- --------------------------------------------------------------------------------
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended JUNE 30, 1999
-------------------------------------------------
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR
15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number: 0-18587
HECTOR COMMUNICATIONS CORPORATION
................................................................................
(Exact name of registrant as specified in its charter)
MINNESOTA 41-1666660
- ------------------------------- --------------------
(State or other jurisdiction of (Federal Employer
incorporation or organization) Identification No.)
211 South Main Street, Hector, MN 55342
................................................................................
(Address of principal executive offices) (Zip Code)
(320) 848-6611
................................................................................
Registrant's telephone number, including area code
................................................................................
(Former name, address, and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. YES X NO
--- ---
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
CLASS
Common Stock, par value Outstanding at July 31, 1999
$.01 per share 3,435,430
Total Pages (16) Exhibit at Page 16
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<PAGE>
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
INDEX
Page No.
Part I. Financial Information
Item 1. Financial Statements
Consolidated Balance Sheets 3
Consolidated Statements of Income and
Comprehensive Income 4
Consolidated Statements of Stockholders' Equity 5
Consolidated Statements of Cash Flows 6
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 9
Part II. Other Information 15
2
<PAGE>
<TABLE>
<CAPTION>
PART I. FINANCIAL INFORMATION
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
Item 1. Financial Statements
CONSOLIDATED BALANCE SHEETS
(unaudited)
June 30 December 31
Assets: 1999 1998
-------------- --------------
Current assets:
<S> <C> <C>
Cash and cash equivalents $ 14,338,075 $ 14,686,034
Construction fund 766,331 200,491
Accounts receivable, net 4,957,460 4,140,992
Materials, supplies and inventories 1,134,725 528,839
Prepaid expenses 86,877 180,134
-------------- --------------
Total current assets 21,283,468 19,736,490
Property, plant and equipment 78,984,754 76,245,233
less accumulated depreciation (28,590,500) (25,434,769)
-------------- --------------
Net property, plant and equipment 50,394,254 50,810,464
Other assets:
Excess of cost over net assets acquired, net 52,221,578 53,003,560
Marketable securities 10,550,937 8,555,336
Wireless telephone investments 9,722,260 9,482,902
Other investments 8,959,675 8,259,419
Deferred debenture issue costs, net 371,311
Other assets 458,728 460,305
-------------- --------------
Total other assets 81,913,178 80,132,833
-------------- --------------
Total Assets $ 153,590,900 $ 150,679,787
============== ==============
Liabilities and Stockholders' Equity:
Current liabilities:
Notes payable and current portion of long-term debt $ 4,850,100 $ 6,808,500
Accounts payable 4,245,919 2,473,526
Accrued expenses 1,993,918 1,945,687
Income taxes payable 407,796 1,955,153
-------------- --------------
Total current liabilities 11,497,733 13,182,866
Long-term debt, less current portion 87,634,525 94,232,389
Deferred investment tax credits 172,526 252,601
Deferred income taxes 9,428,673 8,510,637
Deferred compensation 943,634 990,155
Minority stockholders interest in Alliance
Telecommunications Corp. 11,477,045 10,790,818
Stockholders' Equity 32,436,764 22,720,321
-------------- --------------
Total Liabilities and Stockholders' Equity $ 153,590,900 $ 150,679,787
============== ==============
See notes to consolidated financial statements.
</TABLE>
3
<PAGE>
<TABLE>
<CAPTION>
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
(unaudited)
Three Months Ended June 30 Six Months Ended June 30
------------------------------- --------------------------------
1999 1998 1999 1998
------------- ------------ ------------- ------------
Revenues:
<S> <C> <C> <C> <C>
Local network $ 1,522,746 $ 1,349,369 $ 2,868,295 $ 2,549,338
Network access 4,956,162 4,684,041 9,835,980 8,943,736
Billing and collection 223,257 203,958 417,155 398,520
Nonregulated activities 1,075,951 1,117,695 2,048,866 2,098,976
Cable television revenues 945,441 668,274 1,872,820 1,281,569
------------- ------------ ------------- ------------
Total revenues 8,723,557 8,023,337 17,043,116 15,272,139
Costs and expenses:
Plant operations 1,048,771 1,035,551 2,153,526 1,912,482
Depreciation and amortization 2,045,733 1,933,088 4,039,379 3,756,411
Customer operations 522,258 485,221 1,000,508 939,477
General and administrative 1,121,339 1,114,985 2,343,858 2,199,015
Other operating expenses 638,722 566,024 1,332,984 1,087,799
------------- ------------ ------------- ------------
Total costs and expenses 5,376,823 5,134,869 10,870,255 9,895,184
Operating income 3,346,734 2,888,468 6,172,861 5,376,955
Other income and (expenses):
Investment income 142,736 203,932 337,162 395,894
Interest expense (1,801,762) (1,809,685) (3,474,470) (3,544,990)
Gain on sales of marketable securities 178,910 337,615 982,274 429,469
Partnership and LLC income (loss) 86,799 328,901 (78,229) 504,813
Loss on St. Paul Bank Stock (141,277) (141,277)
------------- ------------ ------------- ------------
Other expense, net (1,534,594) (939,237) (2,374,540) (2,214,814)
Income before income taxes 1,812,140 1,949,231 3,798,321 3,162,141
Income tax expense 788,000 844,000 1,638,000 1,395,000
------------- ------------ ------------- ------------
Income before minority interest 1,024,140 1,105,231 2,160,321 1,767,141
Minority interest in earnings of
Alliance Telecommunications Corporation 305,470 327,108 686,227 555,060
------------- ------------ ------------- ------------
Net income $ 718,670 $ 778,123 $ 1,474,094 $ 1,212,081
------------- ------------ ------------- ------------
Other comprehensive income:
Unrealized holding gains (losses)
on marketable securities 2,613,191 (551,136) 3,651,108 825,677
Less: reclassification adjustment for gains
included in net income (178,910) (337,615) (982,274) (429,469)
------------- ------------ ------------- ------------
Other comprehensive income (loss) before income taxes 2,434,281 (888,751) 2,668,834 396,208
Income tax expense (benefit) related to items of
other comprehensive income (loss) 973,713 (355,500) 1,067,534 158,483
------------- ------------ ------------- ------------
Other comprehensive income (loss) 1,460,568 (533,251) 1,601,300 237,725
------------- ------------ ------------- ------------
Comprehensive income $ 2,179,238 $ 244,872 $ 3,075,394 $ 1,449,806
============= ============ ============= ============
Basic net income per share $ .26 $ .34 $ .55 $ .56
Diluted net income per share $ .22 $ .25 $ .44 $ .42
See notes to consolidated financial statements.
</TABLE>
4
<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, 1997 378,100 $378,100 2,079,364 $ 20,794 $1,712,954 $ 11,726,521 $ (69,724) $ 678,477 $14,447,122
Net income 3,910,243 3,910,243
Issuance of common stock under
Employee Stock Purchase Plan 10,753 107 73,013 73,120
Issuance of common stock under
Employee Stock Option Plan 48,200 482 354,931 355,413
Issuance of common stock in
exchange for preferred stock (35,300) (35,300) 35,300 353 34,947 0
Issuance of common stock from
exercise of outstanding
warrants 7,876 79 61,091 61,170
Conversion of convertible
debentures into common stock 479,569 4,796 4,096,134 4,100,930
ESOP Shares Allocated (6,629) 69,724 63,095
Change in unrealized gains on
marketable securities, net
of deferred taxes (290,772) (290,772
-------- -------- --------- --------- ----------- ------------ ----------- ---------- -----------
BALANCE AT DECEMBER 31, 1998 342,800 342,800 2,661,062 26,611 6,326,441 15,636,764 - 387,705 22,720,321
Net income 1,474,094 1,474,094
Issuance of common stock to
ESOP 2,405 24 19,976 20,000
Issuance of common stock under
Employee Stock Option Plan 34,550 346 266,279 266,625
Issuance of common stock in
exchange for preferred stock (1,500) (1,500) 1,500 15 1,485 0
Conversion of convertible
debentures into common stock 730,438 7,304 6,347,120 6,354,424
Change in unrealized gains on
marketable securities, net of
deferred taxes 1,601,300 1,601,300
-------- -------- --------- --------- ----------- ------------ ----------- ---------- -----------
BALANCE AT JUNE 30, 1999 341,300 $341,300 3,429,955 $ 34,300 $12,961,301 $ 17,110,858 $ - $1,989,005 $32,636,764
======== ======== ========= ========= =========== ============ =========== ========== ===========
See notes to consolidated financial statements.
</TABLE>
5
<PAGE>
<TABLE>
<CAPTION>
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
Six Months Ended June 30
------------------------------
1999 1998
------------ ------------
Cash Flows from Operating Activities:
<S> <C> <C>
Net income $ 1,474,094 $ 1,212,081
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 4,154,539 3,849,981
Minority stockholders' interest in earnings of Alliance
Telecommunications Corporation 686,227 555,060
Gain on sales of marketable securities (982,274) (429,469)
Loss (income) from partnership and LLC investments 78,229 (504,813)
Loss from investment in St. Paul Bank stock 141,277
Proceeds from wireless telephone investments 299,859 496,571
Changes in assets and liabilities net of effects from
the purchase of Felton Telephone Company:
Increase in accounts receivable (816,468) (593,417)
Increase in materials, supplies and inventories (605,886) (634,175)
Decrease in prepaid expenses 93,257 135,909
Increase in accounts payable 1,772,393 472,116
Increase (decrease) in accrued expenses 185,805 (195,412)
Decrease in income taxes payable (1,547,357) (67,030)
Decrease in deferred investment credits (80,075) (85,342)
Decrease in deferred taxes (149,498) (292,840)
Decrease in deferred compensation (46,521) (46,521)
------------ ------------
Net cash provided by operating activities 4,657,601 3,872,699
Cash Flows from Investing Activities:
Capital expenditures, net (2,832,245) (4,673,390)
Sales of temporary cash investments 300,000
Sales of marketable securities 1,655,506 1,108,827
Increase in construction fund (565,840) (227)
Purchases of wireless telephone investments (617,446) (572,572)
Purchases of other investments (841,533) (1,150,340)
Increase in excess of cost over net assets acquired (2,797,123)
Increase in other assets (7,363) (409,241)
Increase in cash from purchase of Felton Telephone Company 196,500
------------ ------------
Net cash used in investing activities (3,208,921) (7,997,566)
Cash Flows from Financing Activities:
Repayment of long-term debt (5,955,898) (2,139,471)
Proceeds from issuance of notes payable and long-term debt 3,892,634 2,000,000
Issuance of common stock 266,625 386,583
------------ ------------
Net cash provided by (used in) financing activities (1,796,639) 247,112
------------ ------------
Net Decrease in Cash and Cash Equivalents (347,959) (3,877,755)
Cash and Cash Equivalents at Beginning of Period 14,686,034 12,455,399
------------ ------------
Cash and Cash Equivalents at End of Period $ 14,338,075 $ 8,577,644
============ ============
Supplemental disclosures of cash flow information:
Interest paid during the period $ 1,700,115 $ 3,606,504
Income taxes paid during the period 3,414,839 1,702,443
See notes to consolidated financial statements.
</TABLE>
6
<PAGE>
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
NOTE 1 - CONSOLIDATED FINANCIAL STATEMENTS
The balance sheet and statement of stockholders' equity as of June 30, 1999 and
the statements of income and comprehensive income and the statements of cash
flows for the periods ended June 30, 1999 and 1998 have been prepared by the
Company without audit. In the opinion of management, all adjustments (which
include only normal recurring adjustments) necessary to present fairly the
financial position, results of operations, and changes in cash flows at June 30,
1999 and 1998 have been made.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted. It is suggested these condensed financial
statements be read in conjunction with the financial statements and notes
thereto included in the Company's December 31, 1998 Annual Report to
Shareholders. The results of operations for the periods ended June 30 are not
necessarily indicative of the operating results for the entire year.
Certain amounts in the 1998 financial statements have been reclassified to
conform to the 1999 financial statement presentation. These reclassifications
had no effect on net income or stockholders' equity as previously reported.
NOTE 2 - MARKETABLE SECURITIES AND GAINS ON SALES OF INVESTMENTS
Marketable securities consist principally of equity securities of other
telecommunications companies. The Company's marketable securities portfolio is
classified as available-for-sale. The cost and fair value of available-for-sale
investment securities was as follows: <TABLE> <CAPTION>
Gross Gross
Unrealized Unrealized Fair
Cost Gains Losses Value
<S> <C> <C> <C> <C>
June 30, 1999 $7,319,164 $3,232,523 $ (750) $10,550,937
December 31, 1998 7,992,397 1,949,794 (1,386,855) 8,555,336
</TABLE>
Net unrealized gains on marketable securities, net of related deferred taxes,
are included in accumulated other comprehensive income as follows:
Accumulated
Net Deferred Other
Unrealized Income Comprehensive
Gains Taxes Income
June 30, 1999 $ 3,231,773 $ (1,242,768) $ 1,989,005
December 31, 1998 562,939 (175,234) 387,705
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 $1,656,000 and
$1,109,000 in the six-month periods ended June 30, 1999 and 1998, respectively.
Gross realized gains on sales of these securities were $982,000 and $429,000 in
the respective 1999 and 1998 periods. Realized gains on sales are based on the
difference between net sales proceeds and the book value of securities sold,
using the specific identification method.
7
<PAGE>
NOTE 3 - WIRELESS TELEPHONE INVESTMENTS
The Company's investments in wireless telephone partnerships and limited
liability companies are recorded on the equity method of accounting, which
reflects original cost and recognition of the Company's share of income or
losses. At June 30, 1999, the Company owned 10.7% of Midwest Wireless
Communications LLC and 14.3% of Wireless North LLC.
Income recognized on cellular telephone investments, net of amortization, was
$681,000 and $929,000 for the six-month periods ended June 30, 1999 and 1998
respectively. The 1998 period included income from a 12.25% interest in Sioux
Falls Cellular, Ltd. which the Company sold in December 1998. Losses from PCS
investments were $808,000 and $470,000 for the six-month periods ended June 30,
1999 and 1998, respectively.
The Company made additional cash investments of $617,000 and $573,000 in the
respective 1999 and 1998 periods to support the operations of its wireless
investments. Cash distributions received from cellular telephone investments
were $300,000 and $497,000 in 1999 and 1998, respectively.
NOTE 4 - INCOME TAXES AND INVESTMENT CREDITS
Income taxes have been calculated in proportion to the earnings and tax credits
generated by operations. Investment tax credits have been deferred and are
included in income over the estimated useful lives of the related assets. The
Company's effective income tax rate is higher than the U.S. rate due to the
effect of state income taxes and non-deductible expenses.
NOTE 5 - 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. Segment information is as follows:
<TABLE>
<CAPTION>
Six Months Ended June 30, 1999 Six Months Ended June 30, 1998
Hector Alliance Consolidated Hector Alliance Consolidated
------------ ------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
Revenues $ 4,204,931 $ 12,838,185 $ 17,043,116 $ 3,892,382 $ 11,379,757 $ 15,272,139
Costs and expenses 3,301,553 7,568,702 10,870,255 2,940,729 6,954,455 9,895,184
------------ ------------ ------------ ------------ ------------ ------------
Operating income 903,378 5,269,483 6,172,861 951,653 4,425,302 5,376,955
Interest expense (863,152) (2,611,318) (3,474,470) (1,032,328) (2,512,662) (3,544,990)
Partnership and LLC income (loss) (89,332) 11,103 (78,229) 49,018 455,795 504,813
Investment income 91,730 245,432 337,162 105,393 290,501 395,894
Gain on sale of marketable securities 982,274 982,274 429,469 429,469
Loss on St. Paul Bank Stock (141,277) (141,277)
------------ ------------ ------------ ------------ ------------ ------------
Income before income taxes $ 42,624 $ 3,755,697 $ 3,798,321 $ 73,736 $ 3,088,405 $ 3,162,141
============ ============ ============ ============ ============ ============
Depreciation and Amortization $ 1,215,758 $ 2,823,621 $ 4,039,379 $ 1,021,860 $ 2,734,551 $ 3,756,411
============ ============ ============ ============ ============ ============
Capital Expenditures $ 1,318,001 $ 1,514,244 $ 2,832,245 $ 699,326 $ 3,974,064 $ 4,673,390
============ ============ ============ ============ ============ ============
Total Assets $ 25,861,988 $127,728,912 $153,590,900 $ 26,043,447 $121,968,055 $148,011,502
============ ============ ============ ============ ============ ============
</TABLE>
8
<PAGE>
<TABLE>
<CAPTION>
Three Months Ended June 30, 1999 Three Months Ended June 30, 1998
Hector Alliance Consolidated Hector Alliance Consolidated
------------ ------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
Revenues $ 2,199,491 $ 6,524,066 $ 8,723,557 $ 2,056,747 $ 5,966,590 $ 8,023,337
Costs and expenses 1,663,802 3,713,021 5,376,823 1,508,632 3,626,237 5,134,869
------------ ------------ ------------ ------------ ------------ ------------
Operating income 535,689 2,811,045 3,346,734 548,115 2,340,353 2,888,468
Interest expense (467,146) (1,334,616) 1,801,762) (505,078) (1,304,607) (1,809,685)
Partnership and LLC income 2,896 83,903 86,799 49,630 279,271 328,901
Investment income 50,856 91,880 142,736 54,765 149,167 203,932
Gain on sale of marketable securities 178,910 178,910 337,615 337,615
Loss on St. Paul Bank Stock (141,277) 141,277)
------------ ------------ ------------ ------------ ------------ ------------
Income before income taxes $ 122,295 $ 1,689,845 $ 1,812,140 $ 147,432 $ 1,801,799 $ 1,949,231
============ ============ ============ ============ ============ ============
Depreciation and Amortization $ 607,953 $ 1,437,780 $ 2,045,733 $ 511,158 $ 1,421,930 $ 1,933,088
============ ============ ============ ============ ============ ============
Capital Expenditures $ 1,062,471 $ 1,088,406 $ 2,150,877 $ 321,188 $ 3,647,716 $ 3,968,904
============ ============ ============ ============ ============ ============
</TABLE>
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations
Six Months Ended June 30, 1999 Compared to
Six Months Ended June 30, 1998
Hector Communications Corporation ("HCC") owns a 100% interest in five local
exchange telephone subsidiaries and one cable television subsidiary. At June 30,
1999, these subsidiaries provided telephone service to 7,163 customers in 9
rural communities in Minnesota and Wisconsin. They also owned 30 cable
television systems serving 4,938 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.
HCC owns a 68% interest in Alliance Telecommunications Corporation ("Alliance").
At June 30, 1999, Alliance, through its five local exchange telephone
subsidiaries, provided telephone service to 27,681 customers in 26 rural
communities in Minnesota, South Dakota and Iowa. Alliance's 16 cable television
systems provided cable television services to 8,137 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 have other investments.
Consolidated revenues increased 12% to $17,043,000. The revenue breakdown by
operating group was as follows:
<TABLE>
<CAPTION>
Alliance Hector
Six Months Ended June 30 Six Months Ended June 30
1999 1998 1999 1998
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Local Network $ 2,056,808 $ 1,784,488 $ 811,487 $ 764,850
Network Access 7,532,228 6,872,531 2,303,752 2,071,205
Billing and Collection 336,265 310,717 80,890 87,803
Nonregulated activities 1,756,487 1,837,205 292,379 261,771
Cable Television 1,156,397 574,816 716,423 706,753
------------ ------------ ------------ ------------
$ 12,838,185 $ 11,379,757 $ 4,204,931 $ 3,892,382
============ ============ ============ ============
</TABLE>
9
<PAGE>
Consolidated local service revenues increased $319,000 or 13%. The increase was
due to increases in access lines served, which increased to 34,844 and increased
extended area service revenues (EAS). Alliance's South Dakota exchanges added
EAS to Sioux Falls in March, 1999. Access line 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 effective March 31, 1998.
Network access revenues increased $892,000 or 10%. The increase was chiefly due
to increased use of the telephone network by customers and increased universal
service support funds.
Nonregulated revenues decreased $50,000 or 2%. Cable television revenues
increased $591,000 or 46% due to the acquisition by Alliance of additional cable
systems from Spectrum Cablevision Limited Partnership in June 1998. Billing and
collection revenues increased $19,000.
Consolidated operating costs and expenses increased $975,000 or 10%. Costs and
expenses by operating group were as follows:
<TABLE>
<CAPTION>
Alliance Hector
Six Months Ended June 30 Six Months Ended June 30
1999 1998 1999 1998
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Plant operations $ 1,601,800 $ 1,453,327 $ 551,726 $ 459,155
Depreciation and amortization 2,823,621 2,734,551 1,215,758 1,021,860
Customer operations 845,845 753,302 154,663 186,175
General and administrative 1,589,367 1,481,125 754,491 717,890
Other operating expenses 708,069 532,150 624,915 555,649
------------ ------------ ------------ ------------
$ 7,568,702 $ 6,954,455 $ 3,301,553 $ 2,940,729
============ ============ ============ ============
</TABLE>
Consolidated plant operations expenses increased $241,000 or 13%, due to
increases in the Company's customer base and the acquisition of Felton.
Depreciation and amortization increased $283,000 or 8% due to the acquisitions
of Felton and the Spectrum cable television systems and increased depreciation
on telephone switching equipment. Customer operations expenses increased
$61,000, or 6% due largely to growth in the number of customers served. General
and administrative expenses increased $145,000 or 7% due to the Company's
expanded operations. Other operating expenses increased $245,000 or 23% due to
increased cable television expenses from the Spectrum systems. Consolidated
operating income increased $796,000 or 15%.
Interest expenses decreased $71,000 due to interest reductions on convertible
debentures that were retired or converted into common stock in the second and
third quarters of 1998. The June 1999 period also includes $87,000 of interest
expense for call premiums and deferred issue expenses related to convertible
debentures redeemed for cash on June 25, 1999. Interest expenses also increased
due to reduced accruals of patronage dividends on interest paid to St. Paul Bank
for Cooperatives ("SPBC"). The Company accrued a loss of $141,000 on its
investment in SPBC stock due to its revaluation for SPBC's merger with CoBank,
ACB. The Company also incurred interest expense on 1998 borrowings to finance
the acquisitions of Felton and the Spectrum cable systems.
The Company recorded a loss from partnership and LLC investments of $78,000 for
the 1999 period compared to income of $505,000 in 1998. Income from Midwest
Wireless LLC was $681,000 compared to $710,000 in the 1998 period. Losses from
the Company's Wireless North PCS investment totaled $808,000 compared to
$470,000 in 1998. 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. 1998 income from the Sioux Falls,
South Dakota MSA was $241,000. The Company sold its interest in the MSA in
December 1998.
10
<PAGE>
Investment income decreased $59,000. Alliance had gains on sales of marketable
securities of $982,000 and $429,000 in 1999 and 1998, respectively. Alliance
continues to hold a significant portfolio of marketable securities.
Income before income taxes increased 20% to $3,798,000. The Company's effective
income tax rate of 43% is higher than the standard U.S. tax rate due to state
income taxes and the effect of nondeductible amortization expenses. Income
before minority interest increased 22% to $2,160,000. Minority interest on
earnings of Alliance were $686,000 compared to $555,000 in 1998. Net income
increased 22% to $1,474,000.
Three Months Ended June 30, 1999 Compared to
Three Months Ended June 30, 1998
Consolidated revenues increased 9% to $8,724,000. The revenue breakdown by
operating group was as follows:
<TABLE>
<CAPTION>
Alliance Hector
Three Months Ended March 31 Three Months Ended March 31
1999 1998 1999 1998
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Local Network $ 954,762 $ 828,405 $ 390,787 $ 371,564
Network Access 3,766,263 3,296,393 1,113,555 963,302
Billing and Collection 153,874 149,142 40,024 45,420
Nonregulated activities 863,882 875,448 109,033 105,833
Cable Television 575,338 263,779 352,041 349,516
------------ ------------ ------------ ------------
$ 6,314,119 $ 5,413,167 $ 2,005,440 $ 1,835,635
============ ============ ============ ============
</TABLE>
Consolidated local service revenues increased $173,000 or 13%. The increase was
due to increases in access lines served, which increased to 34,844 and increased
extended area service revenues (EAS). Alliance's South Dakota exchanges added
EAS to Sioux Falls in March 1999. Network access revenues increased $272,000 or
6%. The increase was chiefly due to increased use of the telephone network by
customers. The addition of EAS service to Sioux Falls reduced the growth rate of
network access revenues.
Nonregulated revenues decreased $42,000 or 4%. Cable television revenues
increased $277,000 or 41% due to the acquisition by Alliance of additional cable
systems from Spectrum Cablevision Limited Partnership in June 1998. Billing and
collection revenues increased $19,000.
Consolidated operating costs and expenses increased $242,000 or 5%. Costs and
expenses by operating group were as follows:
<TABLE>
<CAPTION>
Alliance Hector
Three Months Ended June 30 Three Months Ended June 30
1999 1998 1999 1998
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Plant operations $ 774,227 $ 801,515 $ 274,544 $ 234,036
Depreciation and amortization 1,437,780 1,421,930 607,953 511,158
Customer operations 444,522 373,353 77,736 111,868
General and administrative 732,796 745,345 388,543 369,640
Other operating expenses 323,696 284,094 315,026 281,930
------------ ------------ ------------ ------------
$ 3,713,021 $ 3,626,237 $ 1,663,802 $ 1,508,632
============ ============ ============ ============
</TABLE>
11
<PAGE>
Consolidated plant operations expenses increased $13,000 or 1%, due to increases
in the Company's customer base. Depreciation and amortization increased $113,000
or 6% due to the acquisition of the Spectrum cable television systems and
increased depreciation on telephone switching equipment. Customer operations
expenses increased $37,000, or 8% due largely to growth in the number of
customers served. General and administrative expenses increased $7,000. Other
operating expenses increased $73,000 or 13% due to increased cable television
expenses from the Spectrum systems. Consolidated operating income increased
$458,000 or 16%.
Interest expenses decreased $8,000. The decrease was due to interest reductions
on convertible debentures that were retired or converted into common stock in
the second and third quarters of 1998. This reduction was offset by $87,000 of
interest expense for call premiums and deferred issue expenses related to
convertible debentures redeemed for cash on June 25, 1999. Interest expenses
also increased due to reduced accruals of patronage dividends on interest paid
to St. Paul Bank for Cooperatives ("SPBC"). The Company accrued a loss during
the 1999 period of $141,000 on its investment in SPBC stock due to its
revaluation for SPBC's merger with CoBank. The Company also incurred additional
interest expense on 1998 borrowings to finance the acquisition of the Spectrum
cable systems.
The Company recorded income from partnership and LLC investments of $87,000 for
the 1999 period compared to income of $329,000 in 1998. Income from Midwest
Wireless LLC was $416,000 compared to $431,000 in the 1998 period. Losses from
the Company's Wireless North PCS investment totaled $362,000 compared to
$234,000 in 1998. 1998 income from the Sioux Falls, South Dakota MSA was
$141,000. The Company sold its interest in the MSA in December 1998.
Investment income decreased $61,000. Alliance had gains on sales of marketable
securities of $179,000 and $338,000 in 1999 and 1998, respectively. Alliance
continues to hold a significant portfolio of marketable securities.
Income before income taxes decreased $137,000, or 7%. Income before minority
interest decreased $81,000 or 7% to $1,024,000. Minority interest on earnings of
Alliance were $305,000 compared to $327,000 in 1998. Net income decreased 8% to
$719,000.
Liquidity and Capital Resources
Cash flows from consolidated operating activities for the six-month periods were
$4,658,000 and $3,873,000 in 1999 and 1998, respectively. The increase in
operating cash flow was due to increased earnings and increased accounts payable
related to capital additions. At June 30, 1999, the Company's cash, cash
equivalents, temporary cash investments and marketable securities totaled
$24,889,000 compared to $23,241,000 at December 31, 1998. Alliance's cash and
securities were $20,558,000 of this total. Working capital at June 30, 1999 was
$9,786,000 compared to $6,554,000 at December 31, 1998. The current ratio was
1.9 to 1 at June 30, 1999.
The Company makes periodic improvements to its facilities to provide up-to-date
services to its telephone and cable television customers. Hector's plant
additions in the 1999 and 1998 six-month periods were $1,318,000 and $699,000,
respectively. Alliance's plant additions in the same periods were $1,514,000 and
$3,974,000, 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.
12
<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 the 1999 period, Alliance received $1,656,000 from sales of a portion of its
investment in MediaOne Group, Inc and Rural Cellular Corp. Alliance's proceeds
from sales of marketable securities were $1,109,000 in the 1998 period. At June
30, 1999, Alliance continued to maintain a significant marketable securities
portfolio (valued at $10,432,000 at June 30, 1999 compared to $8,418,000 at
December 31, 1998) consisting primarily of shares of Rural Cellular Corporation,
U.S. West Communications, Inc. and MediaOne Group, Inc.
The Company is an investor in Wireless North, a limited liability corporation
that has acquired licenses to operate PCS systems in 13 markets in Minnesota,
Wisconsin, North Dakota and South Dakota. The PCS systems are in start-up mode
and have incurred significant losses to date. 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. The Company invested cash of $761,000 in Wireless North in 1998 and
an additional $617,000 in the first six months of 1999. Investments in Wireless
North in 1997 and 1996 consisted of $510,000 of cash and debt guarantees of
$1,373,000. The Company has committed to making additional capital contributions
of $225,000 in the third and fourth quarters of 1999 in an effort to increase
Wireless North's financial stability. It cannot predict how much additional
funding that might be required beyond that amount. The Company continues to
maintain its ownership in cellular telephone systems through its 10.0% interest
in Midwest Wireless LLC. 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.
The Company continues to carry a significant amount of debt associated with
Alliance's 1996 acquisition of Ollig Utilities Company. HCC 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. To finance its equity investment in Alliance, HCC
borrowed $6,000,000 from St. Paul Bank (since refinanced through Rural Telephone
Finance Cooperative) and used part of the proceeds from its 1995 convertible
debenture offering. The Company called some of the outstanding debentures in
1998. The remaining debentures were called June 25, 1999. Debentures totaling
$6,493,000 were converted into common stock as a result of this call; $1,455,000
of debentures were redeemed for cash.
Alliance financed the acquisition of Ollig 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 June 30, 1999 was $49,174,000. St. Paul Bank
is a cooperative, owned and controlled by its customers. Each customer borrowing
from the bank on a patronage basis shares in the bank's net income through
payment of patronage refunds. The Company accrued for a patronage refund in the
1998 period but, due to losses at the Bank on its agricultural loans, did not do
so in 1999. St. Paul Bank has entered into a merger agreement with CoBank, ACB
effective in the third quarter of 1999. As a result of the merger, the Company
accrued a $141,000 loss on revaluation of its St. Paul Bank stock.
The Company's LEC subsidiaries use 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 $3,893,000 in the first
six months of 1999. 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 June 30, 1999
unadvanced loan commitments from the RUS and RTB to the LEC subsidiaries totaled
$13,659,000.
13
<PAGE>
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 was a member
of investor groups seeking to acquire rural telephone properties offered for
sale by GTE and U.S. West Communications in 1999. Attempts to acquire some of
those properties have been unsuccessful. The Company cannot predict if it will
be successful in acquiring additional properties and does not have financing
plans in place to pay for possible acquisitions.
By utilizing cash flow from operations, current cash and investment balances,
and other available financing sources, the Company feels it has adequate
resources to meet its anticipated operating, debt service and capital
expenditure requirements.
Year 2000 Issues
The software used by the Company's data processing and telephone switching
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. 1999 is abbreviated as
"99". Most software using this system does not recognize that the year 2000,
abbreviated as "00", follows 1999. This causes computing errors in date
sensitive processes. The Company has surveyed its telephone switching and data
processing systems to locate computer systems that may be subject to this error.
The Company's survey determined that the switching equipment used in its local
telephone exchanges to connect customer calls and record telephone usage was not
Year 2000 compliant. If not corrected, this could interrupt telephone services
for customers, interrupt connections between the Company's telephone systems and
the national and worldwide telephone networks, and make the Company unable to
accurately bill customers for telephone usage. The Company's systems 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 systems 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 of all the new hardware was completed in July
1999. Testing of software interconnections will 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 local telephone services to customers or cause material
disruptions to its own operations. It is possible that customers will have
difficulty making telephone connections through certain interexchange carriers
or to certain foreign countries, depending on the respective carriers and
countries' state of Year 2000 readiness. Customers could also be vulnerable to
14
<PAGE>
Year 2000 problems within their own internal telephone networks. 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 material
loss of service to customers, but will continue to monitor the situation and
modify its business plans and procedures as the situation warrants.
- --------------------------------------------------------------------------------
Statements regarding the Company's anticipated performance in future periods are
forward looking and involve risks and uncertainties, including but not limited
to: changes in government rules and regulations, new technological developments,
and other risks involving the telecommunications industry generally.
- --------------------------------------------------------------------------------
PART II. OTHER INFORMATION
Items 1 - 3. Not Applicable
Item 4. Submission of Matters to a Vote of Securities Holders The Annual Meeting
of the Shareholders of the Registrant was held on May 18, 1999 in Minneapolis,
MN. The total number of shares outstanding and entitled to vote at the meeting
was 2,663,968 of which 2,559,918 were present either in person or by proxy.
Shareholders re-elected board members Curtis A. Sampson and Steven H. Sjogren to
three-year terms expiring at the 2002 Annual Meeting of Shareholders. The vote
for these board members was as follows:
In Favor Abstaining
Curtis A. Sampso 2,497,897 62,021
Steven H. Sjogren 2,498,456 61,462
Shareholders also approved the Company's 1999 Stock Plan which authorizes the
issuance of up to 300,000 shares pursuant to options and other awards granted
under the Plan. The Plan also increases from 1,000 to 2,000 the number of stock
option shares automatically granted to each nonemployee director reelected at or
continuing in office after the annual meeting of shareholders. The shareholder
vote on the 1999 Stock Plan was 1,430,145 in favor, 240,637 against, 7,565
abstaining and 881,571 not voting.
Item 5. Not applicable.
Item 6(a). Exhibits
Exhibit 11, "Calculation of Earnings Per Share" is attached to this Form 10-Q.
Item 6(b). Exhibits and Reports on Form 8-K.
On June 4, 1999, the Company filed a Form 8-K dated May 27, 1999 related to its
investment in St. Paul Bank for Cooperatives and the merger of that bank with
CoBank, ACB.
Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereto duly authorized.
Hector Communications Corporation
By /s/Charles A. Braun
---------------------------------
Charles A. Braun
Chief Financial Officer
Date: August 13, 1999
15
<PAGE>
<TABLE>
<CAPTION>
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
EXHIBIT 11
CALCULATION OF EARNINGS PER SHARE
Three Months Ended June 30 Six Months Ended June 30
----------------------------- -----------------------------
Basic: 1999 1998 1999 1998
- ------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Net income $ 718,670 $ 778,123 $1,474,094 $1,212,081
========== ========== ========== ==========
Common shares:
Weighted average number of common shares outstanding 2,766,863 2,263,174 2,694,432 2,178,162
Number of unallocated shares held by ESOP (6,042) (6,042)
---------- ---------- ---------- ----------
2,766,863 2,257,132 2,694,432 2,172,120
========== ========== ========== ==========
Net income per common share $ .26 $ .34 $ .55 $ .56
========== ========== ========== ==========
Diluted:
- -------------
Net income $ 718,670 $ 778,123 $1,474,094 $1,212,081
Interest on convertible debentures 158,916 249,804 327,811 518,438
Amortization of debenture issue costs 85,455 46,323 115,160 93,570
Income tax effect (97,748) (118,451) (177,188) (244,803)
---------- ---------- ---------- ----------
Adjusted net income $ 865,293 $ 955,799 $1,739,877 $1,579,286
========== ========== ========== ==========
Common and common equivalent shares:
Weighted average number of common shares outstanding 2,766,863 2,263,174 2,694,432 2,178,162
Assumed conversion of convertible
debentures into common stock 763,783 1,175,850 849,272 1,175,850
Dilutive effect of convertible preferred shares outstanding 341,997 351,762 342,397 363,096
Dilutive effect of stock options outstanding after
application of treasury stock method 45,076 62,217 36,955 57,852
Dilutive effect of Employee Stock
Purchase Plan shares subscribed 4,534 4,537 4,002 4,288
Dilutive effect of warrants outstanding 10,545 23,181 6,141 20,179
Weighted average number of
unallocated shares held by ESOP (6,042) (6,042)
---------- ---------- ---------- ----------
3,932,798 3,874,679 3,933,199 3,793,385
========== ========== ========== ==========
Diluted net income per share $ .22 $ .25 $ .44 $ .42
========== ========== ========== ==========
</TABLE>
16
<PAGE>
<TABLE> <S> <C>
<ARTICLE> 5
<CIK> 0000863437
<NAME> HECTOR COMMUNICATIONS CORPORATION
<MULTIPLIER> 1
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> JUN-30-1999
<EXCHANGE-RATE> 1
<CASH> 14,338,075
<SECURITIES> 0
<RECEIVABLES> 4,957,460
<ALLOWANCES> 0
<INVENTORY> 1,134,725
<CURRENT-ASSETS> 21,283,468
<PP&E> 78,984,754
<DEPRECIATION> 28,590,500
<TOTAL-ASSETS> 153,590,900
<CURRENT-LIABILITIES> 11,497,733
<BONDS> 87,634,525
0
341,300
<COMMON> 34,300
<OTHER-SE> 32,061,164
<TOTAL-LIABILITY-AND-EQUITY> 153,590,900
<SALES> 17,043,116
<TOTAL-REVENUES> 17,043,116
<CGS> 10,870,255
<TOTAL-COSTS> 10,870,255
<OTHER-EXPENSES> (1,099,930)
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 3,474,470
<INCOME-PRETAX> 3,798,321
<INCOME-TAX> 1,638,000
<INCOME-CONTINUING> 2,160,321
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,474,094
<EPS-BASIC> 0.55
<EPS-DILUTED> 0.44
</TABLE>
