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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, 1998
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 $16,745,000 based upon the closing sale price of
the Company's common stock on the American Stock Exchange on March 24, 1999.
As of March 24, 1999 there were outstanding 2,663,467 shares of the Registrant's
common stock.
Documents Incorporated by Reference: The Company's
Proxy Statement for its Annual Meeting of
Shareholders to be held on May 18, 1999 is
incorporated by reference into Part III of
this Form 10-K.
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<PAGE>
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, 1998, the Company's wholly and majority owned telephone
subsidiaries (generally referred to as "local exchange carriers" or "LECs")
served approximately 34,700 access lines and provided telephone service to 35
rural communities in Minnesota, Wisconsin, South Dakota and Iowa. In addition,
at such date, through its cable television subsidiaries and four LEC
subsidiaries, the Company provided cable television services to approximately
13,000 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
6,800 access lines at December 31, 1998. 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. Golden West
Telecommunications Cooperative, Inc. of Wall, South Dakota, and Split Rock
Telecom Cooperative, Inc. of Garretson, South Dakota own the remaining interests
in Alliance.
[b] FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS
The Company is organized in two business segments, Hector Communications
Corporation and its wholly owned subsidiaries, and Alliance Telecommunications
Corporation and its subsidiaries. Information regarding segment operations is
provided in Note 11 to the financial statements found under Item 8 of this
report.
[c] NARRATIVE DESCRIPTION OF BUSINESS
(1) 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
approval, where required, will be received.
2
<PAGE>
(2) Telephone
The Company provides modern, high-quality local telephone service and
access to long distance telephone service through its five wholly owned and five
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 LEC subsidiaries at December 31, 1998, 1997 and 1996:
<TABLE>
<CAPTION>
Telephone Company Access Lines*
- ------------------ December 31
--------------------------------------------------
1998 1997 1996
----------- ----------- -----------
Hector Communications Corporation:
<S> <C> <C> <C>
Arrowhead Communications Corporation 780 749 748
Eagle Valley Telephone Company 676 685 678
Granada Telephone Company 274 275 276
Pine Island Telephone Company 3,019 2,919 2,775
Indianhead Telephone Company 2,109 2,076 2,057
Alliance Telecommunications Corporation:
Loretel Systems, Inc. 12,675 12,023 11,852
Sleepy Eye Telephone Company 6,197 5,998 5,814
Sioux Valley Telephone Company 5,679 5,457 5,355
Hills Telephone Company 2,618 2,545 2,465
Felton Telephone Company 735
---------- ---------- ----------
34,762 32,727 32,020
========== ========== ==========
</TABLE>
* 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.
In Minnesota, telephone companies serving fewer than 50,000 access lines
can elect to provide service under an alternate form of regulation. Companies
choosing alternative regulation are not subject to rate of return review by the
Public Utilities Commission. 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
<PAGE>
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 $951,000, $656,000 and $617,000 of the Company's network
access revenues in 1998, 1997 and 1996, 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 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. 100%
of the Company's access lines use digital switching technology and it 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.
At December 31, 1998, the Company's local exchange carrier subsidiaries
had unadvanced loan commitments under the RUS and RTB programs aggregating
approximately $17,552,000 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.
4
<PAGE>
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 7.5%. The Company
made only interest payments on the loan in 1996. Principal payments began in
January 1997 and will continue until March 2011.
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, 1998 was
$3,258,000. 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. The Company did not accrue a patronage refund for 1998.
Approximately 30% of the patronage refunds were received in cash, with the
balance in stock of St. Paul Bank. Patronage refunds are shown in the Company's
operating statement as a reduction of interest expense. The Company cannot
predict what patronage refunds might be in future years.
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. In 1998, the Company replaced this loan with a 15-year
term loan from Rural Telephone Financing Cooperative ("RTFC"). Interest rate on
the loan varies according to the rate charged by the Lender for similar loans
(6.1% at December 31, 1998).
In 1998, the Company negotiated a $5,000,000 revolving line of credit
from RTFC. Interest on outstanding borrowings against the credit line is at the
bank's prime rate plus 1.5% (6.7% at December 31, 1998). The Company borrowed
$2,000,000 against the credit line in 1998 to help finance the purchase of
additional cable television systems from Spectrum Cablevision Limited
Partnership. It expects to replace this debt with longer term financing in 1999.
Both the term loan and the credit line are secured by a pledge of the stock of
HCC's wholly owned subsidiaries.
In February 1995, the Company completed a $12,650,000 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. The debentures include restrictions on payment of dividends to the
Company's shareholders and are subordinated to $4,000,000 of senior indebtedness
owed by the Company to RTFC. As of February 15, 1999, the Company has the right
to call the debentures at a price ranging from 100% to 102% of par value. During
1998, the Company issued two separate calls to retire debentures, which resulted
in $4,264,000 of debentures being converted into stock and $438,000 of
debentures being purchased and retired. The offering's underwriters also
received warrants to purchase shares of the Company's common stock at a price of
$8.70 per share. At December 31, 1998, 112,140 warrants remain outstanding and
expire February 15, 2000.
Competition
- -----------
Under provisions of the Telecommunications Act of 1996, LECs must allow
competitors access to the local network facilities. The law also 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 until rule making by the FCC and state
regulatory agencies is complete. Several provisions of the law are also being
contested in the courts, making some applications of the law subject to the
judicial process. The Company is monitoring developments regarding the
regulatory climate closely, and expects its operations will be materially
affected by new rules, but cannot predict what effect the law and regulations
adopted pursuant to the law will have on its business.
5
<PAGE>
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 as competition expands in the new
regulatory environment. 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 the 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 that 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.
New telecommunications laws and recent FCC rulings, which seek 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 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
<PAGE>
The FCC established 733 cellular service areas in the United States,
consisting of 305 Metropolitan Statistical Areas ("MSAs") and 428 Rural Service
Areas ("RSAs"). The FCC 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, 1998, the Company was an investor in limited liability
companies which provide cellular telephone service in five RSAs in Minnesota,
one RSA in North Dakota and the Rochester, Minnesota MSA. The Company accounts
for these investments using the equity method. Income recognized on these
wireless investments was $1,508,000, $1,210,000, and $391,000 in 1998, 1997 and
1996, 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, 1998:
<TABLE>
<CAPTION>
Total Company's
Population Percent Share of
Name of Venture Service Area Equivalents(1) Ownership Total POPs
- -------------------- ----------------- -------------- ---------- -----------
<S> <S> <C> <C> <C>
Midwest Wireless Rochester, MN MSA 948,000 10.00% 94,800
Communications LLC and MN RSAs 7, 8,
9, 10 and 11
Red River Cellular, Inc. ND RSA 3 92,000 1.60% 1,472
</TABLE>
(1) Estimated population based on the 1990 United States Census.
In December, 1998, the Company sold its interest in a cellular telephone
partnership serving the Sioux Falls, South Dakota MSA. Proceeds from the sale
were $6,725,000. Gain on the sale, after income taxes and before minority
interest, was $2,890,000. Income recognized from the Company's investment in
this partnership was $334,000, $377,000 and $109,000 in 1998, 1997 and 1996,
respectively.
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, the Company sold 61,133 shares of
RCC and recorded a gain on sale of $485,000. In 1997, the Company sold an
additional 161,469 shares of RCC for a gain of $1,464,000. In 1998, the Company
sold 40,000 shares of RCC for a gain of $179,000. As part of the acquisition of
Felton Telephone Company, the Company acquired an additional 167,664 shares of
RCC in 1998. At December 31, 1998, the Company owned approximately 3.7% 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 13.06% 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 $1,271,000 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 $1,066,000, $435,000 and $73,000 in 1998, 1997 and 1996,
respectively. The Company has committed to providing $664,000 of additional
capital to these entities. It cannot predict if additional funding beyond this
amount will be required.
7
<PAGE>
There are a number of recent technological developments in the wireless
telephone industry. Currently most cellular telephone systems use equipment that
processes information digitally but transmits radio signals 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.
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 12.0% 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 that 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
The Company, through its cable television and local exchange carrier
subsidiaries, owns and operates 46 cable television systems serving
approximately 13,000 subscribers in Minnesota, North Dakota, South Dakota and
Wisconsin. All of its cable television systems offer one or more channels of
premium programming, featuring motion pictures 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 $14.95 to $26.28 per month. Basic service generally
includes the major television networks, non-network independent stations, sports
programming, news services and automated information channels, children's
programming, access channels for public, governmental, educational and leased
use, senior citizens' programming and religious programming. Premium programming
services are provided to subscribers for an additional fee of $6.95 to $10.95
per month per channel. Approximately one-third of the Company's cable television
customers subscribe to a premium channel. 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
<PAGE>
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 FCC regulates the Company's cable television systems. 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, 1999, the Company had 150 full-time and part-time employees,
of which 101 employees work in the Alliance operations and 49 work in Hector
operations. None of the Company's employees are represented under collective
bargaining agreements. HCC believes its employee relations to be good.
9
<PAGE>
(5) Executive Officers of Registrant
The executive officers of the Company and their ages at March 1, 1999
were as follows:
Name Age Position
----------------- --- -------------------------------
Curtis A. Sampson 65 Chairman of the Board and Chief
Executive Officer
Steven H. Sjogren 56 President and Chief Operating
Officer
Paul N. Hanson 52 Vice President and Treasurer
Charles A. Braun 41 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
<PAGE>
ITEM 2. PROPERTIES
The Company and its wholly-owned and majority-owned subsidiaries own and
operate local exchange telephone property in Minnesota, Wisconsin, South Dakota
and Iowa. The Company also has cable television properties in Minnesota,
Wisconsin, North Dakota and South Dakota. HCC and its wholly-owned subsidiaries
hold approximately 32% of net consolidated property, plant and equipment.
Alliance and its subsidiaries hold the remaining 68%.
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
<PAGE>
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS
[a] MARKET INFORMATION
The Company's common stock is currently being traded on the American
Stock Exchange. Prior to February 20, 1998, the Company's common stock traded on
the National Market System of the National Association of Securities Dealers
Automated Quotation System ("NASDAQ").
The table below presents the range of high and low trading prices for the
Company's stock for each period as reported by the respective exchanges.
1998 1997
Quarter High Low High Low
- --------------------------------------------------------------------------------
First $12.63 $9.00 $8.50 $7.25
Second 12.25 10.50 9.75 7.38
Third 11.25 7.75 10.50 7.88
Fourth 9.00 7.38 10.13 8.50
[b] HOLDERS
At March 1, 1999 there were approximately 570 holders of record of
Hector Communications Corporation common stock.
[c] DIVIDENDS
HCC has not paid cash dividends on its common stock or preferred stock
since it began operating as a public company in 1990, nor does HCC have any
obligations to pay dividends on its preferred stock. The financing agreements
between HCC's subsidiaries and their lenders, and HCC and its lenders restrict
the ability of HCC to pay dividends. At the present time, HCC intends to retain
earnings to finance the expansion of its business, and does not anticipate any
cash dividends will be paid in the foreseeable future. See Management's
Discussion and Analysis of Financial Condition and Results of Operations, and
also Note 6 to the Consolidated Financial Statements under Item 8 herein for a
description of restrictions on dividends.
12
<PAGE>
<TABLE>
<CAPTION>
ITEM 6. SELECTED FINANCIAL DATA
SELECTED CONSOLIDATED FINANCIAL INFORMATION
(in thousands except per share amounts)
Year Ended December 31
------------------------------------------------------------
1998 1997 1996 1995 1994
- --------------------------------------------------------------------------------------------------------------------------------
Selected Income Statement Information
<S> <C> <C> <C> <C> <C>
Revenues $ 31,839 $ 28,866 $ 20,658 $ 5,844 $ 5,740
Costs and Expenses 21,192 19,113 14,066 4,992 4,175
- --------------------------------------------------------------------------------------------------------------------------------
Operating Income 10,647 9,753 6,592 852 1,565
Other Income (Expenses), net (40) (3,367) (3,518) (980) 2,055
- --------------------------------------------------------------------------------------------------------------------------------
Income (Loss) Before Income Taxes 10,606 6,386 3,074 (128) 3,620
Income Tax Expense (Benefit) 4,949 2,867 1,540 (51) 1,415
- --------------------------------------------------------------------------------------------------------------------------------
Income (Loss) Before Minority Interest 5,657 3,519 1,534 (77) 2,205
Minority Interest in Earnings of Alliance
Telecommunications Corporation 1,747 798 325
- --------------------------------------------------------------------------------------------------------------------------------
Net Income (Loss) $ 3,910 $ 2,721 $ 1,209 $ (77) $ 2,205
================================================================================================================================
Basic Net Income (Loss) Per Common Share $ 1.63 $ 1.44 $ .65 $ (.04) $ 1.18
Diluted Net Income (Loss) Per Common Share: $ 1.15 $ .93 $ .53 $ (.04) $ .97
Average Shares Outstanding:
Common shares only 2,403 1,893 1,870 1,866 1,863
Common and potential common shares 3,937 3,732 3,694 1,866 2,266
===============================================================================================================================
Selected Balance Sheet Information
Working Capital $ 6,554 $ 8,504 $ 1,307 $ 9,679 $ 4,740
Property, Plant and Equipment, net 50,810 45,927 47,039 14,609 13,019
Excess of Cost Over Net Assets Acquired, net 53,004 51,170 52,510 907 839
Total Assets 150,680 139,291 137,348 33,518 22,749
Long-Term Debt 94,232 97,793 96,127 22,096 10,528
Stockholders' Equity 22,720 14,447 9,946 8,134 8,230
- --------------------------------------------------------------------------------------------------------------------------------
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.
</TABLE>
13
<PAGE>
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. At December
31, 1998, these subsidiaries provided telephone service to 6,858 customers in 9
rural communities in Minnesota and Wisconsin. They also owned 30 cable
television systems serving 4,840 customers in 36 communities in Minnesota and
Wisconsin. HCC also directly owns substantial investments in other
telecommunications ventures, including, Midwest Wireless LLC, Wireless North LLC
and MEANS.
In 1996, the Company joined with Golden West Telecommunications Cooperative and
Split Rock Telecom Cooperative to organize Alliance Telecommunications
Corporation ("Alliance"). The Company owns a 68% interest in Alliance. Effective
April 25, 1996, Alliance acquired Ollig Utilities Company ("Ollig"). At December
31, 1998, Alliance, through Ollig and its five local exchange telephone
subsidiaries, provided telephone service to 27,904 customers in 26 rural
communities in Minnesota, South Dakota and Iowa. Alliance's 16 cable television
systems provided cable television services to approximately 8,160 subscribers in
Minnesota, South Dakota and North Dakota. Alliance's subsidiaries also own
substantial investments in Midwest Wireless LLC, Wireless North LLC and MEANS,
own marketable securities portfolios with investments in telecommunications
providers like U.S. West Communications, Inc., MediaOne Group, Inc. and Rural
Cellular Corporation, and has other investments.
Results of Operations
- ---------------------
General
- -------
The Company's telephone revenues are principally derived from the local
service and access revenues received by its local exchange carrier ("LEC")
subsidiaries. Local service revenues are earned by providing customers with
local service to connecting points within the local exchange boundaries and, in
certain cases, to nearby local exchanges under extended area service ("EAS")
plans that eliminate long distance charges to the neighboring exchanges. Monthly
rates for telephone service differ among the LECs depending upon the cost of
providing service, the type and grade of service, the number of customers and
calling patterns within the toll free calling area and other factors.
Access revenues are received by LECs for intrastate and interstate
exchange services provided to long distance carriers (generally referred to as
interexchange carriers or "IXCs") 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.
14
<PAGE>
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: <TABLE> <CAPTION>
Year Ended December 31
--------------------------------------------------
1998 1997 1996
----------- ---------- -----------
<S> <C> <C> <C>
Local network 16.6% 16.9% 17.8%
Network access 55.6 58.0 55.8
Nonregulated telephone activities 15.0 13.3 13.0
Billing and collecting 2.7 3.5 4.3
Cable television 10.1 8.3 9.1
----------- ----------- -----------
100.0 % 100.0% 100.0%
=========== =========== ===========
</TABLE>
1998 Compared to 1997
- ---------------------
Consolidated revenues increased 10% to $31,839,000. The revenue breakdown
by operating group was as follows:
<TABLE>
<CAPTION>
Alliance Hector
Year Ended December 31 Year Ended December 31
1998 1997 1998 1997
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Local Network $ 3,730,079 $ 3,346,733 $ 1,560,732 $ 1,519,514
Network Access 13,480,391 12,845,426 4,229,530 3,892,682
Billing and Collection 683,132 820,540 182,635 209,642
Nonregulated activities 4,283,839 3,469,234 489,528 369,188
Cable Television 1,774,495 1,027,602 1,424,333 1,365,804
------------ ------------ ------------- ------------
$ 23,951,936 $ 21,509,535 $ 7,886,758 $ 7,356,830
============ ============ ============= ============
</TABLE>
Consolidated local service revenues increased $425,000 or 9%. The increase was
due to increases in access lines served, which increased 6% to 34,760. Growth
was due to increased development within the Company's service areas, increased
demand for telephone lines to provide advanced telephone services such as
internet services, and the acquisition by Alliance of Felton Telephone Company
("Felton"). Network access revenues increased $972,000 or 6%. Excluding Felton,
the increase was $581,000 or 3%. The increase was chiefly due to increased use
of the telephone network by customers and increased universal service support
funds. 1997 access revenues were high due to a one-time retroactive tariff
settlement received by an Alliance subsidiary.
Nonregulated revenues increased $935,000 or 24%. Revenue increases were
due to increased internet revenues, commissions on sales of long distance
services and leases of fiber-optic transport facilities. Cable television
revenues increased $805,000 or 34% due to the acquisition by Alliance of
additional cable systems from Spectrum Cablevision Limited Partnership. Billing
and collection revenues declined $164,000 or 16% as IXCs continued the trend
toward self-billing of customers.
Consolidated operating costs and expenses increased $2,079,000 or 11%.
Costs and expenses by operating group were as follows:
<TABLE>
<CAPTION>
Alliance Hector
Year Ended December 31 Year Ended December 31
1998 1997 1998 1997
------------ ------------ ------------- ------------
<S> <C> <C> <C> <C>
Plant operations $ 2,821,318 $ 2,714,192 $ 933,994 $ 916,638
Depreciation and amortization 5,712,509 5,336,031 2,068,701 1,973,699
Customer operations 1,549,019 1,430,676 254,649 243,435
General and administrative 2,575,215 2,324,079 1,375,954 1,269,042
Other operating expenses 2,646,862 1,830,921 1,253,586 1,074,244
------------ ------------ ------------- ------------
$ 15,304,923 $ 13,635,899 $ 5,886,884 $ 5,477,058
============ ============ ============= ============
</TABLE>
15
<PAGE>
Consolidated plant operations expenses increased $124,000 or 3%, due to
the acquisition of Felton. Depreciation and amortization increased $471,000 or
6% due to the acquisitions of Felton and the Spectrum cable television systems.
Customer operations expenses increased $130,000, or 7% due largely to growth in
the number of customers served. General and administrative expenses increased
$358,000 or 10% due to the Company's expanded operations. Other operating
expenses increased $995,000 or 34% due to increased cable television expenses
from the Spectrum systems. Consolidated operating income increased $893,000 or
9%.
Interest expenses increased $518,000. The biggest factor in the interest
expense increase was the lack of patronage dividends on interest paid to St.
Paul Bank. This dividend was $694,000 in 1997, and the Company had anticipated a
similar dividend in 1998. However, St. Paul Bank has substantial loan exposures
in the agricultural economy, and poor performance by that economy during the
third and fourth quarters of 1998 prevented the payment of patronage dividends
at anticipated rates. The Company also had interest on new borrowings to finance
the acquisitions of Felton and the Spectrum cable systems. This was offset to
some degree by interest reductions on convertible debentures that were retired
or converted into common stock in the second and third quarters of 1998.
Income from partnership and LLC investments decreased $425,000 from 1997.
Income from Midwest Wireless LLC increased $298,000 to $1,508,000, due to
continuing growth in the number of customers using cellular services. Income
from the Sioux Falls, South Dakota MSA prior to its sale was $334,000 compared
to $377,000 for all of 1997. Losses from the Company's Wireless North PCS
investment totaled $1,066,000 compared to $435,000 in 1997. While the Company
anticipated substantial losses from this operation's start-up phase, it is
concerned that anticipated future capital investments may be inadequate to
finance Wireless North's expansion plans. Accordingly, the Company and its
fellow investors are reviewing Wireless North's business plans with the goal of
reducing operating losses and attracting more investment capital to the
operation.
Investment income declined $17,000. Alliance had gains on sales of
marketable securities totaling $965,000 in 1998. Alliance continues to hold a
significant portfolio of marketable securities. In December, 1998, Alliance sold
its 12.25% interest in a cellular telephone partnership serving the Sioux Falls,
South Dakota MSA to CommNet Cellular, Inc. for $6,725,000. Alliance's gain on
the sale before income taxes was $4,817,000. Hector had gains on marketable
securities sales of $1,496,000 in 1997.
Income before income taxes increased 66% to $10,606,000. The Company's
effective income tax rate of 46.7% is higher than the standard U.S. tax rate due
to state income taxes and the effect of nondeductible amortization expenses
associated with the acquisition of Ollig Utilities. Income before minority
interest increased 61% to $5,657,000. Minority interest on earnings of Alliance
were $1,747,000 compared to $798,000 in 1997. Net income increased 44% to
$3,910,000.
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 Hector.
<TABLE>
<CAPTION>
Alliance
Year Ended Eight Months Ended Hector
December 31 December 31 Year Ended December 31
1997 1996 1997 1996
------------ ------------ ------------- ------------
<S> <C> <C> <C> <C>
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
============ ============ ============= ============
</TABLE>
16
<PAGE>
Revenues from Hector'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.
Consolidated 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. <TABLE> <CAPTION>
Alliance
Year Ended Eight Months Ended Hector
December 31 December 31 Year Ended December 31
1997 1996 1997 1996
------------ ------------ ------------- ------------
<S> <C> <C> <C> <C>
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
============ ============= ============= ============
</TABLE>
Operating costs and expenses for Hector'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 Hector 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.
Liquidity and Capital Resources
- -------------------------------
Cash flows from consolidated operating activities were $9,623,000,
$8,365,000 and $7,064,000 in 1998, 1997, and 1996, respectively. At December 31,
1998, the Company's total cash, cash equivalents, temporary cash investments and
marketable securities totaled $23,241,000 compared to $18,241,000 at December
31, 1997. Alliance's cash and securities were $18,908,000 of this total. Working
capital at December 31, 1998 was $6,554,000 compared to $8,504,000 at December
31, 1997. The current ratio was 1.5 to 1.
17
<PAGE>
Effective April 1, 1998, Alliance acquired all the outstanding common
stock of Felton Telephone Company ("Felton"); a rural telephone company located
in northwestern Minnesota adjacent to areas already served by the Company's
telephone subsidiaries. Felton serves approximately 700 access lines and holds a
significant portfolio of marketable securities, including investments in Rural
Cellular Corporation, U.S. West Communications, Inc. and MediaOne Group, Inc.
Purchase price was $3,650,000, which includes a cash downpayment and seller
financing of the balance through a $3,149,000 note payable bearing interest at
8.25%. The note matures April 1, 2005.
Effective June 9, 1998, Alliance acquired the assets of 8 cable
television systems serving 4,000 customers in 19 rural communities in Minnesota
and North Dakota from Spectrum Cablevision Limited Partnership ("Spectrum").
Several of these communities are also served by Alliance's telephone
subsidiaries. Purchase price was approximately $4,572,000. Financing for this
purchase included $2,000,000 from a new line of credit arrangement with Rural
Telephone Finance Cooperative. In September 1996, Hector acquired two additional
cable systems serving 320 subscribers for $319,000. In 1997, Alliance acquired
one small system for $120,000.
On April 25, 1996, Alliance 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 7.5%. The
outstanding balance on this loan at December 31, 1998 was $50,525,000.
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
1998, as a condition of maintaining its loan, the Company invested an additional
$509,000 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 $3,258,000 at December 31, 1998.
In 1996, the Company borrowed $6,000,000 from St. Paul Bank to help
finance its $16,903,000 cash investment in Alliance. In 1997, the Company repaid
principal of $2,000,000 on the loan and converted the remaining balance into a
five-year term loan. In 1998, the Company refinanced the loan with a 15-year
term loan from Rural Telephone Finance Cooperative.
The Company makes periodic improvements to its facilities to provide
up-to-date services to its telephone and cable television customers. LEC
subsidiaries serve its telephone customers with a 100%-digital switching network
and almost 100% buried outside plant. Hector's plant additions in 1998, 1997 and
1996 were $2,652,000, $2,316,000 and $2,268,000, respectively. Alliance's plant
additions in 1998, 1997 and 1996 were $5,163,000 (excluding the acquisitions of
Felton and Spectrum), $2,379,000 and $2,901,000, respectively. Plant additions
for 1999 for Hector and Alliance are expected to total $3,237,000 and
$3,245,000, respectively, and will provide customers with additional advanced
switching services, upgrade the telephone switching system to Year 2000
compliance and expand usage of high capacity fiber optics in the telephone
network.
Hector's LEC subsidiaries have used loans from the Rural Utilities
Service ("RUS") and the Rural Telephone Bank ("RTB") to help finance asset
additions. Proceeds from long-term borrowings from RUS and RTB were $737,000,
$2,026,000, and $411,000 in 1998, 1997 and 1996, respectively. The average
interest rate on outstanding RUS and RTB loans is 5.6%. Substantially all of the
LEC's assets are pledged or are subject to mortgages to secure obligations 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. At December 31, 1998 unadvanced loan commitments from the RUS and RTB
to Hector's and Alliance's LEC subsidiaries totaled $17,552,000.
18
<PAGE>
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 1998, Alliance received $1,820,000 from sales of interests in
Rural Cellular Corporation, MediaOne Group, Inc., Comnet Cellular, Inc. and
Illuminet, Inc. In 1997, Hector sold 161,469 shares of Rural Cellular
Corporation for $1,728,000. In 1996, Hector 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. Hector also received $554,000
from 61,133 shares of Rural Cellular Corporation sold in that company's initial
public offering of its common stock in February 1996. At December 31, 1998,
Alliance continued to maintain a significant marketable securities portfolio
consisting primarily of shares of Rural Cellular Corporation, U.S. West
Communications, Inc. and MediaOne Group, Inc. owned by Ollig Utilities Company
and Felton Telephone Company prior to their acquisition by the Alliance.
In December, 1998, the Company sold its 12.25% interest in Sioux Falls
Cellular, Ltd., which provides cellular service in the Sioux Falls, South Dakota
MSA to CommNet Cellular, Inc. for $6,725,000. The Company continued to maintain
its ownership in Midwest Wireless through acquisition of additional partnership
interests. Cash expended to purchase Midwest Wireless interests was $380,000 in
1998, increasing the Company's total ownership percentage to 10%.
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 cash of $761,000 in Wireless North
in 1998. Investments in Wireless North in 1997 and 1996 consisted of $510,000 of
cash and debt guarantees of $1,373,000. The PCS systems are in start-up mode and
have incurred significant losses to date. The Company has committed to providing
$664,000 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.
Acquisitions
- ------------
The Company is always looking to acquire properties that advance its plan
to be a provider of top quality telecommunications services to rural customers.
In 1998, the Company acquired Felton Telephone Company and eight cable
television systems from Spectrum Cablevision Limited Partnership. The Company is
currently a member of investor groups seeking to acquire rural telephone
properties expected to be offered for sale by GTE and U.S. West Communications
in 1999. The Company cannot predict if it will be successful in acquiring
additional properties, nor does it have financing in place for possible
acquisitions.
Effects of Inflation
- --------------------
The Company's local exchange telephone companies are subject to the
jurisdiction of Minnesota, Iowa, South Dakota and Wisconsin regulatory
authorities with respect to a variety of matters, including rates for intrastate
access services, the conditions and quality of service, issuance of debt,
depreciation rates and accounting methods. Rates for local telephone service are
not established directly by regulatory authorities, but their authority over
other matters limits the Company's ability to implement rate increases. In
addition, the regulatory process inherently restricts the Company's ability to
immediately pass cost increases along to customers unless the cost increases are
anticipated and the rate increases implemented prospectively.
Year 2000 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 that may be subject to this error.
19
<PAGE>
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 relies on switching equipment and software provided by
Nortel, Inc. and does not itself have the technical expertise required to make
all the necessary hardware and software corrections required to bring its system
into Year 2000 compliance. It has contracted with Nortel, Inc. to upgrade its
equipment to Year 2000 compliance. It is the Company's understanding that
Nortel, Inc. has completed testing of the new software and hardware and that no
additional action related to this problem will be required when installation is
complete. Estimated cost is $658,000. The Company began upgrading its central
office equipment and related software to Year 2000 compliance in the third
quarter of 1998. Installation and testing of all the new hardware and software
interconnections is expected to be completed in November 1999.
The Company's billing, accounting and management information systems
utilize software provided by Martin and Associates. The Company believes this
software to be Year 2000 compliant.
At the present time, the Company does not expect Year 2000 problems to
cause any interruption of service to customers or cause material disruptions to
its own operations. The Company is in constant contact with its equipment
supplier and with management and service personnel of other telephone service
providers and affected customers as the upgrade and integration process moves
forward. The Company also plans to have additional personnel available as
required to address any new Year 2000 problems that arise. The Company does not
expect Year 2000 problems to cause any loss of service to customers, but will
continue to monitor the situation and modify its business plans and procedures
as the situation warrants.
New Accounting Standards
- ------------------------
Effective January 1, 1998, the Company adopted the provisions of
Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive
Income". This statement establishes standards for reporting and presenting
comprehensive income and its components in the financial statements. The Company
has adjusted the presentation of its financial statements for earlier periods to
comply with the standard. Adoption of the standard resulted in the addition of
the change in unrealized marketable securities gains and losses to the Company's
results of operations.
Effective January 1, 1998, the Company adopted the provisions of
Statement of Financial Accounting Standards No. 131, "Disclosures about Segments
of an Enterprise and Related Information". This statement revises the standards
for the way public enterprises report financial and descriptive information
about operating segments in financial statements. Adoption of this standard had
no material effect on the Company's results of operations or financial position,
but did change the disclosure of segment information contained elsewhere in this
report to more closely reflect the Company's management and ownership structure
(Note 11).
In June 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative
Instruments and Hedging Activities" which is effective January 1, 2000. SFAS 133
requires companies to record derivatives on the balance sheet as assets or
liabilities, measured at fair value. Gains or losses resulting from changes in
the values of those derivatives would be accounted for depending on the use of
the derivative and whether it qualifies for hedge accounting. The Company does
not believe the new standard will have a material effect on its financial
position or results of operations.
20
<PAGE>
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, Year 2000 problems, 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 29, 1999 Chief Financial Officer
21
<PAGE>
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, 1998 and 1997 and
the related consolidated statements of income and comprehensive income,
stockholders' equity, and cash flows for each of the three years in the period
ended December 31, 1998. 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, 1998 and 1997 and
the results of their operations and their cash flows for each of the three years
in the period ended December 31, 1998 in conformity with generally accepted
accounting principles.
/s/ Olsen Thielen & Co., Ltd.
- -----------------------------
Olsen Thielen & Co., Ltd.
February 17, 1999
St. Paul, Minnesota
22
<PAGE>
<TABLE>
<CAPTION>
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
ASSETS
December 31
-----------------------------------
1998 1997
-------------- --------------
CURRENT ASSETS:
<S> <C> <C>
Cash and cash equivalents $ 14,686,034 $ 12,455,399
Temporary cash investments 300,000
Construction fund (Note 6) 200,491 77,690
Accounts receivable (net of allowance for doubtful accounts of
$234,000 and $5,000, respectively) 4,140,992 4,003,184
Materials, supplies and inventories, at average cost 528,839 542,681
Prepaid expenses 180,134 216,351
-------------- --------------
TOTAL CURRENT ASSETS 19,736,490 17,595,305
PROPERTY, PLANT AND EQUIPMENT,net (Notes 1 and 5) 50,810,464 45,927,153
OTHER ASSETS:
Excess of cost over net assets acquired, less amortization
of $4,890,000 and $3,391,000 (Note 1) 53,003,560 51,169,677
Marketable securities (Note 3) 8,555,336 5,485,698
Wireless telephone investments (Note 4) 9,482,902 10,680,655
Other investments (Notes 1 and 6) 8,259,419 7,231,868
Deferred debenture issue costs (Note 6) 371,311 780,089
Other assets (Note 1) 460,305 420,511
-------------- --------------
TOTAL OTHER ASSETS 80,132,833 75,768,498
-------------- --------------
TOTAL ASSETS $ 150,679,787 $ 139,290,956
============== ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Notes payable and current portion of long-term debt (Note 6) $ 6,808,500 $ 4,770,000
Accounts payable (Note 10) 2,473,526 1,591,546
Accrued expenses 1,945,687 2,247,972
Income taxes payable 1,955,153 481,831
-------------- --------------
TOTAL CURRENT LIABILITES 13,182,866 9,091,349
LONG-TERM DEBT, less current portion (Note 6) 94,232,389 97,793,195
DEFERRED INVESTMENT TAX CREDITS (Note 7) 252,601 381,180
DEFERRED INCOME TAXES (Note 7) 8,510,637 7,594,092
DEFERRED COMPENSATION (Note 9) 990,155 940,425
COMMITMENTS AND CONTINGENCIES (Note 4)
MINORITY INTEREST IN ALLIANCE TELECOMMUNICATIONS, CORP. 10,790,818 9,043,593
STOCKHOLDERS' EQUITY: (Notes 1, 6 and 8)
Preferred stock, par value $1.00 per share; 3,000,000 shares authorized:
Convertible Series A, 342,800 and 378,100 shares issued and outstanding 342,800 378,100
Common stock, par value $.01 per share; 10,000,000 shares authorized;
2,661,062 and 2,079,364 shares issued and outstanding 26,611 20,794
Additional paid-in capital 6,326,441 1,712,954
Retained earnings 15,636,764 11,726,521
-------------- --------------
22,332,616 13,838,369
Unearned employee stock ownership shares (69,724)
Accumulated other comprehensive income (Note 3) 387,705 678,477
-------------- --------------
TOTAL STOCKHOLDERS' EQUITY 22,720,321 14,447,122
-------------- --------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 150,679,787 $ 139,290,956
============== ==============
See notes to consolidated financia statements.
</TABLE>
23
<PAGE>
<TABLE>
<CAPTION>
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
Year Ended December 31
---------------------------------------------------
1998 1997 1996
------------- ------------- -------------
REVENUES:
<S> <C> <C> <C>
Local network $ 5,290,811 $ 4,866,247 $ 3,682,129
Network access 17,709,921 16,738,108 11,534,882
Billing and collection 865,767 1,030,182 881,614
Nonregulated activities 4,773,367 3,838,422 2,690,255
Cable television revenues 3,198,828 2,393,406 1,868,641
------------- ------------- -------------
TOTAL REVENUES 31,838,694 28,866,365 20,657,521
COSTS AND EXPENSES:
Plant operations 3,755,312 3,630,830 2,707,885
Depreciation and amortization 7,781,210 7,309,730 5,427,785
Customer operations 1,803,668 1,674,111 1,190,941
General and administrative 3,951,169 3,593,121 2,763,207
Other operating expenses 3,900,448 2,905,165 1,976,050
------------- ------------- -------------
TOTAL COSTS AND EXPENSES 21,191,807 19,112,957 14,065,868
------------- ------------- -------------
OPERATING INCOME 10,646,887 9,753,408 6,591,653
OTHER INCOME (EXPENSES):
Interest expense (7,315,153) (6,797,354) (5,399,617)
Partnership and LLC income (Note 4) 883,096 1,308,346 502,837
Investment income 609,071 625,582 691,215
Gain on sale of marketable securities (Note 3) 965,069 1,495,999 687,947
Gain on sale of cellular partnership (Note 4) 4,817,498
------------- ------------- -------------
OTHER EXPENSES, net (40,419) (3,367,427) (3,517,618)
------------- ------------- -------------
INCOME BEFORE INCOME TAXES 10,606,468 6,385,981 3,074,035
INCOME TAX EXPENSE (Note 7) 4,949,000 2,867,000 1,540,000
------------- ------------- -------------
INCOME BEFORE MINORITY INTEREST 5,657,468 3,518,981 1,534,035
MINORITY INTEREST IN EARNINGS OF
ALLIANCE TELECOMMUNICATIONS CORPORATION 1,747,225 798,228 325,365
------------- ------------- -------------
NET INCOME 3,910,243 2,720,753 1,208,670
------------- ------------- -------------
OTHER COMPREHENSIVE INCOME:
Unrealized holding gains on marketable securities 492,287 1,754,213 1,465,455
Reclassification adjustment for gains included in net income (965,069) (1,495,999) (687,947)
------------- ------------- -------------
OTHER COMPREHENSIVE INCOME (LOSS) BEFORE
INCOME TAXES (472,782) 258,214 777,508
------------- ------------- -------------
Income tax expense related to unrealized holding gains
on marketable securities 189,519 752,667 464,521
Income tax benefit related to reclassification adjustment for
gains included in net income (371,529) (641,877) (218,066)
------------- ------------- -------------
Income tax expense (benefit) related to items of other
comprehensive income (182,010) 110,790 246,455
------------- ------------- -------------
Other Comprehensive Income (Loss) (290,772) 147,424 531,053
------------- ------------- -------------
COMPREHENSIVE INCOME $ 3,619,471 $ 2,868,177 $ 1,739,723
============= ============= =============
BASIC NET INCOME PER COMMON SHARE (Note 1) $ 1.63 $ 1.44 $ .65
============= ============= =============
DILUTED NET INCOME PER COMMON SHARE (Note 1) $ 1.15 $ .93 $ .53
============= ============= =============
AVERAGE SHARES OUTSTANDING (Notes 1 and 8):
Common shares only 2,403,000 1,893,000 1,870,000
Common and potential common shares 3,937,000 3,732,000 3,694,000
See notes to consolidated financial statements.
</TABLE>
24
<PAGE>
<TABLE>
<CAPTION>
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Unearned Accumulated
Preferred Stock Common Stock Additional Employee Other
----------------- ------------------ Paid-in Retained Stock Owner- Comprehensive
Shares Amount Shares Amount Capital Earnings ship Shares Income Total
-------- -------- --------- --------- ----------- ------------ ----------- ---------- -----------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
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
Change in unrealized gains on
marketable securities, net
of deferred taxes 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
Change in unrealized gains on
marketable securities, net
of deferred taxes 147,424 147,424
-------- -------- --------- --------- ----------- ------------ ----------- ---------- -----------
BALANCE AT DECEMBER 31, 1997 378,100 378,100 2,079,364 20,794 1,712,954 11,726,521 (69,724) 678,477 14,447,122
Net income 3,910,243 3,910,243
Issuance of common stock under
Employee Stock Purchase Plan 10,753 107 73,013 73,120
Issuance of common stock under
Employee Stock Option Plan 48,200 482 354,931 355,413
Issuance of common stock in
exchange for preferred stock (35,300) (35,300) 35,300 353 34,947 0
Issuance of common stock from
exercise of outstanding
warrants 7,876 79 61,091 61,170
Conversion of convertible
debentures into common stock 479,569 4,796 4,096,134 4,100,930
ESOP Shares Allocated (6,629) 69,724 63,095
Change in unrealized gains on
marketable securities, net
of deferred taxes (290,772) (290,772
-------- -------- --------- --------- ----------- ------------ ----------- ---------- -----------
BALANCE AT DECEMBER 31, 1998 342,800 $342,800 2,661,062 $ 26,611 $ 6,326,441 $ 15,636,764 $ - $ 387,705 $22,720,321
======== ======== ========= ========= =========== ============ =========== ========== ===========
See notes to consolidated financial statements.
</TABLE>
25
<PAGE>
<TABLE>
<CAPTION>
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31
----------------------------------------------
1998 1997 1996
------------ ------------ -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
<S> <C> <C> <C>
Net Income $ 3,910,243 $ 2,720,753 $ 1,208,670
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization 7,957,527 7,500,078 5,617,722
Minority stockholders' interest in earnings
of Alliance Telecommunications Corporation 1,747,225 798,228 325,365
Gain on sales of marketable securities (965,069) (1,495,999) (687,947)
Gain on sale of wireless partnership investment (4,817,498)
Income from partnership and LLC investments (883,096) (1,308,346) (502,837)
Proceeds from wireless telephone investments 1,206,505 792,622 437,371
Noncash patronage refunds (661,923) (220,662)
Changes in assets and liabilities net of effects from
the purchase of Ollig Utilities, Inc. and Felton Telephone Company:
Decrease in marketable securities 1,499,072
Increase in accounts receivable (37,845) (37,430) (408,601)
Decrease (increase) in materials, supplies and inventories 21,188 (30,567) 75,557
Decrease (increase) in prepaid expenses 46,455 (56,060) (6,057)
Increase (decrease) in accounts payable 866,321 (269,033) (585,734)
Increase (decrease) in accrued expenses (193,287) 157,333 708,528
Increase (decrease) in income taxes payable 1,455,010 422,816 (615,843)
Decrease in deferred investment tax credits (136,016) (145,167) (129,000)
Increase (decrease) in deferred income taxes (604,706) 25,394 380,000
Increase (decrease) in deferred compensation 49,730 (47,519) (31,679)
------------ ------------ -----------
Net cash provided by operating activities 9,622,687 8,365,180 7,063,925
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property, plant and equipment (9,716,135) (4,695,301) (5,168,997)
Sales of temporary cash investments 300,000 779,900 94,806
Sales of marketable securities 1,819,653 1,728,115 553,645
Purchases of wireless telephone investments (1,140,457) (98,933) (250,000)
Decrease (increase) in construction fund (122,801) (3,353) 100,393
Purchases of other investments (1,083,592) (1,193,105) (1,274,443)
Proceeds from sale of wireless partnership investment 6,725,140
Proceeds from other investments 114,536 27,667 29,911
Increase in excess of cost over net assets acquired (2,797,123) (61,107) (88,517)
Decrease (increase) in other assets (62,012) 12,534 107,198
Increase in cash from purchase of Felton Telephone Company 196,500
Payment for purchase of Ollig Utilities Company,
net of cash acquired (69,189,692)
------------ ------------ -----------
Net cash used in investing activities (5,766,291) (3,503,583) (75,085,696)
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of notes payable and long-term debt (8,911,738) (5,637,184) (2,607,031)
Proceeds from issuance of notes payable and long-term debt 6,733,179 2,026,000 63,168,775
Minority interest in Alliance Telecommunications Corporation 7,920,000
Issuance of common stock 489,703 1,575,107 21,768
ESOP shares allocated 63,095 58,000 50,000
------------ ------------ -----------
Net cash provided by (used in) financing activities (1,625,761) (1,978,077) 68,553,512
------------ ------------ -----------
NET INCREASE IN CASH AND CASH EQUIVALENTS 2,230,635 2,883,520 531,741
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 12,455,399 9,571,879 9,040,138
------------ ------------ -----------
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 14,686,034 $ 12,455,399 $ 9,571,879
============ ============ ===========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Interest paid $ 7,096,930 $ 7,316,215 $ 4,974,256
Income taxes paid 4,262,666 2,564,157 1,890,825
See notes to consolidated financial statements.
</TABLE>
26
<PAGE>
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 five local exchange telephone companies,
two cable television companies, an engineering company, and a credit card
communications company. At December 31, 1998, the Company's wholly and majority
owned subsidiaries provided telephone service to 34,700 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, 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).
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 at the balance
sheet date, and the reported amounts of revenues and expenses during the
reporting period. 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. 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.
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 $6,260,624, $5,807,103 and
$4,305,212 for 1998, 1997 and 1996, respectively. Maintenance and repairs are
charged to operations and additions or betterments are capitalized. Items of
property sold, retired or otherwise disposed of are removed from assets and any
gains or losses are included in accumulated depreciation.
Wireless telephone investments: The Company has significant investments in
Midwest Wireless, LLC and Wireless North, LLC. The Company is the largest
shareholder of Midwest Wireless, LLC and the second largest shareholder of
Wireless North, LLC and has the ability to influence the operating and financial
policies of these companies. The Company recognizes income and losses from these
investments on the equity method of accounting. Income and losses recognized
from these investments are material to the Company's operating results.
Other assets: The excess of cost over net assets of subsidiaries acquired in
purchase transactions is being amortized on the straight-line method over
periods ranging from fifteen to forty years. Amortization included in costs and
expenses was $1,499,456, $1,401,889 and $961,981 in 1998, 1997 and 1996,
respectively.
Deferred debenture issue costs are the underwriting, legal and accounting fees
incurred by the Company in completing its February, 1995 public offering of
convertible subordinated debentures. The debenture issue costs are being
amortized over the seven-year life of the debentures (Note 6). Amortization cost
included in interest expense was $176,317, $189,112 and $189,112 in 1998, 1997
and 1996, respectively. When debentures are converted into common stock, any
remaining issue costs are charged to capital. $233,549 of debenture issue costs
was charged to capital in 1998. Accumulated amortization was $460,425 and
$543,698 at December 31, 1998 and 1997, respectively.
27
<PAGE>
Other investments consist of Rural Telephone Bank stock, Minnesota Equal Access
Network Services, Inc. stock, St. Paul Bank for Cooperatives stock, and
investments in stock companies and partnerships of other telecommunications
service providers. Long-term investments in companies that are not intended for
resale or are not readily marketable are valued at cost, which does not exceed
net realizable value. Investments in joint ventures, 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 operating
income or losses from the respective operations.
Other assets are cable television franchises owned by the Company and other
deferred charges. Amortization included in expenses was $21,130, $100,738 and
$161,417 for 1998, 1997 and 1996, respectively.
Financial instruments: The fair value of the Company's financial instruments
approximates carrying value except for long-term investments in other companies
and long-term debt payable to the Rural Utilities Service ("RUS") and Rural
Telephone Bank ("RTB"). Other long-term investments are not intended for resale
and not readily marketable, thus a reasonable estimate of fair value is not
practicable. The fair value of long-term debt owed to RUS and RTB was
$31,183,000 and $30,215,000 at December 31, 1998 and 1997, respectively. Fair
values were estimated based on current rates offered to the Company for debt
with similar terms and maturities.
Revenue recognition: Revenues are recognized when earned, regardless of the
period in which they are billed. Network access revenues are furnished in
conjunction with interexchange carriers and are determined by cost separation
studies and nationwide average schedules. Revenues include estimates pending
finalization of cost studies. Network access revenues are based upon interstate
tariffs filed with the Federal Communications Commission by the National
Exchange Carriers Association and state tariffs filed with state regulatory
agencies. Management believes recorded revenues are reasonable based on
estimates of final cost separation studies, which are typically settled within
two years.
Income taxes and investment tax credits: The provision for income taxes consists
of an amount for taxes currently payable and a provision for tax consequences
deferred to future periods. For financial statement purposes, deferred
investment tax credits are being amortized as a reduction of the provision for
income taxes over the estimated useful lives of the related property, plant and
equipment.
Net income per share: 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.
Statement of cash flows: The Company considers temporary cash investments with
an original maturity of three months or less to be cash equivalents. During
1998, the Company issued two separate calls to retire outstanding convertible
debentures. As a result of these calls, $4,264,000 of debentures was converted
into common stock in noncash transactions.
New accounting principles: Effective January 1, 1998, the Company adopted the
provisions of Statement of Financial Accounting Standards No. 130, "Reporting
Comprehensive Income". This statement establishes standards for reporting and
presenting comprehensive income and its components in the financial statements.
The Company has adjusted the presentation of its financial statements for
earlier periods to comply with the standard. Adoption of the standard resulted
in the addition of the change in unrealized marketable securities gains and
losses to the Company's results of operations.
Effective January 1, 1998, the Company adopted the provisions of Statement of
Financial Accounting Standards No. 131, "Disclosures about Segments of an
Enterprise and Related Information". This statement revises the standards for
the way public enterprises report financial and descriptive information about
operating segments in financial statements. Adoption of this standard had no
material effect on the Company's results of operations or financial position,
but did change the disclosure of segment information contained elsewhere in this
report to more closely reflect the Company's management and ownership structure
(Note 11).
28
<PAGE>
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative
Instruments and Hedging Activities" which is effective January 1, 2000. SFAS 133
requires companies to record derivatives on the balance sheet as assets or
liabilities, measured at fair value. Gains or losses resulting from changes in
the values of those derivatives would be accounted for depending on the use of
the derivative and whether it qualifies for hedge accounting. The Company does
not believe the new standard will have a material effect on its financial
position or results of operations.
Basis of presentation: Certain amounts in the 1996 and 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 - ACQUISITIONS.
Effective April 1, 1998, Alliance Telecommunications Corporation acquired all
the outstanding common stock of Felton Telephone Company ("Felton"); a rural
telephone company located in northwestern Minnesota adjacent to areas already
served by the Company's telephone subsidiaries. Felton serves approximately 700
access lines and holds a significant portfolio of marketable securities,
including investments in Rural Cellular Corporation, U.S. West Communications,
Inc. and MediaOne Group, Inc. Purchase price was $3,650,000, which includes a
cash downpayment and seller financing of the balance through a $3,149,000 note
payable bearing interest at 8.25%. The note matures April 1, 2005. The
acquisition is being accounted for as a purchase. Excess of cost over net assets
acquired in the transaction was $536,000, which is being amortized on a
straight-line basis over 40 years. The operations of Felton, which were not
material to the Company's financial statements, are included in the Company's
financial results from the purchase date. In the acquisition, the following
assets were acquired and liabilities assumed:
Property, plant and equipment $ 1,427,800
Excess of cost over net assets acquired 536,215
Marketable securities 4,363,854
Long-term debt (1,770,895)
Deferred taxes and credits (1,709,976)
Other assets and liabilities 803,002
-----------------
Total purchase price 3,650,000
Less notes payable issued to seller (3,149,358)
Less cash and cash equivalents acquired (590,944)
Less deposits and acquisition costs paid in 1997 (106,198)
-----------------
Increase in cash from purchase of Felton
Telephone Company $ 196,500
=================
Effective June 9, 1998, Alliance acquired the assets of 8 cable television
systems from Spectrum Cablevision Limited Partnership ("Spectrum"). These
systems serve 4,000 cable television customers in 19 rural communities in
Minnesota and North Dakota, including several communities also served by the
Company's telephone subsidiaries. Purchase price was approximately $4,572,000.
The acquisition is being accounted for as a purchase. Excess of cost over net
assets acquired in the transaction was $2,797,000, which is being amortized over
15 years on a straight-line basis. The operations of the cable systems, which
were not material to the Company's financial statements, are included in the
Company's financial results from the purchase date.
29
<PAGE>
Effective April 25, 1996, Alliance purchased Ollig Utilities Company ("Ollig")
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 debt financing provided by St. Paul Bank for
Cooperatives ("St. Paul Bank"). The Company's cash investment in Alliance was
approximately $16,903,000. The acquisition was accounted for as a purchase. The
excess of cost over net assets acquired in the transaction was $51,948,000
(including $6,272,000 allocated to wireless telephone investments) which is
being amortized on a straight line basis over 40 years. The results of
operations of Ollig have been included in the Company's financial results
subsequent to April 25, 1996.In the acquisition, the following assets were
acquired and liabilities assumed:
Property, plant and equipment $ 31,566,292
Excess of cost over net assets acquired 52,404,243
Wireless telephone investments 8,704,392
Marketable securities 4,334,814
Long-term debt (23,023,316)
Deferred credits (7,028,096)
Other assets and liabilities 13,041,671
-----------------
Total purchase price 80,000,000
Acquisition costs 72,730
-----------------
Total acquisition expenditures 80,072,730
Less cash and cash equivalents acquired (8,092,802)
Less deposits and acquisition costs paid in 1995 (2,790,236)
------------------
Payment for purchase of Ollig Utilities
Company, net of cash acquired $ 69,189,692
=================
NOTE 3 - MARKETABLE SECURITIES AND GAINS ON SALES OF INVESTMENTS
Marketable securities consist principally of equity securities of other
telecommunications companies obtained by the Company's subsidiaries in sales of
investments in wireless telephone partnerships. The acquisition of Felton
Telephone Company included a substantial portfolio of marketable securities of
this type. The Company's marketable securities portfolio was classified as
available-for-sale at December 31, 1998 and December 31, 1997. The cost and fair
values of available-for-sale investment securities was as follows:
<TABLE>
<CAPTION>
Gross Gross
Unrealized Unrealized Fair
Cost Gains Losses Value
--------------- -------------- -------------- --------------
<S> <C> <C> <C> <C>
December 31, 1998 $ 7,792,397 $ 1,949,794 $ (1,386,855) $ 8,555,336
December 31, 1997 4,449,976 1,035,722 - 5,485,698
</TABLE>
Net unrealized gains on marketable securities, net of related deferred taxes,
are included in stockholders' equity as accumulated other comprehensive income
at December 31, 1998 and 1997 as follows: <TABLE> <CAPTION>
Net Deferred Accumulated
Unrealized Income Comprehensive
Gains Taxes Income
-------------- -------------- ---------------
<S> <C> <C> <C>
December 31, 1998 $ 562,939 $ (175,235) $ 387,705
December 31, 1997 1,035,722 (357,245) 678,477
</TABLE>
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 $1,820,000,
$1,728,000 and $554,000 in 1998, 1997 and 1996, respectively. Gross realized
gains on sales of these securities were $965,000, $1,496,000 and $485,000 in
1998, 1997 and 1996, respectively. Realized gains on sales are based on the
difference between net sales proceeds and the book value of the securities sold,
using the specific identification method.
Gross proceeds from sales of securities in 1996, which were classified as
trading securities at December 31, 1995, were $1,499,000. Gross realized gains
on these sales were $203,000 in 1996.
30
<PAGE>
NOTE 4 - WIRELESS TELEPHONE INVESTMENTS
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 December 31,
1998, the Company owned 10.00% of Midwest Wireless Communications LLC, which
provides cellular service to the former RSA partnership areas in southern
Minnesota and the Rochester, Minnesota MSA. Income from this investment, net of
associated amortization expense, was $1,508,000, $1,210,000 and $391,000 in
1998, 1997 and 1996, respectively. Cash distributions received from Midwest
Wireless were $848,000, $397,000 and $203,000 in 1998, 1997 and 1996,
respectively. The excess of cost over the Company's share of equity in Midwest
Wireless, net of amortization reserves, was $5,990,000 and $5,818,000 at
December 31, 1998 and 1997, respectively. Excess cost is being amortized on the
straight-line method over forty years. Amortization expense was $158,000,
$151,000 and $105,000 in 1998, 1997 and 1996, respectively. At December 31,
1998, the Company's cumulative share of income from Midwest Wireless was
$3,406,000, of which $2,155,000 was undistributed.
The Company owns 13.06% of Wireless North, a consortium of three limited
partnerships and one LLC with licenses to provide personal communications
services in Minnesota, Wisconsin, North Dakota and South Dakota. At December 31,
1998, the Company had invested $1,271,000 of cash and guaranteed debt of
$1,373,000 in Wireless North. Its PCS systems are in start-up mode and have not
been profitable to date. Losses were $1,066,000, $435,000 and $73,000 in 1998,
1997 and 1996, respectively. The Company has committed to providing $664,000 of
additional capital to these entities. It cannot predict if additional funding
beyond this amount will be required.
Summarized audited financial information for these companies for 1998, 1997 and
1996 is as follows:
Year Ended Year Ended Six Months Ended
December 31 December December 31
1998 1997 1996
---------------- --------------- ---------------
Current assets $ 14,894,978 $ 14,361,193 $ 6,211,038
Noncurrent assets 84,844,144 68,816,885 35,243,820
Current liabilities 14,856,061 10,796,036 4,299,058
Noncurrent liabilities 51,090,911 43,117,318 17,393,410
Members' equity 33,792,150 29,264,724 19,762,390
Revenues 50,268,747 40,330,759 17,982,165
Expenses 41,649,381 30,581,537 13,970,615
Net income 8,619,366 9,749,222 4,011,550
In December, 1998, the Company sold its 12.25% interest in Sioux Falls Cellular,
Ltd., which provides cellular service in the Sioux Falls, South Dakota MSA for
$6,725,000 of cash. Gain on the sale was $4,817,000. Income from this investment
prior to the sale, net of associated amortization expense, was $334,000,
$377,000 and $109,000 in 1998, 1997 and 1996, respectively. Amortization expense
was $29,000, $36,000 and $24,000 in 1998, 1997 and 1996, respectively. The
excess of cost over the Company's share of equity in the partnership, net of
amortization reserves, was $1,356,000 at December 31, 1997.
31
<PAGE>
NOTE 5 - PROPERTY, PLANT AND EQUIPMENT
The cost of property, plant and equipment and the estimated useful lives are as
follows:
December 31
Estimated --------------------------------
useful life 1998 1997
----------- ------------ ------------
Land $ 589,560 $ 556,976
Buildings 5-40 years 5,379,836 5,171,387
Machinery and equipment 3-15 years 1,238,040 2,089,598
Furniture and fixtures 5-10 years 2,129,062 471,489
Telephone plant 5-33 years 57,385,560 50,638,166
Cable television plant 10-15 years 8,495,861 6,190,412
Construction in progress 1,027,314 676,535
------------ ------------
76,245,233 65,794,563
Less accumulated depreciation 25,434,769 19,867,410
------------ ------------
$ 50,810,464 $ 45,927,153
============ ============
NOTE 6 - NOTES PAYABLE AND LONG-TERM DEBT
<TABLE>
<CAPTION>
December 31
----------------------------
1998 1997
------------ ------------
Notes payable to St. Paul Bank for Cooperatives, payable by Alliance
Telecommunications Corporation in monthly installments, average interest rate
of 7.5%,
<S> <C> <C>
due 1999 to 2011 $ 50,524,700 $ 53,063,200
Rural Utilities Service ("RUS") and Rural Telephone Ban ("RTB") mortgage notes,
payable by telephone company subsidiaries in monthly and quarterly
installments,
average rate of 5.6%, due 1999 to 2026 33,761,429 32,715,608
Convertible subordinated debentures, payable to
bondholders, interest rate of 8.5%, due 2002 7,948,000 12,650,000
Notes payable to former owners of Felton Telephone
Company, payable by a subsidiary of Alliance Tele-
communications Corporation in monthly installments,
interest rate of 8.25%, due 2005 2,891,908
Notes payable to Rural Telephone Finance Cooperative
In quarterly installments, interest rate of 6.1%, due 2013 3,914,852
Notes payable on line of credit from Rural Telephone
Finance Cooperative, interest rate of 6.7%, due 1999 2,000,000
Note payable to St. Paul Bank for Cooperatives,
interest rate of 8.0% 4,000,000
Notes payable to former cable television system owners,
payable annually by cable television subsidiary,
interest rate of 6% 134,387
------------ ------------
101,040,889 102,563,195
Less current portion 6,808,500 4,770,000
------------ ------------
$ 94,232,389 $ 97,793,195
============ ============
</TABLE>
Substantially all assets of the Company's telephone subsidiaries are pledged as
collateral under the RUS and RTB debt agreements. The telephone company
subsidiaries also have restrictions on distributions of capital to the parent
company relative to their outstanding indebtedness. At December 31, 1998,
$1,300,000 of retained earnings of these subsidiaries was available for dividend
payments to HCC.
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 approximately 7.5%. The Company
made only interest payments on the loan in 1996. Principal payments began in
January 1997 and will continue until March 2011.
32
<PAGE>
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, 1998 and 1997 was
$3,258,000 and $2,749,000, respectively. 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 did not accrue a patronage refund for
1998, and cannot predict what patronage refunds might be in future years.
In 1996, the Company and one of its cable television subsidiaries negotiated a
loan agreement with the St. Paul Bank to provide additional financing for the
acquisition of Ollig Utilities Company. The outstanding loan balance at December
31, 1997 was $4,000,000. In 1998, the Company replaced this loan with a 15-year
term loan from Rural Telephone Financing Cooperative ("RTFC"). Interest rate on
the loan varies according to the rate charged by the Lender for similar loans
(6.1% at December 31, 1998).
In 1998 the Company negotiated a $5,000,000 revolving line of credit from RTFC.
Interest on outstanding borrowings against the credit line is at the bank's
prime rate plus 1.5% (6.7% at December 31, 1998). The Company borrowed
$2,000,000 against the credit line in 1998 to help finance the purchase of
additional cable television systems from Spectrum Cablevision Limited
Partnership. It expects to replace this debt with longer term financing in 1999.
Both the credit line and the term loan are secured by a pledge of the stock of
HCC's wholly owned subsidiaries.
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. As of February 15, 1999, 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 102% of par. During 1998, the Company issued
two separate calls to retire debentures, which resulted in $4,264,000 of
debentures being converted into stock and $438,000 of debentures being purchased
and retired. The debentures include restrictions on payment of dividends to the
Company's shareholders and are subordinated to $4,000,000 of senior indebtedness
owed by the Company to RTFC.
The annual requirements for principal payments on notes payable and long-term
debt are as follows:
1999 $6,808,500
2000 5,165,600
2001 5,512,400
2002 13,814,600
2003 6,236,900
The Company is continuing its construction program to upgrade its telephone and
cable television properties. Planned expenditures for HCC and Alliance
properties in 1999 are $3,237,000 and $3,245,000, respectively. The Company
intends to use RUS and RTB loan funds to help finance these projects. Loan funds
received are deposited in construction fund accounts and disbursements are
restricted, subject to RUS approval, to construction costs authorized by the
loan agreements. The Company has unadvanced loan funds available from RUS and
RTB totaling $17,552,000.
33
<PAGE>
NOTE 7 - INCOME TAXES
Hector Communications Corporation and its wholly owned subsidiaries file a
consolidated tax return separate from the consolidated return for Alliance
Telecommunications Corporation and its subsidiaries. Income tax expenses
(benefits) consist of the following: <TABLE> <CAPTION>
Year Ended December 31
--------------------------------------------------------
1998 1997 1996
----------------- ------------------ -----------------
Currently payable taxes:
<S> <C> <C> <C>
Federal $ 4,445,000 $ 2,305,000 $ 964,000
State 1,244,000 682,000 325,000
----------------- ------------------ -----------------
5,689,000 2,987,000 1,289,000
Deferred income taxes (benefit) (604,000) 25,000 380,000
Deferred investment tax credits (136,000) (145,000) (129,000)
------------------ ------------------- ------------------
$ 4,949,000 $ 2,867,000 $ 1,540,000
================== =================== ==================
</TABLE>
<TABLE>
<CAPTION>
Deferred tax assets and (liabilities) as of December 31 related to the following:
1998 1997
----------------- ------------------
<S> <C> <C>
Accelerated depreciation $ (6,291,637) $ (6,329,092)
Alternative minimum tax credits 69,000 60,000
Marketable securities (2,947,000) (1,824,000)
Deferred compensation 400,000 381,000
Other 259,000 118,000
----------------- ------------------
$ (8,510,637) $ (7,594,092)
================== ===================
</TABLE>
<TABLE>
<CAPTION>
The provision for income taxes varied from the federal statutory tax rate as follows:
Year Ended December 31
--------------------------------------------------------
1998 1997 1996
----------------- ------------------ -----------------
<S> <C> <C> <C>
Tax at U.S. statutory rate 35.0% 35.0% 35.0%
Surtax exemption (1.0) (1.0) (1.0)
State income taxes, net of federal benefit 7.8 7.4 7.5
Excess of cost over net assets acquired 5.1 8.3 12.1 .
Investment tax credits (1.3) (2.3) (4.2)
Other 1.1 (2.5) .7
----------------- ------------------ -----------------
Effective tax rate 46.7% 44.9% 50.1%
================= ================== =================
</TABLE>
NOTE 8 - STOCKHOLDERS' EQUITY
Preferred stock is entitled to share ratably with common shareholders in any
dividends or distributions paid by the Company, but are not entitled to any
dividend distribution separate from common shareholders. Preferred shareholders
have no voting rights. Each share of preferred stock is convertible into one
share of common stock.
Common shares are reserved for issuance in connection with a stock option plan
(1990 Plan) under which 500,000 shares may be issued to key employees. The plan
was effective August 1, 1990 and expires July 31, 2000. The term of the stock
options may not exceed ten years. The exercise price of options issued will not
be less than fair market value at the time of the grant. Another provision of
the 1990 plan automatically grants 1,000 shares of nonqualified stock options
per year to each nonemployee director. Options issued under this provision have
a ten-year term and an exercise price not less than fair market value at date of
grant. At December 31, 1998, 173,975 shares remained available to be issued
under the plan.
A summary of changes in outstanding employee and director stock options during
the three years ended December 31, 1998 is as follows:
34
<PAGE>
Average
Number of exercise price
shares per share
Outstanding at December 31, 1995 201,350 $ 7.12
Granted 48,825 6.67
Canceled (38,000) 6.53
----------------- -------------
Outstanding at December 31, 1996 212,175 7.12
Granted 69,775 7.87
Exercised (9,000) 6.89
Canceled (33,200) 7.69
----------------- -------------
Outstanding at December 31, 1997 239,750 7.27
Granted 74,775 11.50
Exercised (48,200) 6.75
Canceled (300) 7.50
----------------- -------------
Outstanding at December 31, 1998 266,025 $ 8.55
================= =============
At December 31, 1998, 198,583 stock options are currently exercisable. The
following table summarizes the status of stock options outstanding at December
31, 1998:
Weighted Average Weighted
Remaining Average
Range of Exercise Prices Shares Option Life Exercise Price
$ 6.50 to $ 8.50 191,250 2.4 years $ 7.40
$ 10.94 to $12.51 74,775 4.7 years 11.50
Effective August 1, 1990, the 1990 Employee Stock Purchase Plan ("ESPP") was
adopted, for which 100,000 shares were reserved. Under terms of the plan,
eligible employees may acquire shares of common stock through payroll deductions
of not more than 10% of compensation. The price of shares purchased by the
employees is 85% of the lower of fair market value for such shares on one of two
specified dates in each plan year. A participant is limited to the acquisition
in any plan year to the number of shares which their payroll deductions for the
year would purchase based on the market price on the first day of the year or
$25,000, whichever is less. Shares issued to employees under the plan were
10,753, 3,695 and 3,563 for the plan years ended August 31, 1998, 1997 and 1996,
respectively. At December 31, 1998 employees had subscribed to purchase an
additional 16,804 shares in the current plan cycle ending August 31, 1999.
The Company has adopted the disclosure provisions of SFAS No. 123, "Accounting
for Stock-Based Compensation", but applies APB Opinion No. 25, "Accounting for
Stock Issued to Employees" for measurement and recognition of stock-based
transactions with its employees. If the Company had elected to recognize
compensation cost for its stock based transactions using the method prescribed
by SFAS No. 123, net income and earnings per share would have been as follows:
<TABLE>
<CAPTION>
Year Ended December 31
--------------------------------------------------------------
1998 1997 1996
-------------------- -------------------- ------------------
<S> <C> <C> <C>
Net income $ 3,709,988 $ 2,579,427 $ 1,139,265
Basic net income per share $ 1.54 $ 1.36 $ .61
Diluted net income per share $ 1.10 $ .89 $ .51
</TABLE>
The fair value of the Company's stock options and Employee Stock Purchase Plan
transactions used to compute pro forma net income and net income per share
disclosures is the estimated present value at grant date using the Black-Scholes
option-pricing model. The following table displays the assumptions used in the
model.
<TABLE>
<CAPTION>
Year Ended December 31
--------------------------------------------------------------
1998 1997 1996
-------------------- -------------------- ------------------
<S> <C> <C> <C>
Expected volatility 23.3% 21.4% 21.2%
Risk free interest rate 5.6% 6.5% 6.8%
Expected holding period - employees 4 years 4 years 4 years
Expected holding period - directors 7 years 7 years 7 years
Dividend yield 0% 0% 0%
</TABLE>
35
<PAGE>
Pro forma stock-based compensation cost was $200,255, $141,326 and $69,405 in
1998, 1997 and 1996, respectively. Fair value of all options issued was
$271,770, $180,134 and $98,040, in 1998, 1997 and 1996, respectively.
At December 31, 1997, the Company had $12,650,000 (par value) of convertible
subordinated debentures outstanding. 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. During 1998, the Company issued two separate calls that resulted in
$4,264,000 of debentures being converted into common stock and $438,000 of
debentures being retired for cash. At December 31, 1998, $7,948,000 of
debentures remained outstanding. If these remaining debentures were converted
into common stock, they would represent 894,150 additional common shares. The
underwriters of the debenture offering also received warrants to purchase shares
of the Company's common stock at a price of $8.70 per share. In 1998, 7,876
shares were issued upon conversion of warrants. Warrants for 112,140 shares
remain outstanding, are currently exercisable and expire February 15, 2000.
Effective August 1, 1990, the Board of Directors adopted a leveraged employee
stock ownership plan ("ESOP"). Contributions to the ESOP are determined by the
Board on an annual basis and can be made in cash or by issuing shares of the
Company's common stock. ESOP expense reflects the market value of company stock
contributed to the accounts of eligible employees at the time of the
contribution. ESOP expense was $83,000, $60,000 and $50,000 for 1998, 1997 and
1996, respectively. At December 31, 1998, the ESOP held 54,667 shares of the
Company's common stock, all of which had been allocated to the accounts of
participating employees. All eligible employees of Hector Communications
Corporation participate in the plan after completing one year of service.
Employees of Alliance Telecommunications Corporation do not participate in the
plan. Contributions are allocated to each participant based on compensation and
vest 30% after three years of service and incrementally thereafter, with full
vesting after seven years.
NOTE 9 - EMPLOYEE BENEFIT PLANS
The Company has 401(k) savings plans for its employees. Employees who meet
certain age and service requirements may contribute up to 10% of their salaries
to the plan on a pretax basis. The Company matches a portion of employee
contributions. Contributions to the plan by the Company for 1998, 1997 and 1996
were approximately $134,800, $121,400 and $85,700, respectively.
Employees of Alliance Telecommunications Corporation who meet certain age and
service requirements are eligible to participate in a profit sharing plan.
Contributions are determined annually by Alliance's Board of Directors and are
allocated proportionately to the participants in each allocation group.
Contributions to the plan by the Company in 1998, 1997 and 1996 were $177,000,
$166,000 and $128,900, respectively.
Ollig Utilities Company had a deferred compensation agreement with two of its
former officers that the Company has assumed. Under the agreement, the salaries
of these officers were continued after their retirement based on a formula
stated in the agreement. The Company's 1998 expense under the plan was $143,000.
The Company accrued no expense under this agreement in 1997 or 1996. Payments
made under the agreement in 1998, 1997 and 1996 were $93,000, $47,500 and
$31,700, respectively.
NOTE 10 - TRANSACTIONS WITH COMMUNICATIONS SYSTEMS, INC.
Transactions between the Company and Communications Systems, Inc. (CSI), the
Company's former parent, are based on a distribution agreement, which provides
for the Company's use of certain of CSI's staff and facilities, with related
costs paid by the Company. Services provided by CSI aggregated approximately
$300,000, $264,000 and $258,000 in 1998, 1997 and 1996, respectively.
Employees of the Company also participate in a joint self-funded medical
insurance program with employees of CSI. Costs paid by the Company into this
program were $595,000, $535,000, and $157,000 in 1998, 1997 and 1996,
respectively.
Costs of services from CSI may not be indicative of the costs of such services
had they been obtained from a different party. Intercompany accounts with CSI
are handled on an open account basis. Outstanding amounts payable to CSI were
$645,000 and $357,000 at December 31, 1998 and 1997, respectively.
36
<PAGE>
NOTE 11 - SEGMENT INFORMATION
The Company is organized into two business segments: Hector Communications
Corporation and its wholly owned subsidiaries, and Alliance Telecommunications
Corporation and its subsidiaries. No single customer accounted for a material
portion of the Company's revenues in any of the last three years. Segment
information is as follows:
<TABLE>
<CAPTION>
Hector Alliance Consolidated
------------ ------------ ------------
Year Ended December 31, 1998
<S> <C> <C> <C>
Revenues $ 7,886,758 $ 23,951,936 $ 31,838,694
Costs and expenses 5,886,884 15,304,923 21,191,807
------------ ------------ ------------
Operating income 1,999,874 8,647,013 10,646,887
Interest expense (1,835,244) (5,479,909) (7,315,153)
Partnership and LLC income 60,665 822,431 883,096
Investment income 199,094 409,977 609,071
Gain on sale of marketable securities 965,069 965,069
Gain on sale of cellular partnership 4,817,498 4,817,498
------------ ------------ ------------
Income before income taxes $ 424,389 $ 10,182,079 $ 10,606,468
============ ============ ============
Depreciation and Amortization $ 2,068,701 $ 5,712,509 $ 7,781,210
============ ============ ============
Total Assets $ 26,215,059 $124,464,728 $150,679,787
============ ============ ============
Capital Expenditures $ 2,651,776 $ 7,064,359 $ 9,716,135
============ ============ ============
Year Ended December 31, 1997
Revenues $ 7,356,830 $ 21,509,535 $ 28,866,365
Costs and expenses 5,477,058 13,635,899 19,112,957
------------ ------------ ------------
Operating income 1,879,772 7,873,636 9,753,408
Interest expense (2,059,948) (4,737,406) (6,797,354)
Partnership and LLC income 259,050 1,049,296 1,308,346
Investment income 169,878 455,704 625,582
Gain on sale of marketable securities 1,495,999 1,495,999
------------ ------------ ------------
Income before income taxes $ 1,744,751 $ 4,641,230 $ 6,385,981
============ ============ ============
Depreciation and Amortization $ 1,973,699 $ 5,336,031 $ 7,309,730
============ ============ ============
Total Assets $ 25,917,132 $113,373,824 $139,290,956
============ ============ ============
Capital Expenditures $ 2,316,025 $ 2,379,276 $ 4,695,301
============ ============ ============
Year Ended December 31, 1996
Revenues $ 6,961,097 $ 13,696,424 $ 20,657,521
Costs and expenses 5,179,280 8,886,588 14,065,868
------------ ------------ ------------
Operating income 1,781,817 4,809,836 6,591,653
Interest expense (2,001,556) (3,398,061) (5,399,617)
Partnership and LLC income 98,538 404,299 502,837
Investment income 318,523 372,692 691,215
Gain on sale of marketable securities 687,947 687,947
------------ ------------ ------------
Income before income taxes $ 885,269 $ 2,188,766 $ 3,074,035
============ ============ ============
Depreciation and Amortization $ 1,934,117 $ 3,493,668 $ 5,427,785
============ ============ ============
Total Assets $ 25,115,243 $112,232,770 $137,348,013
============ ============ ============
Capital Expenditures $ 2,268,183 $ 2,900,814 $ 5,168,997
============ ============ ============
</TABLE>
37
<PAGE>
(b) SUPPLEMENTAL FINANCIAL INFORMATION
<TABLE>
<CAPTION>
Unaudited Quarterly Operating Results
(in thousands except per share amounts)
Quarter Ended
--------------------------------------------------------
March 31 June 30 Sept 30 Dec 31
- ------------------------------------------------------------------------------------------------------------------
1998
<S> <C> <C> <C> <C>
Revenues $ 7,249 $ 8,023 $ 8,027 $ 8,539
Operating income 2,449 2,928 2,992 2,278
Net income 434 778 874 1,824
Basic net income per share $ .21 $ .34 $ .34 $ .69
Diluted net income per share $ .16 $ .25 $ .26 $ .50
1997
Revenues $ 6,882 $ 6,855 $ 7,975 $ 7,154
Operating income 1,979 2,190 3,243 2,340
Net income 131 1,080 696 814
Basic net income per share $ .07 $ .58 $ .37 $ .43
Diluted net income per share $ .06 $ .34 $ .24 $ .27
</TABLE>
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE
Not applicable.
38
<PAGE>
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information called for by paragraphs (a), (c), (d), (e), and (f) of Item 401
under Regulation S-K, to the extent applicable, will be set forth under the
caption "Election of Directors" in the Company's definitive proxy material for
its May 18, 1999 Annual Meeting of Shareholders to be filed within 120 days from
the end of the Registrant's fiscal year, which information is expressly
incorporated by reference herein. The information called for by paragraph (b) of
Item 401 is set forth under Item 1(c) herein. The information called for by Item
405 under Regulation S-K, to the extent applicable, will be set forth under the
caption "Certain Transactions" in the Company's above referenced definitive
proxy material.
ITEM 11. EXECUTIVE COMPENSATION
The information called for by Item 402 under Regulation S-K to the extent
applicable, will be set forth under the caption "Executive Compensation" in the
Company's definitive proxy materials for its May 18, 1999 Annual Meeting to be
filed within 120 days from the end of the Registrant's fiscal year, which
information is expressly incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information called for by Item 403 under Regulation S-K will be set forth
under the captions "Security Ownership of Certain Beneficial Owners and
Management" and "Election of Directors" in the Company's definitive proxy
materials for its May 18, 1999 Annual Meeting to be filed within 120 days from
the end of the Registrant's fiscal year, which information is expressly
incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information called for by Item 404 under Regulation S-K will be set forth
under the caption "Certain Transactions" in the Company's definitive proxy
materials for its May 18, 1999 Annual Meeting to be filed within 120 days from
the end of the Registrant's fiscal year, which information is expressly
incorporated herein by reference.
39
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE, AND REPORTS ON FORM 8-K
(a) (1) Consolidated Financial Statements
The following Consolidated Financial Statements of Hector
Communications Corporation and subsidiaries appear at pages 22 to 37 herein:
Independent Auditors' Report for the years ended
December 31, 1998, 1997 and 1996
Consolidated Balance Sheets as of December 31, 1998 and 1997
Consolidated Statements of Income and Comprehensive Income for the
years ended December 31, 1998, 1997 and 1996
Consolidated Statements of Stockholders' Equity for the years ended
December 31, 1998, 1997 and 1996
Consolidated Statements of Cash Flows for the years ended
December 31, 1998, 1997 and 1996
Notes to Consolidated Financial Statements
(a) (2) Financial Statement Schedule Page Herein
---------------------------- -----------
The following financial statement schedule is being filed as part of
this Form 10-K Report:
Independent Auditors' Report on financial statement schedule
for the years ended December 31, 1998, 1997 and 1996 43
Schedule I - Condensed Financial Information of Registrant 44-47
All other schedules are omitted as the required information
is inapplicable or the information is presented in the
financial statements or related notes.
Separate financial statements of Midwest Wireless
Communications LLC, a 50 percent or less owned equity method
investment, included as this entity constitutes a "significan
subsidiary" pursuant to the provisions of Regulation S-X,
Article 3-09. 48-60
(a) (3) Exhibits
The exhibits which accompany or are incorporated by reference in this
report, including all exhibits required to be filed with this report, are
described on the Exhibit Index, which begins on page 62 of the sequential
numbering system used in this report.
(b) REPORTS ON FORM 8-K FILED DURING THE THREE MONTHS ENDED DECEMBER 31, 1998
Not Applicable.
40
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
HECTOR COMMUNICATIONS CORPORATION
Dated: March 29, 1999 /s/ Curtis A. Sampson
----------------------------------------
Curtis A. Sampson, Chairman of the Board
of Directors and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant in the capacities and on the dates indicated:
Each person whose signature appears below constitutes and appoints
CURTIS A. SAMPSON and PAUL N. HANSON as his true and lawful attorneys-in-fact
and agents, each acting alone, with full power of substitution and
resubstitution, for him and in his name, place and stead, in any and all
capacities, to sign any or all amendments to this Annual Report on Form 10-K and
to file the same, with all exhibits thereto, and other documents in connection
therewith, with the Securities and Exchange Commission, granting unto said
attorneys-in-fact and agents, each acting alone, full power and authority to do
and perform each and every act and thing requisite and necessary to be done in
and about the premises, as fully to all intents and purposes as he might or
could do in person, hereby ratifying and confirming all said attorneys-in-fact
and agents, each acting alone, or his substitute or substitutes, may lawfully do
or cause to be done by virtue thereof.
Signature Title Date
/s/Curtis A. Sampson Chairman of the Board of Directors, March 29, 1999
- -------------------- Chief Executive Officer and Director
Curtis A. Sampson
/s/Steven H. Sjogren President, Chief Operating Officer, March 29, 1999
- -------------------- and Director
Steven H. Sjogren
/s/Paul N. Hanson Vice President, Treasurer and March 29, 1999
- -------------------- Director
Paul N. Hanson
/s/Charles A. Braun Chief Financial Officer and March 29, 1999
- -------------------- Principal Accounting Officer
Charles A. Braun
/s/Charles R. Dickman
- -------------------- Director March 29, 1999
Charles R. Dickman
/s/James O. Ericson
- -------------------- Director March 29, 1999
James O. Ericson
/s/Paul A. Hoff
- -------------------- Director March 29, 1999
Paul A. Hoff
/s/Wayne E. Sampson
- -------------------- Director March 29, 1999
Wayne E. Sampson
/s/Edward E. Strickland
- -------------------- Director March 29, 1999
Edward E. Strickland
41
<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
OF
HECTOR COMMUNICATIONS CORPORATION
FOR
YEAR ENDED DECEMBER 31, 1998
FINANCIAL STATEMENT SCHEDULE
42
<PAGE>
INDEPENDENT AUDITORS' REPORT ON FINANCIAL STATEMENT SCHEDULE
Shareholders and Board of Directors
Hector Communications Corporation
The audit of the consolidated financial statements of Hector Communications
Corporation and subsidiaries referred to in our opinion dated February 17, 1999,
included the related financial statement schedule as listed in item 14(a)2. In
our opinion, this financial statement schedule, when considered in relation to
the basic consolidated financial statements, present fairly in all material
respects the information set forth therein.
/s/ Olsen Thielen and Co., Ltd.
- -------------------------------
Olsen Thielen and Co., Ltd.
St. Paul, Minnesota
February 17, 1999
43
<PAGE>
HECTOR COMMUNICATIONS CORPORATION
SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
HECTOR COMMUNICATIONS CORPORATION (PARENT COMPANY)
BALANCE SHEETS
December 31
----------------------------
1998 1997
------------ -------------
Assets:
Cash $ 8,024 $ 49,969
Investment in subsidiaries 30,297,399 27,620,410
Other current assets 159,219 69,056
Property, plant and equipment, net 88,603 134,288
Accounts with subsidiaries 5,809,257 2,873,495
Other investments 616,286 270,021
Deferred bond issue costs 371,311 780,089
------------ -------------
Total Assets $ 37,350,099 $ 31,797,328
============ =============
Liabilities and Stockholders' Equity:
Accounts payable $ 387,242 $ 146,352
Other current liabilities 379,684 553,854
Current portion of long-term debt 2,171,000 715,000
Long-term debt 11,691,852 15,935,000
Stockholders' equity:
Preferred stock, par value $1.00 per share;
3,000,000 shares authorized:
Convertible Series A, 342,800 and 378,100
shares issued and outstanding 342,800 378,100
Common stock, par value $.01 per share;
10,000,000 shares authorized; 2,661,062 and
2,079,364 shares issued and outstanding 26,611 20,794
Additional paid-in capital 6,326,441 1,712,954
Retained earnings 15,636,764 11,726,521
Unearned employee stock ownership shares (69,724)
Accumulated other comprehensive income 387,705 678,477
------------ -------------
Total Liabilities and Stockholders' Equity $ 37,350,099 $ 31,797,328
============ =============
44
<PAGE>
<TABLE>
<CAPTION>
HECTOR COMMUNICATIONS CORPORATION
SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
HECTOR COMMUNICATIONS CORPORATION (PARENT COMPANY)
STATEMENT OF INCOME AND COMPREHENSIVE INCOME
Year Ended December 31
---------------------------------------------
1998 1997 1996
------------ ------------- -------------
Revenues:
<S> <C> <C> <C>
Sales $ 286,569 $ 287,345 $ 285,799
Expenses:
Operating expenses 103,164 90,464 80,716
Amortization of goodwill 41,245 52,126 51,519
Gain on sale of marketable securities (1,464,409) (484,553)
Interest expense, net 1,329,491 1,571,655 1,396,393
Income tax expense (benefit) 412,835) 24,315 (272,257)
------------ ------------- -------------
Total expenses 1,061,065 274,151 771,818
Income (loss) before equity in earnings of
subsidiaries (774,496) 13,194 (486,019)
Equity in earnings of subsidiaries 4,684,739 2,707,559 1,694,689
------------ ------------- -------------
Net income 3,910,243 2,720,753 1,208,670
Other comprehensive income (loss):
Unrealized holding gains of subsidiaries on
marketable securities 492,287 1,754,213 1,465,455
Reclassification adjustment for gains o
subsidiaries included in net income (965,069) (1,495,999) (687,947)
------------ ------------- -------------
Other comprehensive income (loss) before
income taxes (472,782) 258,214 777,508
------------ ------------ -------------
Income tax expense related to unrealized
holding gains of subsidiaries on marketable
securities 189,519 752,667 464,521
Income tax benefit related to reclassification
adjustment for gains of subsidiaries included
in net income (371,529) (641,877) (218,066)
------------ ------------- -------------
Income tax expense (benefit) related to items
of other comprehensive income (182,010) 110,790 246,455
------------ ------------- -------------
Other comprehensive income (loss) (290,772) 147,424 531,053
------------ ------------- -------------
Comprehensive income $ 3,619,471 $ 2,868,177 $ 1,739,723
============ ============= =============
</TABLE>
45
<PAGE>
<TABLE>
<CAPTION>
HECTOR COMMUNICATIONS CORPORATION
SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
HECTOR COMMUNICATIONS CORPORATION (PARENT COMPANY)
STATEMENTS OF CASH FLOWS
Year Ended December 31
-----------------------------------------------
1998 1997 1996
------------- ------------- -------------
Cash flows from operating activities:
<S> <C> <C> <C>
Net income $ 3,910,243 $ 2,720,753 $ 1,208,670
Adjustments to reconcile net income to net cash
provided by operating activities:
Gain on sale of marketable securities (1,464,409) (484,553)
Equity in earnings of subsidiaries (4,684,739) (2,707,559) (1,694,689)
Dividends from subsidiaries 1,671,639 527,444
Depreciation and amortization 272,326 304,700 293,601
Changes in assets and liabilities:
Decrease (increase) in other current assets (90,163) 186,866 (178,633)
Decrease (increase) in accounts with subsidiaries (2,935,762) (428,294) 1,487,228
Increase (decrease) in accounts payable 240,890 (19,803) (17,027)
Increase (decrease) in other current liabilities (103,691) (166,479) 877
------------- ------------- -------------
Net cash provided by (used in) operating activities (1,719,257) (1,046,781) 615,474
Cash flows from investing activities:
Purchases of property, plant and equipment (10,167) (71,485) (16,286)
Acquisition costs of stock of affiliate (12,346,388)
Purchases of other investments (342,171) (169,737)
Cash proceeds from other investments 1,646,900 715,598
------------- ------------- -------------
Net cash provided by (used in) investing activities (352,338) 1,405,678 (11,647,076)
Cash flows from financing activities:
Issuance of debt 5,996,281 6,000,000
Repayment of long-term debt (4,519,429) (2,000,000)
Issuance of common stock 489,703 1,575,107 21,768
ESOP shares allocated 63,095 58,000 50,000
------------- ------------- -------------
Net cash provided by (used in) financing activities 2,029,650 (366,893) 6,071,768
------------- ------------- -------------
Net decrease in cash and cash equivalents (41,945) (7,996) (4,959,834)
Beginning cash and cash equivalents 49,969 57,965 5,017,799
------------- ------------- -------------
Ending cash and cash equivalents $ 8,024 $ 49,969 $ 57,965
============= ============= =============
Supplemental disclosures of cash flow information:
Interest paid $ 1,231,676 $ 1,420,884 $ 1,248,308
Income taxes paid 45,000 450,000 300,000
</TABLE>
46
<PAGE>
NOTES TO CONDENSED FINANCIAL STATEMENT OF REGISTRANT
Note 1 - Basis of Presentation
Pursuant to the rules and regulations of the Securities and Exchange Commission,
the Condensed Financial Statements of the Registrant do not include all of the
information and notes normally included in financial statements prepared in
accordance with generally accepted accounting principles. It is suggested that
these Condensed Financial Statements be read in conjunction with the
Consolidated Financial Statements and Notes thereto included in the Registrant's
Annual Report as referenced in Form 10-K, Part II, Item 8, page 23.
Note 2 - Cash Dividends from Subsidiaries
The Registrant received dividends from its subsidiaries of $1,671,639 and
$527,444 in 1998 and 1997, respectively. No dividends were received in 1996.
Note 3 - Long Term Debt
<TABLE>
<CAPTION>
December 31
----------------------------------------
1998 1997
-------------------- ------------------
Convertible subordinated debentures, payable to
<S> <C> <C>
debentureholders, interest rate of 8.5%, due 2002 $ 7,948,000 $ 12,650,000
Notes payable to Rural Telephone Finance Cooperative
In quarterly installments, interest rate of 6.1%, due 2013 3,914,852
Notes payable on line of credit from Rural Telephone
Finance Cooperative, interest rate of 6.7%, due 1999 2,000,000
Note payable to St. Paul Bank for Cooperatives,
interest rate of 8.0% 4,000,000
-------------------- ------------------
13,862,852 16,650,000
Less current portion 2,171,000 715,000
-------------------- ------------------
$ 11,691,852 $ 15,935,000
==================== ==================
</TABLE>
The annual requirements for principal payments on notes payable and long-term
debt are as follows:
1999 $2,171,000
2000 183,000
2001 195,000
2002 8,157,000
2003 223,000
Note 4 - Acquisitions
Acquisition costs in stock of affiliate relate to the Registrant's investment in
Alliance Telecommunications Corporation in 1996.
47
<PAGE>
MIDWEST WIRELESS COMMUNICATIONS L.L.C.
REPORT ON AUDIT OF CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
48
<PAGE>
Report of Independent Accountants
To the Board of Managers
Midwest Wireless Communications L.L.C.:
In our opinion, the accompanying consolidated statements of financial position
and the related consolidated statements of operations, changes in members'
equity and cash flows present fairly, in all material respects, the financial
position of Midwest Wireless Communications L.L.C. (the Company) and subsidiary
at December 31, 1998 and 1997, and the consolidated results of its operations
and its cash flows for the years then ended in conformity with generally
accepted accounting principles. 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 of these statements in accordance with generally accepted auditing
standards which 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, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.
PRICEWATERHOUSECOOPERS LLP
February 5, 1999
49
<PAGE>
Midwest Wireless Communications L.L.C.
Consolidated Statements of Financial Position
as of December 31, 1998 and 1997
<TABLE>
<CAPTION>
ASSETS 1998 1997
Current assets:
<S> <C> <C>
Cash and cash equivalents $ 3,147,979 $ 2,063,280
Marketable securities 3,946,270 5,911,871
Accounts receivable, less allowance for doubtful accounts of
$282,287 and $360,122 in 1998 and 1997, respectively 4,228,358 4,548,991
Inventories 1,624,026 770,617
Other 352,624 327,417
----------------- -----------------
Total current assets 13,299,257 13,622,176
Property, cellular plant and equipment, net 34,078,742 21,032,370
Investment in Switch 2000 - 1,466,820
FCC licenses, net 16,736,528 16,832,224
Investments and other 1,673,287 398,195
----------------- -----------------
Total assets $ 65,787,814 $ 53,351,785
================= =================
LIABILITIES AND MEMBERS' EQUITY
Current liabilities:
Current portion of long-term debt $ 1,279,048 $ 2,767,000
Accounts payable 6,212,502 2,106,461
Accrued commissions 615,757 649,891
Accrued liabilities 3,676,552 2,880,534
----------------- -----------------
Total current liabilities 11,783,859 8,403,886
Other liabilities 517,491 195,247
Long-term debt 15,648,092 15,149,410
----------------- -----------------
Total liabilities 27,949,442 23,748,543
Members' equity 37,838,372 29,603,242
----------------- -----------------
Total liabilities and members' equity $ 65,787,814 $ 53,351,785
================= =================
The accompanying notes are an integral part of the financial statements.
</TABLE>
50
<PAGE>
Midwest Wireless Communications L.L.C.
Consolidated Statements of Operations
for the years ended December 31, 1998 and 1997
<TABLE>
<CAPTION>
1998 1997
Operating revenues:
<S> <C> <C>
Retail service $ 33,403,860 $ 27,785,727
Roamer service 12,393,902 10,374,827
Equipment sales 3,321,271 2,123,505
----------------- -----------------
49,119,033 40,284,059
----------------- -----------------
Operating expenses:
Operations and maintenance 10,054,893 8,464,911
Cost of equipment sold 3,897,151 2,988,131
Depreciation 4,707,905 3,068,687
Amortization 481,392 448,864
Selling, general and administrative 11,024,317 9,517,110
Home roamer costs 1,353,930 804,709
----------------- -----------------
31,519,588 25,292,412
----------------- -----------------
Operating income 17,599,445 14,991,647
----------------- -----------------
Other income (expense):
Equity loss on Switch 2000 (710,330) (482,459)
Interest expense (890,930) (1,106,380)
Interest and dividend income 711,388 220,628
Other 262,375 -
----------------- -----------------
(627,497) (1,368,211)
---------------- -----------------
Net income $ 16,971,948 $ 13,623,436
================= =================
The accompanying notes are an integral part of the financial statements.
</TABLE>
51
<PAGE>
Midwest Wireless Communications L.L.C.
Consolidated Statements of Changes in Members' Equity
for the years ended December 31, 1998 and 1997
<TABLE>
<CAPTION>
Total
Capital Accumulated Members'
Contributions Income Equity
<S> <C> <C> <C>
Balance, December 31, 1996 $ 15,750,840 $ 4,011,550 $ 19,762,390
Redemption of units (2,646) (24,468) (27,114)
Distributions to members - (3,755,470) (3,755,470)
Net income - 13,623,436 13,623,436
----------------- ----------------- -----------------
Balance, December 31, 1997 15,748,194 13,855,048 29,603,242
Redemption of units (11,416) (119,438) (130,854)
Distributions to members - (8,605,964) (8,605,964)
Net income - 16,971,948 16,971,948
----------------- ----------------- -----------------
Balance, December 31, 1998 $ 15,736,778 $ 22,101,594 $ 37,838,372
================= ================= =================
The accompanying notes are an integral part of the financial statements.
</TABLE>
52
<PAGE>
Midwest Wireless Communications L.L.C.
Consolidated Statements of Cash Flows
for the years ended December 31, 1998 and 1997
<TABLE>
<CAPTION>
1998 1997
Cash flows from operating activities:
<S> <C> <C>
Net income $ 16,971,948 $ 13,623,436
Adjustments to reconcile net income to net cash provided
by operating activities:
Provision for bad debts 266,901 769,330
Depreciation 4,707,905 3,068,687
Amortization 481,392 448,864
Equity loss on investments in Switch 2000 710,330 482,459
Appreciation rights 322,244 195,247
Accretion of discount (210,403) (106,506)
Changes in assets and liabilities:
Accounts receivable 53,732 (1,178,753)
Inventories (853,409) (345,351)
Accounts payable (994,241) 1,166,996
Accrued liabilities 761,884 1,321,436
Other (25,207) 689
------------------- -----------------
Net cash provided by operating activities 22,193,076 19,446,534
------------------- -----------------
Cash flows from investing activities:
Payments for property, cellular plant and equipment (11,514,175) (7,893,976)
Purchases of marketable securities (12,794,926) (10,805,365)
Proceeds received upon maturity of marketable securities 14,970,930 5,000,000
Purchase of Switch 2000 interests (383,330) -
Purchase of FCC licenses (385,696) -
Purchases of investments (1,150,092) (173,427)
Other (125,000) -
------------------- -----------------
Net cash used in investing activities (11,382,289) (13,872,768)
------------------- -----------------
Cash flows from financing activities:
Proceeds on long-term debt borrowings 16,372,239 -
Payments on long-term debt (17,361,509) (1,046,000)
Distributions to members (8,605,964) (3,755,470)
Redemption of units (130,854) (27,114)
------------------- -----------------
Net cash used in financing activities (9,726,088) (4,828,584)
------------------- -----------------
Net change in cash and cash equivalents 1,084,699 745,182
Cash and cash equivalents, beginning of year 2,063,280 1,318,098
------------------- -----------------
Cash and cash equivalents, end of year $ 3,147,979 $ 2,063,280
=================== =================
Supplemental disclosure:
Cash paid during the year for interest $ 1,015,834 $ 1,116,505
=================== =================
The accompanying notes are an integral part of the financial statements.
</TABLE>
53
<PAGE>
Midwest Wireless Communications L.L.C.
Notes to Consolidated Financial Statements
1. Organization and Significant Accounting Policies:
Organization and Basis of Consolidation:
Midwest Wireless Communications L.L.C. (the Company) is a Delaware limited
liability company organized to provide cellular communications services in
certain service areas within the State of Minnesota. The latest date the
Company may be dissolved is December 31, 2034.
The consolidated financial statements of the Company include its
subsidiary, Switch 2000 L.L.C. (Switch 2000) as of December 31, 1998 and
for the period October 1, 1998 to December 31, 1998 (see Note 2). All
intercompany transactions have been eliminated from the consolidated
financial statements.
Estimates:
The Company prepares its financial statements in conformity with generally
accepted accounting principles, which require management to make estimates
and assumptions that affect the reported amounts of assets, liabilities,
revenues and expenses during the period presented. They also affect the
disclosure of contingencies. Actual results could differ from those
estimates.
Cash and Cash Equivalents:
For the purpose of the statements of cash flows, the Company considers all
investments purchased with original maturities of three months or less to
be cash equivalents.
Marketable Securities:
Marketable securities which the Company has the positive intent and ability
to hold to maturity are stated at cost adjusted for accretion of discounts
computed under a method which approximates the interest method. The
marketable securities have maturity dates ranging from March 1999 to June
1999. The market value approximated amortized cost at December 31, 1998.
Unrealized gains and losses were not significant.
Cellular Telephone Inventories:
Inventories consist primarily of cellular phones and accessories held for
resale with cost determined using the specific identification method.
Consistent with industry practice, losses on sales of cellular phones are
recognized in the period in which sales are made as a cost of acquiring
subscribers.
54
<PAGE>
Midwest Wireless Communications L.L.C.
Notes to Consolidated Financial Statements, Continued
1. Organization and Significant Accounting Policies, continued:
Property, Cellular Plant and Equipment:
Property, cellular plant and equipment is stated at its original cost.
Depreciation is provided on a straight-line basis over the estimated useful
lives of the cellular plant and equipment, which range from three to
fifteen years. Property, cellular plant and equipment consists of the
following:
1998 1997
Land $ 1,442,308 $ 1,212,608
Plant in service 49,641,677 29,184,958
Plant under construction 3,112,679 1,273,872
-------------- --------------
54,196,664 31,671,438
Less accumulated depreciation (20,117,922) (10,639,068)
-------------- --------------
$ 34,078,742 $ 21,032,370
============== ==============
At December 31, 1998 and 1997, accounts payable includes $5,100,282 and
$418,396, respectively, related to the purchase of property, cellular plant
and equipment. The Company capitalized interest in the amount of $248,377
and $151,361 for the years ended December 31, 1998 and 1997, respectively.
Income Taxes:
No provision for income taxes has been recorded since all income, losses
and tax credits are allocated to the members for inclusion in their
respective income tax returns.
Advertising:
Advertising costs are expensed as incurred. Total advertising expenses were
$1,412,628 and $1,049,000 for the years ended December 31, 1998 and 1997,
respectively.
55
<PAGE>
Midwest Wireless Communications L.L.C.
Notes to Consolidated Financial Statements, Continued
1. Organization and Significant Accounting Policies, continued:
Federal Communications Commission (FCC) Licenses:
The Company acquired a FCC license to provide cellular service in FCC
market NO. 288B in conjunction with the purchase of the Rochester service
area on June 28, 1996. This license was recorded at fair market value and
is being amortized on a straight-line basis over 39 years.
During 1998, the Company acquired FCC licenses to provide LMDS services
within the Company's service area. The licenses were recorded at fair
market value and are being amortized on a straight-line basis over 10
years. FCC licenses consist of the following:
1998 1997
Cellular license $ 17,505,700 $ 17,505,700
LMDS licenses 357,696 -
Other 28,000 -
-------------- --------------
17,891,396 17,505,700
Less accumulated amortization (1,154,868) (673,476)
-------------- --------------
$ 16,736,528 $ 16,832,224
============== ==============
2. Investment in Switch 2000:
Switch 2000 provides switching and interconnection services to the Company.
During 1997, and for the period January 1, 1998 through September 30, 1998,
the Company had ownership and voting interests in Switch 2000 of 54.93% and
45.55%, respectively. Accordingly, during this period, this investment was
accounted for using the equity method of accounting.
During September and October of 1998, the Company gained 100% ownership
interest in Switch 2000 by acquiring the remaining equity interest in
Switch 2000 for a purchase price of $383,330 in cash and equipment with a
fair market value of $700,277, The acquisition was accounted for under the
purchase method of accounting; accordingly, the assets and liabilities of
Switch 2000, principally cellular plant and equipment, were recorded at
fair value. The cellular plant and equipment acquired is being depreciated
over a period of two years.
56
<PAGE>
Midwest Wireless Communications L.L.C.
Notes to Consolidated Financial Statements, Continued
2. Investment in Switch 2000, continued:
Effective June 30, 1997, Switch 2000 and the Company entered into a
Management Agreement which expired on December 3l, 1997. The Company
continued to provide management services to Switch 2000 through September
30, 1998. Under the terms of the Management Agreement, Switch 2000 retained
the services of the Company to manage the operations of Switch 2000,
including administration of transport and switching services and other
general business operations. Switch 2000 was required to pay a management
fee equal to the total costs incurred by the Company related to the
management of Switch 2000. Total management fees paid to the Company during
1998 and 1997 were $196,000 and $119,000, respectively.
Switch 2000, in turn, allocated management fees and certain other expenses,
primarily network costs, to its owners, which included the Company. Amounts
billed to the Company totaled approximately $l,802,000 for the period from
January 1, 1998 to September 30, 1998 and $2,879,000 for the year ended
December 31, 1997. The Company had an amount due to Switch 2000 of $227,000
at December 31, 1997.
Switch 2000 had assets of $3,376,866 and liabilities of $708,893 at
December 31, 1997.
3. Members' Capital:
Members' capital includes capital contributions made by the members and the
accumulated income resulting from operations. Company income or loss is
allocated to the individual members based upon their ownership percentage,
as defined in the Limited Liability Company Agreement (the Agreement).
Pursuant to the Agreement, members are not obligated for the debts and
obligations of the Company, including accumulated losses in excess of
capital contributions.
Each member is entitled to one vote for each unit owned. Certain
restrictions on voting rights exist when units are sold to an acquiring
person as defined in the Agreement.
4. Debt:
Effective July 29, 1998, the Company entered into an agreement (the
Agreement) with the Rural Telephone Finance Cooperative (the Cooperative)
to refinance the indebtedness of the Company. Proceeds in the amount of
$16,372,239 received under the agreement were used to pay the entire
outstanding principal balance on the previous debt.
57
<PAGE>
Midwest Wireless Communications L.L.C.
Notes to Consolidated Financial Statements, Continued
4. Debt, continued:
The Agreement includes a term note with principal and interest payable in
quarterly installments beginning October 31, 1998, with final maturity in
2008. The Agreement provides the Company the option to fix the interest
rate on borrowings (or portions thereof) through the maturity date. The
variable rate is based on the Cooperative's cost of capital and is adjusted
monthly. This rate was 6.1% as of December 31, 1998. As of December 31,
1998, the Company had borrowings of $8,087,356 outstanding under the
variable rate and $8,839,784 at a fixed rate of 5.75%.
The Agreement provides for an acquisition note of up to $36,842,105.
Advances under the acquisition note are subject to the lender's review and
of the Company's acquisition plan and any regulatory approval required to
accomplish the contemplated acquisition. Borrowings under the acquisition
are subject to the same interest rate terms as the term note. The
acquisition note becomes due ten years after the date of the initial
borrowing, at which time the outstanding principal and interest are due. As
of December 31, 1998, no amounts were outstanding under the acquisition
note.
The Agreement also provides for a revolving loan of up to $10,000,000.
Borrowings under the revolving loan bear interest at the prime rate plus
one and one-half percent. The revolving loan expires July 29, 2003, at
which time the outstanding principal and interest are due. The Company had
no amounts outstanding under the revolving loan as of December 31, 1998.
The Agreement requires the Company to maintain an investment in the
Cooperative in the amount of at least 5% of the outstanding debt balance.
The Agreement also contains covenants that restrict distributions to
members and require the Company to maintain a debt coverage service ratio
of not less than 1.25. Substantially all assets of the Company are pledged
as collateral under the Agreement.
Maturities of long-term debt are as follows:
1999 $ 1,279,048
2000 1,366,249
2001 1,459,395
2002 1,558,892
2003 1,665,173
Thereafter 9,598,383
--------------
$ 16,927,140
==============
58
<PAGE>
Midwest Wireless Communications L.L.C.
Notes to Consolidated Financial Statements, Continued
5. Commitments:
Future minimum rental payments required under operating leases, principally
for real estate related to tower sites and other contractual commitments
that have initial or remaining noncancellable terms in excess of one year
as of December 31, 1998, are as follows:
1999 $ 353,091
2000 181,245
2001 120,628
2002 117,378
2003 112,878
Thereafter 1,668,436
--------------
$ 2,553,656
==============
Rental expense was $433,550 and $424,554 for the year ended December 31,
1998 and 1997, respectively.
6. Cell Site Sharing Agreements:
The Company is subject to an agreement with a partnership located in
Wisconsin, to jointly operate common cellular base station facilities (Cell
Sites) in Nelson, Wisconsin and Red Wing, Minnesota. Under the agreement,
both parties agreed to share: the costs to construct the Cell Sites,
selected ongoing costs of operation and roamer revenues attributable to the
Cell Sites.
The Company has included its proportionate share of the assets,
liabilities, revenues and expenses of the Cell Sites in these financial
statements. As of December 3l, 1998 and 1997, these assets were
approximately $769,000 and $766,000 and liabilities were approximately $800
and $2,700, respectively. For the years ended December 31, 1998 and 1997,
revenues were approximately $573,000 and $521,000 and operating expenses
were $275,000 and $165,000, respectively.
7. Concentration of Credit Risk:
The Company provides cellular service and sells cellular telephones to a
diversified group of consumers within a concentrated geographical area. The
Company performs credit evaluations of its customers and requires a deposit
when deemed necessary. Receivables are generally due within 30 days. Credit
losses related to customers have been within management's expectations.
59
<PAGE>
Midwest Wireless Communications L.L.C.
Notes to Consolidated Financial Statements, Continued
8. Employee Benefits:
The Company established the Midwest Wireless Communications L.L.C. 401(k)
Profit Sharing Plan and Trust (the 401(k) Plan) for all employees who meet
certain service and age requirements. The 401(k) Plan is comprised of an
employer matching contribution component and a profit sharing component.
Employer matching contributions to this component of the plan were $128,219
and $91,968 for the years ended December 31, 1998 and 1997, respectively.
Profit sharing contributions are 100% vested after five years employment.
Profit sharing contribution expenses were $155,286 and $118,411 for the
years ended December 31, 1998 and 1997, respectively.
Effective January 1, 1997, the Company established the Midwest Wireless
Communications L.L.C. Appreciation Rights Plan (the Plan) for certain key
employees. The Plan is designed to create two classes of appreciation
rights, Class A and Class B, which become fully vested three years and five
years after the first day of the year the rights are granted, respectively.
Participants in the Plan are eligible to receive awards based on the change
in members' equity from the date of grant through the end of the vesting
period. The Board of Managers granted both Class A and Class B appreciation
rights in 1997. Under the terms of the Plan, no additional Class B
appreciation rights will be granted, and additional Class A appreciation
rights will be granted at the discretion of the Board of Managers. The
Company recognized $322,244 and $195,247 in compensation expense related to
the Plan for the years ended December 31, 1998 and 1997, respectively.
60
<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
OF
HECTOR COMMUNICATIONS CORPORATION
FOR
YEAR ENDED DECEMBER 31, 1998
EXHIBITS
61
<PAGE>
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
Exhibit Index To
Form 10-K for the Year Ended December 31, 1998
Regulation S-K Location in Consecutive Numbering
Exhibit Table System as Filed With the
Reference Title of Document Securities and Exchange Commission
3.1 Articles of Incorporation, Filed as Exhibit 3.1 to the Form 10
as amended of the Company, File No. 0-18587
(the "Form 10") and incorporated
hereby by reference
3.2 Bylaws, as amended Filed as Exhibit 3.2 to the Form 10
of the Company and incorporated
hereby by reference.
4.1 Indenture dated Filed as Exhibit 4.1 to the
February 24, 1995 between Company's Registration Statement on
Hector Communications Corp. Form S-2 File No. 33-87888 and
and National City Bank of incorporated herein by reference
Minneapolis, trustee
10.1 1990 Stock Plan Filed as Exhibit 10.1 to the Form 10
of the Company and incorporated
herein by reference.
10.2 Employee Stock Purchase Plan Filed as Exhibit 10.2 to the Form 10
of the Company and incorporated
herein by reference.
10.3 Employee Stock Ownership Plan Filed as Exhibit 10.3 to the Form 10
of the Company and incorporated
herein by reference.
10.4 Employee Savings Plan and Trust Filed as Exhibit 10.4 to the Form 10
of the Company and incorporated
herein by reference.
10.5 Distribution Agreement Filed as Exhibit 10.5 to the Form 10
of the Company and incorporated
herein by reference.
10.7 Flexible Benefit Plan Filed as Exhibit 10.7 to the 1993
Form 10-K and incorporated herein
by reference.
11 Calculation of Earnings Filed herewith at page 63.
Per Share
21 Subsidiaries of the Registrant Filed herewith at page 64.
23 Independent Auditors' Consent Filed herewith at page 65.
24 Power of Attorney Included in signatures at page 41.
The exhibits referred to in this Exhibit Index will be supplied to a shareholder
at a charge of $.25 per page upon written request directed to HCC's Assistant
Secretary at the executive offices of the Company.
62
<PAGE>
<TABLE>
<CAPTION>
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
EXHIBIT 11
CALCULATION OF EARNINGS PER SHARE
Year Ended December 31
---------------------------------------------
Basic: 1998 1997 1996
- ------- ----------- ----------- -----------
<S> <C> <C> <C>
Net income $ 3,910,243 $ 2,720,753 $ 1,208,670
=========== =========== ==========
Common shares:
Weighted average number of common shares outstanding 2,402,794 1,901,508 1,881,472
Number of unallocated shares held by ESOP 0 (8,930) (11,817)
----------- ----------- -----------
2,402,794 1,892,578 1,869,655
=========== =========== ===========
Net income per common share $ 1.63 $ 1.44 $ .65
=========== =========== ===========
Diluted:
- -------------
Net income $ 3,910,243 $ 2,720,753 $ 1,208,670
Interest on convertible debentures, net of tax 620,594 758,616 758,616
----------- ----------- -----------
Adjusted net income $ 4,530,837 $ 3,479,369 $ 1,967,286
=========== =========== ===========
Common and common equivalent shares:
Weighted average number of common shares outstanding 2,402,794 1,901,508 1,881,472
Assumed conversion of convertible
debentures into common stock 1,119,683 1,423,125 1,423,125
Dilutive effect of convertible preferred shares outstanding 352,867 378,100 389,487
Dilutive effect of stock options outstanding after
application of treasury stock method 45,441 36,130 11,649
Dilutive effect of Employee Stock
Purchase Plan shares subscribed 4,664 2,455 577
Dilutive effect of warrants outstanding 11,623
Weighted average number of
unallocated shares held by ESOP 0 (8,930) (11,817)
----------- ----------- -----------
3,937,072 3,732,388 3,694,493
=========== =========== ===========
Diluted net income per share $ 1.15 $ .93 $ .53
=========== =========== ===========
</TABLE>
63
<PAGE>
SUBSIDIARIES OF HECTOR COMMUNICATIONS CORPORATION
EXHIBIT 21
Subsidiaries Jurisdiction of Incorporation
Arrowhead Communications Corporation Minnesota
Eagle Valley Telephone Company Minnesota
Granada Telephone Company Minnesota
Indianhead Telephone Company Wisconsin
North American Communications Corporation Minnesota
Pine Island Telephone Company Minnesota
Indianhead Communications Corporation Wisconsin
Alliance Telecommunications Corporation Minnesota
Ollig Utilities Company Minnesota
Felton Telephone Company Minnesota
Loretel Systems, Inc. Minnesota
Sleepy Eye Telephone Company Minnesota
Sioux Valley Telephone Company South Dakota
Hills Telephone Company Minnesota
OU Connection, Inc. Minnesota
Aurora Cable TV, Inc. South Dakota
Loretel Financial Systems, Inc. Minnesota
Hastad Engineering Co. Minnesota
Valley Cablevision of SD, Inc. South Dakota
Arrowhead Communications Corporation, Eagle Valley Telephone Company, Granada
Telephone Company, Indianhead Telephone Company, North American Communications
Corporation and Indianhead Communications Corporation are 100% owned by Hector
Communications Corporation. Pine Island Telephone Company is 69% owned by Hector
Communications Corporation and 31% owned by Indianhead Telephone Company.
Alliance Telecommunications Corporation is 68% owned by Hector Communications
Corporation, 20% owned by Golden West Telecommunications Cooperative, Inc. of
Wall, South Dakota and 12% owned by Split Rock Telecom Cooperative of Garretson,
South Dakota.
Loretel Systems, Inc., Sleepy Eye Telephone Company, Sioux Valley Telephone
Company, Hills Telephone Company, Felton Telephone Company, OU Connection, Inc.,
Aurora Cable TV, Inc., Loretel Financial Systems, Inc., Hastad Engineering Co.
and Valley Cablevision of SD, Inc. are 100% owned by Alliance Telecommunications
Corporation.
The financial statements of these subsidiaries are included in the Consolidated
Financial Statements of Hector Communications Corporation.
64
<PAGE>
EXHIBIT 23
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in Registration Statements No.
33-39865, 33-39866, 33-65176, 33-87888, 333-45971 and 333-45975 of Hector
Communications Corporation of our report dated February 17, 1999, appearing in
this Annual Report on Form 10-K of Hector Communications Corporation and its
subsidiaries for the year ended December 31, 1998.
/s/ Olsen Thielen and Co., Ltd.
- -------------------------------
Olsen Thielen and Co., Ltd.
March 29, 1999
St. Paul, Minnesota
<TABLE> <S> <C>
<ARTICLE> 5
<CIK> 0000863437
<NAME> HECTOR COMMUNICATIONS CORPORATION
<MULTIPLIER> 1
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<EXCHANGE-RATE> 1
<CASH> 14,686,034
<SECURITIES> 0
<RECEIVABLES> 4,374,992
<ALLOWANCES> 234,000
<INVENTORY> 528,839
<CURRENT-ASSETS> 19,736,490
<PP&E> 76,245,233
<DEPRECIATION> 25,434,769
<TOTAL-ASSETS> 150,679,787
<CURRENT-LIABILITIES> 13,182,866
<BONDS> 94,232,389
0
342,800
<COMMON> 26,611
<OTHER-SE> 22,350,910
<TOTAL-LIABILITY-AND-EQUITY> 150,679,787
<SALES> 31,838,694
<TOTAL-REVENUES> 31,838,694
<CGS> 21,191,807
<TOTAL-COSTS> 21,191,807
<OTHER-EXPENSES> (7,274,734)
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 7,315,153
<INCOME-PRETAX> 10,606,468
<INCOME-TAX> 4,949,000
<INCOME-CONTINUING> 5,657,468
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 3,910,243
<EPS-PRIMARY> 1.63
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