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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, 2001
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 $38,403,000 based upon the closing sale price of
the Company's common stock on the American Stock Exchange on March 22, 2002.
As of March 22, 2002 there were outstanding 3,508,879 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 16, 2002 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 15
4. Submission of Matters to a Vote of Security Holders 15
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 16
7a. Disclosures About Market Risk 23
8. Financial Statements and Supplementary Data 24
9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure 40
PART III
10. Directors and Executive Officers of the Registrant 40
11. Executive Compensation 40
12. Security Ownership of Certain Beneficial Owners and Management 40
13. Certain Relationships and Related Transactions 41
PART IV
14. Exhibits, Financial Statement Schedule and Reports on Form 8-K 41
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
7,529 access lines in 9 rural communities in Minnesota and Wisconsin at December
31, 2001. HCC, through its subsidiaries, also provides cable television service
to 4,786 subscribers in Minnesota and Wisconsin.
HCC's 68% owned subsidiary, Alliance Telecommunications Corporation, owns
and operates six additional LEC subsidiaries which served 31,350 access lines in
28 rural communities in Minnesota, Wisconsin, Iowa and South Dakota at December
31, 2001. Alliance, through its subsidiaries, also served 9,042 cable television
subscribers in Minnesota, North Dakota, South Dakota and Iowa. 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.
Effective June 9, 2000, Alliance acquired all the outstanding common
stock of Hager TeleCom, Inc. ("Hager"); a rural telephone company located in
southwestern Wisconsin. Hager serves approximately 2,100 access lines, provides
internet service to 2,700 customers in Hager City, WI and Red Wing, MN and has
an ownership interest in Midwest Wireless Holdings, LLC.
[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
The Company derives the majority of its revenues from providing basic
telephone services (often referred to as "plain old telephone service" or
"POTS") to residential and business customers within its service territories.
POTS revenues consist mainly of fees for local service which are billed directly
to customers and access revenues which are received for intrastate and
interstate exchange services provided to long distance carriers. POTS revenues
are subject to regulation by a number of state and federal government agencies.
The Company also earns revenues by providing a number of nonregulated
telecommunications services to customers. The most significant of these
nonregulated services is cable television. Other services include internet
services, lease of fiber optic transport facilities, billing and collection
services to long distance carriers, telephone directory services, engineering
services and equipment rental. The Company also makes retail sales of consumer
telecommunications equipment and sells wireless telephone services on a
commission basis.
The following table presents the percentage of revenues derived from
local service revenues, access revenues, nonregulated telecommunications
activities and cable television operations for the last three years:
3
Year Ended December 31
--------------------------------------------------
2001 2000 1999
----------- ---------- -----------
Local network 17.6% 17.6% 17.3%
Network access 55.0 55.1 56.9
Nonregulated activities 17.2 16.8 14.7
Cable television 10.2 10.5 11.1
----------- ----------- -----------
100.0% 100.0% 100.0%
=========== =========== ===========
The Company also owns minority interests in partnerships and limited
liability corporations ("LLCs") that provide a wide variety of
telecommunications services, including wireless telephone services, fiber-optic
transport services and telephone switching services. The most significant of
these investments is Midwest Wireless Holdings, LLC.
(1) Plain Old Telephone Service ("POTS")
Local Network
The Company's LEC subsidiaries provide basic local telephone services to
residential and business customers in Minnesota, Wisconsin, South Dakota, North
Dakota and Iowa. 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. The
following chart presents the number of access lines served by Hector's and
Alliance's LEC subsidiaries at December 31, 2001, 2000 and 1999:
Access Lines*
---------------------------------------------------------
December 31
--------------------------------------------------
2001 2000 1999
----------- ----------- -----------
Hector Communications Corporation:
Arrowhead Communications Corporation 808 806 817
Eagle Valley Telephone Company 727 731 734
Granada Telephone Company 289 288 289
Pine Island Telephone Company 3,313 3,263 3,154
Indianhead Telephone Company 2,392 2,334 2,234
---------- ---------- ----------
Total Hector Access Lines 7,529 7,422 7,228
---------- ---------- ----------
Alliance Telecommunications Corporation:
Loretel Systems, Inc. 13,300 13,234 12,967
Sleepy Eye Telephone Company 6,556 6,511 6,467
Sioux Valley Telephone Company 5,893 5,939 5,756
Hills Telephone Company 2,812 2,788 2,706
Felton Telephone Company 752 764 743
Hager TeleCom, Inc. 2,037 2,087
---------- ---------- ----------
Total Alliance Access Lines 31,350 31,323 28,639
---------- ---------- ----------
Total Access Lines 38,879 38,745 35,867
========== ========== ==========
* An "access line" is a single or multi-party circuit between the customer's
establishment and the central switching office.
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.
4
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.
Access Revenues
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. In 2001, approximately 64% of the Company's access revenues were from
interstate sources and 36% were from intrastate sources.
A portion of the Company's interstate access revenue is derived from
subscriber line charges ("SLCs") determined by the FCC and billed directly to
end users for access to long distance carriers. Another portion consists of
universal service funds received based upon the high cost of providing service
to rural areas. The balance of the interstate access revenue 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.
Intrastate access revenues are received from long distance carriers based
on recorded customer usage multiplied by the appropriate tariff rate. Where
applicable, HCC's LECs 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.
(2) Nonregulated Telecommunications Activities
Revenues from internet services were $1,977,000 and $1,304,000 in 2001
and 2000, respectively. Internet access is 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. The Company provided dial-up internet
services to 8,859 and 7,876 customers at December 31, 2001 and 2000,
respectively. At December 31, 2001 an additional 1,162 customers subscribed to
DSL service.
Revenues from leases of fiber-optic transport facilities were $1,301,000
and $1,282,000 in 2001 and 2000, respectively. However, due to changes in market
conditions, the Company has renegotiated several of its leases, resulting in a
significant decline in anticipated future lease revenue. All of the fiber-optic
facilities leased are owned by HCC's LEC subsidiaries and are located within the
LEC's local exchange boundaries.
HCC's LECs sell and lease customer premise telephone equipment, provide
inside wiring services 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.
5
(3) Cable Television
The Company, through its cable television and LEC subsidiaries, owns and
operates 49 cable television systems serving 13,828 subscribers in Minnesota and
the surrounding states. Cable television revenues are derived almost exclusively
from monthly fees for basic and premium programming. Fees for basic services
range from $9.75 to $26.50 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 $1.75 to $11.00 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.
In 2001 the Company deployed broadband equipment manufactured by Next
Level Communications, Inc. in its exchanges serving Pine Island, MN and Goodhue,
MN. This equipment makes it possible to deliver POTS, video and high speed
Internet services to the customer over the same circuit. Video programming is
delivered utilizing a digital "super headend" owned by Broadband Visions, Inc.,
in which the Company is an investor. The Company is planning to install
broadband equipment in its Sleepy Eye, MN exchange in 2002 and in additional
exchanges in future years. The Company's broadband product offerings are
dependent on the availability of equipment from Next Level Communications, Inc.
If the Company cannot obtain necessary equipment it could have a material
adverse affect on its operations.
(4) Investments in Unconsolidated Affiliates
Wireless Telephone Services
- ---------------------------
The Company is the largest shareholder of Midwest Wireless Holdings, LLC,
with a 10.4% ownership stake. Midwest Wireless acquired additional wireless
operations in Wisconsin and Iowa in 2000, which significantly increased Midwest
Wireless' service area, but reduced the Company's percentage ownership of the
operation. Midwest Wireless now serves eleven rural service areas and one
metropolitan service area in Minnesota, Wisconsin and Iowa. Population of the
service areas is approximately 1,590,000. Midwest Wireless offers complete
wireless service, including custom calling features, facsimile and data
transmission and presently has 227,000 customers. The Company accounts for its
investment in Midwest Wireless using the equity method. Income recognized was
$1,475,000, $1,248,000, and $1,481,000 in 2001, 2000 and 1999, respectively.
The Company owns 10.4% 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 was unsuccessful and is
being liquidated. Its licenses and systems are being sold to other operators. In
2001, the Company made payments to Wireless North's primary lender of $1,129,000
to satisfy loan guarantees it gave with respect to Wireless North's debt. Cash
investments in Wireless North by the Company totaled $3,202,000. The Company has
written off its entire investment in Wireless North, has no obligation to
provide additional funding and does not expect to realize any additional value
from this investment.
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. The Company sold 326,707 shares of RCC stock in 1999 and recorded gains
on sales of securities of $11,600,000. At December 31, 2001, the Company owned
approximately 10,700 shares of RCC's common stock.
Onvoy, Inc.
- -----------
Onvoy, Inc. is a privately held company that provides integrated voice,
data, and network services through its fiber optic communications network
linking communities throughout Minnesota, including all major metropolitan
areas. Onvoy,
6
Inc. is a leading provider of Internet, long distance, video-conferencing and
high-speed data networking services. Onvoy's customers include Minnesota based
Fortune 500 companies and many small-to-medium sized businesses. Onvoy also
serves the state's higher education institutions, the state's K-12 schools,
public libraries, state and county governments, more than 70 regional Internet
service providers and the state's independent local telephone companies.
During 2001 and 2000 the Company purchased $190,000 and $446,000
respectively, of debt issued by Onvoy to provide additional working capital to
Onvoy's operations. The Company is presently the second largest common
shareholder of Onvoy. At the end of 2000 the Company determined that due to
losses incurred by Onvoy's operations, the value of the Company's investment in
Onvoy's common stock was impaired. Accordingly, the Company established a
valuation reserve of $1,273,000 against substantially all of its investment in
Onvoy common stock during the fourth quarter of 2000.
Fiber-Optic Transport Investments
- ---------------------------------
The Company has invested approximately $1,707,000 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.
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 $4,991,000, $4,694,000 and $4,644,000 at December 31, 2001, 2000 and
1999, 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 an investor
in Fibercom LC, a compteting local exchange carrier ("CLEC") that has been
established to provide local communications services to business customers in
the Sioux City, Iowa area. The Company is also an investor in Desktop Media,
Inc., a CLEC using a network employing Ethernet architecture to provide
telecommunications services in southeastern Minnesota.
(5) Competition
Telephone
- ---------
LECs are subject to many forms of competition. Its principal competitors
are:
- - Facilities-based competition from providers, including cable television
service 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 networks. However, there is no
assurance that interconnection may not be required in the future.
Most customers currently see wireless telephone service 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.
7
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.
(6) 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.
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
8
- - 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. However, at this time it is not possible to predict what
changes, if any, may be made.
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. In 1984 the FCC 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 SLC was increased in 1989 to a $3.50 cap on residence and single
line business lines and a $6.00 cap on multi-line business lines. The remaining
portions of the interstate local loop costs were recovered from interstate
access charges to interexchange carriers.
In November 2001 the FCC adopted access charge reforms based in part on a
proposal by the Multi-Association Group (the "MAG Plan"). The MAG Plan increases
the maximum rate caps for SLCs as follows:
Residential and Single Line Business
January 1, 2002 Increase from $3.50 to $5.00
July 1, 2002 Increase from $5.00 to $6.00
July 1, 2003 Increase from $6.00 to $6.50
Multi-line Business
January 1, 2002 Increase from $6.00 to $9.20
The increased SLC revenues will be offset by reductions in recovery of
local loop costs from interexchange carriers. The plan is intended to be revenue
neutral for affected LECs.
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 universal
service fund support accounted for $1,744,000, $1,490,000 and $1,035,000 of the
Company's network access revenues in 2001, 2000 and 1999, respectively.
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
9
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
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. HCC's LECs located in Minnesota and Wisconsin
participate in the traffic sensitive NECA pools. HCC's LECs located in Iowa and
South Dakota do not participate 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, however, 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 in 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:
10
- - 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,
- - 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 and 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.
The Company'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.
11
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 except in
one area where a wireless competitor was approved as an eligible provider. 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
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.
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 agreed 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
(except Felton Telephone Company) 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. In
2001, the Company increased its local service rate for Sleepy Eye Telephone
Company. The commission did not review the rate increase.
The Minnesota Public Utilities Commission is investigating intrastate
access rates charged by local telephone companies to IXCs. The commission has
proposed a plan reducing intrastate access charges and implementing a state
universal service fund to compensate high cost companies. The Company cannot
predict the outcome of the rate investigation or if any part of the proposed
plan will be adopted.
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:
12
- - "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.
(7) 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.
(8) Employees
At March 1, 2002, the Company had 169 full-time and part-time employees,
of which 112 employees work in the Alliance operations and 57 work in Hector
operations. None of the Company's employees are represented under collective
bargaining agreements. HCC believes its employee relations to be good.
13
(9) Executive Officers of Registrant
The executive officers of the Company and their ages at March 1, 2002
were as follows:
Name Age Position
---- --- --------
Curtis A. Sampson 68 Chairman of the Board and Chief
Executive Officer
Steven H. Sjogren 59 President and Chief Operating
Officer
Paul N. Hanson 55 Vice President and Treasurer
Charles A. Braun 44 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 50% 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.
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.
14
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.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS
[a] MARKET INFORMATION
The Company's common stock is traded on the American Stock Exchange
("AMEX"). The table below presents the range of high and low trading prices for
the Company's stock for each period as reported by AMEX:
2001 2000
------------------------ -------------------------
Quarter High Low High Low
------- ------ ------- -------
First $ 11.50 $ 9.65 $ 15.75 $ 11.63
Second 13.30 9.60 14.88 11.38
Third 15.25 12.20 14.25 12.38
Fourth 16.65 13.60 13.25 10.00
[b] HOLDERS
At March 1, 2002 there were 555 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
------------------------------------------------------------
2001 2000 1999 1998 1997
- --------------------------------------------------------------------------------------------------------------------------------
Selected Income Statement Information
Revenues $ 40,633 $ 37,790 $ 34,117 $ 31,839 $ 28,866
Costs and Expenses 30,112 26,799 23,063 21,192 19,113
- --------------------------------------------------------------------------------------------------------------------------------
Operating Income 10,521 10,991 11,054 10,647 9,753
Other Income (Expenses), net 1,170 (2,471) 7,401 (40) (3,367)
- --------------------------------------------------------------------------------------------------------------------------------
Income Before Income Taxes 11,691 8,520 18,455 10,606 6,386
Income Tax Expense 5,321 4,207 7,513 4,949 2,867
- --------------------------------------------------------------------------------------------------------------------------------
Income Before Minority Interest 6,370 4,313 10,942 5,657 3,519
Minority Interest in Earnings of Alliance
Telecommunications Corporation 1,754 1,004 3,463 1,747 798
- --------------------------------------------------------------------------------------------------------------------------------
Net Income $ 4,616 $ 3,309 $ 7,479 $ 3,910 $ 2,721
================================================================================================================================
Basic Net Income Per Common Share $ 1.33 $ .93 $ 2.42 $ 1.63 $ 1.44
Diluted Net Income Per Common Share $ 1.23 $ .86 $ 1.96 $ 1.15 $ .93
Average Shares Outstanding:
Common shares only 3,465 3,544 3,095 2,403 1,893
Common and potential common shares 3,762 3,851 3,945 3,937 3,732
===============================================================================================================================
Selected Balance Sheet Information
Working Capital $ 7,633 $ 8,960 $ 18,736 $ 6,554 $ 8,504
Property, Plant and Equipment, net 57,362 56,227 51,410 50,810 45,927
Excess of Cost Over Net Assets Acquired, net 53,663 55,475 51,405 53,004 51,170
Total Assets 158,251 158,678 166,797 150,680 139,291
Long-Term Debt 79,642 84,378 86,282 94,232 97,793
Stockholders' Equity 42,241 39,108 39,982 22,720 14,447
- --------------------------------------------------------------------------------------------------------------------------------
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, 2001,
these subsidiaries provided telephone service to 7,529 customers in 9 rural
communities in Minnesota and Wisconsin. They also owned cable television systems
serving 4,786 customers in Minnesota and Wisconsin. HCC's 100%-owned
subsidiaries also have substantial investments in other telecommunications
ventures, including, Midwest Wireless Holdings, LLC.
HCC also owns a 68% interest in Alliance Telecommunications Corporation
("Alliance"). At December 31, 2001, Alliance, through its six LEC subsidiaries,
provided telephone service to 31,350 customers in 28 rural communities in
Minnesota, Wisconsin, South Dakota and Iowa. Alliance's subsidiaries also
provided cable television services to 9,042 subscribers in Minnesota, South
Dakota and North Dakota. Alliance's subsidiaries also own substantial
investments in Midwest Wireless Holdings, LLC and have other investments. The
minority interest in Alliance is owned by Golden West Telecommunications
Cooperative and Split Rock Telecom Cooperative.
16
Results of Operations
2001 Compared to 2000
Consolidated revenues increased 8% to $40,633,000 in 2001 from
$37,790,000 in 2000. The following table shows revenues by operating group for
2001 compared to 2000:
Alliance Hector
Year Ended December 31 Year Ended December 31
2001 2000 2001 2000
--------------- ---------------- ---------------- -----------------
Local network $ 5,586,670 $ 4,934,548 $ 1,562,398 $ 1,715,694
Network access 16,689,138 15,299,095 5,652,977 5,513,268
Nonregulated activities 5,859,932 5,407,525 1,126,656 966,561
Cable television 2,690,063 2,469,407 1,465,078 1,484,004
--------------- ---------------- ---------------- -----------------
$ 30,825,803 $ 28,110,575 $ 9,807,109 $ 9,679,527
--------------- ---------------- ---------------- -----------------
Consolidated local service revenues grew to $7,149,000 in 2001 from
$6,650,000 in 2000, an increase of $499,000 or 8%. Revenue growth in Alliance
was due to the acquisition of Hager TeleCom, Inc. in June 2000 and a local
service rate increase at Sleepy Eye Telephone Company. Hector's local network
revenues declined due to rate reductions in Wisconsin exchanges mandated by the
public service commission.
Network access revenues increased to $22,342,000 in 2001 compared to
$20,812,000 in 2000, an increase of $1,530,000 or 7%. The increase was due to
the acquisition of Hager TeleCom, Inc., which accounted for $402,000 of the
increase, increased universal service support payments and increased settlements
payments from NECA.
Nonregulated revenues grew to $6,987,000 in 2001 from $6,374,000 in 2000,
an increase of $613,000 or 10%. The acquisition of Hager TeleCom, Inc. accounted
for $371,000 of the increase. Revenues from internet services, excluding Hager,
increased $437,000, which offset decreases in billing and collection revenues.
Cable television revenues rose to $4,155,000 in 2001 from $3,953,000 in 2000, an
increase of $202,000 or 5% due to the acquisition of additional cable systems in
South Dakota.
Consolidated operating costs and expenses grew to $30,112,000 in 2001
from $26,799,000 in 2000, an increase of $3,313,000 or 12%. The acquisition of
Hager TeleCom, Inc. accounted for $1,113,000 of the increase. The following
table shows costs and expenses by operating group for 2001 compared to 2000:
Alliance Hector
Year Ended December 31 Year Ended December 31
2001 2000 2001 2000
--------------- ---------------- ---------------- -----------------
Plant operations $ 3,974,169 $ 3,586,255 $ 1,381,781 $ 1,224,546
Depreciation and amortization 8,138,515 7,354,503 3,178,259 2,821,781
Customer operations 2,051,760 1,805,330 384,286 310,304
General and administrative 3,307,150 2,803,504 1,565,399 1,772,180
Other operating expenses 4,472,835 3,666,506 1,657,742 1,454,337
--------------- ---------------- ---------------- -----------------
$ 21,944,429 $ 19,216,098 $ 8,167,467 $ 7,583,148
--------------- ---------------- ---------------- -----------------
Consolidated plant operations expenses increased to $5,356,000 in 2001
from $4,811,000 in 2000, an increase of $545,000 or 11% due to the acquisition
of Hager ($187,000 of the increase), and increased labor costs. Depreciation and
amortization increased to $11,317,000 in 2001 from $10,176,000 in 2000, an
increase of $1,141,000 or 11% due to increased depreciation on new telephone
equipment and the acquisition of Hager. Customer operations expenses increased
15% to $2,436,000 in 2001 from $2,116,000 in 2000 due to increased marketing and
sales costs. General and administrative expenses increased to $4,873,000 in 2001
from $4,576,000 in 2000, an increase of $297,000 or 6% due to the acquisition of
Hager. Other operating expenses increased $1,010,000 or 20% due to increased
cable television and internet service fees.
17
Consolidated operating income decreased $470,000 or 4% to $10,521,000 in
2001 from $10,991,000 in 2000.
Consolidated interest expenses decreased $653,000 to $5,302,000 in 2001
from $5,955,000 in 2000. The decrease was due to lower interest rates on
variable rate debt and increased patronage refunds from CoBank.
Income from investments in unconsolidated affiliates increased to
$2,140,000 in 2001 from $611,000 in 2000. The Company took a charge against
earnings of $1,273,000 in 2000 based on its revaluation of its investment in
Onvoy, Inc. Income from Midwest Wireless Holdings, LLC increased to $1,475,000
in 2001 from $1,248,000 in 2000.
Alliance had gains on sales of marketable securities totaling $3,659,000
in 2001 compared to gains on sales of $1,622,000 in 2000. Most of the gains were
on sales of Illuminet, Inc. (which was acquired by VeriSign) stock sold in 2001
and Qwest stock sold in 2000. Interest and dividend income decreased to $673,000
in 2001 from $1,251,000 in 2000 due to lower interest rates on invested funds
and lower dividend yields from marketable security investments.
Consolidated income before income taxes increased to $11,691,000 in 2001
from $8,520,000 in 2000. The Company's effective income tax rate of 45.5% is
higher than the standard U.S. tax rate due to state income taxes and because the
goodwill amortization expenses from the Company's acquisitions cannot be
deducted. Income before the minority interest in Alliance's earnings increased
to $6,370,000 in 2001 from $4,313,000 in 2000. Minority interest on earnings of
Alliance was $1,754,000 in 2001 compared to $1,004,000 in 2000. Net income
increased to $4,616,000 in 2001 compared to $3,309,000 in 2000.
2000 Compared to 1999
- ---------------------
Consolidated revenues increased 11% to $37,790,000 in 2000 from
$34,117,000 in 1999. The following table shows revenues by operating group for
2000 compared to 1999:
Alliance Hector
Year Ended December 31 Year Ended December 31
2000 1999 2000 1999
--------------- ---------------- ---------------- -----------------
Local network $ 4,934,548 $ 4,250,474 $ 1,715,694 $ 1,664,204
Network access 15,299,095 14,587,083 5,513,268 4,831,878
Nonregulated activities 5,407,525 4,178,484 966,561 821,115
Cable television 2,469,407 2,306,786 1,484,004 1,477,292
--------------- ---------------- ---------------- -----------------
$ 28,110,575 $ 25,322,827 $ 9,679,527 $ 8,794,489
--------------- ---------------- ---------------- -----------------
Consolidated local service revenues grew to $6,650,000 in 2000 from
$5,915,000 in 1999, an increase of $735,000 or 12%. Revenue growth was due to
the acquisition of Hager TeleCom, Inc. in June 2000, which added $348,000 to
local service revenues in 2000 and also due to increased demand for telephone
lines to provide advanced telecommunications services such as Internet services.
Network access revenues rose to $20,812,000 in 2000 from $19,419,000 in
1999, an increase of $1,393,000 or 7%. The acquisition of Hager TeleCom, Inc.
accounted for $523,000 of the increase. Increased universal service support
payments accounted for $224,000. The balance was due to increased use of the
telephone network by customers and increased settlements payments from NECA.
Nonregulated revenues grew to $6,374,000 in 2000 from $5,000,000 in 1999,
an increase of $1,374,000 or 27%. The acquisition of Hager TeleCom, Inc.
accounted for $790,000 of the increase. The Company's deregulated revenues
consist mainly of internet service fees, rents from leased of fiber-optic cable
facilities, sales of telecommunications equipment, engineering fees, directory
revenues and sales commissions and billing and collection revenues. Cable
television revenues rose to $3,953,000 in 2000 from $3,784,000 in 1999, an
increase of $169,000 or 4% due to increased customer service rates.
18
Consolidated operating costs and expenses grew to $26,799,000 in 2000
from $23,063,000 in 1999, an increase of $3,736,000 or 16%. The acquisition of
Hager TeleCom, Inc. accounted for $1,265,000 of the increase. The following
table shows costs and expenses by operating group for 2000 compared to 1999:
Alliance Hector
Year Ended December 31 Year Ended December 31
2000 1999 2000 1999
--------------- ---------------- ---------------- -----------------
Plant operations $ 3,586,255 $ 2,944,902 $ 1,224,546 $ 1,142,021
Depreciation and amortization 7,354,503 5,930,740 2,821,781 2,616,879
Customer operations 1,805,330 1,784,422 310,304 329,191
General and administrative 2,803,504 2,223,743 1,772,180 1,544,670
Other operating expenses 3,666,506 3,020,202 1,454,337 1,526,310
--------------- ---------------- ---------------- -----------------
$ 19,216,098 $ 15,904,009 $ 7,583,148 $ 7,159,071
--------------- ---------------- ---------------- -----------------
Consolidated plant operations expenses increased to $4,811,000 in 2000
from $4,087,000 in 1999, an increase of $724,000 or 18% due to the acquisition
of Hager, increased labor costs and increased charges from suppliers.
Depreciation and amortization increased to $10,176,000 in 2000 from $8,548,000
in 1999, an increase of $1,628,000 or 19% due to increased depreciation on new
telephone switching equipment and the acquisition of Hager. Customer operations
expenses were $2,116,000 in 2000 compared to $2,114,000 in 1999. General and
administrative expenses increased to $4,576,000 in 2000 from $3,768,000 in 1999,
an increase of $808,000 or 21% due to the acquisition of Hager. Other operating
expenses increased $574,000 or 13% due to the acquisition of Hager and increased
cable television and internet service fees.
Consolidated operating income decreased $63,000 or 1% to $10,991,000 in
2000 from $11,054,000 in 1999.
Consolidated interest expenses decreased $628,000 to $5,955,000 in 2000
from $6,583,000 in 1999. The decrease was due to expense reductions on
convertible debentures that were retired or converted into common stock in 1999.
In 2000, the Company had income from unconsolidated affiliates of
$611,000 compared to a loss of $336,000 in 1999. The Company recorded income on
its Wireless North PCS investment (due to adjustments in its debt guarantee) of
$15,000 in 2000 compared to a loss of $1,597,000 in 1999. Income from the
Company's investments in Northern Transport Group and South Dakota Networks
totaled $535,000 in the 2000 period. The Company took a charge against earnings
of $1,273,000 in 2000 based on its revaluation of its investment in Onvoy, Inc.
Income from Midwest Wireless Holdings, LLC decreased to $1,248,000 in 2000 from
$1,481,000,in 1999. The decrease was due to price competition from other
wireless service providers and costs associated with its acquisition of
additional service areas in Iowa and Wisconsin.
Alliance had gains on sales of marketable securities totaling $1,622,000
in 2000 compared to gains on sales of $13,203,000 in 1999. Most of the gains
were on sales of Qwest stock sold in 2000 and sales of Rural Cellular
Corporation in 1999. At December 31, 2000, Alliance continued to hold a
significant portfolio of marketable securities. Interest and dividend income
increased to $1,251,000 in 2000 from $1,116,000 in 1999 due to investments of
the cash proceeds from the marketable securities sales.
Consolidated income before income taxes decreased to $8,520,000 in 2000
from $18,455,000 in 1999. The Company's effective income tax rate of 49.4% is
higher than the standard U.S. tax rate due to state income taxes and because the
goodwill amortization expenses from the Company's acquisitions cannot be
deducted. Income before the minority interest in Alliance's earnings decreased
to $4,313,000 in 2000 from $10,942,000 in 1999. Minority interest on earnings of
Alliance was $1,004,000 in 2000 compared to $3,463,000 in 1999. Net income
decreased to $3,309,000 in 2000 compared to $7,479,000 in 1999.
19
Liquidity and Capital Resources
Operations
----------
Cash flows from consolidated operating activities were $13,679,000,
$7,981,000 and $6,693,000 in 2001, 2000 and 1999, respectively. The increase in
cash flows from operations in 2001 was due to increased net income, increased
noncash expenses, lower accounts receivable levels and lower income tax
payments. At December 31, 2001, the Company's cash, cash equivalents and
marketable securities totaled $13,502,000 compared to $16,729,000 at December
31, 2000. Alliance's cash and securities were $7,536,000 of this total at
December 31, 2001. Working capital at December 31, 2001 was $7,633,000 compared
to $8,960,000 at December 31, 2000. The current ratio was 1.6 to 1 at December
31, 2001 compared to 1.8 to 1 at December 31, 2000.
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 2001, 2000 and 1999 were $3,985,000, $3,111,000 and
$2,902,000, respectively. Alliance's plant additions in 2001, 2000 (excluding
the acquisition of Hager TeleCom, Inc.) and 1999 were $6,634,000, $6,335,000 and
$4,640,000, respectively. Plant additions for 2002 for Hector and Alliance are
expected to total $2,993,000 and $9,300,000, 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 2001 Alliance received $3,675,000 from sales of marketable
securities, principally Illuminet, Inc. common stock. In 2000 Alliance received
$5,421,000 from sales of marketable securities, principally Qwest common stock.
In 1999 Alliance received $18,920,000 from sales of marketable securities,
principally Rural Cellular Corporation common stock. The Company does not expect
proceeds from marketable securities sales in future years to approach these
levels.
The Company owns 10.4% of 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. Wireless North was unsuccessful and is
being liquidated. Its licenses and systems are being sold to other operators. In
2001, the Company made payments to Wireless North's primary lender of $1,129,000
to satisfy loan guarantees made on Wireless North's debt. The Company had
accrued these payments in prior periods and they did not affect 2001 net income.
Total cash invested by the Company over the life of its investment in Wireless
North was $3,202,000. The Company has no additional obligations to provide
funding for Wireless North. The Company does not expect to realize any
additional value or incur additional costs from this investment.
The Company regularly invests cash in new telecommunications technologies
and ventures and in support of its existing affiliated interests. In 2001 the
Company invested $500,000 in Desktop Media, Inc., a start-up company providing
voice, data and internet telecommunications services in southeastern Minnesota.
The Company also invested $360,000 to support its investment in a fiber optic
transport company in northwestern Minnesota. In 2000, the Company invested
$700,000 in Broadband Visions, Inc., which constructed a digital "super headend"
in Hutchinson, MN. The Company expects to make additional investments of this
type as opportunities arise.
20
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 1998, the Company replaced the loan with a 15-year term
loan from Rural Telephone Finance Cooperative ("RTFC"). At December 31, 2001 the
outstanding balance on this loan was $3,366,000. The interest rate on the loan
varies according to the rate RTFC charges for similar loans. The interest rate
was 5.25% at December 31, 2001.
The Company carries a significant amount of debt due to Alliance`s
borrowing to finance the acquisition of Ollig Utilities Company. Interest rates
on a portion of Alliance's acquisition loan from CoBank have been locked for
periods of one to ten years. At December 31, 2001 interest rates on the loan
averaged 6.6%. The outstanding balance on this loan at December 31, 2001 was
$41,532,000. 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 of cash in the bank in 1999. 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. The 1999
calls resulted in $6,493,000 of debentures being converted into stock and
$1,455,000 of debentures being purchased and retired.
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 $2,201,000, $700,000
and $6,156,000 in 2001, 2000 and 1999, respectively. The average interest rate
on outstanding RUS and RTB loans is 5.5%. At December 31, 2001 unadvanced loan
commitments from the RUS and RTB to Hector's and Alliance's LEC subsidiaries
totaled $23,202,000.
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.
Common Stock
------------
The Company's Board of Directors has authorized the purchase and
retirement, from time to time, of shares of the Company's stock on the open
market, or in private transactions consistent with overall market and financial
conditions. In 2001 the Company purchased and retired 109,704 shares at a cost
of $1,268,000. In 2000, the Company purchased and retired 221,950 shares at a
cost of $3,155,000. At December 31, 2001 286,000 shares could be repurchased
under outstanding Board authorizations.
In 1995 the underwriters of the convertible debenture offering also
received warrants to purchase shares of the Company's common stock at a price of
$8.70 per share. Proceeds to the Company from exercises of outstanding warrants
were $757,000 in 2000. Proceeds to the Company from exercises of employee stock
options and employee stock purchase plan shares totaled $550,000, $382,000 and
$466,000 in 2001, 2000 and 1999, respectively.
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.
21
Potential Breakup of Alliance Telecommunications Corp.
------------------------------------------------------
Golden West Telecommunications Cooperative, Inc. and Split Rock Telecom
Cooperative, Inc., the 20% and 12% minority shareholders of Alliance, have
advised the Company that they are interested in exchanging their minority
investment for a share of the assets and liabilities of Alliance. Preliminary
discussions have been held regarding possible terms and effects of a breakup but
to date no conclusions or agreements have been reached. The Company has not
completed its analysis of the effect a breakup of Alliance would have on its
financial position or results of operations.
Acquisitions
------------
Effective June 9, 2000, Alliance acquired all the outstanding common
stock of Hager TeleCom, Inc. ("Hager"); a rural telephone company located in
southwestern Wisconsin. Hager serves approximately 2,100 access lines, provides
internet service to 2,700 customers in Hager, WI and Red Wing, MN and has an
ownership interest in Midwest Wireless Holdings, LLC. The purchase price was
$9,124,500 of cash plus acquisition costs.
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 the past, the Company has been a member of investor groups that sought
unsuccessfully to acquire rural telephone properties offered for sale by major
telephone companies. 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.
New Accounting Standards
- ------------------------
In October, 2001 the Financial Accounting Standards Board ("FASB") issued
SFAS No. 144, "Accounting for Impairment or Disposal of Long-Lived Assets". SFAS
No. 144 is effective January 1, 2002. SFAS No. 144 sets forth requirements for
measuring and recognizing impairment losses on long-lived assets. The statement
also establishes financial reporting requirements when impairment losses are
recognized. The Company does not expect adoption of SFAS No. 144 to have a
material effect on its financial statements.
In July 2001 the FASB issued Statement of Financial Accounting Standards
("SFAS") No. 141, "Business Combinations". SFAS No. 141 requires that the
purchase method of accounting be used for all business combinations initiated
after June 30, 2001. SFAS No. 141 also requires that intangible assets acquired
in a business combination be recognized and reported apart from goodwill.
Adoption of this statement had no impact on the Company's financial position or
operating results in 2001.
In July 2001 the FASB also issued SFAS No. 142, "Goodwill and Other
Intangible Assets". SFAS No. 142 is effective January 1, 2002. It requires that
goodwill and intangible assets with indefinite useful lives no longer be
amortized, but instead tested on a regular (at least annual) basis for
impairment. Intangible assets with determinable useful lives will remain subject
to amortization. At December 31, 2001 the Company had unamortized goodwill of
$53,663,000. Amortization expense in 2001 was $1,813,000. Some of the
unconsolidated affiliates in which the Company is invested have material amounts
of intangible assets. The Company believes adoption of SFAS No. 142 could have a
material positive effect on net income. However, the Company has not completed
the complex valuation processes required to definitively determine its impact.
22
In June 2001 the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations". SFAS No. 143 is effective for fiscal years beginning
after June 15, 2002. The statement establishes accounting standards for
recognition and measurement of a liability for an asset retirement obligation
and an associated asset retirement cost. The statement applies to tangible
long-lived assets, including individual assets, functional groups of related
assets and significant parts of assets. It covers a company's legal obligations
resulting from the acquisition, construction, development or normal operation of
a capital asset. The Company is currently evaluating the provisions of SFAS No.
143, but does not expect its adoption to have a material impact on its financial
position or operating results.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities" (as amended) which was to be effective
January 1, 2000 but was deferred to fiscal years beginning after June 15, 2000.
Adoption of SFAS No. 133 did not have a material effect on the Company's
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, changes in laws and
regulations determining access revenues and universal service fund allocations
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.
ITEM 7A. DISCLOSURES ABOUT MARKET RISK
The Company does not use derivative financial instruments in its
operations or investment portfolio. Its operations are not subject to risks
associated with changes in the value of foreign currencies. Portions of the
Company's long-term debt have variable interest rates based on the lenders' cost
of money. The Company has investments in money market funds that earn interest
at prevailing market rates. In the opinion of management, the Company does not
have a material exposure to loss caused by market risk.
23
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
(a) FINANCIAL STATEMENTS
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 accounting
principles generally accepted in the United States of America 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 /s/ Charles A. Braun
---------------------------- --------------------------
Curtis A. Sampson Charles A. Braun
Chairman and Chief Executive Officer Chief Financial Officer
INDEPENDENT AUDITORS' REPORT
To the Shareholders and Board of Directors of
Hector Communications Corporation
We have audited the accompanying consolidated balance sheets of Hector
Communications Corporation and subsidiaries as of December 31, 2001 and 2000 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, 2001. 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 auditing standards generally accepted
in the United States of America. 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, 2001 and 2000 and
the results of their operations and their cash flows for each of the three years
in the period ended December 31, 2001 in conformity with accounting principles
generally accepted in the United States of America.
/s/ Olsen Thielen & Co., Ltd.
- -------------------------------
Olsen Thielen & Co., Ltd.
February 13, 2002
St. Paul, Minnesota
24
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
ASSETS
December 31
-----------------------------------
2001 2000
-------------- --------------
CURRENT ASSETS:
Cash and cash equivalents $ 13,083,481 $ 13,834,110
Construction fund (Note 6) 759,934 317,837
Accounts receivable (net of allowance for doubtful accounts of
$396,000 and $360,000, respectively) 4,736,131 5,548,622
Materials, supplies and inventories, at average cost 1,249,109 825,673
Other current assets 186,451 302,704
-------------- --------------
TOTAL CURRENT ASSETS 20,015,106 20,828,946
PROPERTY, PLANT AND EQUIPMENT,net (Notes 1 and 5) 57,362,325 56,226,525
OTHER ASSETS:
Excess of cost over net assets acquired, less amortization
of $10,025,000 and $8,212,000 (Note 1) 53,662,750 55,475,430
Marketable securities (Note 3) 419,004 2,895,272
Wireless telephone investments (Note 4) 14,174,179 12,509,975
Other investments (Notes 1 and 6) 12,290,004 10,527,727
Other assets (Note 1) 327,685 214,106
-------------- --------------
TOTAL OTHER ASSETS 80,873,622 81,622,510
-------------- --------------
TOTAL ASSETS $ 158,251,053 $ 158,677,981
============== ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Notes payable and current portion of long-term debt (Note 6) $ 6,752,100 $ 6,337,200
Accounts payable (Note 10) 2,497,804 2,664,520
Accrued expenses 2,409,669 2,479,779
Income taxes payable 722,797 387,100
-------------- --------------
TOTAL CURRENT LIABILITES 12,382,370 11,868,599
LONG-TERM DEBT, less current portion (Note 6) 79,641,269 84,378,149
DEFERRED INVESTMENT TAX CREDITS (Note 7) 48,269 79,668
DEFERRED INCOME TAXES (Note 7) 5,975,119 6,603,310
DEFERRED COMPENSATION (Note 9) 931,529 904,071
COMMITMENTS AND CONTINGENCIES (Note 4)
MINORITY INTEREST IN ALLIANCE TELECOMMUNICATIONS, CORP. 17,031,204 15,736,317
STOCKHOLDERS' EQUITY: (Notes 1, 6 and 8)
Preferred stock, par value $1.00 per share; 3,000,000 shares authorized:
Convertible Series A, 220,100 and 221,300 shares issued and outstanding 220,100 221,300
Common stock, par value $.01 per share; 10,000,000 shares authorized;
3,476,569 and 3,504,363 shares issued and outstanding 34,766 35,044
Additional paid-in capital 13,212,970 12,844,776
Retained earnings 28,702,145 24,945,512
-------------- --------------
42,169,981 38,046,632
Accumulated other comprehensive income (Note 3) 71,312 1,061,235
-------------- --------------
TOTAL STOCKHOLDERS' EQUITY 42,241,293 39,107,867
-------------- --------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 158,251,053 $ 158,677,981
============== ==============
See notes to consolidated financial
statements.
25
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
Year Ended December 31
--------------------------------------------------
2001 2000 1999
------------- ------------- -------------
REVENUES:
Local network $ 7,149,068 $ 6,650,242 $ 5,914,678
Network access 22,342,115 20,812,363 19,418,961
Nonregulated activities 6,986,588 6,374,086 4,999,599
Cable television revenues 4,155,141 3,953,411 3,784,078
------------- ------------- -------------
TOTAL REVENUES 40,632,912 37,790,102 34,117,316
COSTS AND EXPENSES:
Plant operations 5,355,950 4,810,801 4,086,923
Depreciation and amortization 11,316,774 10,176,284 8,547,619
Customer operations 2,436,046 2,115,634 2,113,613
General and administrative 4,872,549 4,575,684 3,768,413
Other operating expenses 6,130,577 5,120,843 4,546,512
------------- ------------- -------------
TOTAL COSTS AND EXPENSES 30,111,896 26,799,246 23,063,080
------------- ------------- -------------
OPERATING INCOME 10,521,016 10,990,856 11,054,236
OTHER INCOME (EXPENSES):
Interest expense (5,302,058) (5,954,603) (6,582,536)
Income (loss) from investments in unconsolidated
affiliates (Note 4) 2,140,230 610,846 (335,537)
Interest and dividend income 672,584 1,250,748 1,116,098
Gain on sale of marketable securities (Note 3) 3,659,055 1,622,226 13,203,062
------------- ------------- -------------
OTHER INCOME (EXPENSES), net 1,169,811 (2,470,783) 7,401,087
------------- ------------- -------------
INCOME BEFORE INCOME TAXES 11,690,827 8,520,073 18,455,323
INCOME TAX EXPENSE (Note 7) 5,321,000 4,207,000 7,513,000
------------- ------------- -------------
INCOME BEFORE MINORITY INTEREST 6,369,827 4,313,073 10,942,323
MINORITY INTEREST IN EARNINGS OF
ALLIANCE TELECOMMUNICATIONS CORPORATION 1,753,673 1,003,650 3,463,142
------------- ------------- -------------
NET INCOME 4,616,154 3,309,423 7,479,181
------------- ------------- -------------
OTHER COMPREHENSIVE INCOME (LOSS):
Unrealized holding gains (losses) on marketable securities 1,199,251 (3,903,896) 20,784,075
Reclassification adjustment for gains included in net income (3,659,055) (1,622,226) (13,203,062)
------------- ------------- -------------
OTHER COMPREHENSIVE INCOME (LOSS) BEFORE
INCOME TAXES (2,459,804) (5,526,122) 7,581,013
------------- ------------- -------------
Income tax expense (benefit) related to unrealized
holding gains and losses on marketable securities 492,948 (1,539,833) 8,450,555
Income tax benefit related to reclassification adjustment for
gains included in net income (1,504,043) (639,862) (5,368,207)
------------- ------------- -------------
Income tax expense (benefit) related to items of other
comprehensive income (loss) (1,011,095) (2,179,695) 3,082,348
Minority interest in other comprehensive income (loss) of
Alliance Telecommunications Corporation (458,786) (1,081,180) 1,559,887
------------- ------------- -------------
Other Comprehensive Income (Loss) (989,923) (2,265,247) 2,938,778
------------- ------------- -------------
COMPREHENSIVE INCOME $ 3,626,231 $ 1,044,176 $ 10,417,959
============= ============= =============
BASIC NET INCOME PER COMMON SHARE (Note 1) $ 1.33 $ .93 $ 2.42
============= ============= =============
DILUTED NET INCOME PER COMMON SHARE (Note 1) $ 1.23 $ .86 $ 1.96
============= ============= =============
AVERAGE SHARES OUTSTANDING (Notes 1 and 8):
Common shares only 3,465,000 3,544,000 3,095,000
Common and potential common shares 3,762,000 3,851,000 3,945,000
See notes to consolidated financial statements.
26
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Accumulated
Additional Other
Preferred Stock Common Stock Paid-in Retained Comprehensive
Shares Amount Shares Amount Capital Earnings Income Total
------- -------- --------- ------- ----------- ----------- ---------- -----------
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
Net income 3,309,423 3,309,423
Issuance of common stock under
Employee Stock Purchase Plan 10,742 108 115,167 115,275
Issuance of common stock under
Employee Stock Option Plan 37,620 376 266,813 267,189
Issuance of common stock in
exchange for preferred stock (8,000) (8,000) 8,000 80 7,920 0
Issuance of common stock from
exercise of outstanding warrants 88,311 883 756,417 757,300
Issuance of common stock to ESOP 6,928 69 96,923 96,992
Purchase and retirement of
common stock (221,950) (2,219) (1,672,908) (1,479,856) (3,154,983)
Change in unrealized gains on
marketable securities, net of
deferred taxes (2,265,247) (2,265,247)
------- -------- --------- ------- ----------- ----------- ---------- -----------
BALANCE AT DECEMBER 31, 2000 221,300 221,300 3,504,363 35,044 12,844,776 24,945,512 1,061,235 39,107,867
Net income 4,616,154 4,616,154
Issuance of common stock under
Employee Stock Purchase Plan 11,626 116 136,998 137,114
Issuance of common stock under
Employee Stock Option Plan 52,375 524 412,351 412,875
Issuance of common stock in
exchange for preferred stock (1,200) (1,200) 1,200 12 1,188 0
Issuance of common stock to ESOP 16,709 167 225,026 225,193
Purchase and retirement of
common stock (109,704) (1,097) (407,369) (859,521) (1,267,987)
Change in unrealized gains on
marketable securities, net of
deferred taxes (989,923) (989,923)
------- -------- --------- ------- ----------- ----------- ---------- -----------
BALANCE AT DECEMBER 31, 2001 220,100 $220,100 3,476,569 $34,766 $13,212,970 $28,702,145 $ 71,312 $42,241,293
======= ======== ========= ======= =========== =========== ========== ===========
See notes to consolidated financial
statements.
27
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31
---------------------------------------------------
2001 2000 1999
------------- ------------- -------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income $ 4,616,154 $ 3,309,423 $ 7,479,181
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 11,318,010 10,177,520 8,663,181
Minority stockholders' interest in earnings
of Alliance Telecommunications Corporation 1,753,673 1,003,650 3,463,142
Gain on sales of marketable securities (3,659,055) (1,622,226) (13,203,062)
(Income) loss from unconsolidated affiliates (2,140,230) (610,846) 335,537
Proceeds from wireless cellular investments 901,295 716,653 709,668
Noncash patronage refunds (270,793) (8,780) (12,569)
Noncash investment income (48,325)
Changes in assets and liabilities net of effects from
the purchase of Hager Telecom, Inc.:
Decrease (increase) in accounts receivable 812,491 (566,951) (727,508)
Increase in materials, supplies and inventories (423,436) (172,847) (88,146)
Decrease in other current assets 116,253 111,795 8,702
Increase (decrease) in accounts payable (166,716) (62,254) 7,981
Increase in accrued expenses 155,083 121,137 477,147
Increase (decrease) in income taxes payable 335,697 (3,426,965) 1,942,370
Decrease in deferred investment tax credits (31,399) (60,718) (112,215)
Increase (decrease) in deferred income taxes 382,904 (934,383) (2,157,467)
Increase (decrease) in deferred compensation 27,458