value of certain of the Company’s reporting units (as defined by SFAS No. 142, “Goodwill and Other Intangible Assets”). The Company determines the fair value of its reporting units by application of a discounted cash flow analysis. Management makes estimates that are included in its discounted cash flow analysis based upon the best available information at the time that the determinations of fair value are made. If circumstances change, HickoryTech’s estimates of fair value will also change and could result in a determination of additional impairment charges to reduce the carrying value of goodwill.

The carrying value of HickoryTech’s goodwill decreased from $27,109,000 as of December 31, 2005 to $26,943,000 as of June 30, 2006 due to the working capital adjustment and purchase price allocation adjustment (see Note 4).

The components of HickoryTech’s other intangible assets are as follows:

				June 30, 2006						December 31, 2005
				Gross Carrying			Accumulated			Gross Carrying			Accumulated
(Dollars in Thousands)		Useful Lives		Amount			Amortization			Amount			Amortization
Definite-lived intangible assets
Customers		1 - 8 years		$	4,229		$	1,024		$	4,229		$	544
Other intangibles		1 - 5 years		730			209			730			103
Total				$	4,959		$	1,233		$	4,959		$	647

 

As required by SFAS No. 142, we periodically reassess the carrying value, useful lives and classification of identifiable intangible assets. Amortization expense related to the definite-lived intangible assets for the three months ended June 30, 2006 and 2005 was $293,000 and $26,000, respectively. Amortization expense related to the definite-lived intangible assets for the six months ended June 30, 2006 and 2005 was $586,000 and $52,000, respectively. Total estimated amortization expense for the remaining six months of 2006 and the five years subsequent to 2006 is as follows: 2006 (July 1 through December 31) - $586,000; 2007 - $1,157,000; 2008 - $1,127,000; 2009 - $853,000; 2010 - $3,000 and 2011 - $0.

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NOTE 7. QUARTERLY SECTOR FINANCIAL SUMMARY

					Information			Enterprise						Corporate and			HickoryTech
(Dollars In Thousands)		Telecom			Solutions			Solutions			Enventis			Eliminations			Consolidated
Three Months Ended June 30, 2006
Operating revenue from unaffiliated customers		$	18,378		$	534		$	2,545		$	15,178		$	—		$	36,635
Intersegment revenues		51			1,189			—			—			(1,240		)	—
Total		18,429			1,723			2,545			15,178			(1,240		)	36,635
Depreciation and amortization		3,293			420			28			768			20			4,529
Operating income/(loss)		4,420			(420		)	(395		)	731			(249		)	4,087
Interest and other income		1			6			—			4			26			37
Interest expense		3			15			1			—			1,811			1,830
Income taxes/(benefit)		1,766			(172		)	(158		)	298			(814		)	920
Net income/(loss)		2,652			(257		)	(238		)	437			(1,220		)	1,374
Identifiable assets		149,562			6,270			5,479			53,926			9,796			225,033
Property, plant and equip., net		113,836			5,577			198			31,709			162			151,482
Capital expenditures		3,609			239			24			2,593			—			6,465

 

					Information			Enterprise						Corporate and			HickoryTech
(Dollars In Thousands)		Telecom			Solutions			Solutions			Enventis (1)			Eliminations			Consolidated
Three Months Ended June 30, 2005
Operating revenue from unaffiliated customers		$	19,286		$	914		$	5,068		$	—		$	—		$	25,268
Intersegment revenues		52			1,087			—			—			(1,139		)	—
Total		19,338			2,001			5,068			—			(1,139		)	25,268
Depreciation and amortization		3,564			639			31			—			13			4,247
Operating income/(loss)		5,464			(617		)	44			—			(18		)	4,873
Interest expense		2			15			—			—			1,010			1,027
Income taxes/(benefit)		2,211			(255		)	18			—			(405		)	1,569
Income (loss)/from Continuing operations		3,252			(374		)	26			—			(595		)	2,309
Loss from discontinued operations Including intersegment revenues		101			—			—			—			—			101
Net income/(loss)		3,353			(374		)	26			—			(595		)	2,410
Identifiable assets		143,347			4,377			8,965			—			7,846			164,535
Property, plant and equip., net		107,085			4,356			271			—			88			111,800
Capital expenditures		2,678			474			20			—			—			3,172

 

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					Information			Enterprise						Corporate and			HickoryTech
(Dollars In Thousands)		Telecom			Solutions			Solutions			Enventis			Eliminations			Consolidated
Six Months Ended June 30, 2006
Operating revenue from unaffiliated customers		$	36,346		$	1,222		$	5,282		$	29,262		$	—		$	72,112
Intersegment revenues		102			2,277			—			—			(2,379		)	—
Total		36,448			3,499			5,282			29,262			(2,379		)	72,112
Depreciation and amortization		6,499			791			56			1,506			44			8,896
Operating income/(loss)		9,084			(823		)	(673		)	1,296			(858		)	8,026
Interest and other income		4			6			—			4			53			67
Interest expense		(130		)	26			1			—			3,582			3,479
Income taxes/(benefit)		3,688			(337		)	(270		)	525			(1,755		)	1,851
Net income/(loss)		5,530			(505		)	(405		)	773			(2,630		)	2,763
Identifiable assets		149,562			6,270			5,479			53,926			9,796			225,033
Property, plant and equip., net		113,836			5,577			198			31,709			162			151,482
Capital expenditures		6,571			504			29			3,100			93			10,297

 

					Information			Enterprise						Corporate and			HickoryTech
(Dollars In Thousands)		Telecom			Solutions			Solutions			Enventis (1)			Eliminations			Consolidated
Six Months Ended June 30, 2005
Operating revenue from unaffiliated customers		$	38,631		$	1,402		$	8,343		$	—		$	—		$	48,376
Intersegment revenues		103			2,183			—			—			(2,286		)	—
Total		38,734			3,585			8,343			—			(2,286		)	48,376
Depreciation and amortization		7,100			1,295			63			—			27			8,485
Operating income/(loss)		11,228			(1,369		)	(154		)	—			(310		)	9,395
Interest expense		3			28			—			—			1,973			2,004
Income taxes/(benefit)		4,544			(565		)	(62		)	—			(911		)	3,006
Income/(loss) from continuing operations		6,684			(829		)	(92		)	—			(1,338		)	4,425
Income from discontinued operations including intersegment revenues		101			—			—			—			—			101
Net income/(loss)		6,785			(829		)	(92		)	—			(1,338		)	4,526
Identifiable assets		143,347			4,377			8,965			—			7,846			164,535
Property, plant and equip., net		107,085			4,356			271			—			88			111,800
Capital expenditures		4,050			558			20			—			—			4,628

 

(1) No information provided due to the fact that Enventis was purchased on December 30, 2005.

NOTE 8. CONTINGENCIES

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

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NOTE 9. STOCK COMPENSATION

On January 1, 2006, the Company adopted Statement of Financial Accounting Standards No. 123(R) (revised 2004), “Share-Based Payment,” (“SFAS 123(R)”) which requires the measurement and recognition of compensation expense for all share-based payment awards made to employees and directors, including employee stock options and employee stock purchases related to the Employee Stock Purchase Plan, based on estimated fair values. SFAS 123(R) supersedes the Company’s previous accounting under Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”) for periods beginning in fiscal 2006. In March 2005, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 107 (“SAB 107”) relating to SFAS 123(R). The Company has applied the provisions of SAB 107 in its adoption of SFAS 123(R).

The Company adopted SFAS 123(R) using the modified prospective transition method, which requires the application of the accounting standard as of January 1, 2006. The Company’s Consolidated Financial Statements as of and for the six months ended June 30, 2006 reflect the impact of SFAS 123(R). In accordance with the modified prospective transition method, the Company’s Consolidated Financial Statements for prior periods have not been restated to reflect, and do not include, the impact of SFAS 123(R) or any modifications to outstanding stock options prior to the adoption of SFAS 123(R). Share-based compensation expense recognized under SFAS 123(R) for the three-months ended June 30, 2006 was $41,000 pre-tax and $25,000 after tax. In addition, Share-based compensation expense recognized under SFAS 123(R) for the six-months ended June 30, 2006 was $86,000 pre-tax and $52,000 after tax. The majority of this expense relates to the expensing of stock options, and a small amount relates to the Employee Stock Purchase Plan. The adoption of FAS123R had minimal impact on earnings per share for the Company’s three month period ending June 30, 2006 and a $0.01 reduction for basic and diluted earnings per share through June 30, 2006. Also, adopting FAS 123(R) had minimal impact on cash flow from financing and operations.

Share-based compensation expense recognized during the period is based on the value of the portion of share-based payment awards that are ultimately expected to vest during the period. Share-based compensation expense recognized in the Company’s Consolidated Statements of Operations for the first six months of 2006 included compensation expense for share-based payment awards granted prior to, but not yet vested as of December 31, 2005, based on the grant date fair value estimated in accordance with the fair value provisions of SFAS 123. Because share-based compensation expense recognized in the Consolidated Statements of Operations for the six months ended June 30, 2006 is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures. SFAS 123(R) requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. The Company accounted for forfeitures as they occurred for the periods prior to 2006. The cumulative adjustment for the change in accounting principle was immaterial.

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

There have been no changes in the quantity or type of instruments used in stock-based compensation programs. There have been no changes in the terms of stock-based compensation arrangements.

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

Options were last granted under the Company’s Stock Award Plan in February of 2005. The Stock Award Plan does provide for the issuance of stock options, but no current compensation programs have options as a component.

As of June 30, 2006, there was $152,000 of total unrecognized compensation costs related to non-vested stock options granted under the Company’s Stock Award Plan. This expense is expected to be recognized over a weighted average period of two years.

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A summary of stock option activity of the Stock Award Plan is as follows:

				Weighted Average			Aggregate
		Shares		Exercise Price			Intrinsic Value
Outstanding at January 1, 2006		578,850		$	12.63		—
Granted		—		—			—
Exercised		—		—			—
Forfeited		24,999		11.13			—
Expired		2,400		9.38			—
Outstanding at June 30, 2006		551,451		$	12.71		$	—
Exercisable at June 30, 2006		502,161		$	12.86		$	—

 

The following table provides certain information with respect to stock options outstanding at June 30, 2006:

				Weighted			Weighted
		Stock		Average			Average
Range of		Options		Exercise			Remaining
Exercise Prices		Outstanding		Price			Contractual Life
$8.00 - $12.00		245,401		$	10.24		6.88 years
$12.00 - $16.00		245,550		13.83			4.60 years
$16.00 - $21.00		60,500		18.17			4.76 years
		551,451		$	12.71		5.63 years

 

The following table provides certain information with respect to stock options exercisable at June 30, 2006:

				Weighted
		Stock		Average			Average
Range of		Options		Exercise			Remaining
Exercise Prices		Exercisable		Price			Contractual Life
$8.00 - $12.00		196,111		$	10.02		6.55 years
$12.00 - $16.00		245,550		13.83			4.60 years
$16.00 - $21.00		60,500		18.17			4.76 years
		502,161		$	12.86		5.38 years

 

The following table provides the range of assumptions used for valuing stock options:

 

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If HickoryTech had elected to recognize compensation cost based on the fair value of the options as prescribed by SFAS No. 123(R) for the three and six month periods ended June 30, 2005, the following operating results would have resulted using the Black-Scholes option-pricing model to determine the fair value of the options: 

		Three Months Ended			Six Months Ended
		June 30, 2005 (1)			June 30, 2005 (1)
Net income:
As reported		$	2,410		$	4,526
Add: Stock-based employee compensation expense included in reported net income, net of related tax effects		14			27
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects		(62		)	(126		)
Pro forma net income		$	2,362		$	4,427
Earnings per share:
As reported:
Basic		$	0.19		$	0.35
Diluted		$	0.18		$	0.34
Pro forma:
Basic		$	0.19		$	0.35
Diluted		$	0.18		$	0.34

 

(1)          2005 Net income and net income per share do not include share-based compensation expense in accordance with SFAS 123(R).

As of June 30, 2006, the number of shares that are available for  future and/or existing grants of the following stock-based compensation plans:

Plan		Shares Available
Employee Stock Purchase Plan		566,190
Retainer Stock Plans for Directors		242,642
Non-Employee Directors’ Incentive Plan		190,000
Stock Award Plan		962,058

Shares issued under other stock-based compensation plans are as follows:

		Three Months Ended			Six Months Ended
		June 30, 2006			June 30, 2006
Retainer Stock Plans for Directors		2,382 shares			4,379 shares
market price/fair value at time of grant		$	6.83/share		$	6.83/share
Non-Employee Director’s Incentive Plan		1,000 shares			10,000 shares
market price/fair value at time of grant		$	8.03/share		$	8.03/share
Stock Award Plan		841 shares			1,620 shares
market price/fair value at time of grant		$	7.79/share		$	7.79/share

 

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NOTE 10. FINANCIAL DERIVATIVE INSTRUMENTS

HickoryTech accounts for derivative instruments in accordance with SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended by SFAS No. 149, “Amendment of Statement 133 Accounting for Derivative Instruments and Hedging Activities,” which requires derivative instruments to be recorded on the balance sheet at fair value. Changes in fair value of derivative instruments must be recognized in earnings unless specific hedge accounting criteria are met, in which case the gains and losses are included in other comprehensive income rather than in earnings.

		Interest Rate
(Dollars in Thousands)		Swap Agreement
Accumulated other comprehensive income balance at December 31, 2005		$	2,064
Market value increase on interest rate swap agreement, net of related tax effects		209
Accumulated other comprehensive income balance at June 30, 2006		$	2,273

 

HickoryTech has variable rate debt instruments, which subject the Company to interest rate risk. Beginning in the second quarter of 2003, HickoryTech entered into interest rate swap agreements, with remaining maturities of twenty-four months, to manage its exposure to interest rate movements on a portion of its variable rate debt obligations. The market value of the cumulative gain or loss on these derivative instruments is reported as a component of accumulated other comprehensive income/loss in shareholders’ equity and will be recognized in earnings when the term of the swap agreement is concluded.

The fair value of HickoryTech’s derivatives at June 30, 2006 and December 31, 2005 is a net asset of $3,777,000 and $3,429,000, respectively, which is included in other assets in the accompanying consolidated balance sheet.

NOTE 11. EMPLOYEE POST-RETIREMENT BENEFITS

HickoryTech provides post-retirement health care and life insurance benefits for certain employees. HickoryTech is not currently funding these post-retirement benefits, but has accrued these liabilities as of June 30, 2006 and 2005.

		Three Months Ended						Six Months Ended
		June 30,						June 30,
(Dollars in Thousands)		2006			2005			2006			2005
Components of net periodic benefit cost:
Service cost		$	81		$	92		$	162		$	184
Interest cost		107			115			214			230
Expected return on plan assets		—			—			—			—
Amortization of transition obligation		15			15			30			30
Amortization of prior service cost		(3		)	(3		)	(6		)	(6		)
Recognized net actuarial loss		31			44			62			88
Net periodic benefit cost		$	231		$	263		$	462		$	526

 

		June 30, 2006
Employer’s contributions for current premiums:
Contributions made for the six months ended June 30, 2006		$	100
Expected contributions for remainder of 2006		100
Total estimated employer contributions for fiscal year 2006		$	200

 

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NOTE 12. SHORT-TERM FINANCING ARRANGEMENT

Enventis has a $10 million credit facility with a financing company to purchase inventories from certain approved vendors. Advances under the financing arrangement are collateralized by the accounts receivable and inventory of Enventis and a guaranty of the principal indebtedness by HickoryTech. The credit facility provides sixty-day payment terms for working capital and can be terminated at any time by either party. Borrowings outstanding under the credit facility at June 30, 2006 totaled $4,546,000.

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

FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, which are subject to the “safe harbor” created by those sections. Statements in this Quarterly Report that are not historical fact are forward-looking statements that are based on management’s current expectations, estimates and projections about the industry in which Hickory Tech Corporation (HickoryTech, we the Company) operates and management’s beliefs and assumptions. Forward-looking statements may be identified by the use of terminology such as “may,” “will,” “believes,” “does not believe,” “no reason to believe,” “expects,” “plans,” “intends,” “estimates,” “anticipated” or “anticipates,” and similar expressions, as they relate to HickoryTech or its management. Such forward-looking statements are subject to important risks and uncertainties that could cause HickoryTech’s future actual results to differ materially from such statements. These statements are not guarantees of future performance and involve certain risks, uncertainties and probabilities, which are difficult to predict. Therefore, actual outcomes and results may differ materially from what is expressed or forecasted in such forward-looking statements, whether as a result of new information, future events or otherwise. Factors that might cause such a difference include, but are not limited to, those contained in this “Management’s Discussion and Analysis” (Item 2) and Item 1A, “Risk Factors,” of HickoryTech’s Annual Report on Form 10-K for the year ended December 31, 2005, which is incorporated herein by reference. You are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date on which they were made. Except as otherwise required by federal securities law, HickoryTech undertakes no obligation to update any of its forward-looking statements for any reason.

BUSINESS

HickoryTech operates in four business segments: the Telecom, Information Solutions, Enterprise Solutions and Enventis Sectors. Its largest and oldest business (since 1898) has been the operation of incumbent local exchange carriers (ILECs) or traditional wireline telephone service. The ILEC business is included in HickoryTech’s Telecom Sector. In 1998, HickoryTech began its competitive local exchange carrier (CLEC) line of business, competing for telephone dial tone, dial-up and broadband Internet access, data, digital TV and long distance calling business in ILEC territories owned by others. The CLEC business is included in HickoryTech’s Telecom Sector. Since 1964, HickoryTech’s Information Solutions Sector has provided computer data processing and software, predominantly for HickoryTech’s Telecom Sector operations and also to other telecommunications companies. HickoryTech acquired its Enterprise Solutions Sector in 1990 and it operates as a telecommunications, data and Internet Protocol equipment distributor from a base in Minneapolis/St. Paul, Minnesota. On December 30, 2005, HickoryTech purchased Enventis Telecom, Inc. (Enventis). Enventis is a Minnesota-based regional provider of integrated fiber network, Internet Protocol telephony, and data services, with 1,500 route miles of fiber network serving more than 300 business customers in over 40 communities in the Upper Midwest.

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The eight current subsidiaries of HickoryTech and the business segments in which they operate are:

TELECOM SECTOR
		Mankato Citizens Telephone Company (MCTC)
		Mid-Communications, Inc. (Mid-Comm)
		Heartland Telecommunications Company of Iowa, Inc. (Heartland)
		Cable Network, Inc. (CNI)
		Crystal Communications, Inc. (Crystal)
INFORMATION SOLUTIONS SECTOR
		National Independent Billing, Inc. (NIBI)
ENTERPRISE SOLUTIONS SECTOR
		Collins Communications Systems Co. (Collins)
ENVENTIS SECTOR
	Enventis Telecom, Inc. (Enventis)

 

HickoryTech and its subsidiaries are engaged in businesses that provide services to their customers for a fee. Many of these services are recurring, and, as a result, backlog orders and seasonality are not significant factors. Working capital requirements for the Telecom Sector involve financing the construction of networks involving switches and cable, maintaining a high amount of fixed assets, paying payroll costs of highly skilled labor, maintaining inventory to service its capital projects and its network and telephone equipment customers, and providing for the carrying value of trade accounts receivable, which may take several months to collect in the normal course of business. Working capital requirements for the Information Solutions Sector involve capital for software development, operating losses, payroll costs of highly skilled labor, and the carrying value of trade accounts receivable. Working capital requirements for the Enterprise Solutions Sector involve capital for payroll costs, inventory to service its customers, the carrying value of trade accounts receivable, work-in-process, and operating losses. Working capital requirements for the Enventis Sector involve capital for payroll costs, the carrying value of accounts receivable, and work-in-process.

The materials and supplies that are necessary for the operation of the businesses of HickoryTech and its subsidiaries are available from a variety of sources. All of HickoryTech’s central office switches and fiber optic equipment, as well as a majority of HickoryTech’s equipment sold in its Enterprise Solutions and Enventis Sectors, are supplied by Nortel, Motorola and Cisco. These vendors are leading suppliers of communications and data equipment, and HickoryTech’s dependence on these brands is not viewed as a significant risk.

INDUSTRY SEGMENTS

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

TELECOM SECTOR

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

The Telecom Sector also includes Crystal, a CLEC. Crystal provides local telephone service, long distance, dial-up and broadband Internet access and digital TV on a competitive basis. Crystal also connects communication networks of interexchange and wireless carriers with the equipment and facilities of end users. Crystal has customers in ten rural communities, encompassing eight exchanges, in Minnesota and three communities, encompassing two exchanges, in Iowa that are not in HickoryTech’s ILEC service areas. Crystal also provides digital TV service in eight Minnesota communities in addition to its telephone services described above.

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HickoryTech also owns and operates fiber optic cable facilities in Minnesota in its Telecom Sector, in addition to its Enventis Sector. These facilities are used to transport interexchange communications as a service to telephone industry customers. HickoryTech’s Minnesota ILECs and CLEC are the primary users of the fiber optic cable facilities in the Telecom Sector. None of the companies in the Telecom Sector experienced major changes in operations during the first and second quarters of 2005 or 2006.

MCTC derives its principal revenues and income from local services charged to subscribers in its service area, access services charged to interexchange carriers, and the operation of a toll tandem-switching center in Mankato, Minnesota. Revenues and income for Mid-Comm are also derived from local service charges in its area of operation and by providing access to long distance services for its subscribers through the toll center in Mankato. Local and interexchange telephone access for the two companies is provided on an integrated basis. The local and interexchange telephone access for both telephone companies utilize the same facilities and equipment and are managed and maintained by a common workforce. Heartland derives its principal revenues and income from local services charged to subscribers in its service area in Iowa, as well as from providing interexchange access for its subscribers. Interexchange telephone access is provided by all three of HickoryTech’s ILEC subsidiaries by connecting the communications networks of interexchange and wireless carriers with the equipment and facilities of end users through its switched networks or private lines.

MCTC and Mid-Comm are Minnesota public utilities operating pursuant to indeterminate permits issued by the Minnesota Public Utilities Commission (MPUC). Heartland is also a public utility, which operates pursuant to a certificate of public convenience and necessity issued by the Iowa Utilities Board (IUB). These state agencies regulate the services provided by MCTC, Mid-Comm and Heartland. CNI’s operations are not subject to regulation by the state regulatory authority. Neither the MPUC nor the IUB regulate the rate of return or profits of each of HickoryTech’s ILEC operations due to the size of these companies relative to state regulation. In Minnesota, regulators monitor MCTC and Mid-Comm’s price and service levels. MCTC’s and Mid-Comm’s local service rates are below those of most Minnesota ILECs. HickoryTech and its subsidiaries will change rates determined by various factors, including economic and competitive circumstances.

As local exchange telephone companies, MCTC, Mid-Comm and Heartland provide end office switching and dedicated circuits to long distance interexchange carriers. These relationships allow HickoryTech’s telephone subscribers to place long distance telephone calls across to the telephone network. HickoryTech provides interexchange access to its network for interexchange carriers to conduct long distance business with individual customers who select a long distance carrier and for termination of calls to all customers. This interexchange access business is separate and distinct from HickoryTech’s own long distance retail business, which is operated in its Crystal subsidiary. The long distance interexchange carriers are significant customers of HickoryTech, but no carrier represents more than ten percent of HickoryTech’s consolidated revenues.

Alternatives to HickoryTech service include customers leasing private lines in lieu of switched voice services and data services in or adjacent to the territories served by HickoryTech, which permits the bypassing of local telephone switching facilities. Additionally, services provided by other companies utilizing various internet, wireline or wireless technologies permit bypass of the local exchange network. These alternatives to local exchange service represent a potential threat to HickoryTech’s long-term ability to provide local exchange service at economical rates.

Competition exists in several of HickoryTech’s ILEC service areas. A municipality has overbuilt Heartland’s network in one community in Iowa and now serves over half of that market. Additionally, cable TV providers are poised to offer voice services in several Heartland communities, two Mid-Comm communities, and also in Mankato.

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

 

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