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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 [FEE REQUIRED]
For the fiscal year ended December 31, 1999
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
Commission File Number: 0-18587
HECTOR COMMUNICATIONS CORPORATION
(Exact name of registrant as specified in its charter)
Minnesota 41-1666660
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(State or other jurisdiction (Federal Employer
of incorporation or organization) Identification No.)
211 South Main Street
Hector, MN 55342
(Address of principal executive offices and zip code)
Registrant's telephone number, including area code: (320) 848-6611
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Common Stock, $.01 par value
Securities registered pursuant to Section 12(g) of the Act: None
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
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Indicate by a check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. (X)
The aggregate market value of the voting stock held by non-affiliates of the
Registrant was approximately $40,992,000 based upon the closing sale price of
the Company's common stock on the American Stock Exchange on March 17, 2000.
As of March 17, 2000 there were outstanding 3,555,454 shares of the Registrant's
common stock.
Documents Incorporated by Reference: The Company's Proxy Statement for its
Annual Meeting of Shareholders to be held on May 18, 2000 is incorporated by
reference into Part III of this Form 10-K.
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TABLE OF CONTENTS
Item Page
PART I
1. Business 3
2. Properties 14
3. Legal Proceedings 14
4. Submission of Matters to a Vote of Security Holders 14
PART II
5. Market for Company's Common Equity and Related
Stockholder Matters 15
6. Selected Financial Data 16
7. Management's Discussion and Analysis of Financial
Condition and Results of Operations 17
8. Financial Statements and Supplementary Data 26
9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure 42
PART III
10. Directors and Executive Officers of the Registrant 43
11. Executive Compensation 43
12. Security Ownership of Certain Beneficial
Owners and Management 43
13. Certain Relationships and Related Transactions 43
PART IV
14. Exhibits, Financial Statement Schedule and
Reports on Form 8-K 44
2
PART I.
ITEM 1. BUSINESS
[a] GENERAL DEVELOPMENT OF BUSINESS
Hector Communications Corporation ("HCC" or "Company") is a
telecommunications holding company which, through its wholly-owned and
majority-owned subsidiaries, primarily provides local telephone and cable
television service. The Company also invests in other companies providing
wireless telephone and other telecommunications related services.
HCC operates five wholly-owned local exchange company subsidiaries
(generally referred to as "local exchange carriers" or "LECs") which served
7,200 access lines in 9 rural communities in Minnesota and Wisconsin at December
31, 1999. HCC, through its subsidiaries, also provides cable television service
to 4,900 subscribers in Minnesota and Wisconsin.
HCC's 68% owned subsidiary, Alliance Telecommunications Corporation, owns
and operates five additional LEC subsidiaries which served 28,600 access lines
in 26 rural communities in Minnesota, Iowa, North Dakota and South Dakota at
December 31, 1999. Alliance, through its subsidiaries, also served 8,200 cable
television subscribers in Minnesota, North Dakota and South Dakota. Golden West
Telecommunications Cooperative, Inc. of Wall, South Dakota, and Split Rock
Telecom Cooperative, Inc. of Garretson, South Dakota own the remaining interests
in Alliance.
[b] FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS
The Company is organized in two business segments, Hector Communications
Corporation and its wholly-owned subsidiaries, and Alliance Telecommunications
Corporation and its subsidiaries. Information regarding segment operations is
provided in Note 11 to the financial statements found under Item 8 of this
report.
[c] NARRATIVE DESCRIPTION OF BUSINESS
(1) Telephone
The Company's LEC subsidiaries provide basic local telephone services to
35,867 residential and business customers in Minnesota, Wisconsin, South Dakota,
North Dakota and Iowa. Basic local service enables customers to originate and
receive telephone calls within a defined exchange area. Approximately 81% of the
Company's customers are residential and approximately 19% are businesses. Most
customers pay a fixed monthly fee for service.
The following chart presents the number of access lines served by the
Company's LEC subsidiaries at December 31, 1999, 1998 and 1997:
3
Access Lines*
--------------------------------------------------
December 31
--------------------------------------------------
1999 1998 1997
----------- ---------- ------------
Hector Communications Corporation:
Arrowhead Communications Corporation 817 780 749
Eagle Valley Telephone Company 734 676 685
Granada Telephone Company 289 274 275
Pine Island Telephone Company 3,154 3,019 2,919
Indianhead Telephone Company 2,234 2,109 2,076
Alliance Telecommunications Corporation:
Loretel Systems, Inc. 12,967 12,675 12,023
Sleepy Eye Telephone Company 6,467 6,197 5,998
Sioux Valley Telephone Company 5,756 5,679 5,457
Hills Telephone Company 2,706 2,618 2,545
Felton Telephone Company 743 735
----------- ---------- ----------
35,867 34,762 32,727
=========== ========== ==========
* An "access line" is a single or multi-party circuit between the customer's
establishment and the central switching office.
The Company maintains a local presence in each of its LEC subsidiaries.
The Company provides its LEC subsidiaries with various services, including
finance, accounting and treasury services, marketing, customer service,
purchasing, engineering and construction, customer billing, rate administration,
credit and collection, and development of administrative and procedural
practices.
The Company's LEC subsidiaries also provide network access services,
which allow customers to originate and terminate long distance calls. Long
distance calls typically involve more than one company in providing service on
an end-to-end basis. Because long distance calls usually are billed to the
customer originating the call, mechanisms are required to compensate each
company providing services to complete the call. In the case of interstate
calls, access revenues are determined according to rules promulgated by the
Federal Communications Commission ("FCC") and administered by the National
Exchange Carriers Association ("NECA"), a not-for-profit membership corporation
of local exchange carriers. Interstate access revenues are received from NECA,
which collects payments from long distance service providers (also referred to
as interexchange carriers or "IXCs") and distributes payments to the member
LECs. In the case of intrastate calls, access revenues are determined by state
regulatory agencies. A portion of the Company's access revenues is received from
universal service funds based upon the high cost of providing service to rural
areas. Interstate universal service fund support accounted for $1,040,000,
$951,000 and $656,000 of the Company's network access revenues in 1999, 1998 and
1997, respectively. A small portion of access revenues are derived from
subscriber line fees determined by the FCC and billed directly to customers.
The Company's LEC subsidiaries offer their customers a number of enhanced
telecommunications services, including custom calling features like call
waiting, caller identification and voice mail. Charges for custom calling
services are generally billed monthly together with the customers' local service
bill. Internet access is also available, through local dial-up telephone
numbers, to all of the Company's local service customers. Digital subscriber
lines ("DSL") permit high-speed Internet access and are available in many of the
Company's service areas.
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(2) Cable Television
The Company, through its cable television and LEC subsidiaries, owns and
operates 46 cable television systems serving 13,100 subscribers in Minnesota,
North Dakota, South Dakota and Wisconsin. Cable television revenues are derived
almost exclusively from monthly fees for basic and premium programming. Fees for
basic services range from $14.95 to $26.28 per month. Basic service generally
includes the major television networks, non-network independent stations, sports
programming, news services and automated information channels, children's
programming, access channels for public, governmental, educational and leased
use, senior citizens' programming and religious programming. Premium programming
services, such as the HBO or ShowTime movie services, are provided to
subscribers for an additional fee of $6.95 to $10.95 per month per channel.
Approximately one-third of the Company's cable television customers subscribe to
a premium channel. Premium programming is obtained from suppliers for a flat
monthly fee per subscriber and/or a fee based on the monthly charge to
subscribers for the service.
(3) Investments
Wireless Telephone Services
The Company is the largest shareholder of Midwest Wireless
Communications, LLC, with a 10.69% ownership stake. Midwest Wireless serves five
rural service areas and one metropolitan service area in southern Minnesota.
Population of the service area is approximately 950,000. Midwest Wireless offers
complete wireless service, including custom calling features, facsimile and data
transmission and presently serves more than 100,000 customers. Midwest Wireless
is acquiring additional wireless operations in Wisconsin and Iowa. When
completed, these acquisitions would significantly increase Midwest Wireless'
service area, but would reduce the Company's percentage ownership of the
operation. The Company accounts for its investment in Midwest Wireless using the
equity method. Income recognized was $1,481,000, $1,508,000, and $1,210,000 in
1999, 1998 and 1997, respectively.
The Company owns 13.36% of Wireless North, which provides personal
communications services ("PCS") to parts of Minnesota, Wisconsin, Iowa, North
Dakota and South Dakota. Wireless North has secured FCC licenses to provide PCS
services in 13 basic trading areas in these states, encompassing 110,000 square
miles and a population of 2.4 million. Wireless North is in its start-up phase,
and is building infrastructure in four markets, where it presently serves 7,800
customers. Its operations have not been profitable to date. Losses recorded by
the Company on this investment were $1,597,000, $1,066,000 and $435,000 in 1999,
1998 and 1997, respectively. At December 31, 1999, the Company had invested
$2,303,000 of cash and had outstanding loan guarantees of $1,373,000 in Wireless
North.
The Company has had a significant investment in Rural Cellular
Corporation ("RCC"), a publicly traded company providing cellular telephone
services in Minnesota and New England. The Company obtained its investment in
RCC through its ownership interests in the RSAs serving northern Minnesota and
through the acquisitions of Ollig Utilities Company and Felton Telephone
Company. Company sales of RCC stock were 326,707 shares, 40,000 shares, and
161,469 shares in 1999, 1998 and 1997, respectively. Gains on sales of these
securities were $11,600,000, $179,000, and $1,464,000 in 1999, 1998 and 1997,
respectively. At December 31, 1999, the Company owned approximately 10,700
shares of RCC's common stock.
In December, 1998, an Alliance subsidiary sold its interest in a
cellular telephone partnership serving the Sioux Falls, South Dakota MSA.
Proceeds from the sale were $6,725,000. Gain on the sale was $4,817,000. Income
recognized from the Company's investment in this partnership was $334,000 and
$377,000 in 1998 and 1997, respectively.
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Onvoy, Inc.
The Company has a $1,276,000 investment in the common stock of Onvoy,
Inc. (formerly MEANS, or Minnesota Equal Access Network Services). Onvoy, Inc.,
a privately held company, is a competing local exchange carrier ("CLEC") that
provides integrated voice, data, and network services through its fiber optic
communications network linking communities throughout Minnesota, including all
major metropolitan areas. Onvoy, Inc. is also Minnesota's largest Internet
service provider and is a leading provider of long distance, video- conferencing
and high-speed data networking services. It serves the majority of
small-to-medium sized businesses and Minnesota based Fortune 500 companies, most
of the state's higher education institutions, nearly all of the state's K-12
schools, public libraries, state and county governments, more than 70 regional
Internet service providers and more than two-thirds of the state's independent
local telephone companies.
Fiber Optic Transport Facilities
The Company has invested approximately $1 million in five companies
that build and lease fiber optic transport facilities. These facilities afford
high-quality, high-capacity communications links and generally are used to carry
long-distance traffic. Through these investments, the Company owns pieces of
fiber routes serving the Twin Cities, Duluth-Superior, Sioux Falls,
Fargo-Moorhead, Rochester, St. Cloud and Grand Forks, and extending into Iowa
and Wisconsin.
Marketable Securities
Through its acquisitions of Ollig Utilities Company and Felton Telephone
Company, and due to the success of the Company's investments in
telecommunications ventures that were ultimately sold to the public, the Company
has acquired a portfolio of marketable securities. In addition to its holdings
in Rural Cellular Corporation, the Company presently has significant investments
in mutual funds, USWest Communications and Illuminet Holdings, Inc.
Bank Stocks
As part of its borrowing agreements, the Company has investments in
CoBank, Rural Telephone Finance Cooperative and the Rural Telephone Bank that
totaled $4,644,000 and $4,365,000 at December 31, 1999 and 1998, respectively.
Other Investments
The Company has a small ownership interest in South Dakota Network
Services and Iowa Network Services, each of which provide integrated voice, data
and network services within their respective states. The Company is also an
investor in Fibercom LLC, a CLEC that has been established to provide local
communications services to business customers in the Sioux City, Iowa area.
(4) Competition
Telephone
LECs may be subject to many forms of competition. Among potential
competitors are:
- Facilities-based competition from providers with their own local service
network;
- Resale competition from resale interconnection (providers who purchase
local services from the LEC at wholesale rates and resell the services to
their customers);
- Competition from unbundled network element interconnection (providers who
lease some of the network elements from the LEC) - Wireless providers who
may charge a competitive fee for services that could compete with
wireline based local service.
Rural areas like those served by the Company are less likely to
experience competition from facilities-based competitors due to the significant
investment in plant and equipment required in relation to the lower customer
density in rural markets. Competition from resale interconnection or unbundled
network element interconnection is more likely. Under the Telecommunications Act
of 1996, the Company's LECs are not currently required to lease facilities to
competitors seeking to interconnect with our network. However, there is no
assurance that Congress may not require interconnection in the future.
6
Wireless telephone service is currently seen as a complementary service
to traditional wireline based local service. Wireless service does directly
compete with traditional local service among certain classes of customers,
principally customers with seasonal or lake homes. Developments in technology
related to cellular, PCS, digital microwave, coaxial cable, fiber optics and
other wireline or wireless services could also lead to greater competition for
traditional local services.
LECs are increasingly subject to competition from competing access
providers ("CAPs") which construct, modify or lease facilities that enable high
volume long distance users to bypass the local telephone network. Cable
television companies may also be able to modify their networks to carry
telephone messages that bypass the local telephone network. The Company believes
its LEC subsidiaries have experienced only a small loss of traffic due to
bypass.
Cable Television
In addition to competition from off-air television, other technologies
also supply services that compete with cable television. These include low power
television stations, multi-point distribution systems, over-the-air subscription
television and direct broadcast satellite ("DBS"). Cable television also
competes for customers in local markets with providers of other forms of
entertainment, news and information. These competitors include radio,
newspapers, magazines, motion picture theaters, video cassettes and Internet
service providers.
All of the Company's cable television franchises are non-exclusive. The
1992 Cable Act prohibits franchising authorities from unreasonably refusing to
grant franchises to competing cable television systems. The Company competes
with a municipally owned cable system in one community it serves. The degree of
competition from other cable providers will be dependent upon the state and
federal regulations concerning entry, interconnection requirements and the
degree of unbundling of the LECs' networks. Competition will be based upon
product, service quality, breadth of services offered and, to a lesser extent,
on price.
Maintaining and expanding the Company's cable television subscriber base
depends on numerous factors, including the quality and quantity of signals
available from "off-air" television stations, demand for satellite and premium
television channels and average household income in the cable service area.
Promotional efforts for cable television include telephone and door-to-door
selling and local media advertising.
(5) Regulation
The Company's LECs and cable television systems are subject to federal,
state and local regulation. The Communications Act of 1934 and the
Telecommunications Act of 1996 govern Federal regulations. Under these federal
statutes, the FCC exercises jurisdiction over all interstate telecommunications
activities. Intrastate activities are governed by rules and regulations set by
the respective state public utility commissions.
Federal Regulations
Under federal regulations, incumbent local exchange carriers ("ILECs")
are required to comply with the Communications Act of 1934 and rules issued by
the FCC. While the Telecommunications Act of 1996 amended the earlier law to
reduce regulatory burdens and promote competition, ILECs remain subject to
extensive regulatory requirements. ILECs are required to maintain accounting
records according to Uniform System of Accounts, to structure access charges
according to FCC rules and to reflect their charges for interstate services at a
rate of return prescribed by the FCC. The FCC also regulates transfer of control
and assignments of operating authorizations and construction licenses. The FCC
requires carriers providing access services to file tariffs with the FCC
reflecting rates, terms and conditions of the services. Tariffs filed are
subject to review and potential objection by third parties.
Regulation of Cost Recovery and Nonregulated Revenue Allocation
As a regulated common carrier, the Company's LEC subsidiaries can set
maximum rates at a level that allows recovery of reasonable costs incurred to
provide regulated service and earns a reasonable return on the investment
required to provide these services.
7
Costs are recovered through:
- Monthly charges to end users for basic local telephone services and
enhanced services;
- Access charges to interexchange carriers for originating and terminating
interstate and intrastate interexchange calls; and
- Payments from the federal Universal Service Fund and the state universal
service funds (where applicable) that offset the high cost of providing
service in certain rural markets.
Rates for regulated services and the amount of universal service fund
support are set forth by the FCC with respect to interstate services and by
state regulatory agencies with respect to intrastate services.
In conjunction with the recovery of costs and establishment of rates, a
LEC must first determine its aggregate costs and then allocate those costs
between regulated and nonregulated services. After identifying the regulated
costs of providing local telephone service, a LEC must allocate those costs
among its various local exchange and interstate and intrastate interexchange
services and between state and federal jurisdictions. Allocating costs is
complicated because the same pieces of a LEC's plant and equipment are utilized
for different services, such as local telephone and interstate and intrastate
access services. The allocation process is called "separation" and is governed
primarily by FCC regulations. The purpose of separation is to determine how a
carrier's expenses are allocated and recovered from federal and state
jurisdictions. The FCC is considering whether to change or eliminate this
process. Any change in separation rules by the FCC could reduce or increase the
LEC's revenues.
Interstate End-User Rates
The part of the local telephone network running from the switching
facility to the customer is called the "local loop." Costs to construct, operate
and maintain the loop are among the most significant costs incurred by a local
exchange carrier. The FCC has established a rate structure that provides for the
recovery of a portion of the cost of the local loop allocated to interstate
jurisdiction directly from end-users through the assessment of a subscriber line
charge. The remaining portions of the interstate local loop costs are recovered
from interstate access charges to interexchange carriers.
Due to demographic and geographic conditions, costs to provide local loop
and switching services are often higher, on a per customer basis, in rural areas
compared to urban areas. Absent a regulatory framework to permit recovery of
these costs, rural LECs would be compelled to charge considerably higher rates
for local network services. Consequently, the FCC provides for additional
interstate recovery by eligible telecommunications carriers through the federal
Universal Service Fund. Funds from the federal Universal Service Fund are
available to local exchange carriers whose local loop costs are significantly
above the national average as determined by FCC rules.
Interstate Access Rates
Interstate access rates are developed on the basis of a LEC's measurement
of its interstate costs to provide access service to IXCs divided by its
projected demand for service. The resulting rates are published in the LEC's
interstate access tariff and filed with the FCC, at which time they are subject
to challenge by third parties and to review by the FCC.
The FCC recognized that the rate making and tariff filing process is
administratively burdensome for small local exchange carriers. In 1983, the FCC
established the National Exchange Carriers Association ("NECA") to develop and
administer interstate access service rates, terms and conditions. NECA develops
interstate access rates on the basis of data provided by participating local
exchange carriers and blended to yield average rates. These rates are intended
to generate revenue equal to the aggregate costs plus a return on the investment
of all of the participants.
Individual LECs are likely to have service costs that differ from the
revenues generated by applying the overall NECA tariff rates. To allow for this,
revenues generated by participating LECs are pooled and redistributed on the
basis of each individual company's costs. This process eliminates the burden of
individual tariff filing and produces a system in which small companies can
share and spread risk. For example, if a small local exchange carrier filed its
8
own tariff and subsequently suffered the loss of major customers that utilize
interstate access service, the local exchange carrier could suffer significant
under-recovery of its costs. In the NECA pool environment, the impact of this
loss is reduced because it is spread over all of the pool participants.
NECA operates separate pools for traffic sensitive costs (primarily
switching costs) and non-traffic sensitive costs (primarily loop costs). LECs
can choose to develop and administer their own interstate access charges and not
participate in the NECA pools. All but one of HCC's LECs participates in the
traffic sensitive NECA pools. All of HCC's LECs participate in the non-traffic
sensitive NECA pools.
The FCC is reviewing its rates and policies governing interstate access
and the rate of return applicable to incumbent local exchange carriers who are
subject to rate-of-return, rather than price cap, regulation. The outcome of
this review could directly affect HCC's earnings. The outcome of this proceeding
cannot be predicted at this time.
The Telecommunications Act
The Telecommunications Act was enacted to promote competition without
jeopardizing the availability of nationwide universal service at affordable
rates. These two objectives have resulted in a complex set of rules intended to
promote competitive entry in the provision of local telephone services, except
where entry would adversely effect the provision of universal service or the
public interest.
- Promotion of Local Service Competition and the Rural Exemptions
The Telecommunications Act made competitive entry into the local
telephone business more attractive to other carriers by removing barriers to
competition. In order to promote competition the Telecommunications Act
established new interconnection rules, generally requiring local exchange
carriers to allow competing carriers to interconnect with their local networks.
Congress recognized, however, that the desire to promote competition conflicted
with the ability of some existing LECs to provide universal service to high cost
customers. Congress exempted these LECs (classified as "Rural Telephone
Companies") from interconnection requirements until the continuation of the
exemption was no longer required by the public interest, as defined in the
Telecommunications Act.
Under the Telecommunications Act, all local exchange carriers, including
both incumbent local exchange carriers and new competitive carriers, are
required to:
- Offer reasonable and nondiscriminatory resale of their
telecommunications services,
- Ensure that customers can keep their telephone numbers when changing
carriers,
- Ensure that competitors' customers can use the same number of digits
when dialing and receive nondiscriminatory access to telephone
numbers, operator service, directory assistance and directory listing,
- Ensure access to telephone poles, ducts, conduits and rights of way and
- Compensate competitors for the costs of terminating traffic.
The Telecommunications Act also requires incumbent local exchange
carriers to:
- Negotiate in good faith the terms and conditions of interconnection
with any competitive carrier making a bona fide request for same,
- Interconnect their facilities and equipment with any requesting
telecommunications carrier at any technically feasible point,
- Unbundle and provide nondiscriminatory access to unbundled network
elements, such as local loops, switches and transport facilities, at
nondiscriminatory rates and on nondiscriminatory terms and conditions,
- Offer resale interconnection at wholesale rates,
9
- Provide reasonable notice of changes in the information necessary for
transmission and routing of services over the incumbent local exchange
carrier's facilities or in the information necessary for
interoperability and
- Provide for the physical collocation of equipment necessary for
interconnection or access to unbundled network elements at the premises
of the incumbent local exchange carrier, at rates, terms an conditions
that are just, reasonable and nondiscriminatory.
In order to implement interconnection requirements, local exchange
carriers generally enter into negotiated interconnection arrangements with
competing carriers. Local exchange carriers may also offer interconnection
tariffs, available to all competitors.
Competitors are required to compensate a local exchange carrier for the
cost of providing interconnection services. In the case of resale
interconnection, the rules provide that the rates charged should be on a
wholesale basis and reflect the current retail rates of the incumbent local
exchange carrier, excluding the portion of costs avoided by the incumbent local
exchange carrier. In the case of unbundled network element interconnection,
rates are based on costing methodologies that employ a forward-looking economic
cost pricing methodology known as total element long run incremental cost. The
Telecommunications Act specifies that resale and unbundled network element rates
are to be negotiated among the parties, or, if the parties fail to reach an
agreement, arbitrated by the relevant state regulatory authority. Once the
parties have come to agreement, the proposed rates are subject to final approval
by the state regulatory commission.
HCC's LEC subsidiaries are defined as "rural telephone companies" under
the Telecommunications Act. As rural telephone companies, they were granted
rural exemptions from the requirements relating to both resale interconnection
and unbundled network element interconnections. The rural exemptions are
continued until regulatory authorities determine that interconnection is
technically feasible, not unduly economically burdensome and consistent with the
Telecommunications Act's universal service provisions.
- Promotion of Universal Service
While the Telecommunications Act promoted Congress' policy of ensuring
that affordable service is provided to consumers universally in rural, high-cost
areas of the country, the Telecommunications Act altered the framework for
providing universal service by:
- Providing for the identification of those services eligible for
universal service support,
- Requiring the FCC to make implicit subsidies explicit,
- Expanding the types of communications carriers required to pay
universal service support and
- Allowing competitive local exchange carriers to be eligible for
funding.
These and other provisions were intended to make provision of universal
service support compatible with a competitive market.
Pursuant to the Telecommunications Act, federal Universal Service Fund
payments are only available to carriers that are designated as eligible
telecommunications carriers by a state public utilities commission. In areas
served by rural LECs, the Telecommunications Act provides that a state public
utilities commission may designate more than one eligible telecommunications
carrier, in addition to the incumbent local exchange carrier, only after
determining that the designation of an additional eligible telecommunications
carrier will serve the public interest. As a result, an incumbent rural LEC has
an opportunity to maintain its status as the sole recipient of federal Universal
Service Fund payments in its service area, even if it is subsequently subjected
to competition. HCC's rural LEC subsidiaries are currently the sole designated
eligible telecommunications carriers in their respective service areas. The
addition of a second eligible telecommunications carrier in these service areas
could have the effect of reducing the amount of funds available to HCC's LECs
10
from the federal Universal Service Fund. Such a reduction could materially
adversely affect HCC's ability to achieve a reasonable rate of return on the
capital invested in its network.
In May 1997, the FCC implemented new rules for interstate universal
service support. The new rules provide for separate federal Universal Service
Fund programs for rural and non-rural telephone companies. The new rules for
non-rural companies base support upon "forward-looking costs" derived from cost
proxy models. It is uncertain whether these models will fully compensate local
exchange carriers for the cost of providing local service in high-cost areas.
The FCC set the implementation date for the new system as January 1, 1999, which
was postponed to January 1, 2000 for non-rural telephone companies. The FCC has
established a Rural Task Force, which will investigate how to adapt the proxy
cost models approved for larger carriers for rural telephone companies. The FCC
has indicated that it will not implement a new system for application to rural
telephone companies for an additional three years after the first step
implementation, or at least until January 1, 2001. In the interim, support
mechanisms for rural carriers remain unchanged. The FCC continues to refine the
cost proxy models to be applied to non-rural telephone companies.
State Regulation of Rural LECs
HCC's LEC subsidiaries are subject to regulation by Minnesota, South
Dakota, Iowa and Wisconsin regulatory agencies with respect to:
o Intrastate toll rates,
o Intrastate access charges billed to intrastate IXCs, o Service areas, o
Service standards, o Accounting and related matters, and o The use of
radio frequencies in telephone operations
In some cases state regulations also apply to local service rates, rate
of return, depreciation rates, construction plans and borrowings, and certain
other financial transactions.
Local service rates are not directly determined by regulatory
authorities, but are limited by regulation of these other areas. The Company has
sought appropriate increases in local and other service rates and approval for
changes in rate structures necessary to achieve reasonable rates and earnings.
The bulk of the Company's access lines are located in Minnesota. A bill
passed by the 1995 Minnesota legislature allows telephone companies serving
fewer than 50,000 access lines to elect to provide service under an alternate
form of regulation. Companies choosing alternative regulation agree not to
increase rates for two years, other than in extraordinary circumstances. These
companies are not subject to rate of return review by the Public Utilities
Commission for the same two years. All of HCC's Minnesota-based LEC subsidiaries
elected alternative rate regulation election effective January 1, 1996. Local
rate increases after January 1, 1998 are not subject to review by the Minnesota
Public Utilities Commission unless the lower of 500 or five percent of customers
file a petition requesting such review.
Where applicable, our HCC's LECs also participate in intrastate access
tariffs approved by state regulatory authorities for intrastate intra-LATA
(Local Access Transport Area) and inter-LATA services. These intrastate
arrangements are intended to compensate LECs for the costs, including a fair
rate of return, of facilities provided in originating and terminating intrastate
long distance services.
Cable Television System Regulation
The FCC regulates the providers of satellite communications services and
facilities for the transmission of programming services, the cable television
systems that carry such services, and, to some extent, the availability of the
programming services themselves through its regulation of program licensing.
Municipalities and other state and local government authorities also regulate
cable television systems. FCC regulations contain many detailed provisions
including:
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- "Must carry" rules regarding the broadcast television and translator
signals that must be included in channel offerings to subscribers,
- Exclusivity provisions which require the deletion of certain programming
carried by out-of-area stations where it would duplicate programming
carried by local stations,
- Technical standards and performance testing requirements, and - Franchise
fees applicable to state and local cable television franchises.
Thus far, HCC's cable systems have not experienced any difficulty in complying
with the FCC rules.
In Minnesota, the award of cable franchises and certain aspects of cable
operations are subject to rules of the Minnesota Cable Communications Board.
Cable television systems are operated under 15 year, non-exclusive franchises
granted by local government authorities. Franchises contain many conditions,
including time limitations on commencement or completion of construction,
approval of initial fees charged to subscribers for basic service, the number of
channels offered and the types of programming. HCC does not anticipate
difficulty in obtaining renewal of its franchises at the expiration of their
current terms.
The regulation of cable television at the federal, state and local levels
is subject to the political process and has been in constant flux over the past
decade. This process continues in the context of legislative proposals for new
laws and the adoption or deletion of administrative regulations and policies.
The Company anticipates further material developments in these areas, but cannot
anticipate their direction and impact on its cable television operations.
(6) Business Strategy
The Company is focused on business opportunities in rural
telecommunications. Its three-part strategy is to:
- Expand its existing operations through internal growth - Pursue
acquisitions of attractive properties, particularly the
acquisition of additional rural telephone exchanges and cable
television properties.
- Participate in opportunities afforded by new telecommunications
technologies
Future growth in existing telephone and cable operations is expected to
come from providing service to new or presently unserved homes and businesses,
from sales of enhanced services to existing customers and from providing new
services made possible by improvements in technology.
The Company continually assesses acquisition opportunities. Competition
to acquire attractive telephone or cable television properties is intense.
Acquisitions of rural telephone exchanges are subject to the approval of
regulatory agencies in some states and, in some cases, to federal waivers that
may affect the form of regulation or amount of interstate cost recovery of
acquired telephone exchanges. The Company will aggressively pursue acquisitions
of telephone exchanges, but there is no assurance that acquisitions can be made
on acceptable terms or that regulatory approval, where required, will be
received.
The Company has aggressively invested in new telecommunications
technologies, primarily through investments in partnerships and limited
liability companies. The Company has substantial investments in wireless
communications companies, fiber optic transport groups, CLECs and Internet
service providers. The Company intends to pursue additional investment
opportunities in the future.
(7) Employees
At March 1, 2000, the Company had 159 full-time and part-time employees,
of which 108 employees work in the Alliance operations and 51 work in Hector
operations. None of the Company's employees are represented under collective
bargaining agreements. HCC believes its employee relations to be good.
12
(8) Executive Officers of Registrant
The executive officers of the Company and their ages at March 1, 2000
were as follows:
Name Age Position
Curtis A. Sampson 66 Chairman of the Board and Chief
Executive Officer
Steven H. Sjogren 57 President and Chief Operating Officer
Paul N. Hanson 53 Vice President and Treasurer
Charles A. Braun 42 Chief Financial Officer
Executive officers serve at the pleasure of the Board of Directors and
are elected annually for one-year terms. Each officer above has served the
Company in the indicated capacity since 1990.
Mr. Sjogren devotes his full time to the Company's business. Messrs.
Sampson, Hanson and Braun each devote approximately 40% of their working time to
the Company's business with the balance devoted to management responsibilities
at Communications Systems, Inc. ("CSI"), a diversified telecommunications
holding company also located in Hector, Minnesota, for which they are separately
compensated by CSI.
[d] FINANCIAL INFORMATION ABOUT FOREIGN AND DOMESTIC OPERATIONS AND
EXPORT SALES
Not Applicable.
13
ITEM 2. PROPERTIES
The Company's telephone property consists mainly of central office
switching equipment, the land and buildings in which the equipment is housed,
and connecting lines consisting of aerial and underground cable, conduit, and
poles and wires which connect customers' premises with central offices.
Connecting lines are generally located under or above public rights of way or
land owned, for the most part, by others, pursuant to consents of various
governmental bodies or private leases, permits, easements, agreements or
licenses. The Company also owns customer-leased telephones and related terminal
equipment and a small amount of connecting lines that are located on customers'
premises.
The connecting lines constitute approximately 56% of the Company's
telephone property in service. Central office switching equipment represents
approximately 33%. Telephones and related equipment constitute approximately 1%.
Land, buildings, data processing equipment, service vehicles and construction
equipment constitute the remaining 10%. The Company owns substantially all the
land and buildings in which its central office equipment is located. HCC's
principal general offices, administrative services department and business
office are located in Hector, Minnesota and leased to HCC from CSI. Alliance
owns the building in Ada, Minnesota where its general offices are located.
The physical assets of the Company's cable television systems consist of
signal reception equipment and distribution electronics and cables. The
receiving equipment is comprised of a tower and antennas for reception of
broadcast television signals and one or more satellite dishes for reception of
satellite signals. The Company owns or leases the land on which the towers for
its cable systems and the buildings containing other receiving equipment are
located. Pole attachment space is leased from utilities serving the community.
See Note 6 of "Notes to Consolidated Financial Statements for additional
information regarding pledged assets.
ITEM 3. LEGAL PROCEEDINGS
No material litigation or other claims are presently pending against the
Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
14
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS
[a] MARKET INFORMATION
The Company's common stock is currently being traded on the American
Stock Exchange. Prior to February 20, 1998, the Company's common stock traded on
the National Market System of the National Association of Securities Dealers
Automated Quotation System ("NASDAQ").
The table below presents the range of high and low trading prices for the
Company's stock for each period as reported by the respective exchanges.
1999 1998
------------------------ --------------------------
Quarter High Low High Low
First $ 9.63 $ 8.06 $ 12.63 $ 9.00
Second 11.13 8.00 12.25 10.50
Third 14.88 10.00 11.25 7.75
Fourth 17.25 12.00 9.00 7.38
[b] HOLDERS
At March 1, 2000 there were 565 holders of record of Hector
Communications Corporation common stock.
[c] DIVIDENDS
HCC has not paid cash dividends on its common stock or preferred stock
since it began operating as a public company in 1990, nor does HCC have any
obligations to pay dividends on its preferred stock. The financing agreements
between HCC's subsidiaries and their lenders, and HCC and its lenders restrict
the ability of HCC to pay dividends. At the present time, HCC intends to retain
earnings to finance the expansion of its business, and does not anticipate any
cash dividends will be paid in the foreseeable future. See Management's
Discussion and Analysis of Financial Condition and Results of Operations, and
also Note 6 to the Consolidated Financial Statements under Item 8 herein for a
description of restrictions on dividends.
15
ITEM 6. SELECTED FINANCIAL DATA
SELECTED CONSOLIDATED FINANCIAL INFORMATION
(in thousands except per share amounts)
Year Ended December 31
------------------------------------------------------------
1999 1998 1997 1996 1995
- --------------------------------------------------------------------------------------------------------------------------------
Selected Income Statement Information
Revenues $ 34,117 $ 31,839 $ 28,866 $ 20,658 $ 5,844
Costs and Expenses 23,063 21,192 19,113 14,066 4,992
- --------------------------------------------------------------------------------------------------------------------------------
Operating Income 11,054 10,647 9,753 6,592 852
Other Income (Expenses), net 7,401 (40) (3,367) (3,518) (980)
- --------------------------------------------------------------------------------------------------------------------------------
Income (Loss) Before Income Taxes 18,455 10,606 6,386 3,074 (128)
Income Tax Expense (Benefit) 7,513 4,949 2,867 1,540 (51)
- --------------------------------------------------------------------------------------------------------------------------------
Income (Loss) Before Minority Interest 10,942 5,657 3,519 1,534 (77)
Minority Interest in Earnings of Alliance
Telecommunications Corporation 3,463 1,747 798 325
- --------------------------------------------------------------------------------------------------------------------------------
Net Income (Loss) $ 7,479 $ 3,910 $ 2,721 $ 1,209 $ (77)
================================================================================================================================
Basic Net Income (Loss) Per Common Share $ 2.42 $ 1.63 $ 1.44 $ .65 $ (.04)
Diluted Net Income (Loss) Per Common Share $ 1.96 $ 1.15 $ .93 $ .53 $ (.04)
Average Shares Outstanding:
Common shares only 3,095 2,403 1,893 1,870 1,866
Common and potential common shares 3,945 3,937 3,732 3,694 1,866
================================================================================================================================
Selected Balance Sheet Information
Working Capital $ 18,736 $ 6,554 $ 8,504 $ 1,307 $ 9,679
Property, Plant and Equipment, net 51,410 50,810 45,927 47,039 14,609
Excess of Cost Over Net Assets Acquired, net 51,405 53,004 51,170 52,510 907
Total Assets 166,797 150,680 139,291 137,348 33,518
Long-Term Debt 86,282 94,232 97,793 96,127 22,096
Stockholders' Equity 39,982 22,720 14,447 9,946 8,134
- --------------------------------------------------------------------------------------------------------------------------------
All potential common shares are anti-dilutive for 1995 and are excluded from calculation of net income per share
Operating results for 1996 include the operations of Ollig Utilities Company
from the April 25, 1996 purchase date.
16
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Hector Communications Corporation ("HCC") owns a 100% interest in five
LEC subsidiaries and one cable television subsidiary. At December 31, 1999,
these subsidiaries provided telephone service to 7,228 customers in 9 rural
communities in Minnesota and Wisconsin. They also owned cable television systems
serving 4,934 customers in Minnesota and Wisconsin. HCC's 100%-owned
subsidiaries also have substantial investments in other telecommunications
ventures, including, Midwest Wireless Communications, LLC, Wireless North LLC
and Onvoy, Inc..
HCC also owns a 68% interest in Alliance Telecommunications Corporation
("Alliance"). At December 31, 1999, Alliance, through its five LEC subsidiaries,
provided telephone service to 28,639 customers in 26 rural communities in
Minnesota, South Dakota and Iowa. Alliance's subsidiaries also provided cable
television services to 8,186 subscribers in Minnesota, South Dakota and North
Dakota. Alliance's subsidiaries also own substantial investments in Midwest
Wireless Communications, LLC, Wireless North LLC and Onvoy, Inc., own marketable
securities portfolios with investments in telecommunications providers like U.S.
West Communications, Inc., Illuminet Holdings, Inc. and Rural Cellular
Corporation, and have other investments. The minority interest in Alliance is
owned by Golden West Telecommunications Cooperative and Split Rock Telecom
Cooperative.
Results of Operations
General
The Company's telephone revenues are principally derived from the local
service and access revenues received by its local exchange carrier ("LEC")
subsidiaries. Local service revenues are earned by providing customers with
local service to connecting points within the local exchange boundaries and, in
certain cases, to nearby local exchanges under extended area service ("EAS")
plans that eliminate long distance charges to the neighboring exchanges. Monthly
rates for telephone service differ among the LECs depending upon the cost of
providing service, the type and grade of service, the number of customers and
calling patterns within the toll free calling area and other factors.
Access revenues are received by LECs for intrastate and interstate
exchange services provided to long distance carriers (generally referred to as
interexchange carriers or "IXCs"). These services enable IXCs to provide long
distance service to end users in the local exchange network.
Access revenues are determined, in the case of interstate calls,
according to rules promulgated by the Federal Communications Commission ("FCC")
and administered by the National Exchange Carriers Association ("NECA"). In the
case of intrastate calls, access revenues are determined by state regulatory
agencies. A relatively small portion of the Company's access revenues are
derived from subscriber line fees determined by the FCC and billed directly to
end users for access to long distance carriers. The balance of the Company's
interstate access revenues is received from NECA, which collects payments from
IXCs and distributes settlement payments to LECs.
Settlement payments are based on a number of factors, including the cost
of providing service and the amount of time the local network is utilized to
provide long distance services. Since 1984, a variety of factors, including
increased subscriber counts, cultural and technological changes, and rate
reductions by IXCs, have resulted in a consistent pattern of increasing use of
the nation's telephone network. This growth has produced higher revenues for
NECA and increased settlements for its participating LECs. The Company's
settlements from NECA have increased every year since the pool was established
in 1984, but there can be no assurance that this trend will continue.
HCC's LECs also sell and lease customer premise telephone equipment,
provide inside wiring services and custom calling features, provide Internet
access and sell and lease other facilities for private line, teletype, data
transmission and other communications services. They also provide billing and
collection services for certain IXCs in lieu of such IXCs directly billing
customers within the LEC's service areas.
17
The Company's cable television revenues are derived almost exclusively
from monthly fees for basic and premium services.
The following table presents the percentage of revenues derived from
local service revenues, access revenues, billing and collection services,
nonregulated telephone activities and cable television operations for the last
three years:
Year Ended December 31
------------------------------------------------
1999 1998 1997
----------- ---------- ---------
Local network 17.3% 16.6% 16.9%
Network access 56.9 55.6 58.0
Nonregulated telephone activities 12.3 15.0 13.3
Billing and collecting 2.4 2.7 3.5
Cable television 11.1 10.1 8.3
----------- ----------- ---------
100.0 % 100.0% 100.0%
=========== ========== ==========
1999 Compared to 1998
Consolidated revenues increased 7% from $31,839,000 in 1998 to
$34,117,000 in 1999. The following table shows revenues by operating group for
1999 compared to 1998:
Alliance Hector
Year Ended December 31 Year Ended December 31
1999 1998 1999 1998
------------ ------------ ------------ ------------
Local network $ 4,250,474 $ 3,730,079 $ 1,664,204 $ 1,560,732
Network access 14,587,083 13,480,391 4,831,878 4,229,530
Billing and collection 650,839 683,132 173,700 182,635
Nonregulated activities 3,527,645 4,283,839 647,415 489,528
Cable television 2,306,786 1,774,495 1,477,292 1,424,333
------------ ------------ ------------ ------------
$ 25,322,827 $ 23,951,936 $ 8,794,489 $ 7,886,758
============ ============ ============ ============
Consolidated local service revenues grew from $5,291,000 in 1998 to
$5,915,000 in 1999, an increase of $624,000 or 12%. Revenue growth was due to:
- - Addition of extended area service to Sioux Falls from Alliance's South Dakota
telephone exchanges
- - Increased demand for telephone lines to provide advanced telecommunications
services such as Internet services
- - Increased development within the LECs' service areas, and - The full year
effect of Alliance's acquisition of Felton Telephone Company
("Felton").
The number of access lines served by the LECs increased 3% from 34,762 to
35,867.
Network access revenues rose from $17,710,000 in 1998 to $19,419,000 in
1999, an increase of $1,709,000 or 10%. The increase was chiefly due to
increased use of the telephone network by customers, increased settlements
payments from NECA and increased universal service support funds.
Nonregulated revenues fell from $4,773,000 in 1998 to $4,175,000 in 1999,
a decrease of $598,000 or 13%. Revenue decreases from equipment leases in 1999
more than offset increased Internet revenues. Cable television revenues rose
from $3,199,000 in 1998 to $3,784,000 in 1999, an increase of $585,000 or 18%
due to rate increases and the full-year effect of the June 1998 acquisition by
Alliance of additional cable systems from Spectrum Cablevision Limited
Partnership. Billing and collection revenues declined from $866,000 in 1998 to
$825,000 in 1999, a decrease of $41,000 or 5% as IXCs continued the trend toward
self-billing of customers.
Consolidated operating costs and expenses grew from $21,192,000 in 1998
to $23,063,000 in 1999, an increase of $1,871,000 or 9%. The following table
shows costs and expenses by operating group for 1999 compared to 1998:
18
Alliance Hector
Year Ended December 31 Year Ended December 31
1999 1998 1999 1998
------------ ------------ ------------ ------------
Plant operations $ 2,944,902 $ 2,821,318 $ 1,142,021 $ 933,994
Depreciation and amortization 5,930,740 5,712,509 2,616,879 2,068,701
Customer operations 1,583,327 1,549,019 329,191 254,649
General and administrative 3,149,918 2,575,215 1,544,670 1,375,954
Other operating expenses 2,295,122 2,646,862 1,526,310 1,253,586
------------ ------------ ------------ ------------
$ 15,904,009 $ 15,304,923 $ 7,159,071 $ 5,886,884
============ ============ ============ ============
Consolidated plant operations expenses increased from $3,755,000 in 1998
to $4,087,000 in 1999, an increase of $332,000 or 9%, due to training and
maintenance contracts associated with new telephone switches and offerings of
enhanced telephone services. Depreciation and amortization increased from
$7,781,000 in 1998 to $8,548,000 in 1999, an increase of $767,000 or 10% due to
increased depreciation on new telephone switching equipment. Customer operations
expenses increased 6% from $1,804,000 in 1998 to $1,913,000 in 1999 due largely
to growth in the number of customers served. General and administrative expenses
increased from $3,951,000 in 1998 to $4,695,000 in 1999, an increase of $744,000
or 19% due to increased cable television selling and administrative expenses.
Other operating expenses decreased $79,000 or 2%.
Consolidated operating income increased $407,000 or 4% from $10,647,000
in 1998 to $11,054,000 in 1999.
Consolidated interest expenses decreased $732,000 from $7,315,000 in 1998
to $6,583,000 in 1999. The decrease was due to expense reductions on convertible
debentures that were retired or converted into common stock in 1998 and 1999.
In 1999, the Company had a consolidated loss from partnership and LLC
investments of $336,000 compared to consolidated income of $883,000 in 1998. The
Company's share of loss from its Wireless North PCS investment was $1,597,000 in
1999 compared to $1,066,000 in 1998. The Company and its partners are
negotiating with potential new investors to inject more investment capital into
Wireless North's operations in order make the operations large enough to be
financially viable. Income from Midwest Wireless Communications, LLC decreased
from $1,508,000 in 1998 to $1,481,000,in 1999. The decrease was due to price
competition from other wireless service providers. The Company had income in
1998 from the Sioux Falls, South Dakota MSA, prior to its sale by Alliance, of
$334,000 in 1998 compared to no income in 1999.
Alliance had gains on sales of marketable securities totaling $13,203,000
in 1999 compared to gains on sales of $965,000 in 1998. Most of the gains were
on sales of Rural Cellular Corporation stock that Alliance sold over the course
of 1999. Alliance continues to hold a significant portfolio of marketable
securities. Consolidated investment income increased $507,000 from $609,000 in
1998 to $1,116,000 in 1999 due to investments of the cash proceeds from the
marketable securities sales. Alliance's 1998 income included a gain before
income taxes of $4,817,000 from the sale of its 12.25% interest in a cellular
telephone partnership serving the Sioux Falls, South Dakota MSA to CommNet
Cellular, Inc.
Consolidated income before income taxes increased from $10,606,000 in
1998 to $18,455,000 in 1999. The Company's effective income tax rate of 40.7% is
higher than the standard U.S. tax rate due to state income taxes and because the
goodwill amortization expenses from the acquisition of Ollig Utilities cannot be
deducted. Income before the minority interest in Alliance's earnings increased
93% from $5,657,000 in 1998 to $10,942,000. Minority interest on earnings of
Alliance were $3,463,000 in 1999 compared to $1,747,000 in 1998. Net income
increased 91% to $7,479,000 in 1999 compared to $3,910,000 in 1998.
19
1998 Compared to 1997
Consolidated revenues increased 10% from $28,866,000 in 1997 to
$31,839,000 in 1998. The following table shows revenues by operating group for
1998 compared to 1997:
Alliance Hector
Year Ended December 31 Year Ended December 31
1998 1997 1998 1997
------------ ------------ ------------ ------------
Local network $ 3,730,079 $ 3,346,733 $ 1,560,732 $ 1,519,514
Network access 13,480,391 12,845,426 4,229,530 3,892,682
Billing and collection 683,132 820,540 182,635 209,642
Nonregulated activities 4,283,839 3,469,234 489,528 369,188
Cable television 1,774,495 1,027,602 1,424,333 1,365,804
------------ ------------ ------------ ------------
$ 23,951,936 $ 21,509,535 $ 7,886,758 $ 7,356,830
============ ============ ============ ============
Consolidated local service revenues grew from $4,866,000 in 1997 to
$5,291,000 in 1998, an increase of $425,000 or 9%. Revenue growth was due to:
- - Alliance's acquisition of Felton Telephone Company ("Felton") - Increased
development within the LECs' service areas, and - Increased demand for telephone
lines to provide advanced telecommunications services such as Internet services.
The number of access lines served by the LECs increased 6% from 32,727 to
34,762.
Network access revenues rose from $16,738,000 in 1997 to $17,710,000 in
1998, an increase of $972,000 or 6%. Excluding Felton's revenues reduces the
increase to $581,000 or 3%. The increase was chiefly due to increased use of the
telephone network by customers and increased universal service support funds.
Access revenues in 1997 were higher than normal due to a one-time retroactive
tariff settlement received by an Alliance subsidiary.
Nonregulated revenues grew from $3,838,000 in 1997 to $4,773,000 in 1998,
an increase of $935,000 or 24%. Revenue increases in 1998 were due to increased
Internet revenues, commissions on sales of long distance services and leases of
fiber-optic transport facilities. Cable television revenues rose from $2,393,000
in 1997 to $3,199,000 in 1998, an increase of $806,000 or 34% due to the
acquisition by Alliance of additional cable systems from Spectrum Cablevision
Limited Partnership. Billing and collection revenues declined from $1,030,000 in
1997 to $866,000 in 1998, a decrease of $164,000 or 16% as IXCs continued the
trend toward self-billing of customers.
Consolidated operating costs and expenses grew from $19,113,000 in 1997
to $21,192,000 in 1998, an increase of $2,079,000 or 11%. The following table
shows costs and expenses by operating group for 1998 compared to 1997:
Alliance Hector
Year Ended December 31 Year Ended December 31
1998 1997 1998 1997
------------ ------------ ------------ ------------
Plant operations $ 2,821,318 $ 2,714,192 $ 933,994 $ 916,638
Depreciation and amortization 5,712,509 5,336,031 2,068,701 1,973,699
Customer operations 1,549,019 1,430,676 254,649 243,435
General and administrative 2,575,215 2,324,079 1,375,954 1,269,042
Other operating expenses 2,646,862 1,830,921 1,253,586 1,074,244
------------ ------------ ------------ ------------
$ 15,304,923 $ 13,635,899 $ 5,886,884 $ 5,477,058
============ ============ ============ ============
Consolidated plant operations expenses increased from $3,631,000 in 1997
to $3,755,000 in 1998, an increase of $124,000 or 3%, due primarily to
Alliance's acquisition of Felton. Depreciation and amortization increased from
$7,310,000 in 1997 to $7,781,000 in 1998, an increase of $471,000 or 6% due to
Alliance's acquisition of Felton and a group of cable television systems from
20
Spectrum Cablevision ("Spectrum"). Customer operations expenses increased 7%
from $1,674,000 in 1997 to $1,804,000 in 1998 due largely to growth in the
number of customers served. General and administrative expenses increased from
$3,593,000 in 1997 to $3,951,000 in 1998, an increase of $358,000 or 10% due to
the Company's expanded operations. Other operating expenses increased $995,000
or 34% due mainly to increased cable television expenses from the Spectrum
systems.
Consolidated operating income increased $894,000 or 9% from $9,753,000 in
1997 to $10,647,000 in 1998.
Consolidated interest expenses increased $518,000 from $6,797,000 in 1997
to $7,315,000 in 1998. The biggest factor in the interest expense increase was
the lack of patronage dividends on interest paid to St. Paul Bank for
Cooperatives ("St. Paul Bank"). This dividend was $694,000 in 1997 compared to
no dividend in 1998. St. Paul Bank has substantial loan exposures in the
agricultural economy, and poor performance by that economy during the third and
fourth quarters of 1998 prevented the payment of patronage dividends at
anticipated rates. The Company also had interest expense on new borrowings to
finance the acquisitions of Felton and Spectrum. This was offset to some degree
by interest reductions on convertible debentures that were retired or converted
into common stock in the second and third quarters of 1998.
Consolidated income from partnership and LLC investments decreased
$425,000 from $1,308,000 in 1997 to $883,000 in 1998. Income from Midwest
Wireless Communications, LLC increased $298,000 from $1,210,000 in 1997 to
$1,508,000 in 1998. The increase was due to continuing growth in the number of
customers using cellular services. Income from the Sioux Falls, South Dakota MSA
prior to its sale by Alliance was $334,000 in 1998 compared to $377,000 for all
of 1997. Losses from the Company's Wireless North PCS investment totaled
$1,066,000 in 1998 compared to $435,000 in 1997. While the Company anticipated
substantial losses from this operation's start-up phase, it is concerned that
anticipated future capital investments may be inadequate to finance Wireless
North's expansion plans. Accordingly, the Company and its fellow investors are
reviewing Wireless North's business plans with the goal of reducing operating
losses and attracting more investment capital to the operation.
Consolidated investment income declined $17,000 from $626,000 in 1997 to
$609,000 in 1998. Alliance had gains on sales of marketable securities totaling
$965,000 in 1998. Alliance continues to hold a significant portfolio of
marketable securities. In December, 1998, Alliance sold its 12.25% interest in a
cellular telephone partnership serving the Sioux Falls, South Dakota MSA to
CommNet Cellular, Inc. for $6,725,000. Alliance's gain on the sale before income
taxes was $4,817,000. Hector had gains on marketable securities sales of
$1,496,000 in 1997.
Consolidated income before income taxes increased 66% to $10,606,000. The
Company's effective income tax rate of 46.7% is higher than the standard U.S.
tax rate due to state income taxes and because the goodwill amortization
expenses from the acquisition of Ollig Utilities cannot be deducted. Income
before the minority interest in Alliance's earnings increased 61% from
$3,519,000 in 1997 to $5,657,000 in 1998. Minority interest on earnings of
Alliance were $1,747,000 in 1998 compared to $798,000 in 1997. Net income
increased 44% to $3,910,000 in 1998 compared to $2,721,000 in 1997.
Liquidity and Capital Resources
Operations
Cash flows from consolidated operating activities were $6,693,000,
$9,623,000 and $8,365,000 in 1999, 1998, and 1997, respectively. The decrease in
cash flows from operations in 1999 was due to income tax payments on gains from
sales of marketable securities. At December 31, 1999, the Company's cash, cash
equivalents and marketable securities totaled $39,274,000 compared to
$23,241,000 at December 31, 1998. Alliance's cash and securities were
$33,027,000 of this total at December 31, 1999. Working capital at December 31,
1999 was $18,736,000 compared to $6,554,000 at December 31, 1998. The current
ratio was 2.3 to 1 at December 31, 1999 compared to 1.5 to 1 at December 31,
1998.
21
The Company makes periodic improvements to its facilities to provide
up-to-date services to its telephone and cable television customers. Hector's
plant additions in 1999, 1998 and 1997 were $2,902,000, $2,652,000 and
$2,316,000, respectively. Alliance's plant additions in 1999, 1998 (excluding
the acquisitions of Felton and Spectrum) and 1997 were $4,640,000, $5,163,000
and $2,379,000, respectively. Plant additions for 2000 for Hector and Alliance
are expected to total $1,894,000 and $5,500,000, respectively. These plant
additions will provide customers with additional advanced telecommunications
services and expand usage of high capacity fiber optics in the telephone
network.
Investments
Investment income has been derived almost exclusively from interest earned
on the Company's cash and cash equivalents. Interest income has fluctuated in
relation to changes in interest rates and availability of cash for investment.
In 1999, Alliance received $18,920,000 from sales of marketable securities,
principally Rural Cellular Corporation common stock. In 1998, Alliance received
$1,820,000 from sales of interests in Rural Cellular Corporation, MediaOne
Group, Inc., Comnet Cellular, Inc. and Illuminet Holdings, Inc. In 1997, Hector
sold 161,469 shares of Rural Cellular Corporation for $1,728,000. At December
31, 1999, Alliance continued to maintain a significant marketable securities
portfolio consisting primarily of shares of Illuminet Holdings, Inc., U.S. West
Communications, Inc. and Rural Cellular Corporation.
The Company is an investor in Wireless North LLC, a limited liability
corporation that has licenses to operate PCS systems in 13 markets in Minnesota,
Wisconsin, North Dakota and South Dakota. The Company invested cash of
$1,032,000 and $761,000 in Wireless North in 1999 and 1998, respectively.
Investments in Wireless North prior to 1998 consisted of $510,000 of cash and
debt guarantees of $1,373,000. The PCS systems are in start-up mode and have
incurred significant losses to date. The Company cannot predict how much
additional capital might be required beyond amounts already invested.
The Company continued to maintain its ownership in Midwest Wireless
Communications, LLC through acquisition of additional partnership interests.
Cash expended to purchase Midwest Wireless Communications, LLC interests was
$380,000 in 1998. At December 31, 1999, the Company's ownership percentage was
10.69%. In December, 1998, the Company sold its 12.25% interest in Sioux Falls
Cellular, Ltd., which provides cellular service in the Sioux Falls, South Dakota
MSA to CommNet Cellular, Inc. for $6,725,000.
Debt and Loan Commitments
As part of financing its 68% ownership interest in Alliance, the Company
borrowed $6,000,000 from CoBank (St. Paul Bank for Cooperatives before its 1999
merger with CoBank). In 1997, the Company repaid principal of $2,000,000 on the
loan and converted the remaining balance into a five-year term loan. In 1998,
the Company replaced the loan with a 15-year term loan from Rural Telephone
Finance Cooperative ("RTFC"). The interest rate on the loan varies according to
the rate RTFC charges for similar loans. The interest rate was 6.95% at December
31, 1999.
The Company carries a significant amount of debt due to Alliance`s
borrowing to finance the acquisition of Ollig Utilities Company. Interest rates
on Alliance's acquisition loan from CoBank have been locked for periods of one
to ten years at rates averaging 7.5%. The outstanding balance on this loan at
December 31, 1999 was $47,580,800. CoBank is a cooperative, owned and controlled
by its customers. Each customer borrowing from the bank on a patronage basis
shares in the bank's net income through payment of patronage refunds. As a
condition of maintaining the loan, Alliance invested $344,000 and $509,000 of
cash in the bank in 1999 and 1998, respectively. The Company recorded a loss of
$200,000 in 1999 due to writedown of the value of this bank stock in the merger
between CoBank and St. Paul Bank for Cooperatives.
In 1995 the Company made a public offering of 8.5% convertible
subordinated debentures. Value of the offering was $12,650,000. Proceeds to the
Company, after underwriting, accounting and legal expenses were $11,300,000.
During 1999 and 1998, the Company issued calls to retire the debentures, which
resulted in $10,757,000 of debentures being converted into stock and $1,893,000
of debentures being purchased and retired.
22
The Company's LEC subsidiaries borrow from the Rural Utilities Service
("RUS") and the Rural Telephone Bank ("RTB") to help finance asset additions.
Proceeds from long-term borrowings from RUS and RTB were $6,156,000, $737,000,
and $2,026,000 in 1999, 1998 and 1997, respectively. The average interest rate
on outstanding RUS and RTB loans is 5.6%. At December 31, 1999 unadvanced loan
commitments from the RUS and RTB to Hector's and Alliance's LEC subsidiaries
totaled $11,655,000.
The Company's loan agreements place significant restrictions on cash
distributions from the subsidiaries to the parent company. Substantially all of
the LEC's assets are pledged or are subject to mortgages to secure obligations
to the RUS and RTB. Alliance's loan covenants with CoBank also restrict dividend
payments at the Alliance level. A portion of any dividend payment from Alliance
to Hector would also be subject to federal and state income taxes. It is the
Company's plan, in so far as possible, to maintain its cash balances at the
subsidiary level to support their operations.
By utilizing cash flow from operations, current cash and investment
balances, and other available financing sources, the Company feels it has
adequate resources to meet its anticipated operating, debt service and capital
expenditure requirements.
Acquisitions
Effective April 1, 1998, Alliance acquired all the outstanding common
stock of Felton Telephone Company ("Felton"); a rural telephone company located
in northwestern Minnesota adjacent to areas already served by the Company's
telephone subsidiaries. Felton serves approximately 700 access lines and held a
significant portfolio of marketable securities, including investments in Rural
Cellular Corporation, U.S. West Communications, Inc. and MediaOne Group, Inc.
Purchase price was $3,650,000, which includes a cash downpayment and seller
financing of the balance through a $3,149,000 note payable bearing interest at
8.25%. The note matures April 1, 2005.
Effective June 9, 1998, Alliance acquired the assets of 8 cable
television systems serving 4,000 customers in 19 rural communities in Minnesota
and North Dakota from Spectrum Cablevision Limited Partnership ("Spectrum").
Several of these communities are also served by Alliance's telephone
subsidiaries. Purchase price was approximately $4,559,000. Financing for this
purchase included $2,000,000 from a new line of credit arrangement with Rural
Telephone Finance Cooperative. In 1997, Alliance acquired one small system for
$120,000.
The Company is always looking to acquire properties that advance its plan
to be a provider of top quality telecommunications services to rural customers.
In 1998, the Company acquired Felton Telephone Company and eight cable
television systems from Spectrum Cablevision Limited Partnership.
In 1999, the Company was a member of investor groups that sought unsuccessfully
to acquire rural telephone properties offered for sale by GTE and U.S. West
Communications. The Company cannot predict if it will be successful in acquiring
additional properties and does not currently have financing plans in place to
pay for possible acquisitions.
Effects of Inflation
The Company's local exchange telephone companies are subject to the
jurisdiction of Minnesota, Iowa, South Dakota and Wisconsin regulatory
authorities with respect to a variety of matters, including rates for intrastate
access services, the conditions and quality of service, issuance of debt,
depreciation rates and accounting methods. Rates for local telephone service are
not established directly by regulatory authorities, but their authority over
other matters limits the Company's ability to implement rate increases. In
addition, the regulatory process inherently restricts the Company's ability to
immediately pass cost increases along to customers unless the cost increases are
anticipated and the rate increases implemented prospectively.
Year 2000
In 1999 the Company contracted with Nortel, Inc. to upgrade its central
office switching equipment to Year 2000 compliance. Cost of the upgrades was
$658,000. The Company completed installation and testing of the new equipment in
November 1999. The Company is not aware of any disruptions of telephone service
to its customers due to Year 2000 problems.
23
New Accounting Standards
In June 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative
Instruments and Hedging Activities" which was to be effective January 1, 2000.
SFAS 133 requires companies to record derivatives on the balance sheet as assets
or liabilities, measured at fair value. Gains or losses resulting from changes
in the values of those derivatives would be accounted for depending on the use
of the derivative and whether it qualifies for hedge accounting. SFAS No. 137,
an amendment of SFAS No. 133, was issued in June of 1999 and defers the
effective date of SFAS No. 133 to fiscal years beginning after June 15, 2000.
The Company has not yet determined the impact of this pronouncement on its
financial statements.
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101, (SAB 101), "Revenue Recognition in Financial
Statements". SAB 101 summarizes certain of the staff's views regarding generally
accepted accounting principles for revenue recognition and deferred costs in the
financial statements. The Company does not believe SAB 101 will have a material
effect on its financial statements.
Factors Affecting Future Performance
From time to time in reports filed with the Securities and Exchange
Commission, in press releases, and in other communications to shareholders and
the investing public, the Company may make statements regarding the Company's
future financial performance. Such forward looking statements are subject to
risks and uncertainties, including but not limited to, the effects of the
Telecommunications Act, new technological developments which may reduce barriers
for competitors entering the Company's local exchange or cable television
markets, higher than expected expenses and other risks involving the
telecommunications industry generally. All such forward-looking statements
should be considered in light of such risks and uncertainties.
24
REPORT OF MANAGEMENT
The management of Hector Communications Corporation and its subsidiary companies
is responsible for the integrity and objectivity of the financial statements and
other financial information contained in the annual report. The financial
statements and related information were prepared in accordance with generally
accepted accounting principles and include amounts that are based on
management's informed judgments and estimates.
In fulfilling its responsibilities for the integrity of financial information,
management maintains accounting systems and related controls. These controls
provide reasonable assurance, at appropriate costs, that assets are safeguarded
against losses and that financial records are reliable for use in preparing
financial statements. Management recognizes its responsibility for conducting
the Company's affairs according to the highest standards of personal and
corporate conduct.
The Audit Committee of the Board of Directors, composed solely of outside
directors, meets with the independent auditors and management periodically to
review accounting, auditing, financial reporting and internal control matters.
The independent auditors have free access to this committee, without management
present to discuss the results of their audit work and their opinion on the
adequacy of internal financial controls and the quality of financial reporting.
/s/ Curtis A. Sampson
------------------------------------
Curtis A. Sampson
Chairman and Chief Executive Officer
/s/ Charles A. Braun
------------------------------------
Charles A. Braun
March 28, 2000 Chief Financial Officer
25
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
(a) FINANCIAL STATEMENTS
INDEPENDENT AUDITORS' REPORT
Shareholders and Board of Directors
Hector Communications Corporation
We have audited the accompanying consolidated balance sheets of Hector
Communications Corporation and subsidiaries as of December 31, 1999 and 1998 and
the related consolidated statements of income and comprehensive income,
stockholders' equity, and cash flows for each of the three years in the period
ended December 31, 1999. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Hector
Communications Corporation and subsidiaries as of December 31, 1999 and 1998 and
the results of their operations and their cash flows for each of the three years
in the period ended December 31, 1999 in conformity with generally accepted
accounting principles.
/s/ Olsen Thielen & Co., Ltd.
Olsen Thielen & Co., Ltd.
February 16, 2000
St. Paul, Minnesota
26
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
ASSETS
December 31
-----------------------------------
1999 1998
-------------- --------------
CURRENT ASSETS:
Cash and cash equivalents $ 27,055,772 $ 14,686,034
Construction fund (Note 6) 283,604 200,491
Accounts receivable (net of allowance for doubtful accounts of
$447,000 and $234,000, respectively) 4,854,365 4,140,992
Materials, supplies and inventories, at average cost 616,985 528,839
Prepaid expenses 171,432 180,134
-------------- --------------
TOTAL CURRENT ASSETS 32,982,158 19,736,490
PROPERTY, PLANT AND EQUIPMENT,net (Notes 1 and 5) 51,410,033 50,810,464
OTHER ASSETS:
Excess of cost over net assets acquired, less amortization
of $6,473,000 and $4,890,000 (Note 1) 51,405,010 53,003,560
Marketable securities (Note 3) 12,218,303 8,555,336
Wireless telephone investments (Note 4) 9,688,981 9,482,902
Other investments (Notes 1 and 6) 8,768,797 8,259,419
Deferred debenture issue costs (Note 6) 371,311
Other assets (Note 1) 323,405 460,305
-------------- --------------
TOTAL OTHER ASSETS 82,404,496 80,132,833
-------------- --------------
TOTAL ASSETS $ 166,796,687 $ 150,679,787
============== ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Notes payable and current portion of long-term debt (Note 6) $ 5,607,100 $ 6,808,500
Accounts payable (Note 10) 2,481,507 2,473,526
Accrued expenses 2,184,626 1,945,687
Income taxes payable 3,973,019 1,955,153
-------------- --------------
TOTAL CURRENT LIABILITES 14,246,252 13,182,866
LONG-TERM DEBT, less current portion (Note 6) 86,281,656 94,232,389
DEFERRED INVESTMENT TAX CREDITS (Note 7) 140,386 252,601
DEFERRED INCOME TAXES (Note 7) 9,435,515 8,510,637
DEFERRED COMPENSATION (Note 9) 897,113 990,155
COMMITMENTS AND CONTINGENCIES (Note 4)
MINORITY INTEREST IN ALLIANCE TELECOMMUNICATIONS, CORP. 15,813,847 10,790,818
STOCKHOLDERS' EQUITY: (Notes 1, 6 and 8)
Preferred stock, par value $1.00 per share; 3,000,000 shares authorized:
Convertible Series A, 229,300 and 342,800 shares issued and outstanding 229,300 342,800
Common stock, par value $.01 per share; 10,000,000 shares authorized;
3,574,712 and 2,661,062 shares issued and outstanding 35,747 26,611
Additional paid-in capital 13,274,444 6,326,441
Retained earnings 23,115,945 15,636,764
-------------- --------------
36,655,436 22,332,616
Accumulated other comprehensive income (Note 3) 3,326,482 387,705
-------------- --------------
TOTAL STOCKHOLDERS' EQUITY 39,981,918 22,720,321
-------------- --------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 166,796,687 $ 150,679,787
============== ==============
See notes to consolidated financial
statements.
27
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
Year Ended December 31
------------------------------------------------
1999 1998 1997
------------- ------------- -------------
REVENUES:
Local network $ 5,914,678 $ 5,290,811 $ 4,866,247
Network access 19,418,961 17,709,921 16,738,108
Billing and collection 824,539 865,767 1,030,182
Nonregulated activities 4,175,060 4,773,367 3,838,422
Cable television revenues 3,784,078 3,198,828 2,393,406
------------- ------------- -------------
TOTAL REVENUES 34,117,316 31,838,694 28,866,365
COSTS AND EXPENSES:
Plant operations 4,086,923 3,755,312 3,630,830
Depreciation and amortization 8,547,619 7,781,210 7,309,730
Customer operations 1,912,518 1,803,668 1,674,111
General and administrative 4,694,588 3,951,169 3,593,121
Other operating expenses 3,821,432 3,900,448 2,905,165
------------- ------------- -------------
TOTAL COSTS AND EXPENSES 23,063,080 21,191,807 19,112,957
------------- ------------- -------------
OPERATING INCOME 11,054,236 10,646,887 9,753,408
OTHER INCOME (EXPENSES):
Interest expense (6,582,536) (7,315,153) (6,797,354)
Partnership and LLC income (loss) (Note 4) (335,537) 883,096 1,308,346
Interest and dividend income 1,116,098 609,071 625,582
Gain on sale of marketable securities (Note 3) 13,203,062 965,069 1,495,999
Gain on sale of cellular partnership (Note 4) 4,817,498
------------- ------------- -------------
OTHER INCOME (EXPENSES), net 7,401,087 (40,419) (3,367,427)
------------- ------------- -------------
INCOME BEFORE INCOME TAXES 18,455,323 10,606,468 6,385,981
INCOME TAX EXPENSE (Note 7) 7,513,000 4,949,000 2,867,000
------------- ------------- -------------
INCOME BEFORE MINORITY INTEREST 10,942,323 5,657,468 3,518,981
MINORITY INTEREST IN EARNINGS OF
ALLIANCE TELECOMMUNICATIONS CORPORATION 3,463,142 1,747,225 798,228
------------- ------------- -------------
NET INCOME 7,479,181 3,910,243 2,720,753
------------- ------------- -------------
OTHER COMPREHENSIVE INCOME:
Unrealized holding gains on marketable securities 20,784,075 492,287 1,754,213
Reclassification adjustment for gains included in net income (13,203,062) (965,069) (1,495,999)
------------- ------------- -------------
OTHER COMPREHENSIVE INCOME (LOSS) BEFORE
INCOME TAXES 7,581,013 (472,782) 258,214
------------- ------------- -------------
Income tax expense related to unrealized holding gains
on marketable securities 8,450,555 189,519 752,667
Income tax benefit related to reclassification adjustment for
gains included in net income (5,368,207) (371,529) (641,877)
------------- ------------- -------------
Income tax expense (benefit) related to items of other
comprehensive income 3,082,348 (182,010) 110,790
Minority interest in other comprehensive income of
Alliance Telecommunications Corporation 1,559,887
------------- ------------- -------------
Other Comprehensive Income (Loss) 2,938,778 (290,772) 147,424
------------- ------------- -------------
COMPREHENSIVE INCOME $ 10,417,959 $ 3,619,471 $ 2,868,177
============= ============= =============
BASIC NET INCOME PER COMMON SHARE (Note 1) $ 2.42 $ 1.63 $ 1.44
============= ============= =============
DILUTED NET INCOME PER COMMON SHARE (Note 1) $ 1.96 $ 1.15 $ .93
============= ============= =============
AVERAGE SHARES OUTSTANDING (Notes 1 and 8):
Common shares only 3,095,000 2,403,000 1,893,000
Common and potential common shares 3,945,000 3,937,000 3,732,000
See notes to consolidated financial
statements.
28
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Unearned Accumulated
Employee
Additional Stock Other
Preferred Stock Common Stock Paid-in Retained Ownership Comprehensive
Shares Amount Shares Amount Capital Earnings Shares Income Total
------- -------- --------- ------- ----------- ----------- ---------- ---------- -----------
BALANCE AT DECEMBER 31, 1996 389,487 $389,487 1,883,857 $18,839 $ 102,003 $ 9,005,768 $(101,312) $ 531,053 $ 9,945,838
Net income 2,720,753 2,720,753
Issuance of common stock 171,425 1,714 1,488,255 1,489,969
Issuance of common stock under
Employee Stock Purchase Plan 3,695 37 23,126 23,163
Issuance of common stock under
Employee Stock Option Plan 9,000 90 61,885 61,975
Issuance of common stock in
exchange for preferred stock (11,387) (11,387) 11,387 114 11,273 0
ESOP Shares Allocated 26,412 31,588 58,000
Change in unrealized gains on
marketable securities, net
of deferred taxes 147,424 147,424
------- ------- --------- ------- ----------- ----------- ---------- ---------- -----------
BALANCE AT DECEMBER 31, 1997 378,100 378,100 2,079,364 20,794 1,712,954 11,726,521 (69,724) 678,477 14,447,122
Net income 3,910,243 3,910,243
Issuance of common stock under
Employee Stock Purchase Plan 10,753 107 73,013 73,120
Issuance of common stock under
Employee Stock Option Plan 48,200 482 354,931 355,413
Issuance of common stock in
exchange for preferred stock (35,300) (35,300) 35,300 353 34,947 0
Issuance of common stock from
exercise of outstanding warrants 7,876 79 61,091 61,170
Conversion of convertible
debentures into common stock 479,569 4,796 4,096,134 4,100,930
ESOP Shares Allocated (6,629) 69,724 63,095
Change in unrealized gains on
marketable securities, net of
deferred taxes (290,772) (290,772)
------- -------- --------- ------- ----------- ----------- ---------- ---------- -----------
BALANCE AT DECEMBER 31, 1998 342,800 342,800 2,661,062 $26,611 6,326,441 15,636,764 - 387,705 22,720,321
Net income 7,479,181 7,479,181
Issuance of common stock under
Employee Stock Purchase Plan 14,890 149 104,267 104,416
Issuance of common stock under
Employee Stock Option Plan 43,675 437 361,475 361,912
Issuance of common stock in
exchange for preferred stock (113,500) (113,500) 113,500 1,135 112,365 0
Issuance of common stock from
exercise of outstanding warrants 8,742 87 (87) 0
Conversion of convertible
debenturex into common stock 730,438 7,304 6,350,007 6,357,311
Issuance of common stock to ESOP 2,405 24 19,976 20,000
Change in unrealized gains on
marketable securities, net of
deferred taxes 2,938,777 2,938,777
------- -------- --------- ------- ----------- ----------- ---------- ---------- -----------
BALANCE AT DECEMBER 31, 1999 229,300 $229,300 3,574,712 $35,747 $13,274,444 $23,115,945 $ - $3,326,482 $39,981,918
======= ======== ========= ======= =========== =========== ========== ========== ===========
See notes to consolidated
financial statements.
29
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31
------------------------------------------------
1999 1998 1997
-------------- ------------- -------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income $ 7,479,181 $ 3,910,243 $ 2,720,753
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 8,663,181 7,957,527 7,500,078
Minority stockholders' interest in earnings
of Alliance Telecommunications Corporation 3,463,142 1,747,225 798,228
Gain on sales of marketable securities (13,203,062) (965,069) (1,495,999)
Gain on sale of wireless partnership investment (4,817,498)
Loss (income) from partnership and LLC investments 335,537 (883,096) (1,308,346)
Proceeds from wireless telephone investments 709,668 1,206,505 792,622
Noncash patronage refunds (12,569) (661,923)
Changes in assets and liabilities net of effects from
the purchase of Felton Telephone Company:
Increase in accounts receivable (727,508) (37,845) (37,430)
Decrease (increase) in materials, supplies and inventories (88,146) 21,188 (30,567)
Decrease (increase) in prepaid expenses 8,702 46,455 (56,060)
Increase (decrease) in accounts payable 7,981 866,321 (269,033)
Increase (decrease) in accrued expenses 477,147 (193,287) 157,333
Increase in income taxes payable 1,942,370 1,455,010 422,816
Decrease in deferred investment tax credits (112,215) (136,016) (145,167)
Increase (decrease) in deferred income taxes (2,157,467) (604,706) 25,394
Increase (decreas