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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, 1997
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
- ---------------------------------- --------------------
(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
8.5% Convertible Debentures due 2002
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
--- ---
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 $17,237,000 based upon the closing sale price of
the Company's common stock on the American Stock Exchange on March 19, 1998.
As of March 19, 1998 there were outstanding 2,099,226 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 19, 1998 is incorporated by
reference into Part III of this Form 10-K.
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PART I.
ITEM 1. BUSINESS
[a] GENERAL DEVELOPMENT OF BUSINESS
Hector Communications Corporation ("HCC" or "Company") is a diversified
telecommunications holding company which, through its wholly-owned and
majority-owned subsidiaries, is principally engaged in providing local telephone
service. At December 31, 1997, the Company's wholly and majority owned telephone
subsidiaries (generally referred to as "local exchange carriers" or "LECs")
served approximately 32,700 access lines and provided telephone service to 34
rural communities in Minnesota, Wisconsin, South Dakota and Iowa. In addition,
at such date, through its cable television subsidiaries and two LEC
subsidiaries, the Company provided cable television services to approximately
8,300 subscribers in Minnesota, South Dakota and Wisconsin. The Company is also
an investor in entities providing wireless telephone and other
telecommunications related services.
Since becoming a publicly-held company in 1990, HCC has owned and
operated five wholly owned local exchange company subsidiaries which served
6,700 access lines at December 31, 1997. On April 25, 1996, HCC, through its 68%
owned subsidiary, Alliance Telecommunications Corporation ("Alliance"), acquired
Ollig Utilities Company ("Ollig"), a privately owned telecommunications holding
company for $80 million. At the time of the acquisition, Ollig subsidiaries
served approximately 25,000 access lines and 3,400 cable television subscribers
in Minnesota, Iowa, North Dakota and South Dakota. In addition to the Company's
68% ownership position, the remaining interests in Alliance are owned by Golden
West Telecommunications Cooperative, Inc. of Wall, South Dakota, and Split Rock
Telecom Cooperative, Inc. of Garretson, South Dakota.
[b] FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS
The Company operates in two business segments, operation of local
exchange telephone companies and cable television. Information regarding
industry segments is provided in Note 11 to the financial statements found under
Item 8 of this report.
[c] NARRATIVE DESCRIPTION OF BUSINESS
(1) Business Strategy
The Company's business strategy is to expand its existing operations
through internal growth and acquisitions, particularly the acquisition of
additional rural telephone exchanges, and to explore other communications
business opportunities, including the acquisition of cable television
properties.
Future growth in existing telephone and cable operations is expected to
come from providing service to new or presently unserved homes and businesses,
from upgrading existing customers to higher grades of service 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.
Further, 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. While management will aggressively pursue
acquisitions of telephone exchanges, there can be no assurance that the Company
will be able to negotiate acquisitions on acceptable terms or that regulatory
approvals, where required, will be received.
2
(2) Telephone Operations
The Company provides modern, high-quality local telephone service and
access to long distance telephone service through its five wholly owned and four
majority owned local exchange carrier subsidiaries. Local service is directly
provided by the Company's LECs and long distance or toll service is provided
through connections with interexchange carriers ("IXCs"), primarily AT&T, MCI
and Sprint. All subscribers have private line service. The Company's customer
base is approximately 81% residential and approximately 19% commercial and
industrial.
The following chart presents the number of access lines served by the
Company's wholly owned LEC subsidiaries at December 31, 1997, 1996 and 1995 and
by the LEC subsidiaries of Alliance at December 31, 1997 and 1996:
Telephone Company Access Lines*
December 31
1997 1996 1995
----------- ----------- ---------
Arrowhead Communications Corporation 749 748 738
Eagle Valley Telephone Company 685 678 659
Granada Telephone Company 275 276 263
Pine Island Telephone Company 2,919 2,775 2,663
Indianhead Telephone Company 2,076 2,057 2,008
Alliance Telecommunications Corporation:
Loretel Systems, Inc. 12,023 11,852
Sleepy Eye Telephone Company 5,998 5,814
Sioux Valley Telephone Company 5,457 5,355
Hills Telephone Company 2,545 2,465
---------- --------
32,727 32,020 6,331
========== ========== =========
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* An "access line" is a single or multi-party circuit between the customer's
establishment and the central switching office.
The Company's policy, insofar as possible, is to maintain local
management in each of its local exchange carrier subsidiaries. The Company
provides its LEC subsidiaries with centralized purchasing, general management
and other services. These services afford the subsidiaries expertise in the
following areas: finance, accounting and treasury services, marketing, customer
service, traffic, engineering and construction, customer billing, rate
administration, credit and collection, and development of administrative and
procedural practices.
Regulation
The LEC subsidiaries are subject to regulation by Minnesota, South
Dakota, Iowa and Wisconsin regulatory agencies with respect to intrastate toll
rates, intrastate access charges billed to intrastate IXCs, service areas,
service standards, accounting and related matters. In some cases, local rates,
rate of return, depreciation rates, construction plans and borrowings and
certain other financial transactions may be subject to regulatory approval.
Local service rates are not directly determined by regulatory authorities, but
are limited by regulation of these other areas. The Company has sought and will
continue to seek appropriate increases in local and other service rates and
changes in rate structures to achieve reasonable rates and earnings.
A bill passed by the 1995 Minnesota legislature allows telephone
companies serving fewer than 50,000 access lines to elect to provide service
under an alternate form of regulation. Companies choosing alternative regulation
agree not to increase rates for two years (other than in extraordinary
circumstances) and are not subject to rate of return review by the Public
Utilities Commission for the same period. All of the Company's Minnesota based
LEC subsidiaries elected to be covered by 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.
3
The Federal Communications Commission ("FCC") regulates interstate toll
rates, interstate access charges paid by IXCs to local exchange carriers and
other matters relating to interstate telephone service. The FCC also regulates
the use of radio frequencies in telephone operations. The Company's telephone
subsidiaries use common line and traffic sensitive tariffs set by the National
Exchange Carriers Association ("NECA") and participate in the access revenue
pools administered by NECA for interstate services. Where applicable, the
Company's subsidiaries also participate in intrastate access tariffs approved by
state regulatory authorities for intrastate intra-LATA (Local Access Transport
Area) and inter-LATA services. Such interstate and intrastate arrangements are
intended to compensate LECs, such as the Company's local exchange carrier
subsidiaries, for the costs, including a fair rate of return, of facilities
furnished in originating and terminating interstate and intrastate long distance
services.
A number of the telephone subsidiaries recover a portion of their costs
via interstate and intrastate support mechanisms. Reevaluation and probable
modification of these mechanisms is expected. The interstate universal service
fund, which is administered by NECA, has been capped and indexed as an interim
measure pending regulatory proceedings. Interstate universal service fund
support accounted for $656,000, $617,000 and $484,000 of the Company's network
access revenues in 1997, 1996 and 1995, respectively. The Telecommunications Act
of 1996 includes provisions to widen the base of providers contributing support
for universal service, but also requires development of new mechanisms and
eligibility criteria. There is no assurance cost recovery through direct and
indirect interstate mechanisms will remain at current levels.
Support and rate structures are in the process of being reduced in
Minnesota and have been recently changed in Wisconsin. There is no assurance the
states will continue to provide for cost recovery from current sources at
current levels. The Company's Wisconsin based LEC subsidiary implemented a local
service rate increase December 1, 1995 to compensate for changes in Wisconsin's
support structure. The Company expects to seek higher local service rates to
recover costs for which current interstate or intrastate recovery may become
unavailable.
Construction and Development Program
The Company's policy is to upgrade the plant and equipment of its local
exchange carrier subsidiaries to maintain modern, high quality telephone
service. Plant additions are made to upgrade service, replace existing
facilities and provide for service expansions. This program also allows the
Company to improve service, increase revenues and reduce costs by taking
advantage of technological developments in the telecommunications industry. The
Company has converted 100% of its access lines to digital switching technology
and is installing high-capacity fiber optic cable facilities where appropriate.
Financing for the telephone construction program is expected to come from
internally generated funds, supplemented by long-term financing from federal
financing programs.
Federal Financing Programs and Other Financing Sources
The Company's primary sources of long-term financing for additions to
telephone plant and equipment have been the Rural Utilities Service (RUS) and
the Rural Telephone Bank (RTB). The RUS has made long-term loans to telephone
companies since 1949, at interest rates of 2% and 5%, for the purpose of
improving telephone service in rural areas. Since October 1, 1991 the RUS is
also authorized to make hardship loans at a 5% interest rate and cost-of-money
loans at a rate reflecting the government's cost of money for a like term. The
RTB advances funds under loan applications approved prior to October 1, 1991 at
interest rates based on the RTB's average cost-of-money. For RTB loan
applications approved after October 1, 1991, advances are at the average U.S.
government cost-of-money for the year for like maturities. In some cases RTB
loans are made concurrently with RUS loans.
Substantially all of the telephone plant of the LEC subsidiaries is
pledged or is subject to mortgages to secure obligations to the RUS and RTB. In
addition, the amount of dividends on common stock that may be paid by the LEC
subsidiaries to the Company is limited by certain financial covenants set forth
in the mortgages.
The LEC subsidiaries have applied for and, in 1997, received approval
for additional loans totaling $14,888,000 from RUS and RTB to meet their
respective capital requirements . At December 31, 1997, the Company's local
4
exchange carrier subsidiaries had unadvanced loan commitments under the RUS and
RTB programs aggregating approximately $17,478,000 to finance specific
construction activities in future years. However, there is no assurance the
Company will be able to draw down funds on these loans and no guarantee the loan
terms or interest rates will be acceptable to the Company. If the Company is
unable to borrow funds through the RUS and RTB programs and the LEC subsidiaries
were to borrow instead from conventional lenders, the cost of new loans might
increase significantly.
In 1996, the Company's 68% owned subsidiary, Alliance
Telecommunications Corporation negotiated a term loan agreement with the St.
Paul Bank for Cooperatives ("St. Paul Bank") to provide financing for the
acquisition of Ollig Utilities Company. The face amount of the loan was
$55,250,000. The loan is secured by a pledge of substantially all the assets of
Alliance and its subsidiaries. The Company has fixed interest rates on this loan
for periods ranging from one to ten years at rates averaging 7.4%. The Company
made only interest payments on the loan in 1996. Principal payments began in
January 1997 and will continue until March, 2011.
In 1996, the Company and one of its cable television subsidiaries,
North American Communications Corporation, negotiated a loan agreement with the
St. Paul Bank for Cooperatives to provide additional financing for the
acquisition of Ollig Utilities Company. The outstanding loan balance at December
31, 1997 was $4,000,000. The loan is payable in quarterly installments of
$143,000, with a final balloon payment due December 31, 2001. Interest rate on
the loan, which varies according to St. Paul Bank's cost of money, was 8.0% at
December 31, 1997. The loan is secured by a pledge of the assets of North
American and the stock of one of the Company's telephone subsidiaries.
St. Paul Bank is a cooperative, owned and controlled by its customers.
As a condition to receiving the loans, the Company purchased stock in the bank.
The Company's investment in St. Paul Bank stock at December 31, 1997 was
$2,749,000. Each customer borrowing from the bank on a patronage basis shares in
the bank's net income through payment of patronage refunds. The Company's
patronage refund from St. Paul Bank was $694,000 and $221,000 in 1997 and 1996,
respectively. Approximately 30% of the patronage refund is received in cash,
with the balance in stock of St. Paul Bank. The patronage refund is shown in the
Company's operating statement as a reduction of interest expense. The Company
cannot predict what patronage refunds will be in future years.
In February 1995, the Company completed a public offering of convertible
subordinated debentures. The debentures carry an interest rate of 8.5% and
mature February 15, 2002. The debentures are convertible into common stock of
the Company at a rate of 112.5 common shares per $1,000 par value debenture. As
of February 15, 1997, the Company has the right to call the debentures at a
price (depending on the trading price of the Company's common stock) ranging
from 100% to 104% of par. The debentures include restrictions on payment of
dividends to the Company's shareholders. The debentures are subordinated to
$4,000,000 of senior indebtedness owed by the Company to St. Paul Bank. Total
value of the offering was $12,650,000. Proceeds to the Company, after
underwriting, accounting and legal expenses were approximately $11,300,000. The
underwriters also received warrants to purchase 123,750 shares of the Company's
common stock at a price of $8.70 per share. The warrants are currently
exercisable and expire February 15, 2000. The offering proceeds were used to pay
down debt associated with cable television acquisitions, finance cable
television plant additions, purchase additional cable television systems and as
a portion of HCC's equity contribution to Alliance to acquire Ollig Utilities
Company.
Competition
In February 1996, President Clinton signed into law the
Telecommunications Act of 1996. The new law represents the biggest change in
legislation governing local service since Congress imposed federal regulation
and established the FCC in 1934. Under its provisions, the monopoly on local
service enjoyed by LECs is eliminated and LECs must allow competitors access to
the local network facilities. Among other provisions, the new law mandates
changes in the rules governing universal service supports, permits LECs to enter
the long distance business, and changes many of the provisions of the 1984
consent decree which broke apart AT&T and still restricts the activities of AT&T
and the Regional Bell Operating Companies. The final results of the changes made
by the new law will not be known for some time until new rule making by the FCC
and state regulatory agencies is complete. Several provisions of the new law are
also being contested in the courts, making applications of the new law subject
to the judicial process. The Company is monitoring developments regarding the
new regulatory climate closely, and expects its operations will be materially
5
affected by the new rules, but cannot predict what effect the new law and
regulations adopted pursuant to the new law will have on its business.
Prior to passage of the new telecommunications law, a series of FCC,
court and state regulatory agency decisions had served to introduce competition
into many sectors of the telephone industry, including interstate and intrastate
long distance services, special access services and customer premises equipment.
The Company is presently the only provider of local telephone service in the
areas it serves. The Company does not know to what extent it will be subject to
local competition in the markets it serves in the new regulatory environment
created by the new telecommunications law. Technological developments in
competing technologies such as wireless telephone, digital microwave, coaxial
cable, fiber optics and other wireless and wired technologies may result in
other forms of competition to the Company's landline services. The Company and
many other members of the local exchange carrier industry are seeking to
maintain a strong, universally affordable public telecommunications network
through policies and programs that are sensitive to the needs of small
communities and rural areas served by the Company's telephone subsidiaries.
Certain providers and users of long distance service may seek to bypass
LEC switching services and local distribution facilities, particularly if these
services are not strategically priced. There are many ways these customers may
bypass the Company's switching services. Users may construct and operate or
lease facilities to transmit their traffic to an interexchange carrier. Certain
interexchange carriers provide services which allow users to divert their
traffic from the LEC's usage sensitive services to flat-rate services. Users may
also choose to use wireless telephone service to bypass the LEC's switching
service. The Company's telephone subsidiaries have experienced only a small loss
of traffic due to bypass. The Company and the local exchange carrier industry
are seeking to address bypass problems by advocating flexible pricing, including
reduced pricing of access and long distance services where appropriate.
The new telecommunications law and recent FCC rulings which are
intended to promote competition in voice and video communications may provide
the Company with increased business opportunities. Recent changes permit local
telephone companies to offer video dial tone services, permitting greater
telephone company participation in the video marketplace. The rules against
cross-ownership of telephone and cable television systems have also been
somewhat relaxed. The FCC has also authorized cellular telephone, personal
communications services and other technologies which may compete with
traditional telephone services and provide new business opportunities. The
Company actively monitors legislative and regulatory changes to protect its own
interests and evaluate new opportunities.
The Clinton administration has actively promoted a national
communications policy directed toward creation of a broadband, interactive
national information infrastructure. The administration has advocated
legislation based on five principles: encouraging private investment, providing
and protecting competition, providing open access to the telecommunications
network, avoiding a society of information "haves" and "have nots", and
encouraging flexible and responsive government action. Given the
Administration's initiatives as well as recent Congressional actions, the
Company expects that eventually there may be open access to every aspect of the
communications industry. However, the new telecommunications law also mandates
continuing support for universal service and bans discrimination in toll rates
based on geography. The Company believes high-cost support funds and similar
cost-averaging methods should continue to be employed to ensure that advanced
communications services reach rural areas. The Company plans to compete by
providing advanced, high-quality voice, data and video services.
Wireless Telephone Services
Cellular telephone services provide high quality, high capacity
communications to and from vehicle mounted or hand held radio telephones
("cellular telephones"). Cellular technology is a major improvement over earlier
mobile telephone technologies. Cellular telephone systems are designed to allow
for maximum mobility of the customer. In addition to mobility, cellular
telephone systems provide access through system interconnects to local,
regional, national and worldwide telecommunications networks. Cellular telephone
systems also offer a full range of ancillary services such as conference
calling, call waiting, call forwarding, voice mail, facsimile and data
transmission.
6
The FCC has established 733 cellular service areas in the United
States, consisting of 305 Metropolitan Statistical Areas ("MSAs") and 428 Rural
Service Areas ("RSAs"). The FCC has granted two licenses to provide cellular
service in each territory. One license was granted to a company or affiliated
group of companies providing local telephone service in the area ("Wireline
Carriers"). The other license was granted to a company not providing local
telephone service and not affiliated with a local telephone company in the
service area ("Non-Wireline Carriers"). The Company acquired its interests in
cellular telephone as part of the Wireline Carrier group in the RSA markets in
which it owns a telephone operating company.
At December 31, 1997, the Company was an investor in limited
partnerships and limited liability corporations which provide cellular telephone
service in five RSAs in Minnesota, one RSA in North Dakota, the Rochester,
Minnesota MSA and the Sioux Falls, South Dakota MSA and serve approximately
90,000 customers. The Company accounts for these investments using the equity
method. Income recognized on these wireless investments was $1,580,000,
$502,000, and $126,000 in 1997, 1996 and 1995, respectively. The following table
provides the Company's percentage of ownership in each venture and the Company's
proportionate share of the population served by each venture at December 31,
1997:
Total Company's
Population Percent Share of
Name of Venture Service Area Equivalents(1) Ownership Total POPs
Midwest Wireless Rochester, MN MSA 948,000 9.78% 92,714
Communications LLC and MN RSAs 7, 8,
9, 10 and 11
Sioux Falls Cellular, Ltd. Sioux Falls, SD MSA 120,000 12.25% 14,700
Red River Cellular, Inc. ND RSA 3 92,000 1.60% 1,472
- ------------------------------------------------------------------
(1) Estimated population based on the 1990 United States Census.
The Company is also an investor in Rural Cellular Corporation ("RCC"),
a publicly traded company providing cellular telephone services in Minnesota and
New England. In February, 1996, RCC completed an initial offering of its common
stock to the public. As part of the offering, HCC sold 61,133 shares of RCC and
recorded a gain on sale of $485,000. In June, 1997, HCC sold an additional
161,469 shares of RCC and recorded a gain on sale of $1,464,000. At December 31,
1997, the Company owned 2.4% of RCC's common stock.
In addition to competition between the two cellular licensees in each
territory, competition for wireless customers includes competing communications
technologies such as conventional land-line and mobile telephone, SMR systems
and radio paging. In addition, emerging technologies such as enhanced
specialized mobile radio ("ESMR"), mobile satellite communications systems,
second generation cordless telephones ("CT-2") and personal communications
services ("PCS") offer competition with cellular services.
The Company owns 11.66% of Wireless North, a consortium of three
limited partnerships and one limited liability corporation which have acquired
16 licenses to operate PCS systems in 13 markets in Minnesota, Wisconsin, North
Dakota and South Dakota. The Company has invested $510,000 of cash and
guaranteed debt of $1,373,000 in these entities. The PCS systems are in start-up
mode and have not been profitable to date. Losses recorded by the Company on its
PCS investments were $435,000 and $73,000 in 1997 and 1996, respectively. The
Company has committed to providing $1,486,000 of additional capital to these
entities. It cannot predict if additional funding beyond this amount will be
required.
There are a number of recent technological developments in the wireless
telephone industry. Currently most cellular telephone systems use equipment
which processes information digitally but does radio transmission on an analog
basis. Digital radio technology offers advantages, including less transmission
noise, greater system capacity and lower incremental costs for additional
customers. The conversion from analog to digital radio technology was expected
to take a number of years, but is being accelerated by competition from digital
PCS systems.
7
The wireless telephone industry is characterized by high initial fixed
costs. Accordingly, when system revenues less variable operating costs exceed
fixed costs, the system should generate an operating profit. Wireless profits,
if any, are dependent on service prices and variable marketing costs which are
affected by the amount and extent of competition. Until technological
limitations on total capacity are approached, additional wireless system
capacity can normally be added in increments that closely match demand and cost
proportionately less than the initial fixed costs.
The licensing (including renewal of licenses), construction, operation,
sale, interconnection arrangements and acquisition of wireless systems are
regulated by the FCC and various state public utility commissions. Changes in
the regulation of wireless operators or their activities and of other mobile
service providers (such as the recent FCC issuances of PCS licenses) could have
a material adverse effect on the Company's investment in wireless operations.
Other Telecommunications Investments
The Company also has investments in several other telecommunications
related businesses, including an 11.7% ownership interest in Minnesota Equal
Access Network Services, Inc. ("MEANS"). MEANS was formed in 1988 to bring
state-of-the-art telecommunications to rural areas of Minnesota. MEANS is owned
by shareholders who represent more than two-thirds of the local exchange
carriers in Minnesota. MEANS operates a fiber optic communications network
linking communities throughout the state, including all the major metropolitan
areas. MEANS also provides long-distance telecommun-ications services to
business and residential customers in rural Minnesota. These services include
toll-free telephone numbers providing access from anywhere in the Unites States
and Canada, cellular telephone service, prepaid calling cards, video
conferencing and internet access.
(3) Cable Television Operations
The Company, through its cable television and local exchange carrier
subsidiaries, owns and operates 34 cable television systems serving
approximately 8,300 subscribers in 51 communities in Minnesota, South Dakota and
Wisconsin. All of its cable television systems offer one or more channels of
premium programming, featuring motion pictures which are presented without
commercial interruption.
The Company's cable television revenues are derived almost exclusively
from monthly fees for basic and premium programming. The Company's fees for
basic services range from $9.75 to $22.50 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 are provided to subscribers for an additional fee of $4.95 to $10.95
per month per channel. Approximately one-third of the Company's cable television
customers subscribe to a premium channel. The Company obtains its premium
programming from suppliers for a flat monthly fee per subscriber and/or a fee
based on the monthly charge to subscribers for the service. Subscribers are free
to discontinue the cable service at any time without penalty. The Company
periodically increases its basic and premium programming subscriber fees to
reflect the addition of new cable television services and increased costs due to
inflation.
The Company's cable television systems are operated under 15 year,
non-exclusive franchises granted by local government authorities. These
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.
The Company does not anticipate it will experience any difficulty in obtaining
renewal of its franchises at the expiration of their current terms.
8
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 area. Cable television
also competes, in varying degrees, with other entertainment and leisure time
activities. Promotional efforts for cable television include telephone and
door-to-door solicitation and local media advertising.
All of the Company's franchises are non-exclusive and the Company
competes with a municipally owned cable system in one community it serves. In
addition to competition from off-air television, other technologies also supply
services provided by cable television. These include low power television
stations, multi-point distribution systems, over-the-air subscription television
and direct broadcast satellite ("DBS"). The Company believes that cable
television presently offers a wider variety of programming at lower cost than
any competing technology. However, the Company is unable to predict the effect
current or developing sources of competition may have on its business.
The Company's cable television systems are regulated by the FCC. FCC
regulations contain many detailed provisions including: "must carry" rules
regarding the broadcast television and translator signals the operator must
include in its channel offerings to subscribers, exclusivity provisions
(requiring 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. To date, the Company has 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. To
date, the Company has not experienced significant difficulties in complying with
the requirements of Minnesota authorities.
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.
Further material developments in these areas are to be anticipated, but their
direction and impact on the Company's cable television operations cannot be
predicted.
(4) Employees
At March 1, 1998, the Company had 135 employees, of which 120 employees
work in the telephone operations, 10 work in cable television and 5 hold
administrative positions. None of the Company's employees are represented under
collective bargaining agreements. HCC believes its employee relations to be
good.
9
(5) Executive Officers of Registrant
The executive officers of the Company and their ages at March 1, 1998
were as follows:
Name Age Position
Curtis A. Sampson 64 Chairman of the Board and Chief
Executive Officer
Steven H. Sjogren 55 President and Chief Operating
Officer
Paul N. Hanson 51 Vice President and Treasurer
Charles A. Braun 40 Chief Financial Officer
Executive officers serve at the pleasure of the Board of Directors and
are elected annually for one year terms. Each officer above has served the
Company in the indicated capacity since 1990.
Mr. Sjogren devotes his full time to the Company's business. Messrs.
Sampson, Hanson and Braun each devote approximately 40% of their working time to
the Company's business with the balance devoted to management responsibilities
at Communications Systems, Inc. ("CSI"), a diversified telecommunications
holding company also located in Hector, Minnesota, for which they are separately
compensated by CSI.
[d] FINANCIAL INFORMATION ABOUT FOREIGN AND DOMESTIC OPERATIONS AND
EXPORT SALES
Not Applicable.
10
ITEM 2. PROPERTIES
Telephone property consists mainly of central office switching equipment,
together with the land and buildings in which such equipment is housed, and
connecting lines which consist of aerial and underground cable, conduit, and
poles and wires, substantially all of which are located within the Company's
operating territories. Substantially all of the customer-leased telephones and
related terminal equipment, including private branch exchanges and a small
amount of connecting lines, are located on customers' premises. These telephones
and related equipment constitute approximately 1% of the Company's telephone
property. The lines, which connect customers' premises with central offices,
constitute approximately 54% of telephone plant. These facilities are 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 to leases, permits,
easements, agreements or licenses, express or implied through use without
objection by the owners.
Central office switching equipment represents approximately 30% of the
Company's telephone property in service. Land, buildings, data processing
equipment, service vehicles and construction equipment constitute the remaining
15%. 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.
The principal physical assets of the Company's cable television system
operations consist of signal reception equipment and distribution electronics
and cables. The receiving equipment is comprised of a tower and antennas for
reception of broadcast television signals and one or more satellite dishes for
reception of satellite signals. The Company owns or leases the land on which the
towers for its cable systems and the buildings containing other receiving
equipment are located. Pole attachment space is leased from utilities serving
the community.
See Note 6 of "Notes to Consolidated Financial Statements for additional
information regarding pledged assets.
ITEM 3. LEGAL PROCEEDINGS
No material litigation or other claims are presently pending against the
Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
11
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS
[a] MARKET INFORMATION
The Company's common stock is currently being traded on the American
Stock Exchange. Prior to February, 20, 1998, the Company's common stock traded
on the National Market System of the National Association of Securities Dealers
Automated Quotation System ("NASDAQ").
The table below presents the range of high and low trading prices for the
Company's stock for each period as reported by NASDAQ.
______1997______ ______1996______
Quarter High Low High Low
First $8.50 $7.25 $8.75 $6.38
Second 9.75 7.38 8.50 6.00
Third 10.50 7.88 8.38 6.88
Fourth 10.13 8.50 8.00 7.00
[b] HOLDERS
At March 1, 1998 there were approximately 1,100 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. 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. The
financing agreements between HCC's subsidiaries and their lenders restrict their
ability to pay dividends to HCC, thereby limiting HCC's ability to pay dividends
to its shareholders. 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.
12
ITEM 6. SELECTED FINANCIAL DATA
SELECTED CONSOLIDATED FINANCIAL INFORMATION
(in thousands except per share amounts)
Year Ended December 31
-------------------------------------------------------------
1997 1996 1995 1994 1993
- ---------------------------------------------------------------------------------------------------------------------------------
Selected Income Statement Information
Revenues $ 28,866 $ 20,658 $ 5,844 $ 5,740 $ 5,354
Costs and Expenses 19,113 14,066 4,992 4,175 4,037
- ---------------------------------------------------------------------------------------------------------------------------------
Operating Income 9,753 6,592 852 1,565 1,317
Other Income (Expenses), net (3,367) (3,518) (980) 2,055 (394)
- ---------------------------------------------------------------------------------------------------------------------------------
Income (Loss) Before Income Taxes 6,386 3,074 (128) 3,620 923
Income Tax Expense (Benefit) 2,867 1,540 (51) 1,415 354
- ---------------------------------------------------------------------------------------------------------------------------------
Income (Loss) Before Minority Interest 3,519 1,534 (77) 2,205 569
Minority Interest in Earnings of Alliance
Telecommunications Corporation 798 325
- ---------------------------------------------------------------------------------------------------------------------------------
Income (Loss) Before Cumulative Effect of
Change in Accounting Principle 2,721 1,209 (77) 2,205 569
Cumulative Effect of Change
in Accounting Principle 51
- ---------------------------------------------------------------------------------------------------------------------------------
Net Income (Loss) $ 2,721 $ 1,209 $ (77) $ 2,205 $ 620
- ---------------------------------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------------------------
Basic Net Income (Loss) Per Common Share:
Before Cumulative Effect of Change
in Accounting Principle $ 1.44 $ .65 $ (.04) $ 1.18 $ .27
Cumulative Effect of Change in
Accounting Principle .02
- ---------------------------------------------------------------------------------------------------------------------------------
Basic Net Income (Loss) Per Share $ 1.44 $ .65 $ (.04) $ 1.18 $ .29
- ---------------------------------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------------------------
Diluted Net Income (Loss) Per Common Share:
Before Cumulative Effect of Change
in Accounting Principle $ .93 $ .53 $ (.04) $ .97 $ .25
Cumulative Effect of Change in
Accounting Principle .02
- ---------------------------------------------------------------------------------------------------------------------------------
Diluted Net Income (Loss) Per Share $ .93 $ .53 $ (.04) $ .97 $ .27
- ---------------------------------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------------------------
Average Shares Outstanding:
Common shares only 1,893 1,870 1,866 1,863 2,162
Common and potential common shares 3,732 3,694 1,866 2,266 2,269
- ---------------------------------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------------------------
Selected Balance Sheet Information
Working Capital $ 8,504 $ 1,307 $ 9,679 $ 4,740 $ 2,202
Property, Plant and Equipment, net 45,927 47,039 14,609 13,019 12,894
Excess of Cost Over Net Assets Acquired, net 51,170 52,510 907 839 723
Total Assets 139,291 137,348 33,518 22,749 21,173
Long-Term Debt 97,793 96,127 22,096 10,528 10,797
Stockholders' Equity 14,447 9,946 8,134 8,230 6,006
- ---------------------------------------------------------------------------------------------------------------------------------
All net income per share numbers from prior years have been restated to comply with the provisions of SFAS No.
128, "Earnings Per Share". All potential common shares are anti-dilutive for 1995 and are excluded from
calculation of net income per share
Operating results for 1996 include the operations of Ollig Utilities Company from the April 25, 1996 purchase date.
13
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Hector Communications Corporation ("HCC") owns a 100% interest in five local
exchange telephone subsidiaries and one cable television subsidiary. Effective
April 25, 1996, a new 68% owned subsidiary of the Company, Alliance
Telecommunications Corporation ("Alliance"), acquired Ollig Utilities Company
("Ollig") for $80,000,000. At December 31, 1997, the Company's wholly and
majority owned subsidiaries provided telephone service to 32,700 access lines in
34 rural communities in Minnesota, Wisconsin, South Dakota and Iowa. Its cable
television operations provided cable television services to approximately 8,300
subscribers in Minnesota, South Dakota and Wisconsin. The Company is also an
investor in businesses providing cellular telephone and other telecommunications
related services.
Results of Operations
General
The Company's telephone revenues are principally derived from the local
service and access revenues received by its local exchange carrier ("LEC")
subsidiaries. Local service revenues are earned by providing customers with
local service to connecting points within the local exchange boundaries and, in
certain cases, to nearby local exchanges under extended area service ("EAS")
plans which eliminate long distance charges to the neighboring exchanges.
Monthly rates for telephone service differ among the LECs depending upon the
cost of providing service, the type and grade of service, the number of
customers and calling patterns within the toll free calling area and other
factors.
Access revenues are received by LECs for intrastate and interstate
exchange services provided to long distance carriers (generally referred to as
interexchange carriers or "IXCs") which 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") and, in the case of intrastate calls, by
state regulatory agencies. A relatively small portion of the Company's access
revenues are derived from subscriber line fees determined by the FCC and billed
directly to end users for access to long distance carriers. The balance of the
Company's interstate access revenues are received from NECA, which collects
payments from IXCs and distributes settlement payments to LECs 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. 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 since 1984. 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.
LECs also sell and lease customer premise telephone equipment, provide
inside wiring services and custom calling features, provide internet access and
sell and lease other facilities for private line, teletype, data transmission
and other communications services. LECs also provide billing and collection
services for certain IXCs in lieu of such IXCs directly billing customers within
the LECs service area.
The Company's cable television revenues are derived almost exclusively
from monthly fees for basic and premium services.
The following table presents the percentage of revenues derived from
local service revenues, access revenues, billing and collection services,
nonregulated telephone activities and cable television operations for the last
three years:
14
Year Ended December 31
------------------------------------------------
1997 1996 1995
----------- ---------- ---------
Local network 16.9% 17.8% 18.4%
Network access 58.0 55.8 59.5
Nonregulated telephone activities 13.3 13.0 4.9
Billing and collecting 3.5 4.3 3.9
Cable television 8.3 9.1 13.3
----------- ----------- ---------
100.0 % 100.0% 100.0%
=========== ========== ==========
1997 Compared to 1996
Consolidated revenues increased 40% to $28,866,000. Most of the increase
was due to the 1996 acquisition by Alliance Telecommunications Corporation of
Ollig Utilities Company. The operations of Alliance, which are substantially
larger than those of HCC prior to the acquisition, had a huge impact on
operating results. 1997 results include twelve months of Alliance operations
compared to just eight months included in 1996. The following table shows
revenues from Alliance's operations separate from those of HCC.
Alliance Telecommunications Corp. Hector Communications Corp.
Year Ended Eight Months Ended Year Ended December 31
December 31 December 31
1997 1996 1997 1996
------------------ ------------------ ------------------ -----------------
Local network $ 3,346,733 $ 2,207,217 $ 1,519,514 $ 1,474,912
Network access 12,845,426 7,817,153 3,892,682 3,717,729
Billing and collection 820,540 656,706 209,642 224,908
Nonregulated activities 3,469,234 2,386,360 369,188 303,895
Cable television 1,027,602 628,988 1,365,804 1,239,653
----------------- ------------------ ------------------ -----------------
$ 21,509,535 $ 13,696,424 $ 7,356,830 $ 6,961,097
================= ================== ================== =================
Revenues from HCC's operations increased $396,000 or 6%. Revenues from
telephone operations increased $270,000, or 5%. Local network revenues increased
$45,000 or 3%, due to increases in the number of access lines served. Network
access revenues increased $175,000 or 5% due to increased interstate settlements
from NECA, which offset lower intrastate access revenues. Billing and collection
revenues decreased $15,000 or 7% as IXCs are continuing to reduce their reliance
on LECs to provide these services. Revenues from nonregulated sources increased
$65,000 or 21% due to increased internet revenues. Cable television revenue
increased $126,000 or 10%. The increase was due to increases in subscriber rates
and the full year effect of the acquisition of two small cable systems in
September, 1996.
Alliance's 1997 revenues benefited from a one-time retroactive network
access settlement of $560,000 received from NECA by one of its subsidiaries.
This settlement included $390,000 related to 1995 and 1996 settlements.
Operating costs and administrative expenses increased $5,047,000 or 36%
over 1996. 1997 results include twelve months of Alliance operating expenses
compared to just eight months included in 1996. The following table shows
operating expenses from Alliance's operations separate from those of the
Company.
Alliance Telecommunications Corp. Hector Communications Corp.
Year Ended Eight Months Ended Year Ended December 31
December 31 December 31
1997 1996 1997 1996
------------------ ------------------ ------------------ -----------
Plant operations $ 2,714,192 $ 1,869,098 $ 916,638 $ 838,787
Depreciation/amortization 5,336,031 3,493,668 1,973,699 1,934,117
Customer operations 1,430,676 945,664 243,435 245,277
General and administrative 2,324,079 1,509,010 1,269,042 1,254,197
Other operating 1,830,921 1,069,148 1,074,244 906,902
----------------- ------------------ ------------------ -----------------
$ 13,635,899 $ 8,886,588 $ 5,477,058 $ 5,179,280
================= ================== ================== =================
15
Operating costs and expenses for HCC's operations increased $298,000 or
6%. Expense increases were due to higher maintenance expenses on telephone plant
and higher cable television expenses due to the acquisition of two new cable
systems in 1996. Consolidated operating income increased $3,162,000, or 48%.
Operating income from HCC's operations increased 98,000 or 5%.
Consolidated interest expense, net of investment income increased
$1,463,000. Net interest expense for HCC increased $207,000, reflecting the full
year effect of interest on borrowings from St. Paul Bank used in the acquisition
of Ollig and reduced income due to decreased cash available for investment. Net
interest expense on Alliance increased $1,256,000 due to the full year effect of
interest on the acquisition loan from St. Paul Bank for Cooperatives associated
with the purchase of Ollig Utilities Company. HCC's investment income benefited
from gains on sales of marketable securities of $1,496,000 and $688,000 in 1997
and 1996, respectively. Income from wireless telephone investments increased
$806,000 or 160%, due primarily to the Company's equity interest in the
increased profits of Midwest Wireless LLC. These earnings were more than enough
to offset start-up losses of $435,000 incurred by PCS partnerships in which the
Company holds equity interests.
Consolidated income before income taxes increased 108% to $6,386,000.
HCC's income before income taxes, excluding Alliance, was $1,745,000 in 1997
compared to $885,000 in 1996. Income tax expense increased to $2,867,000 from
$1,540,000 in 1996. The effective income tax rate of 44.9% in 1997 is higher
than the standard tax rate because the amortization expenses associated with
excess of cost over net assets acquired in the acquisition of Ollig ($1,254,000
in 1997) are not tax deductible. The 32% minority shareholders' interest in
earnings of Alliance was $798,000 in 1997 compared to $325,000 in 1996. Net
income increased 125% to $2,721,000.
1996 Compared to 1995
Effective April 25, 1996, the Company's 68% owned subsidiary, Alliance
Telecommunications Corporation purchased Ollig Utilities Company, a privately
owned telecommunications company which served approximately 25,000 telephone
access lines and 3,400 cable television customers in Minnesota, Iowa, North
Dakota and South Dakota for $80,000,000. Prior to the acquisition, HCC served
approximately 6,300 access lines and 4,200 cable television customers. The
operations of Alliance, which are substantially larger than those of HCC prior
to the acquisition, had a huge impact on operating results over the last eight
months of the year. Consolidated revenues increased $14,813,000 in 1996. The
following table shows revenues from Alliance's operations separate from those of
HCC.
Alliance Telecom. Corp. Hector Communications Corp.
Eight Months Ended Twelve Months Ended December 31
December 31, 1996 1996 1995
-------------------- ----------------- -------------
Local network $ 2,207,217 $ 1,474,912 $ 1,076,801
Network access 7,817,153 3,717,729 3,474,738
Billing and collection 656,706 224,908 228,038
Nonregulated activities 2,386,360 303,895 285,355
Cable television 628,988 1,239,653 779,391
------------------ ------------------ ------------------
Total $ 13,696,424 $ 6,961,097 $ 5,844,323
================== ================== ==================
Revenues from HCC's operations increased $1,117,000 or 19%. Local
network revenues increased $398,000 or 37%. The increase was due to local
service rate increases imposed in the Wisconsin telephone exchanges in December,
1995 to offset revenue lost to the extended community calling (ECC) program.
Network access revenues increased $243,000 or 7% due to increased interstate
settlements from NECA. Cable television revenue increased $460,000 or 59%,
reflecting the full year impact of the August, 1995 acquisition of cable systems
from Lake Cable Partnerships.
Operating cost and administrative expenses increased $9,074,000 or 182%
over 1995. Operating costs and administrative expenses for Alliance operations
and HCC operations are presented separately in the following table.
16
Alliance Telecom. Corp. Hector Communications Corp.
Eight Months Ended Twelve Months Ended December 31
December 31, 1996 1996 1995
-------------------- ----------------- -------------
Plant operations $ 1,869,098 $ 838,787 $ 825,263
Depreciation and amortization 3,493,668 1,934,117 1,706,495
Customer operations 945,664 245,277 287,185
General and administrative 1,509,010 1,254,197 1,520,370
Nonregulated and miscellaneous 1,069,148 906,902 652,609
------------------ ------------------ ------------------
Total $ 8,886,588 $ 5,179,280 $ 4,991,922
================== ================== ==================
Operating costs and expenses for HCC's operations increased $187,000 or
4%. Expense increases were due primarily to increased operating expenses and
depreciation and amortization associated with the Lake Cable acquisition.
Consolidated operating income increased $5,739,000. Operating income from
existing operations increased $929,000 or 109%.
Consolidated interest expense, net of investment income increased
$3,800,000. Net interest expense for HCC increased $775,000, reflecting interest
on $6,000,000 of short-term borrowing from St. Paul Bank used in the acquisition
of Ollig, the full year effect on interest expense of the convertible debentures
issued in 1995, and reduced income due to decreased cash available for
investment. Interest expense on Alliance consists mainly of a $55,250,000
acquisition loan from St. Paul Bank for Cooperatives associated with the
purchase of Ollig Utilities Company, and interest on RUS and RTB loans existing
prior to the acquisition. HCC's investment income benefited from gains on sales
of marketable securities of $687,000 made during the first quarter of 1996.
Income from wireless telephone investments increased $377,000 or 299%, due to
the Company's increased ownership percentages of these operations due to the
Ollig acquisition and also due to the increasing profitability of these
operations.
Consolidated income before income taxes was $3,074,000 compared to a loss
of $128,000 in 1995. HCC's income before income taxes, excluding Alliance, was
$885,000 in 1996. Income tax expense was $1,540,000 compared to a benefit of
$51,000 in 1995. The Company's effective tax rate of 50.1% in 1996 is higher
than the standard tax rate because the amortization expenses associated with
excess of cost over net assets acquired in the acquisition of Ollig ($836,000 in
1996) are not tax deductible. The 32% minority shareholders' interest in
earnings of Alliance was $325,000 in 1996. Net income was $1,209,000 compared to
a loss of $77,000 in 1995.
Liquidity and Capital Resources
On April 25, 1996, a newly formed subsidiary of the Company, Alliance
Telecommunications Corporation, purchased Ollig Utilities Company for
$80,000,000 in cash. The Company owns 68% of Alliance with the remaining
interest owned by Golden West Telecommunications Cooperative, Inc. of Wall,
South Dakota and Split Rock Telecom Cooperative, Inc. of Garretson, South
Dakota. Alliance financed the acquisition using the combined equity investments
of its shareholders and $55,250,000 of long-term debt financing provided by St.
Paul Bank for Cooperatives ("St. Paul Bank"). Interest rates on this debt have
been locked for periods of one to ten years at rates averaging 7.4%. The
outstanding balance on this loan at December 31, 1997 was $53,063,000.
The Company's cash investment in Alliance is approximately $16,903,000,
which included $6,000,000 of short term borrowing from St. Paul Bank, purchase
price deposits made in 1995, and $73,000 of acquisition costs. In 1997, the
Company repaid principal of $2,000,000 on the loan and converted the remaining
balance into a five year term loan.
St. Paul Bank is a cooperative, owned and controlled by its customers. As
a condition to receiving the loans, the Company purchased stock in the bank. In
1997, as a condition of maintaining its loan, the Company invested an additional
$649,000 of cash in the stock of St. Paul Bank. Each customer borrowing from the
bank on a patronage basis shares in the bank's net income through payment of
patronage refunds. The Company's patronage refund from St. Paul Bank was
$694,000 and $221,000 in 1997 and 1996, respectively. Approximately 30% of the
patronage refund is received in cash, with the balance in stock of St. Paul
Bank. Total investment in the bank was $2,749,000 at December 31, 1997.
17
The Company's LEC subsidiaries serve its telephone customers with a
100%-digital switching network and almost 100% buried outside plant. Telephone
plant additions in 1997, 1996 and 1995 were $4,262,000, $4,669,000 and $869,000,
respectively. Telephone plant additions for 1998 are expected to total
$5,371,000 and will provide customers with additional advanced switching
services, upgrade the switching system to Year 2000 compliance and expand usage
of high capacity fiber optics in the telephone network.
The Company is an investor in Wireless North, a consortium of three
limited partnerships and one limited liability corporation which have acquired
licenses to operate PCS systems in 13 markets in Minnesota, Wisconsin, North
Dakota and South Dakota. The Company invested $510,000 of cash and guaranteed
debt of $1,373,000 in these entities in 1997 and 1996. The PCS systems are in
start-up mode and have not been profitable to date. The Company has committed to
providing $1,486,000 of additional capital to these entities. It cannot predict
if additional funding beyond this amount will be required.
Telephone asset additions have been financed by internally generated
funds and drawdowns of Rural Utilities Service ("RUS") and Rural Telephone Bank
("RTB") loan funds. Proceeds from long-term borrowings by the telephone
companies were $2,026,000, $411,000, and $414,000 in 1997, 1996 and 1995,
respectively. The average interest rate on outstanding RUS and RTB loans is
5.6%. Substantially all of the telephone assets are pledged or are subject to
mortgages to secure obligations of its LECs to the RUS and RTB. In addition, the
amount of dividends on common stock that may be paid to the Company by the LEC
subsidiaries is limited by covenants in the mortgages. In 1997, the LEC
subsidiaries received approval from the RUS and RTB for new loans to finance
future capital additions. At December 31, 1997 unadvanced loan commitments from
the RUS and RTB totaled $17,478,000.
In February 1995 the Company completed a public offering of convertible
subordinated debentures. The debentures carry an interest rate of 8.5% and
mature February 15, 2002. The debentures are convertible into common stock at a
rate of 112.5 common shares per $1,000 par value bond. As of February 15, 1997,
the Company has the right to call the debentures at a price (depending on the
trading price of the Company's common stock) ranging from 100% to 104% of par.
The debentures include restrictions on payment of dividends to the Company's
shareholders. The debentures are subordinated to $4,000,000 of senior debt owed
to St. Paul Bank. Total value of the offering was $12,650,000. Proceeds to the
Company, after underwriting, accounting and legal expenses were approximately
$11,300,000. The underwriters also received warrants to purchase 123,750 shares
of common stock at a price of $8.70 per share. The warrants are currently
exercisable and expire February 15, 2000. The offering proceeds were used to pay
down debt associated with its cable television operation, finance cable
television plant additions, purchase additional cable television systems and as
a portion of HCC's equity contribution to Alliance to acquire Ollig Utilities
Company.
In December, 1997, the Company sold 171,425 shares of new common stock in
a private placement. Proceeds from the sale, net of issue costs, were
$1,490,000. Proceeds were used to pay down debt and provide additional working
capital.
Cable television operations have been supported through capital additions
and by purchasing additional systems. In 1995, the Company purchased 22 rural
Minnesota cable systems, serving approximately 2,000 customers, from Lake Cable
Partnership for $2.2 million. In September, 1996, two additional cable systems
serving 320 subscribers were acquired for $319,000. In 1997, one small system
was acquired for $120,000. Other capital additions to support the Company's
cable systems totaled $378,000, $270,000, and $263,000 in 1997, 1996 and 1995,
respectively. Total cable television capital additions for 1998 are estimated at
$250,000.
Cable television provided operating income of $115,000 in 1997 after
being unprofitable in earlier years. The operating improvements have been due to
the cable acquisitions made in 1995 and 1996, which have allowed the Company to
spread its costs over a larger number of subscribers. The cable operations
continue to suffer from a lack of scale economies in all its systems, which
necessitates a higher than industry average ratio of employees to customers.
Continuing improvement of cable operating results depends on increasing the
subscriber base, achieving lower operating expense ratios and increasing system
revenues.
18
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 1996, the Company received $1,499,000 from the sale of its
remaining shares of Telephone and Data Systems, Inc., obtained in the 1994 sale
of its Rochester, MN cellular MSA interest. The Company also sold 61,133 shares
of Rural Cellular Corporation in that company's initial public offering of its
common stock in February, 1996. Proceeds to the Company after selling expenses
were $554,000. In 1997, an additional 161,469 shares of Rural Cellular
Corporation were sold for $1,728,000. At December 31, 1997, the Company's
marketable securities portfolio consisted primarily of shares of Rural Cellular
Corporation, U.S. West Communications, Inc. and U.S. West Media, Inc. owned by
Ollig Utilities Company prior to its acquisition by the Company.
Cash flows from operating activities were $7,573,000, $6,627,000 and
$2,103,000 in 1997, 1996, and 1995, respectively. At December 31, 1997, the
Company's cash, cash equivalents, temporary cash investments and marketable
securities totaled $18,241,000 compared to $16,110,000 at December 31, 1996.
Working capital at December 31, 1997 was $8,504,000 compared to $1,307,000 at
December 31, 1996. The current ratio was 1.9 to 1. By utilizing cash flow from
operations, current cash and investment balances, and other available financing
sources, the Company feels it has adequate resources to meet its anticipated
operating, debt service and capital expenditure requirements.
Acquisitions
Alliance Telecommunications Corporation has entered into a definitive
agreement to purchase all the outstanding common stock of Felton Telephone
Company ("Felton"), a rural telephone company located in northwestern Minnesota
adjacent to areas already served by the Company's telephone subsidiaries. Felton
serves approximately 700 access lines and holds significant portfolio of
marketable securities, including investments in Rural Cellular Corporation, U.S.
West Communications, Inc. and U.S. West Media, Inc. Purchase price is
$3,650,000, which includes a cash downpayment and seller financing of the
balance. The Company is awaiting regulatory approval of the purchase and expects
it to be completed in April, 1998.
Alliance has also entered into a definitive agreement to purchase
Spectrum Cablevision Limited Partnership ("Spectrum"). Spectrum serves 4,600
cable television customers in 20 communities in Minnesota and North Dakota,
including several communities also served by the Company's telephone
subsidiaries. Purchase price is approximately $5,200,000. The Company expects to
use its cash reserves and obtain additional outside financing to make this
purchase. The Company expects to complete this acquisition in the second quarter
of 1998.
Effects of Inflation
The Company's local exchange telephone companies are subject to the
jurisdiction of Minnesota, Iowa, South Dakota and Wisconsin regulatory
authorities with respect to a variety of matters, including rates for intrastate
access services, the conditions and quality of service, issuance of debt,
depreciation rates and accounting methods. Rates for local telephone service are
not established directly by regulatory authorities, but their authority over
other matters limits the Company's ability to implement rate increases. In
addition, the regulatory process inherently restricts the Company's ability to
immediately pass cost increases along to customers unless the cost increases are
anticipated and the rate increases implemented prospectively.
Year 2000 Issues
The software used by the Company's data processing and central office
equipment was originally designed to use references to calendar dates on an
abbreviated basis. Under this system, references to the calendar year are
abbreviated to the last two digits of the year, i.e. 1997 is abbreviated as
"97". Most software using this system does not recognize that the year 2000,
abbreviated as "00", follows 1999. This causes computing errors in date
sensitive processes. The Company has surveyed its telephone and data processing
systems to locate computer systems which may be subject to this error.
19
The Company has determined that the central office switching equipment
used in its local telephone exchanges to connect customer calls and record
telephone usage is not Year 2000 compliant. The Company will be upgrading its
equipment in the third and fourth quarters of 1998 to attain compliance.
Estimated cost is $658,000. No retirements of equipment currently in service
will be required. The Company does not expect Year 2000 problems to cause any
interruption of service to customers.
Changes in Accounting Standards
Effective December 15, 1997, the Company adopted the provisions of
Statement of Financial Accounting Standards No. 128, "Earnings per Share". The
Statement requires the Company to present its net income per share in basic and
diluted forms and to restate net income per share from prior periods to conform
with the new statement. Basic net income per common share is based on the
weighted average number of common shares outstanding during each year. Diluted
net income per common share - takes into effect the dilutive effect of potential
common shares outstanding. The Company's potential common shares outstanding
include preferred stock, stock options, warrants and convertible debentures. The
calculation of the Company's net income per share is included in Exhibit 11 of
this form 10-K.
Effective January 1, 1996, the Company has adopted Statement of Financial
Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to be Disposed Of" (SFAS 121). This statement
requires that assets to be held and used be reviewed for impairment whenever
events or changes in circumstances indicate that the carrying value of an asset
may not be recoverable. An impairment loss should be recognized when the
estimated future cash flows from the asset are less than the carrying value of
the asset. Assets to be disposed of should be reported at the lower of their
carrying amount of fair value less cost to sell. Adoption of this statement did
not have a material effect on the Company's results of operations or financial
position.
Effective January 1, 1996, the Company adopted the pro forma disclosure
provisions of SFAS No. 123, "Accounting for Stock-Based Compensation". This
statement requires the Company to disclose the fair value of stock-based
compensation to employees. The Company has elected to continue to apply APB
Opinion No. 25, "Accounting for Stock Issued to Employees" for measurement and
recognition of stock-based transactions with its employees.
The Financial Accounting Standards Board ("FASB") has issued SFAS No.
130, "Reporting Comprehensive Income". This statement establishes standards for
reporting and presenting comprehensive income and its components in the
financial statements. SFAS No. 130 is effective for fiscal years beginning after
December 15, 1997. Reclassification of financial statements for earlier periods
provided for comparative purposes is required. Adoption of this standard will
have no effect on the Company's results of operations or financial position.
The FASB has also issued SFAS No. 131, "Disclosures about Segments of
an Enterprise and Related Information". This statement establishes standards for
the way public enterprises report information about operating segments in annual
financial statements and requires those enterprises to report selected
information about operating segments in interim financial reports to
shareholders. It also establishes standards for related disclosures about
products and services, geographic areas and major customers. SFAS No. 131 is
effective for fiscal years beginning after December 15, 1997. Financial
statement disclosures from prior periods are required to be restated. Adoption
of this standard will have no effect on the Company's results of operations or
financial position.
20
Factors Affecting Future Performance
From time to time in reports filed with the Securities and Exchange
Commission, in press releases, and in other communications to shareholders and
the investing public, the Company may make statements regarding the Company's
future financial performance. Such forward looking statements are subject to
risks and uncertainties, including but not limited to, the effects of the
Telecommunications Act of 1996, 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.
REPORT OF MANAGEMENT
The management of Hector Communications Corporation and its subsidiary companies
is responsible for the integrity and objectivity of the financial statements and
other financial information contained in the annual report. The financial
statements and related information were prepared in accordance with generally
accepted accounting principles and include amounts that are based on
management's informed judgments and estimates.
In fulfilling its responsibilities for the integrity of financial information,
management maintains accounting systems and related controls. These controls
provide reasonable assurance, at appropriate costs, that assets are safeguarded
against losses and that financial records are reliable for use in preparing
financial statements. Management recognizes its responsibility for conducting
the Company's affairs according to the highest standards of personal and
corporate conduct.
The Audit Committee of the Board of Directors, composed solely of outside
directors, meets with the independent auditors and management periodically to
review accounting, auditing, financial reporting and internal control matters.
The independent auditors have free access to this committee, without management
present to discuss the results of their audit work and their opinion on the
adequacy of internal financial controls and the quality of financial reporting.
/s/ Curtis A. Sampson
------------------------------------
Curtis A. Sampson
Chairman and Chief Executive Officer
/s/ Charles A. Braun
-------------------------------------
Charles A. Braun
March 27, 1998 Chief Financial Officer
21
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
(a) FINANCIAL STATEMENTS
INDEPENDENT AUDITORS REPORT
Shareholders and Board of Directors
Hector Communications Corporation
We have audited the accompanying consolidated balance sheets of Hector
Communications Corporation and subsidiaries as of December 31, 1997 and 1996 and
the related consolidated statements of income, stockholders' equity, and cash
flows for each of the three years in the period ended December 31, 1997. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Hector
Communications Corporation and subsidiaries as of December 31, 1997 and 1996 and
the results of their operations and their cash flows for each of the three years
in the period ended December 31, 1997 in conformity with generally accepted
accounting principles.
/s/ Olsen Thielen & Co., Ltd.
- -----------------------------
Olsen Thielen & Co., Ltd.
February 18, 1998
St. Paul, Minnesota
22
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
ASSETS
December 31
-----------------------------------
1997 1996
-------------- --------------
CURRENT ASSETS:
Cash and cash equivalents $ 12,455,399 $ 9,571,879
Temporary cash investments 300,000 1,079,900
Construction fund (Note 6) 77,690 74,337
Accounts receivable 4,003,184 3,965,754
Materials, supplies and inventories, at average cost 542,681 512,114
Prepaid expenses 216,351 160,291
-------------- --------------
TOTAL CURRENT ASSETS 17,595,305 15,364,275
PROPERTY, PLANT AND EQUIPMENT,net (Notes 1 and 5) 45,927,153 47,038,952
OTHER ASSETS:
Excess of cost over net assets acquired, less amortization
of $3,391,000 and $1,989,000 (Note 1) 51,169,677 52,510,459
Marketable securities (Note 3) 5,485,698 5,458,400
Wireless telephone investments (Note 4) 10,680,655 10,224,910
Other investments (Notes 1 and 6) 7,231,868 5,246,797
Deferred debenture issue costs (Note 6) 780,089 969,201
Other assets (Note 1) 420,511 535,019
-------------- --------------
TOTAL OTHER ASSETS 75,768,498 74,944,786
-------------- --------------
TOTAL ASSETS $ 139,290,956 $ 137,348,013
============== ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Notes payable and current portion of long-term debt (Note 6) $ 4,770,000 $ 10,047,000
Accounts payable (Note 10) 1,591,546 1,860,579
Accrued expenses 2,247,972 2,090,639
Income taxes payable 481,831 59,015
-------------- --------------
TOTAL CURRENT LIABILITES 9,091,349 14,057,233
LONG-TERM DEBT, less current portion (Note 6) 97,793,195 96,127,379
DEFERRED INVESTMENT TAX CREDITS (Note 7) 381,180 526,347
DEFERRED INCOME TAXES (Note 7) 7,594,092 7,457,907
DEFERRED COMPENSATION (Note 9) 940,425 987,944
COMMITMENTS AND CONTINGENCIES (Note 4)
MINORITY INTEREST IN ALLIANCE TELECOMMUNICATIONS, CORP. 9,043,593 8,245,365
STOCKHOLDERS' EQUITY: (Notes 1, 6 and 8)
Preferred stock, par value $1.00 per share; 3,000,000 shares authorized:
Convertible Series A, 378,100 and 389,487 shares issued and outstanding 378,100 389,487
Common stock, par value $.01 per share; 10,000,000 shares authorized;
2,079,364 and 1,883,857 shares issued and outstanding 20,794 18,839
Additional paid-in capital 1,712,954 102,003
Retained earnings 11,726,521 9,005,768
-------------- --------------
13,838,369 9,516,097
Unearned employee stock ownership shares (69,724) (101,312)
Unrealized gains on marketable securities (Note 3) 678,477 531,053
-------------- --------------
TOTAL STOCKHOLDERS' EQUITY 14,447,122 9,945,838
-------------- --------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 139,290,956 $ 137,348,013
============== ==============
See notes to consolidated financial
statements.
23
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
Year Ended December 31
-----------------------------------------------------
1997 1996 1995
------------- ------------- -------------
REVENUES:
Local network $ 4,866,247 $ 3,682,129 $ 1,076,801
Network access 16,738,108 11,534,882 3,474,738
Billing and collection 1,030,182 881,614 228,038
Nonregulated activities 3,838,422 2,690,255 285,355
Cable television revenues 2,393,406 1,868,641 779,391
------------- ------------- -------------
TOTAL REVENUES 28,866,365 20,657,521 5,844,323
COSTS AND EXPENSES:
Plant operations 3,630,830 2,707,885 825,263
Depreciation and amortization 7,309,730 5,427,785 1,706,495
Customer operations 1,674,111 1,190,941 287,185
General and administrative 3,593,121 2,763,207 1,520,370
Other operating expenses 2,905,165 1,976,050 652,609
------------- ------------- -------------
TOTAL COSTS AND EXPENSES 19,112,957 14,065,868 4,991,922
------------- ------------- -------------
OPERATING INCOME 9,753,408 6,591,653 852,401
OTHER INCOME (EXPENSES):
Interest expense (6,797,354) (5,399,617) (1,554,042)
Partnership and LLC income (Note 4) 1,308,346 502,837 125,924
Investment income 625,582 691,215 645,781
Gain on sale of marketable securities (Note 3) 1,495,999 687,947
Unrealized loss on trading marketable securities (Note 3) (197,603)
------------- ------------- -------------
OTHER INCOME (EXPENSES), net (3,367,427) (3,517,618) (979,940)
------------- ------------- -------------
INCOME (LOSS) BEFORE INCOME TAXES 6,385,981 3,074,035 (127,539)
INCOME TAX EXPENSE (BENEFIT) (Note 7) 2,867,000 1,540,000 (51,000)
------------- ------------- -------------
INCOME (LOSS) BEFORE MINORITY INTEREST 3,518,981 1,534,035 (76,539)
MINORITY INTEREST IN EARNINGS OF
ALLIANCE TELECOMMUNICATIONS CORPORATION 798,228 325,365
------------- ------------- -------------
NET INCOME (LOSS) $ 2,720,753 $ 1,208,670 $ (76,539)
============= ============= =============
BASIC NET INCOME (LOSS) ~ PER COMMON SHARE (Note 1) $ 1.44 $ .65 $ (.04)
============= ============= =============
DILUTED NET INCOME (LOSS) ~ PER COMMON SHARE (Note 1) $ .93 $ .53 $ (.04)
============= ============= =============
AVERAGE SHARES OUTSTANDING (Notes 1 and 8):
Common shares only 1,893,000 1,870,000 1,866,000
Common and potential common shares 3,732,000 3,695,000 1,866,000
See notes to consolidated financial
statements.
24
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31
-------------------------------------------------
1997 1996 1995
-------------- -------------- -------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income (loss) $ 2,720,753 $ 1,208,670 $ (76,539)
Adjustments to reconcile net income (loss) to net cash provided by operating
activities:
Depreciation and amortization 7,500,078 5,617,722 1,871,969
Minority stockholders' interest in earnings
of Alliance Telecommunications Corporation 798,228 325,365
Gain on sales of marketable securities (1,495,999) (687,947)
Noncash patronge refunds (661,923) (220,662)
Income from partnership and LLC investments (1,308,346) (502,837) (125,924)
Unrealized losses on investments 231,830
Changes in assets and liabilities net of effects from the purchase of
Ollig Utilities, Inc.:
Decrease in marketable securities 1,499,072 437,521
Decrease (increase) in accounts receivable (37,430) (408,601) 211,145
Decrease (increase) in materials, supplies and inventories (30,567) 75,557 (23,854)
Decrease (increase) in prepaid expenses (56,060) (6,057) 6,365
Increase (decrease) in accounts payable (269,033) (585,734) 55,000
Increase in accrued expenses 157,333 708,528 358,231
Increase (decrease) in income taxes payable 422,816 (615,843) (560,331)
Decrease in deferred investment tax credits (145,167) (129,000) (39,000)
Increase (decrease) in deferred income taxes 25,394 380,000 (243,000)
Decrease in deferred compensation (47,519) (31,679)
-------------- -------------- -------------
Net cash provided by operating activities 7,572,558 6,626,554 2,103,413
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property, plant and equipment (4,695,301) (5,168,997) (3,123,547)
Sales of temporary cash investments 779,900 94,806
Sales of marketable securities 1,728,115 553,645
Proceeds from wireless telephone investments 792,622 437,371
Purchases of wireless telephone investments (98,933) (250,000) (161,638)
Decrease (increase) in construction fund (3,353) 100,393 39,336
Purchases of other investments (1,193,105) (1,274,443) (457,250)
Proceeds from other investments 27,667 29,911 17,057
Increase in excess of cost over net assets acquired (61,107) (88,517) (141,453)
Decrease (increase) in other assets 12,534 107,198 (51,938)
Payment for purchase of Ollig Utilities Company,
net of cash acquired (69,189,692) (2,790,236)
-------------- -------------- -------------
Net cash used in investing activities (2,710,961) (74,648,325) (6,669,669)
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of notes payable and long-term debt (5,637,184) (2,607,031) (1,769,634)
Proceeds from issuance of notes payable and long-term debt 2,026,000 63,168,775 13,064,150
Minority interest in Alliance Telecommunications Corporation 7,920,000
Convertible bond issue costs (1,323,787)
Purchase of Hector Communications Corporation
common stock (30,272)
Issuance of common stock 1,575,107 21,768 22,872
ESOP shares allocated (purchased), net 58,000 50,000 (11,683)
-------------- -------------- -------------
Net cash provided by (used in) financing activities (1,978,077) 68,553,512 9,951,646
-------------- -------------- -------------
NET INCREASE IN CASH AND CASH EQUIVALENTS 2,883,520 531,741 5,385,390
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 9,571,879 9,040,138 3,654,748
-------------- -------------- -------------
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 12,455,399 $ 9,571,879 $ 9,040,138
============== ============== =============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Interest paid $ 7,316,215 $ 4,974,256 $ 1,023,041
Income taxes paid 2,564,157 1,890,825 791,331
See notes to consolidated financial
statements.
25
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Unearned
Employee Unrealized
Additional Stock Gains on
Preferred Stock Common Stock Paid-in Retained Ownership Marketable
Shares Amount Shares Amount Capital Earnings Shares Securities Total
--------- --------- --------- --------- --------- ----------- ---------- ---------- ------------
BALANCE AT DECEMBER 31, 1994 392,287 $392,287 1,877,850 $ 18,778 $ 48,001 $ 7,903,703 $(132,800) $ - $ 8,229,969
Net loss (76,539) (76,539)
Issuance of common stock under
Employee Stock Purchase Plan 3,844 39 22,833 22,872
Purchase of common stock (4,200) (42) (164) (30,066) (30,272)
Issuance of common stock in
exchange for preferred stock (2,800) (2,800) 2,800 28 2,772 0
ESOP Shares Purchased,
net of shares allocated 773 (12,456) (11,683)
--------- --------- --------- --------- --------- ----------- ---------- ---------- ------------
BALANCE AT DECEMBER 31, 1995 389,487 389,487 1,880,294 18,803 74,215 7,797,098 (145,256) - 8,134,347
Net income 1,208,670 1,208,670
Issuance of common stock under
Employee Stock Purchase Plan 3,563 36 21,732 21,768
ESOP Shares Allocated 6,056 43,944 50,000
Unrealized gains on marketable
securities 531,053 531,053
--------- --------- --------- --------- --------- ----------- ---------- ---------- ------------
BALANCE AT DECEMBER 31, 1996 389,487 389,487 1,883,857 18,839 102,003 9,005,768 (101,312) 531,053 9,945,838
Net income 2,720,753 2,720,753
Issuance of common stock 171,425 1,714 1,488,255 1,489,969
Issuance of common stock under
Employee Stock Purchase Plan 3,695 37 23,126 23,163
Issuance of common stock under
Employee Stock Option Plan 9,000 90 61,885 61,975
Issuance of common stock in
exchange for preferred stock (11,387) (11,387) 11,387 114 11,273 0
ESOP Shares Allocated 26,412 31,588 58,000
Unrealized gains on marketable
securities 147,424 147,424
--------- --------- --------- --------- --------- ----------- ---------- ---------- ------------
BALANCE AT DECEMBER 31, 1997 378,100 $ 378,100 2,079,364 $ 20,794 $1,712,954 $11,726,521 $ (69,724) $ 678,477 $14,447,122
========= ========= ========= ========= ========= =========== ========== ========== ============
See notes to
consolidated financial statements.
26
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Description of business: Hector Communications Corporation owns a 100% interest
in five local exchange telephone subsidiaries and one cable television
subsidiary. The Company also owns a 68% interest in Alliance Telecommunications
Corporation, which owns and operates four local exchange telephone companies,
two cable companies, an engineering company, and a credit card communications
company. At December 31, 1997, the Company's wholly and majority owned
subsidiaries provided telephone service to 32,700 access lines in 34 rural
communities in Minnesota, Wisconsin, South Dakota and Iowa. Its cable television
operations provided cable television services to approximately 8,300 subscribers
in Minnesota, South Dakota and Wisconsin. The Company is also an investor in
partnerships and corporations providing wireless telephone and other
telecommunications related services.
Principles of consolidation: The consolidated financial statements include the
accounts of Hector Communications Corporation and its wholly and majority owned
subsidiaries ("HCC" or the "Company"). All material intercompany transactions
and accounts have been eliminated.
Regulatory accounting: Accounting practices prescribed by regulatory authorities
have been considered in the preparation of the financial statements and
formulation of accounting policies for telephone subsidiaries. These policies
conform to generally accepted accounting principles as applied to regulated
public utilities in accordance with Statement of Financial Accounting Standards
No. 71, "Accounting for the Effects of Certain Types of Regulation" (SFAS 71).
As part of the rate-making process, regulators may require recording of an asset
or liability that would not be recognized in an unregulated enterprise. These
costs are recovered through rates authorized in the rate-making process. The
Company's financial statements are also affected by depreciation rates
prescribed by regulators, which may result in different depreciation rates than
for an unregulated enterprise.
Accounting estimates: The presentation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets,
liabilities, and disclosure of contingent assets and liabilities. The estimates
and assumptions used in the accompanying consolidated financial statements are
based upon management's evaluation of the relevant facts and circumstances as of
the time of the financial statements. Actual results could differ from those
estimates.
Property, plant and equipment: Property, plant and equipment is recorded at
cost. Depreciation is computed using principally the straight-line method.
Depreciation included in costs and expenses was $5,807,103, $4,305,212 and
$1,533,240 for 1997, 1996 and 1995, respectively. Maintenance and repairs are
charged to operations and additions or betterments are capitalized. Items of
property sold, retired or otherw