UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended JUNE 30, 1998
------------------------------------------
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR
15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number: 0-18587
HECTOR COMMUNICATIONS CORPORATION
................................................................................
(Exact name of registrant as specified in its charter)
MINNESOTA 41-1666660
(State or other jurisdiction of (Federal Employer
ncorporation or organization) Identification No.)
211 South Main Street, Hector, MN 55342
................................................................................
(Address of principal executive offices) (Zip Code)
(320) 848-6611
................................................................................
Registrant's telephone number, including area code
................................................................................
(Former name, address, and fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. YES X NO
--- ---
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS:
Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Sections 12, 13, or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court. YES ___ NO ___
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuers classes of
common stock, as of the latest practicable date.
CLASS Outstanding at July 24, 1998
Common Stock, par value 2,628,149
$.01 per share
Total Pages (16) Exhibit at Page 16
<PAGE>
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
INDEX
Page No.
Part I. Financial Information
Item 1. Financial Statements
Consolidated Balance Sheets 3
Consolidated Statements of Income and
Comprehensive Income 4
Consolidated Statements of Stockholders' Equity 5
Consolidated Statements of Cash Flows 6
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 9
Part II. Other Information 15
2
<PAGE>
PART I. FINANCIAL INFORMATION
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
<TABLE>
<CAPTION>
Item 1. Financial Statements
CONSOLIDATED BALANCE SHEETS
(unaudited)
June 30 December 31
Assets: 1998 1997
------------ ------------
Current assets:
<S> <C> <C>
Cash and cash equivalents $ 8,577,644 $ 12,455,399
Temporary cash investments 300,000
Construction fund 77,917 77,690
Accounts receivable, net 4,697,771 4,003,184
Materials, supplies and inventories 1,203,287 542,681
Prepaid expenses 89,796 216,351
------------ ------------
Total current assets 14,646,415 17,595,305
Property, plant and equipment 72,366,402 65,794,563
less accumulated depreciation (23,364,905) (19,867,410)
------------ ------------
Net property, plant and equipment 49,001,497 45,927,153
Other assets:
Excess of cost over net assets acquired, net 51,961,532 51,169,677
Marketable securities 9,566,402 5,485,698
Wireless telephone investments 11,261,469 10,680,655
Other investments 8,350,599 7,231,868
Deferred debenture issue costs, net 566,701 780,089
Other assets 2,656,887 420,511
------------ ------------
Total other assets 84,363,590 75,768,498
------------ ------------
Total Assets $ 148,011,502 $ 139,290,956
============ ============
Liabilities and Stockholders' Equity:
Current liabilities:
Notes payable and current portion of long-term debt $ 5,000,100 $ 4,770,000
Accounts payable 2,071,720 1,591,546
Accrued expenses 2,017,708 2,247,972
Income taxes payable 430,428 481,831
------------ ------------
Total current liabilities 9,519,956 9,091,349
Long-term debt, less current portion 100,229,877 97,793,195
Deferred investment tax credits 303,341 381,180
Deferred income taxes 9,161,454 7,594,092
Deferred compensation 893,904 940,425
Minority stockholders interest in Alliance
Telecommunications Corp. 9,598,653 9,043,593
Stockholders' Equity 18,304,317 14,447,122
-------------- --------------
Total Liabilities and Stockholders' Equity $ 148,011,502 $ 139,290,956
============== ==============
See notes to consolidated financial statements.
</TABLE>
3
<PAGE>
<TABLE>
<CAPTION>
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
(unaudited)
Three Months Ended June 30 Six Months Ended June 30
------------------------------- -------------------------------
1998 1997 1998 1997
------------- ------------ ------------- -------------
Revenues:
<S> <C> <C> <C> <C>
Local network $ 1,349,369 $ 1,215,642 $ 2,549,338 $ 2,358,954
Network access 4,684,041 3,762,127 8,943,736 7,747,700
Billing and collection 203,958 264,413 398,520 529,402
Nonregulated activities 1,117,695 993,072 2,098,976 1,918,118
Cable television revenues 668,274 619,959 1,281,569 1,183,130
------------- ------------ ------------ ------------
Total revenues 8,023,337 6,855,213 15,272,139 13,737,304
Costs and expenses:
Plant operations 1,035,551 826,958 1,912,482 1,819,528
Depreciation and amortization 1,933,088 1,821,333 3,756,411 3,643,950
Customer operations 485,221 443,453 939,477 937,246
General and administrative 1,114,985 1,064,301 2,199,015 2,244,705
Other operating expenses 566,024 508,732 1,087,799 922,032
------------- ------------ ------------ ------------
Total costs and expenses 5,134,869 4,664,777 9,895,184 9,567,461
Operating income 2,888,468 2,190,436 5,376,955 4,169,843
Other income and (expenses):
Investment income 203,932 168,375 395,894 337,212
Interest expense (1,809,685) (1,851,522) (3,544,990) (3,598,465)
Gain on sales of marketable securities 337,615 1,495,999 429,469 1,495,999
Partnership and LLC income 328,901 115,145 504,813 230,291
------------- ------------ ------------ ------------
Other expense, net (939,237) (72,003) (2,214,814) (1,534,963)
Income before income taxes 1,949,231 2,118,433 3,162,141 2,634,880
Income tax expense 844,000 934,000 1,395,000 1,225,000
------------- ------------ ------------ ------------
Income before minority interest 1,105,231 1,184,433 1,767,141 1,409,880
Minority interest in earnings of
Alliance Telecommunications Corporation 327,108 104,669 555,060 199,043
------------- ------------ ------------ ------------
Net income $ 778,123 $ 1,079,764 $ 1,212,081 $ 1,210,837
------------- ------------ ------------ ------------
Other comprehensive income:
Unrealized holding gains (losses) on
marketable securities (551,136) 109,979 825,677 503,472
Less: reclassification adjustment for gains
included in net income (337,615) (1,495,999) (429,469) (1,495,999)
------------- ------------ ------------ ------------
Other comprehensive income (loss) before income taxes (888,751) (1,386,020) 396,208 (992,527)
Income tax expense (benefit) related to items of other
comprehensive income (355,500) (554,410) 158,483 (397,013)
------------- ------------ ------------ ------------
Other comprehensive income (533,251) (831,610) 237,725 (595,514)
------------- ------------ ------------ ------------
Comprehensive income $ 244,872 $ 248,154 $ 1,449,806 $ 615,323
============= ============ ============ ============
Basic net income per share $ .34 $ .58 $ .56 $ .65
Diluted net income per share $ .25 $ 34 $ .42 $ .43
See notes to consolidated financial statements.
</TABLE>
4
<PAGE>
<TABLE>
<CAPTION>
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(unaudited)
Accumulated
Other
Preferred Stock Common Stock Additional Unearned Compre-
----------------- -------------------- Paid-in Retained ESOP hensive
Shares Amount Shares Amount Capital Earnings Shares Income Total
-------- -------- ---------- -------- ---------- ----------- --------- ---------- -----------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
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 Option Plan 9,000 90 61,885 61,975
Issuance of common stock under
Employee Stock Purchase Plan 3,695 37 23,126 23,163
Conversion of preferred stock into
common stock (11,387) (11,387) 11,387 114 11,273 0
ESOP Shares Allocated 26,412 31,588 58,000
Change in unrealized gains and
losses on marketable securities,
net of deferred taxes 147,424 147,424
-------- -------- ---------- -------- ---------- ----------- --------- ---------- -----------
BALANCE at December 31, 1997 378,100 378,100 2,079,364 20,794 1,712,954 11,726,521 (69,724) 678,477 14,447,122
Net income 1,212,081 1,212,081
Issuance of common stock under
Employee Stock Option Plan 48,200 482 324,931 325,413
Issuance of common stock from
exercise of outstanding
warrants 7,876 79 61,091 61,170
Conversion of convertible
debentures into common stock 237,753 2,377 2,018,429 2,020,806
Conversion of preferred stock into
common stock (35,300) (35,300) 35,300 353 34,947 0
Change in unrealized gains and
losses on marketable securities,
net of deferred taxes 237,725 237,725
-------- -------- ---------- -------- ---------- ----------- --------- ---------- -----------
BALANCE at June 30, 1998 342,800 $342,800 2,408,493 $ 24,085 $4,152,352 $12,938,602 $ (69,724) $ 916,202 $18,304,317
======== ======== ========== ======== ========== =========== ========= ========== ===========
See notes to consolidated financial statements.
</TABLE>
5
<PAGE>
<TABLE>
<CAPTION>
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
Six Months Ended June 30
-------------------------------
1998 1997
----------- -----------
Cash Flows from Operating Activities:
<S> <C> <C>
Net income $ 1,212,081 $ 1,210,837
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization 3,849,981 3,738,506
Minority stockholders' interest in earnings of Alliance
Telecommunications Corporation 555,060 199,043
Gain on sales of marketable securities (429,469) (1,495,999)
Income from partnership and LLC investments (504,813) (230,291)
Changes in assets and liabilities net of effects from the purchase of Felton
Telephone Company, Inc.
Increase in accounts receivable (593,417) (65,110)
Increase in materials, supplies and inventories (634,175) (542,818)
Decrease in prepaid expenses 135,909 46,899
Increase in accounts payable 472,116 852,221
Increase (decrease) in accrued expenses (195,412) 57 178
Increase (decrease) in income taxes payable (67,030) 263,697
Decrease in deferred investment credits (85,342) (88,346)
Decrease in deferred taxes (292,840) (29,206)
Decrease in deferred compensation (46,521) (23,760)
----------- -----------
Net cash provided by operating activities 3,376,128 3,892,851
Cash Flows from Investing Activities:
Capital expenditures, net (4,673,390) (972,755)
Sales of temporary cash investments 300,000 879,900
Sales of marketable securities 1,108,827 1,728,115
Increase in construction fund (227) (219)
Purchases of wireless telephone investments (572,572)
Proceeds from wireless telephone investments 496,571 229,850
Purchases of other investments (580,091) (1,115,545)
Increase in excess of cost over net assets acquired (952,650)
Increase in other assets (2,253,714) (162,721)
Payment for purchase of Felton Telephone Company, Inc.
net of cash acquired (3,523,107)
----------- -----------
Net cash provided by (used in) investing activities (10,650,353) 586,625
Cash Flows from Financing Activities:
Repayment of long-term debt (2,139,471) (2,651,843)
Proceeds from issuance of notes payable and long-term debt 5,149,358 986,000
Issuance of common stock 386,583 57,662
----------- -----------
Net cash provided by (used in) financing activities 3,396,470 (1,608,181)
----------- -----------
Net Increase (Decrease) in Cash and Cash Equivalents (3,877,755) 2,871,295
Cash and Cash Equivalents at Beginning of Period 12,455,399 9,571,879
----------- -----------
Cash and Cash Equivalents at End of Period $ 8,577,644 $ 12,443,174
=========== ===========
Supplemental disclosures of cash flow information:
Interest paid during the period $ 3,606,504 $ 3,511,537
Income taxes paid during the period 1,702,443 1,078,994
See notes to consolidated financial statements.
</TABLE>
6
<PAGE>
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
NOTE 1 - CONSOLIDATED FINANCIAL STATEMENTS
The balance sheet and statement of stockholders' equity as of June 30, 1998 and
the statements of income and comprehensive income for the three and six month
periods ended June 30, 1998 and 1997 and the statements of cash flows for the
six month periods ended June 30, 1998 and 1997 have been prepared by the Company
without audit. In the opinion of management, all adjustments (which include only
normal recurring adjustments) necessary to present fairly the financial
position, results of operations, and changes in cash flows at June 30, 1998 and
1997 have been made.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted. It is suggested these condensed financial
statements be read in conjunction with the financial statements and notes
thereto included in the Company's December 31, 1997 Annual Report to
Shareholders. The results of operations for the periods ended June 30 are not
necessarily indicative of the operating results for the entire year.
Certain amounts in the 1997 financial statements have been reclassified to
conform to the 1998 financial statement presentation. These reclassifications
had no effect on net income or stockholders equity as previously reported.
NOTE 2 - MARKETABLE SECURITIES AND GAINS ON SALES OF INVESTMENTS
Marketable securities consist principally of equity securities of other
telecommunications companies. The Company's marketable securities portfolio is
classified as available-for-sale. The cost and fair value of available-for-sale
investment securities was as follows:
Gross Gross
Unrealized Unrealized Fair
Cost Gains Losses Value
June 30, 1998 $ 8,134,472 $ 1,794,772 $ (362,842) $ 9,566,402
December 31, 1997 4,449,976 1,035,722 -- 5,485,698
Net unrealized gains on marketable securities, net of related deferred taxes,
are included in accumulated other comprehensive income as follows:
Accumulated
Net Deferred Other
Unrealized Income Comprehensive
Gains Taxes Income
June 30, 1998 $ 1,431,930 $ (515,728) $ 916,202
December 31, 1997 1,035,722 (357,245) 678,477
These amounts have no cash effect and are not included in the statement of cash
flows.
Gross proceeds from sales of available-for-sale securities were $1,109,000 and
$1,728,000 in 1998 and 1997, respectively. Gross realized gains on sales of
these securities were $429,000 and $1,496,000 in 1998 and 1997, respectively.
Income tax expense related to these gains was $172,000 and $598,000 in 1998 and
1997, respectively. Realized gains on sales are based on the difference between
net sales proceeds and the book value of securities sold, using the specific
identification method.
7
<PAGE>
NOTE 3 - WIRELESS TELEPHONE INVESTMENTS
The Company's investments in wireless telephone partnerships and limited
liability companies are recorded on the equity method of accounting which
reflects original cost and recognition of the Company's share of income or
losses. At June 30, 1998, the Company owned 9.8% of Midwest Wireless
Communications LLC, 12.25% of Sioux Falls Cellular, Ltd., and 13.5% of Wireless
North LLC.
Income recognized on cellular telephone investments, net of amortization, was
$929,000 and $230,300 for the six month periods ended June 30, 1998 and 1997
respectively. Losses from PCS investments were $470,400 for the six month period
ended June 30, 1998. Income from other equity method investments was $46,300 for
the six month period ended June 30, 1998.
The Company made additional cash investments of $573,000 in the 1998 period to
support the operations of its wireless investments. Cash distributions received
from cellular telephone investments were $497,000 and $230,000 in 1998 and 1997,
respectively.
NOTE 4 - INCOME TAXES AND INVESTMENT CREDITS
Income taxes have been calculated in proportion to the earnings and tax credits
generated by operations. Investment tax credits have been deferred and are
included in income over the estimated useful lives of the related assets. The
Company's effective income tax rate is higher than the U.S. rate due to the
effect of state income taxes and non-deductible expenses.
NOTE 5 - ACQUISITIONS
Effective April 1, 1998, the Company's 68% owned subsidiary, Alliance
Telecommunications Corporation, acquired all of the outstanding common stock of
Felton Telephone Company, Inc. for $3,650,000 in cash and notes. The acquisition
is being accounted for as a purchase. The excess of cost over net assets
acquired in the transaction was $536,000 which is being amortized on a
straight-line basis over forty years.
Effective June 9, 1998, the Company acquired cable television systems serving 20
rural communities in Minnesota and North Dakota from Spectrum Cablevision
Limited Partnership ("Spectrum") for $5,300,000 in cash. The acquisition is
being accounted for as a purchase. The excess of cost over net assets acquired
in the transaction was $952,650, which is being amortized on a straight-line
basis over fifteen years. Subsequent to the acquisition, the Company sold one of
the acquired systems in exchange for a note receivable of $602,000.
The results of the operations of these acquisitions have been included in the
Company's operating results as of their respective acquisition dates. These
acquisitions were not material to the Company's financial statements.
8
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations
Six Months Ended June 30, 1998 Compared to
Six Months Ended June 30, 1997
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 five local exchange telephone companies, two cable companies, an
engineering company, and a credit card communications company. At June 30, 1998,
the Company's wholly and majority owned subsidiaries provided telephone service
to 34,100 access lines in 35 rural communities in Minnesota, Wisconsin, South
Dakota and Iowa. Its cable television operations provided cable television
services to approximately 13,000 subscribers in Minnesota, North Dakota, South
Dakota and Wisconsin. The Company is also an investor in partnerships and
corporations providing wireless telephone and other telecommunications related
services.
Revenues from the Company's Hector and Alliance operations for the respective
six month periods ending June 30 were as follows:
<TABLE>
<CAPTION>
Alliance Alliance Hector Hector
1998 1997 1998 1997
------------ ------------ ------------ ------------
Revenues:
<S> <C> <C> <C> <C>
Local network $ 1,784,488 $ 1,614,333 $ 764,850 $ 744,621
Network access 6,872,531 5,935,299 2,071,205 1,812,401
Billing and collection 310,717 433,234 87,803 96,168
Nonregulated activities 1,837,205 1,756,367 261,771 161,751
Cable television revenues 574,816 505,214 706,753 677,916
------------ ------------ ------------ ------------
Total revenues $ 11,379,757 $ 10,244,447 $ 3,892,382 $ 3,492,857
============ ============ ============ ============
</TABLE>
Revenues from the Company's 68% owned Alliance Telecommunications Corporation
("Alliance") operations increased $1,135,000 or 11%. Local network revenues
increased $170,000 or 11% due to increases in the number of access lines served
by the Company. Network access revenues increased $937,000 or 16% due to
increased interstate access settlements from NECA. Cable television revenues
increased $70,000 or 14% due to the acquisition of additional cable systems.
Billing and collection revenues declined $123,000 or 28% due to reduced payments
from interexchange carriers ("IXCs") associated with Company efforts to resell
long distance services directly to customers. Revenues from nonregulated
activities increased $81,000 or 5% due to increased revenues from internet
customers.
Revenues from the Company's 100% owned Hector Communications Corporation
("Hector") operations increased $400,000 or 11%. Local network revenues
increased $20,000 or 3% due to increases in the number of access lines served by
the Company. Network access revenues increased $259,000 or 14%. The increase was
principally due to increased interstate access settlements from NECA. Cable
television revenues increased $29,000 or 4%. Billing and collection revenues
declined $8,000 or 9%. Revenues from nonregulated activities increased $100,000
or 62% due to increased revenues from internet customers.
Operating costs and administrative expenses for 1998 increased $328,000 or 3%
from the 1997 period. Operating costs and administrative expenses for Alliance's
operations and Hector's operations for the respective six month periods ended
June 30 were as follows:
9
<PAGE>
<TABLE>
<CAPTION>
Alliance Alliance Hector Hector
1998 1997 1998 1997
------------ ------------ ------------ ------------
Costs and expenses:
<S> <C> <C> <C> <C>
Plant operations $ 1,453,327 $ 1,367,323 $ 459,155 $ 452,205
Depreciation and amortization 2,734,551 2,663,223 1,021,860 980,727
Customer operations 753,302 815,465 186,175 121,781
General and administrative 1,481,125 1,589,574 717,890 655,131
Nonregulated and miscellaneous 532,150 432,081 555,649 489,951
------------ ------------ ------------ ------------
Total costs and expenses: $ 6,954,455 $ 6,867,666 $ 2,940,729 $ 2,699,795
============ ============ ============ ============
</TABLE>
Operating costs and expenses for Alliance operations increased $87,000 or 1%.
Plant operations expenses increased $86,000 or 6%. Depreciation and amortization
expenses increased $71,000 or 3% due to expenses associated with new
acquisitions. Customer operations expenses decreased $62,000 or 8% due to
consolidation of certain job functions with Hector. General and administrative
expenses declined $108,000 or 7% due to cost sharing with Hector. Nonregulated
expenses increased $100,000 or 23% due to increased cable television expenses
associated with acquisitions. Operating income from Alliance's operations
increased $1,048,000 or 31%.
Operating costs and expenses for Hector operations increased $241,000 or 9%.
Plant operations expenses increased $7,000 or 2%. Depreciation and amortization
expenses increased $41,000 or 4%. Customer operations expenses increased $64,000
or 53% due to expenses incurred in integrating Hector's customer service system
with Alliance and upgrading to Year 2000 compliance. General and administrative
expenses increased $63,000 or 10% due to cost sharing with Alliance.
Nonregulated expenses increased $66,000 or 13% due to increased cable television
maintenance expenses and increased internet service expenses. Operating income
from Hector operations increased $159,000 or 20%. Consolidated operating income
increased $1,207,000 or 29%.
Consolidated interest expense, net of investment income decreased $53,000 due to
principal payments made on outstanding borrowings. Income from investments in
partnerships and LLCs increased $275,000 due to above plan performance by
investments in Midwest Wireless LLC, which offset start-up losses on the
Company's personal communications services ("PCS") partnership investments.
Gains on sales of marketable securities held by Alliance were $429,000 in the
1998 period. Gains on sales of marketable securities held by Hector were
$1,496,000 in 1997.
Consolidated income before income taxes was $3,162,000 up 20% from $2,635,000 in
1997. Income tax expense was $1,395,000 in the 1998 period compared to
$1,225,000 in 1997. The Company's effective tax rate of 44% in 1998 is higher
than the standard tax rate because the amortization expenses associated with
excess of cost over net assets acquired in Alliance's 1996 purchase of Ollig
Utilities Company are not tax deductible. The 32% minority shareholders'
interest in earnings of Alliance was $555,000 in the 1998 period compared to
$199,000 in 1997. Net income was $1,212,000 compared to $1,211,000 in 1997.
Three Months Ended June 30, 1998 Compared to
Three Months Ended June 30, 1997
Revenues from the Company's Hector and Alliance operations for the respective
three month periods ending June 30 were as follows:
10
<PAGE>
<TABLE>
<CAPTION>
Alliance Alliance Hector Hector
1998 1997 1998 1997
------------ ------------ ------------ ------------
Revenues:
<S> <C> <C> <C> <C>
Local network $ 956,083 $ 835,996 $ 393,286 $ 379,646
Network access 3,576,138 2,857,024 1,107,903 905,103
Billing and collection 161,575 219,134 42,383 45,279
Nonregulated activities 961,757 902,118 155,938 90,954
Cable television revenues 311,037 277,171 357,237 342,788
------------ ------------ ------------ ------------
Total revenues $ 5,966,590 $ 5,091,443 $ 2,056,747 $ 1,763,770
============ ============ ============ ============
</TABLE>
Revenues from Alliance operations increased $875,000 or 17%. Excluding the
acquisition of Felton Telephone Company, revenues increased $693,000 or 14%.
Local network revenues increased $120,000 or 14% due to increases in the number
of access lines served by the Company. Network access revenues increased
$719,000 or 25% due to increased interstate access settlements from NECA. Cable
television revenues increased $34,000 or 12% due to the acquisition of
additional cable systems. Billing and collection revenues declined $58,000 or
26% due to reduced payments from IXCs associated with Company efforts to resell
long distance services directly to customers. Revenues from nonregulated
activities increased $60,000 or 7% due to increased revenues from internet
customers.
Revenues from Hector operations increased $293,000 or 17%. Local network
revenues increased $14,000 or 4% due to increases in the number of access lines
served by the Company. Network access revenues increased $203,000 or 22%. The
increase was principally due to increased cost-basis interstate access
settlements from NECA. Cable television revenues increased $14,000 or 4%.
Billing and collection revenues declined $3,000 or 6%. Revenues from
nonregulated activities increased $65,000 or 71% due to increased revenues from
internet customers.
Operating costs and administrative expenses for 1998 increased $470,000 or 10%
from the 1997 period. Operating costs and administrative expenses for Alliance's
operations and Hector's operations for the respective three month periods ended
June 30 were as follows:<TABLE> <CAPTION>
Alliance Alliance Hector Hector
1998 1997 1998 1997
------------ ------------ ------------ ------------
Costs and expenses:
<S> <C> <C> <C> <C>
Plant operations $ 801,515 $ 617,883 $ 234,036 $ 209,075
Depreciation and amortization 1,421,930 1,330,967 511,158 490,366
Customer operations 373,353 381,353 111,868 62,100
General and administrative 745,345 729,909 369,640 334,392
Nonregulated and miscellaneous 284,094 261,427 281,930 247,305
------------ ------------ ------------ ------------
Total costs and expenses: $ 3,626,237 $ 3,321,539 $ 1,508,632 $ 1,343,238
============ ============ ============ ============
</TABLE>
Operating costs and expenses for Alliance operations increased $305,000 or 9%.
Excluding the acquisition of Felton Telephone Company, operating costs and
expenses increased $168,000 or 5%. Plant operations expenses increased $184,000
or 30%. Depreciation and amortization expenses increased $91,000 or 7% due to
expenses associated with new acquisitions. Customer operations expenses
decreased $8,000 or 2% due consolidation of certain job functions with Hector.
General and administrative expenses increased $15,000 or 2%. Nonregulated
11
<PAGE>
expenses increased $23,000 or 9% due to increased cable television expenses
associated with acquisitions. Operating income from Alliance's operations
increased $570,000 or 32%.
Operating costs and expenses for Hector operations increased $165,000 or 12%.
Plant operations expenses increased $25,000 or 12%. Depreciation and
amortization expenses increased $21,000 or 4%. Customer operations expenses
increased $50,000 or 80% due to expenses incurred in integrating Hector's
customer service system with Alliance and upgrading to Year 2000 compliance.
General and administrative expenses increased $35,000 or 11% due to cost sharing
with Alliance. Nonregulated expenses increased $35,000 or 14% due to increased
cable television maintenance expenses and increased internet service expenses.
Operating income from Hector operations increased $128,000 or 30%. Consolidated
operating income increased $698,000 or 32%.
Consolidated interest expense, net of investment income decreased $77,000 due to
principal payments made on outstanding borrowings and reduced interest charges
on $2,198,000 of convertible debentures redeemed or converted into common stock
in the period. Income from investments in partnerships and LLCs increased
$214,000 due to above plan performance by investments in Midwest Wireless LLC,
which offset start-up losses on the Company's personal communications services
("PCS") partnership investments. Gains on sales of marketable securities held by
Alliance were $338,000 in the 1998 period. Gains on sales of marketable
securities held by Hector were $1,496,000 in 1997.
Consolidated income before income taxes was $1,949,000 compared to $2,118,000 in
1997. Income tax expense was $844,000 in the 1998 period compared to $934,000 in
1997. The Company's effective tax rate of 43% in 1998 is higher than the
standard tax rate because the amortization expenses associated with excess of
cost over net assets acquired in the Alliance's 1996 purchase of Ollig Utilities
Company are not tax deductible. The 32% minority shareholders' interest in
earnings of Alliance was $327,000 in the 1998 period compared to $105,000 in
1997. Net income was $778,000 compared to $1,080,000 in 1997.
Liquidity and Capital Resources
The Company produced cash from operating activities of $3,376,000 in the first
six months of 1998 compared to $3,893,000 in the 1997 period. The decrease was
primarily due to the timing of accounts receivable collections from IXCs. At
June 30, 1998, the Company's cash, cash equivalents, temporary cash investments
and marketable securities totaled $18,144,000 compared to $18,241,000 at
December 31, 1997. Working capital at June 30, 1998 was $5,126,000 compared to
$8,504,000 at December 31, 1997.
The Company continues to carry a significant amount of debt associated with
Alliance's 1996 acquisition of Ollig Utilities Company. 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"). The
Company has locked in the interest rates on this debt for periods of 1 - 10
years at rates averaging 7.4%. The outstanding balance on this loan at June 30,
1998 was $51,801,000.
The Company's cash investment in Alliance is approximately $16,903,000, which
included $6,000,000 of borrowing by the Company from St. Paul Bank. The Company
repaid $2,000,000 of this debt in 1997 paid down an additional $286,000 in the
first quarter of 1998. In April, 1998, the Company refinanced the remaining debt
through a fifteen-year term loan from Rural Telephone Financing Corporation
("RTFC").
12
<PAGE>
Effective April 1, 1998, Alliance Telecommunications Corporation purchased all
the outstanding common stock of Felton Telephone Company, Inc., 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 a significant portfolio of marketable securities,
including investments in Rural Cellular Corporation, U.S. West Communications,
Inc. and Media One Group, Inc. Purchase price was $3,650,000, which includes a
cash downpayment and a seller financed note payable of $3,149,000.
Effective June 9, 1998, Alliance purchased cable television systems serving
4,600 customers in 20 communities in Minnesota and North Dakota (including
several communities also served by the Company's telephone subsidiaries) from
Spectrum Cablevision Limited Partnership. Purchase price was approximately
$5,235,000. The Company used its cash reserves and funds from its line of credit
with RTFC to make this purchase. Subsequent to the acquisition, the Company sold
one of the acquired systems in exchange for a note receivable of $602,000.
In April, 1998, the Company called $2,000,000 of its outstanding 8.5%
convertible subordinated debentures. Of these called debentures, $84,000 worth
were ultimately redeemed for cash and the balance were converted into common
stock. In June, 1998, the Company called an additional $2,000,000 of debentures
for redemption on July 15. The Company believes that because its common stock
has been trading at a considerable premium to the conversion price available to
debenture holders and the Company has sources of funds available at lower
interest rates than carried by the debentures, that it is in the best interest
of both the Company and the debenture holders that the debentures be replaced
with cheaper debt or converted to stock. The Company expects to continue to
redeem debentures as market conditions and funds availability permit.
The Company finances its telephone asset additions from internally generated
funds and drawdowns of Rural Utilities Service ("RUS") and Rural Telephone Bank
("RTB") loan funds. At June 30, 1998, the Company's local exchange carrier
("LEC") subsidiaries had unadvanced loan commitments from RUS and RTB totaling
$17,478,000. Alliance's LEC subsidiaries are in the process of applying for
additional loans. Expected telephone and cable television plant additions for
1998, excluding the acquisition of the Spectrum cable systems, are $5,621,000 of
which $2,898,000 had been spent to date.
The Company's investment income has been derived almost exclusively from
interest earned on its cash and cash equivalents. Interest income earned by the
Company has fluctuated in relation to changes in interest rates and availability
of cash for investment.
The Company has also derived substantial amounts of net income from sales of
securities held in its marketable securities portfolio, which appreciated
significantly in value in the first half of 1998. In the first half of 1998, the
Company received $1,109,000 from the sales of marketable securities. Proceeds
from securities sales totaled $1,728,000 in 1997 and $2,053,000 in 1996. The
Company believes sales of marketable securities will continue to be a
significant cash source in future periods. At June 30, 1998, the Company's
marketable securities portfolio consisted primarily of shares of Rural Cellular
Corp., U.S. West Communications, Inc. and Media One Group, Inc. owned by Ollig
Utilities Company and Felton Telephone Company, Inc. prior to their acquisition.
The Company is an investor in Wireless North LLC, 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 through December 31, 1997. Capital contributions in
the first half of 1998 totaled $573,000. The PCS systems are in start-up mode
and have not been profitable to date. Losses accrued on this investment were
$470,000 before income tax benefits in the first half of 1998. The Company has
13
<PAGE>
committed to providing $913,000 of additional capital to these entities. It
cannot predict if additional funding beyond this amount will be required.
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.
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. 1998 is abbreviated as "98". 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 central office and data processing systems to locate
computer systems which may be subject to this error.
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. If not corrected, this could
interrupt telephone services for customers, interrupt connections between the
Company's telephone system and the national and worldwide telephone networks,
and make the Company unable to accurately bill customers for telephone usage.
The Company's system may also be vulnerable to Year 2000 problems in other
telephone networks with which it interconnects. The Company cannot estimate what
its liability to customers and regulators from such a loss of service might be.
The Company will be upgrading its equipment and related software in the third
and fourth quarters of 1998 to attain Year 2000 compliance. The Company relies
on switching equipment and software provided by Nortel, Inc. and does not itself
have the technical expertise required to make the necessary hardware and
software corrections. It is the Company's understanding that Nortel, Inc. has
completed testing of the new software and that no additional action related to
this problem will be required when installation is complete. 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.
14
<PAGE>
PART II. OTHER INFORMATION
Items 1 - 3. Not Applicable
Item 4. Submission of Matters to a Vote of Securities Holders The Annual Meeting
of the Shareholders of the Registrant was held on May, 19, 1998 in Minneapolis,
MN. The total number of shares outstanding and entitled to vote at the meeting
was 2,103,226 of which 1,983,700 were present either in person or by proxy.
Shareholders reelected board members James O. Ericson, Paul N. Hanson and Wayne
E. Sampson to three year terms expiring at the 2001 Annual Meeting of
Shareholders. The vote for these board members is summarized below:
In Favor Opposed
James O. Ericson 1,982,840 860
Paul N. Hanson 1,982,640 1,060
Wayne E. Sampson 1,982,640 1,060
Board members continuing in office are Curtis A. Sampson and Steven H. Sjogren
(whose terms expire at the 1999 Annual Meeting of Shareholders) and Charles R.
Dickman, Paul A. Hoff and Edward E. Strickland (whose terms expire at the 2000
Annual Meeting of Shareholders).
Item 5. Not Applicable.
Item 6(a). Exhibits
Exhibit 11, "Calculation of Earnings Per Share" is attached to this Form 10-Q.
Item 6(b). Not Applicable.
Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereto duly authorized.
Hector Communications Corporation
By /s/Charles A. Braun
Charles A. Braun
Chief Financial Officer
Date: August 14, 1998
15
<PAGE>
<TABLE>
<CAPTION>
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
EXHIBIT 11
CALCULATION OF EARNINGS PER SHARE
Three Months Ended June 30 Six Months Ended June 30
--------------------------- ---------------------------
Basic: 1998 1997 1998 1997
- ------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Net income $ 778,123 $ 1,079,764 $ 1,212,081 $ 1,210,837
========== ========== ========== ==========
Common shares:
Weighted average number of common shares outstanding 2,263,174 1,884,503 2,178,162 1,884,182
Number of unallocated shares held by ESOP (6,042) (11,817) (6,042) (11,817)
--------- ---------- ---------- ----------
2,257,132 1,872,686 2,172,120 1,872,365
========= ========== ========== ==========
Net income per common share $ .34 $ .58 $ .56 $ .65
========== ========== ========== ==========
Diluted:
- -------------
Net income $ 778,123 $ 1,079,764 $ 1,212,081 $ 1,210,837
Interest on convertible debentures, net of tax 177,676 189,654 367,205 379,308
---------- ---------- ---------- ----------
Adjusted net income $ 955,799 $ 1,269,418 $ 1,579,286 $ 1,590,145
========== ========== ========== ==========
Common and common equivalent shares:
Weighted average number of common shares outstanding 2,263,174 1,884,503 2,178,162 1,884,182
Assumed conversion of convertible
debentures into common stock 1,175,850 1,423,125 1,175,850 1,423,125
Dilutive effect of convertible preferred shares outstanding 351,762 389,487 363,096 389,487
Dilutive effect of stock options outstanding after
application of treasury stock method 62,217 27,827 57,852 22,148
Dilutive effect of Employee Stock
Purchase Plan shares subscribed 4,537 4,288
Dilutive effect of warrants outstanding 23,181 20,179
Weighted average number of
unallocated shares held by ESOP (6,042) (11,817) (6,042) (11,817)
---------- ---------- ---------- ----------
3,874,679 3,713,125 3,793,385 3,707,125
========== ========== ========== ==========
Diluted net income per share $ .25 $ .34 $ .42 $ .43
========== ========== ========== ==========
</TABLE>
16
<PAGE>
<TABLE> <S> <C>
<ARTICLE> 5
<CIK> 0000863437
<NAME> HECTOR COMMUNICATIONS CORPORATION
<MULTIPLIER> 1
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> JUN-30-1998
<EXCHANGE-RATE> 1
<CASH> 8,577,644
<SECURITIES> 0
<RECEIVABLES> 4,697,771
<ALLOWANCES> 0
<INVENTORY> 1,203,287
<CURRENT-ASSETS> 14,646,415
<PP&E> 72,366,402
<DEPRECIATION> 23,364,905
<TOTAL-ASSETS> 148,011,502
<CURRENT-LIABILITIES> 9,519,956
<BONDS> 100,229,877
0
342,800
<COMMON> 24,085
<OTHER-SE> 17,937,432
<TOTAL-LIABILITY-AND-EQUITY> 148,011,502
<SALES> 15,272,139
<TOTAL-REVENUES> 15,272,139
<CGS> 9,895,184
<TOTAL-COSTS> 9,895,184
<OTHER-EXPENSES> (1,330,176)
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 3,544,990
<INCOME-PRETAX> 3,162,141
<INCOME-TAX> 1,395,000
<INCOME-CONTINUING> 1,767,141
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<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,212,081
<EPS-PRIMARY> 0.56
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