- --------------------------------------------------------------------------------
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended SEPTEMBER 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
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 Outstanding at October 31, 1999
Common Stock, par value 3,504,786
$.01 per share
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)
September 30 December 31
Assets: 1999 1998
------------ ------------
Current assets:
<S> <C> <C>
Cash and cash equivalents $ 16,926,951 $ 14,686,034
Construction fund 284,535 200,491
Accounts receivable, net 6,195,344 4,140,992
Materials, supplies and inventories 1,015,194 528,839
Prepaid expenses 183,999 180,134
------------ ------------
Total current assets 24,606,023 19,736,490
Property, plant and equipment 81,696,542 76,245,233
less accumulated depreciation (30,285,255) (25,434,769)
------------ ------------
Net property, plant and equipment 51,411,287 50,810,464
Other assets:
Excess of cost over net assets acquired, net 51,832,046 53,003,560
Marketable securities 10,396,845 8,555,336
Wireless telephone investments 9,738,885 9,482,902
Other investments 8,997,344 8,259,419
Deferred debenture issue costs, net 371,311
Other assets 549,896 460,305
------------ ------------
Total other assets 81,515,016 80,132,833
------------ ------------
Total Assets $157,532,326 $150,679,787
============ ============
Liabilities and Stockholders' Equity:
Current liabilities:
Notes payable and current portion of long-term debt $ 4,913,700 $ 6,808,500
Accounts payable 2,625,168 2,473,526
Accrued expenses 1,801,002 1,945,687
Income taxes payable 2,753,639 1,955,153
------------ ------------
Total current liabilities 12,093,509 13,182,866
Long-term debt, less current portion 86,112,950 94,232,389
Deferred investment tax credits 132,741 252,601
Deferred income taxes 9,518,512 8,510,637
Deferred compensation 920,374 990,155
Minority stockholders interest in Alliance
Telecommunications Corp. 13,607,016 10,790,818
Stockholders' Equity 35,147,224 22,720,321
------------- -------------
Total Liabilities and Stockholders' Equity $157,532,326 $ 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 September 30 Nine Months Ended September 30
------------------------------- -------------------------------
1999 1998 1999 1998
----------- ----------- ----------- -----------
Revenues:
<S> <C> <C> <C> <C>
Local network $ 1,556,028 $ 1,394,487 $ 4,424,323 $ 3,943,825
Network access 4,996,475 4,345,230 14,832,455 13,288,966
Billing and collection 211,624 235,933 628,779 634,453
Nonregulated activities 1,186,474 1,098,334 3,235,340 3,197,310
Cable television revenues 984,035 953,475 2,856,855 2,235,044
----------- ----------- ----------- -----------
Total revenues 8,934,636 8,027,459 25,977,752 23,299,598
Costs and expenses:
Plant operations 741,647 679,988 2,895,173 2,592,470
Depreciation and amortization 2,171,382 1,973,826 6,210,761 5,730,237
Customer operations 580,267 508,550 1,580,775 1,448,027
General and administrative 1,206,379 1,176,784 3,550,237 3,375,799
Other operating expenses 1,105,432 696,017 2,438,416 1,783,816
----------- ----------- ----------- -----------
Total costs and expenses 5,805,107 5,035,165 16,675,362 14,930,349
Operating income 3,129,529 2,992,294 9,302,390 8,369,249
Other income and (expenses):
Interest expense (1,469,347) (1,843,504) (4,943,817) (5,388,494)
Gain on sales of marketable securities 3,472,200 517,826 4,454,474 947,295
Investment income 438,234 186,439 775,396 582,333
Other investment income (loss) 141,494 390,283 (78,012) 895,096
----------- ----------- ----------- -----------
Other income (expense), net 2,582,581 (748,956) 208,041 (2,963,770)
Income before income taxes 5,712,110 2,243,338 9,510,431 5,405,479
Income tax expense 2,427,000 984,000 4,065,000 2,379,000
----------- ----------- ----------- -----------
Income before minority interest 3,285,110 1,259,338 5,445,431 3,026,479
Minority interest in earnings of
Alliance Telecommunications Corporation 1,053,285 384,853 1,739,512 939,913
----------- ----------- ----------- -----------
Net income $ 2,231,825 $ 874,485 $ 3,705,919 $ 2,086,566
----------- ----------- ----------- -----------
Other comprehensive income:
Unrealized holding gains (losses)
on marketable securities 5,782,597 (555,106) 9,433,705 270,571
Less: reclassification adjustment for gains
included in net income (3,472,200) (517,826) (4,454,474) (947,295)
----------- ----------- ----------- -----------
Other comprehensive income (loss) before income taxes 2,310,397 (1,072,932) 4,979,231 (676,724)
Income tax expense (benefit) related to items of
other comprehensive income (loss) 924,398 (429,173) 1,991,932 (270,690)
Minority interest in other comprehensive income of
Alliance Telecommunications Corporation 1,076,686 1,076,686
----------- ----------- ----------- -----------
Other comprehensive income (loss) 309,313 (643,759) 1,910,613 (406,034)
----------- ----------- ----------- -----------
Comprehensive income $ 2,541,138 $ 230,726 $ 5,616,532 $ 1,680,532
=========== =========== =========== ===========
Basic net income per share $ .65 $ .34 $ 1.26 $ .90
Diluted net income per share $ .57 $ .26 $ 1.01 $ .71
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 3,705,919 3,705,919
Issuance of common stock to
ESOP 2,405 24 19,976 20,000
Issuance of common stock under
Employee Stock Purchase Plan 14,989 150 104,960 105,110
Issuance of common stock under
Employee Stock Option Plan 42,175 422 330,415 330,837
Issuance of common stock in
exchange for preferred stock (2,500) (2,500) 2,500 25 2,475 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 1,910,613 1,910,613
-------- -------- --------- --------- ----------- ------------ ----------- ---------- -----------
BALANCE AT SEPTEMBER 30, 1999 341,300 $341,300 3,456,185 $ 34,562 $13,131,361 $ 19,342,683 $ - $2,298,318 $35,147,224
======== ======== ========= ========= =========== ============ =========== ========== ===========
See notes to consolidated financial statements
</TABLE>
5
<PAGE>
<TABLE>
<CAPTION>
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
Nine Months Ended September 30
------------------------------
1999 1998
----------- -----------
Cash Flows from Operating Activities:
<S> <C> <C>
Net income $ 3,705,919 $ 2,086,566
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization 6,325,921 5,862,719
Minority stockholders' interest in earnings of Alliance
Telecommunications Corporation 1,739,512 939,913
Gain on sales of marketable securities (4,454,474) (947,295)
Loss (income) from partnership and LLC investments 78,012 (895,096)
Proceeds from wireless telephone investments 491,805 486,474
Changes in assets and liabilities net of effects from the purchase of Felton
Telephone Company:
Increase in accounts receivable (1,059,077) (936,502)
Increase in materials, supplies and inventories (486,355) (846,755)
Decrease (increase) in prepaid expenses (3,865) 51,251
Increase in accounts payable 151,642 1,313,719
Decrease in accrued expenses (7,111) (469,795)
Increase in income taxes payable 798,486 100,699
Decrease in deferred investment credits (119,860) (126,451)
Decrease in deferred taxes (984,057) (615,270)
Decrease in deferred compensation (69,781) (69,782)
----------- -----------
Net cash provided by operating activities 6,106,717 5,934,395
Cash Flows from Investing Activities:
Capital expenditures, net (5,626,659) (6,754,582)
Sales of temporary cash investments 300,000
Sales of marketable securities 6,596,921 1,801,879
Increase in construction fund (84,044) (83)
Purchases of wireless telephone investments (825,800) (644,882)
Purchases of other investments (737,925) (1,149,228)
Increase in excess of cost over net assets acquired (2,797,123)
Increase in other assets (103,001) (363,426)
Increase in cash from purchase of Felton Telephone Company 196,500
----------- -----------
Net cash provided by (used in) investing activities (780,508) (9,410,945)
Cash Flows from Financing Activities:
Repayment of long-term debt (7,513,873) (3,766,739)
Proceeds from issuance of notes payable and long-term debt 3,992,634 2,000,000
Issuance of common stock 435,947 459,703
----------- -----------
Net cash used in financing activities (3,085,292) (1,307,036)
----------- -----------
Net Increase (Decrease) in Cash and Cash Equivalents 2,240,917 (4,783,586)
Cash and Cash Equivalents at Beginning of Period 14,686,034 12,455,399
----------- -----------
Cash and Cash Equivalents at End of Period $16,926,951 $ 7,671,813
=========== ===========
Supplemental disclosures of cash flow information:
Interest paid during the period $ 4,845,841 $ 5,536,402
Income taxes paid during the period 3,383,475 2,400,544
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 September 30, 1999
and the statements of income and comprehensive income and the statements of cash
flows for the periods ended September 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
September 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 September 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:
Gross Gross
Unrealized Unrealized Fair
Cost Gains Losses Value
September 30, 1999 $4,854,675 $ 5,548,170 $ (6,000) $ 10,396,845
December 31, 1998 7,992,397 1,949,794 (1,386,855) 8,555,336
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 Minority Comprehensive
Gains Taxes Interest Income
September 30, 1999 $5,542,170 $(2,167,166) $(1,076,686) $ 2,298,318
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.
Proceeds from sales of available-for-sale securities were $7,592,000 (including
$995,000 receivable at September 30, 1999) and $1,802,000 in the nine-month
periods ended September 30, 1999 and 1998, respectively. Gross realized gains on
sales of these securities were $4,454,000 and $947,000 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 September 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
$1,182,000 and $1,537,000 for the nine-month periods ended September 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 $1,237,000 and $772,000 for the nine-month periods ended
September 30, 1999 and 1998, respectively.
The Company made additional cash investments of $826,000 and $645,000 in the
respective 1999 and 1998 periods to support the operations of its wireless
investments. Cash distributions received from cellular telephone investments
were $492,000 and $486,000 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>
Nine Months Ended September 30, 1999 Nine Months Ended September 30, 1998
Hector Alliance Consolidated Hector Alliance Consolidated
------------ ------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
Revenues $ 6,407,411 $ 19,570,341 $ 25,977,752 $ 5,861,822 $ 17,437,776 $ 23,299,598
Costs and expenses 5,273,526 11,401,836 16,675,362 4,457,157 10,473,192 14,930,349
------------ ------------ ------------ ------------ ------------ ------------
Operating income 1,133,885 8,168,505 9,302,390 1,404,665 6,964,584 8,369,249
Interest expense (1,103,667) (3,840,150) (4,943,817) (1,466,377) (3,922,117) (5,388,494)
Investment income 138,733 636,663 775,396 156,896 425,437 582,333
Gain on sale of
marketable securities 4,454,474 4,454,474 947,295 947,295
Other investment income (loss) (125,495) 47,483 (78,012) 82,773 812,323 895,096
------------ ------------ ------------ ------------ ------------ ------------
Income before income taxes $ 43,456 $ 9,466,975 $ 9,510,431 $ 177,957 $ 5,227,522 $ 5,405,479
============ ============ ============ ============ ============ ============
Depreciation and Amortization $ 1,916,171 $ 4,294,590 $ 6,210,761 $ 1,532,755 $ 4,197,482 $ 5,730,237
============ ============ ============ ============ ============ ============
Capital Expenditures $ 2,179,344 $ 3,447,315 $ 5,626,659 $ 1,537,221 $ 5,217,361 $ 6,754,582
============ ============ ============ ============ ============ ============
Total Assets $25,447,215 $132,085,111 $157,532,326 $ 25,161,168 $121,590,159 $146,751,327
============ ============ ============ ============ ============ ============
</TABLE>
8
<PAGE>
<TABLE>
<CAPTION>
Three Months Ended September 30, 1999 Three Months Ended September 30, 1998
Hector Alliance Consolidated Hector Alliance Consolidated
------------ ------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
Revenues $ 2,202,480 $ 6,732,156 $ 8,934,636 $ 1,969,440 $ 6,058,019 $ 8,027,459
Costs and expenses 1,971,973 3,833,134 5,805,107 1,516,428 3,518,737 5,035,165
------------ ------------ ------------ ------------ ------------ ------------
Operating income 230,507 2,899,022 3,129,529 453,012 2,539,282 2,992,294
Interest expense (240,515) (1,228,832) (1,469,347) (434,049) (1,409,455) (1,843,504)
Investment income 47,003 391,231 438,234 51,503 134,936 186,439
Gain on sale of
marketable securities 3,472,200 3,472,200 517,826 517,826
Other investment income (loss) (36,163) 177,657 141,494 33,755 356,528 390,283
------------ ------------ ------------ ------------ ------------ ------------
Income before income taxes $ 832 $ 5,711,278 $ 5,712,110 $ 104,221 $ 2,139,117 $ 2,243,338
============ ============ ============ ============ ============ ============
Depreciation and Amortization $ 700,413 $ 1,470,969 $ 2,171,382 $ 510,895 $ 1,462,931 $ 1,973,826
============ ============ ============ ============ ============ ============
Capital Expenditures $ 861,343 $ 1,933,071 $ 2,794,414 $ 837,895 $ 1,243,297 $ 2,081,192
============ ============ ============ ============ ============ ============
</TABLE>
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Nine Months Ended September 30, 1999 Compared to
Nine Months Ended September 30, 1998
Hector Communications Corporation ("HCC") owns a 100% interest in five local
exchange telephone subsidiaries and one cable television subsidiary. At
September 30, 1999, these subsidiaries provided telephone service to 7,184
customers in 9 rural communities in Minnesota and Wisconsin. They also owned 30
cable television systems serving 4,988 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 Onvoy (formerly MEANS).
HCC owns a 68% interest in Alliance Telecommunications Corporation ("Alliance").
At September 30, 1999, Alliance, through its five local exchange telephone
subsidiaries, provided telephone service to 28,561 customers in 26 rural
communities in Minnesota, South Dakota and Iowa. Alliance's 16 cable television
systems provided cable television services to 7,964 subscribers in Minnesota,
South Dakota and North Dakota. Alliance's subsidiaries also own substantial
investments in Midwest Wireless LLC, Wireless North LLC and Onvoy, 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 11% to $25,978,000. The revenue breakdown by
operating group was as follows:
<TABLE>
<CAPTION>
Alliance Hector
Nine Months Ended September 30 Nine Months Ended September 30
1999 1998 1999 1998
------------ ----------- ----------- -----------
<S> <C> <C> <C> <C>
Local network $ 3,178,637 $ 2,776,230 $ 1,245,686 $ 1,167,595
Network access 11,400,648 10,161,677 3,431,807 3,127,289
Billing and collection 504,919 501,524 123,860 132,929
Nonregulated activities 2,724,965 2,825,657 510,375 371,653
Cable television 1,761,172 1,172,688 1,095,683 1,062,356
------------ ----------- ----------- -----------
$ 19,570,341 $17,437,776 $ 6,407,411 $ 5,861,822
============ =========== =========== ===========
</TABLE>
9
<PAGE>
Consolidated local service revenues increased $480,000 or 12%. The increase was
due to increases in access lines served, which increased to 35,745 and increased
extended area service (EAS) revenues. 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 $1,543,000 or 12%. The increase was chiefly
due to increased use of the telephone network by customers and increased
universal service support funds.
Nonregulated revenues increased $38,000 or 1%. Cable television revenues
increased $622,000 or 28% due to the acquisition by Alliance of additional cable
systems from Spectrum Cablevision Limited Partnership in June 1998. Billing and
collection revenues decreased $6,000.
Consolidated operating costs and expenses increased $1,745,000 or 12%. Costs and
expenses by operating group were as follows:
<TABLE>
<CAPTION>
Alliance Hector
Nine Months Ended September 30 Nine Months Ended September 30
1999 1998 1999 1998
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Plant operations $ 2,042,503 $ 1,910,781 $ 852,670 $ 681,689
Depreciation and amortization 4,294,590 4,197,482 1,916,171 1,532,755
Customer operations 1,340,192 1,175,826 249,583 272,201
General and administrative 2,377,847 2,302,511 1,172,390 1,073,288
Other operating expenses 1,355,704 886,592 1,082,712 897,224
------------ ----------- ----------- -----------
$ 11,410,836 $10,473,192 $ 5,273,526 $ 4,457,157
============ =========== =========== ===========
</TABLE>
Consolidated plant operations expenses increased $303,000 or 12%, due to
increases in the Company's customer base and the acquisition of Felton.
Depreciation and amortization increased $481,000 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
$133,000, or 9% due largely to growth in the number of customers served. General
and administrative expenses increased $174,000 or 5% due to the Company's
expanded operations. Other operating expenses increased $655,000 or 37% due to
increased cable television expenses from the Spectrum systems. Consolidated
operating income increased $933,000 or 11%.
Interest expenses decreased $445,000 due to interest reductions on convertible
debentures that were retired or converted into common stock. Interest expenses
also decreased due to principal payments made which reduced the Company's
long-term debt.
Alliance had gains on sales of marketable securities of $4,454,000 and $947,000
in 1999 and 1998, respectively. During the first nine months of 1999, Alliance
sold 202,000 shares of Rural Cellular Corporation and 16,900 shares of MediaOne
Group, Inc. in open market transactions. At September 30, 1999, Alliance still
held a significant portfolio of marketable securities, including 135,000 shares
of Rural Cellular Corporation. Investment income increased $193,000 due to
investment of the proceeds from the marketable securities sales.
The Company had losses from other investments (principally partnership and LLC
investments) of $78,000 for the 1999 period compared to income of $895,000 in
1998. Income from Midwest Wireless LLC was $1,182,000 compared to $1,196,000 in
the 1998 period. Losses from the Company's Wireless North PCS investment totaled
$1,237,000 compared to $772,000 in 1998. The Company and its fellow investors
are seeking to sell or restructure Wireless North's business in order to reduce
operating losses. 1998 income from the Sioux Falls, South Dakota MSA was
$341,000. The Company sold its interest in the MSA in December 1998.
10
<PAGE>
Income before income taxes increased 76% to $9,510,000. 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 80% to $5,445,000. Minority interest on
earnings of Alliance were $1,740,000 compared to $940,000 in 1998. Net income
increased 78% to $3,706,000.
Three Months Ended September 30, 1999 Compared to
Three Months Ended September 30, 1998
Consolidated revenues increased 11% to $8,935,000. The revenue breakdown by
operating group was as follows:
<TABLE>
<CAPTION>
Alliance Hector
Three Months Ended September 30 Three Months Ended September 30
1999 1998 1999 1998
------------ ----------- ----------- -----------
<S> <C> <C> <C> <C>
Local network $ 1,121,829 $ 991,742 $ 434,199 $ 402,745
Network access 3,868,420 3,289,146 1,128,055 1,056,084
Billing and collection 168,654 190,807 42,970 45,126
Nonregulated activities 968,478 988,452 217,996 109,882
Cable television 604,775 597,872 379,260 355,603
------------ ----------- ----------- -----------
$ 6,732,156 $ 6,058,019 $ 2,202,480 $ 1,969,440
============ =========== =========== ===========
</TABLE>
Consolidated local service revenues increased $162,000 or 12%. The increase was
due to increases in access lines served and increased extended area service
revenues (EAS). Network access revenues increased $651,000 or 15%. The increase
was chiefly due to increased intrastate access revenues caused by increased use
of the telephone network by customers.
Nonregulated revenues increased $88,000 or 8%. Cable television revenues
increased $31,000 or 3% due to small rate increases in some of HCC's cable
systems. Billing and collection revenues decreased $24,000.
Consolidated operating costs and expenses increased $770,000 or 15%. Costs and
expenses by operating group were as follows:
<TABLE>
<CAPTION>
Alliance Hector
Three Months Ended September 30 Three Months Ended September 30
1999 1998 1999 1998
------------ ----------- ----------- -----------
<S> <C> <C> <C> <C>
Plant operations $ 440,703 $ 457,454 $ 300,944 $ 222,534
Depreciation and amortization 1,470,969 1,462,931 700,413 510,895
Customer operations 494,347 422,524 94,920 86,026
General and administrative 788,480 821,386 417,899 355,398
Other operating expenses 647,635 354,442 457,797 341,575
------------ ----------- ----------- -----------
$ 3,842,134 $ 3,518,737 $ 1,971,973 $ 1,516,428
============ =========== =========== ===========
</TABLE>
11
<PAGE>
Consolidated plant operations expenses increased $62,000 or 9%, due to increases
in the Company's customer base. Depreciation and amortization increased $198,000
or 10% due to increased depreciation on telephone switching equipment. Customer
operations expenses increased $72,000, or 14% due largely to growth in the
number of customers served. General and administrative expenses increased
$30,000, or 3%. Other operating expenses increased $409,000 or 59% due to
increased cable television operating expenses and increased expenses for other
nonregulated service offerings. Consolidated operating income increased $137,000
or 5%.
Interest expenses decreased $374,000. The decrease was due to interest
reductions on convertible debentures that were retired or converted into common
stock. Interest expenses also decreased due to principal payments made which
reduced the Company's long-term debt.
Alliance had gains on sales of marketable securities of $3,472,000 and $518,000
in the 1999 and 1998 periods, respectively. During the 1999 three months,
Alliance sold 174,000 shares of Rural Cellular Corporation in open market
transactions. Investment income increased $252,000 in the 1999 period due to
investment of the proceeds from the marketable securities sales.
The Company had income from other investments (principally partnership and LLC
investments) of $141,000 for the 1999 period compared to income of $390,000 in
1998. Income from Midwest Wireless LLC was $501,000 compared to $486,000 in the
1998 period. Losses from the Company's Wireless North PCS investment totaled
$429,000 compared to $302,000 in 1998. The Company and its fellow investors are
seeking to sell or restructure Wireless North's business in order to reduce
operating losses. 1998 income from the Sioux Falls, South Dakota MSA was
$100,000. The Company sold its interest in the MSA in December 1998.
Income before income taxes increased $3,469,000, or 155%. Income before minority
interest increased $2,026,000 or 161% to $3,285,000. Minority interest on
earnings of Alliance were $1,053,000 compared to $385,000 in 1998. Net income
increased 155% to $2,232,000.
Liquidity and Capital Resources
Cash flows from consolidated operating activities for the nine-month periods
were $6,107,000 and $5,934,000 in 1999 and 1998, respectively. The increase in
operating cash flow was due to increased operating income and increased noncash
expenses which offset increases in accounts receivable, increased inventories of
construction materials and decreased deferred income taxes. At September 30,
1999, the Company's cash, cash equivalents, temporary cash investments and
marketable securities totaled $27,324,000 compared to $23,241,000 at December
31, 1998. Alliance's cash and securities were $22,748,000 of this total. Working
capital at September 30, 1999 was $12,513,000 compared to $6,554,000 at December
31, 1998. The current ratio was 2.1 to 1 at September 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 nine-month periods were $2,179,000 and
$1,537,000, respectively. Alliance's plant additions in the same periods were
$3,447,000 and $5,217,000, respectively. Plant additions for 1999 for Hector and
Alliance are expected to total $2,737,000 and $3,745,000, 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.
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.
The market value of Alliance's marketable securities portfolio has risen
dramatically in 1999. In the 1999 period, Alliance sold of a portion of its
investment in MediaOne Group, Inc and Rural Cellular Corp for $7,592,000.
Alliance's proceeds from sales of marketable securities were $1,802,000 in the
1998 period. Alliance's remaining marketable securities portfolio is still very
valuable (worth at $10,266,000 at September 30, 1999 compared to $8,418,000 at
December 31, 1998) and consists primarily of shares of Rural Cellular
Corporation, U.S. West Communications, Inc. and MediaOne Group, Inc.
12
<PAGE>
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 restructuring Wireless North's business plans with the goal of
reducing operating losses and are seeking investors to either buy or invest
capital in the operation. The Company invested cash of $761,000 in Wireless
North in 1998 and an additional $826,000 in the first nine months of 1999. Cash
investments in Wireless North in 1997 and 1996 totaled $510,000. The Company has
also guaranteed $1,373,000 of Wireless North's debt. The Company cannot predict
how much additional funding Wireless North might need beyond amounts already
invested. The Company continues to maintain its ownership in cellular telephone
systems through its 10.7% 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. As a result of this
call debentures totaling $6,493,000 were converted into common stock and
$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"). St. Paul Bank merged with CoBank,
ACB effective in July, 1999. 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 September 30, 1999 was $48,264,000. CoBank is a cooperative, owned
and controlled by its customers. Each customer borrowing from the bank on a
patronage basis shares in the bank's net income through payment of patronage
refunds. The Company accrued for a patronage refund in the 1998 period, but has
not done so in 1999.
The Company's LEC subsidiaries borrow from the Rural Utilities Service ("RUS")
and the Rural Telephone Bank ("RTB") to finance their plant additions. Proceeds
from long-term borrowings from RUS and RTB were $3,993,000 in the first nine
months of 1999. Substantially all of the assets of the LEC subsidiaries 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
September 30, 1999 unadvanced loan commitments from the RUS and RTB to the LEC
subsidiaries totaled $13,559,000.
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.
13
<PAGE>
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 might be if it is unable to provide telephone services due to Year
2000 problems.
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 after 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 has been successfully completed.
However, these tests cannot completely duplicate the real world's communications
environment, so undiscovered problems could still remain.
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
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.
- --------------------------------------------------------------------------------
14
<PAGE>
PART II. OTHER INFORMATION
Items 1 - 5. Not Applicable
- ----------------------------
Item 6(a). Exhibit
- -------------------
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 August 9, 1999, the Company filed a Form 8-K related to adoption of a
Shareholder Rights Plan designed to ensure that all of the Company's
shareholders receive fair and equal treatment in the event of any proposal to
acquire the Company.
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: November 12, 1999
15
<PAGE>
<TABLE>
<CAPTION>
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
EXHIBIT 11
CALCULATION OF EARNINGS PER SHARE
Three Months Ended Sept 30 Nine Months Ended Sept 30
------------------------------ --------------------------
Basic: 1999 1998 1999 1998
- ------- ----------- ---------- ----------- -----------
<S> <C> <C> <C> <C>
Net income $ 2,231,825 $ 874,485 $ 3,705,919 $ 2,086,566
=========== ========== =========== ===========
Common shares:
Weighted average number of common shares outstanding 3,439,952 2,586,476 2,945,669 2,315,763
Number of unallocated shares held by ESOP (6,042) (6,042)
----------- ---------- ----------- -----------
3,439,952 2,580,434 2,945,669 2,309,721
=========== ========== =========== ===========
Net income per common share $ .65 $ .34 $ 1.26 $ .90
=========== ========== =========== ===========
Diluted:
- -------------
Net income $ 2,231,825 $ 874,485 $ 3,705,919 $ 2,086,566
Interest on convertible debentures 186,135 327,811 704,573
Amortization of debenture issue costs 38,912 115,160 132,482
Income tax effect (90,019) (177,188) (334,822)
----------- ---------- ----------- -----------
Adjusted net income $ 2,231,825 $1,009,513 $ 3,971,702 $ 2,588,799
=========== ========== =========== ===========
Common and common equivalent shares:
Weighted average number of common shares outstanding 3,439,952 2,586,476 2,945,669 2,315,763
Assumed conversion of convertible
debentures into common stock 894,150 576,448 894,150
Dilutive effect of convertible preferred shares outstanding 340,648 342,800 341,807 356,256
Dilutive effect of stock options outstanding after
application of treasury stock method 93,057 41,868 56,347 52,921
Dilutive effect of Employee Stock
Purchase Plan shares subscribed 1,522 4,379 5,302
Dilutive effect of warrants outstanding 31,387 9,162 16,276 16,781
Weighted average number of
unallocated shares held by ESOP (6,042) (6,042)
----------- ---------- ----------- -----------
3,906,566 3,872,793 3,936,547 3,635,131
=========== ========== =========== ===========
Diluted net income per share $ .57 $ .26 $ 1.01 $ .71
=========== ========== =========== ===========
</TABLE>
16
<PAGE>
<TABLE> <S> <C>
<ARTICLE> 5
<CIK> 0000863437
<NAME> HECTOR COMMUNICATIONS CORPORATION
<MULTIPLIER> 1
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> SEP-30-1999
<EXCHANGE-RATE> 1
<CASH> 16,926,951
<SECURITIES> 0
<RECEIVABLES> 6,195,344
<ALLOWANCES> 0
<INVENTORY> 1,015,194
<CURRENT-ASSETS> 24,606,023
<PP&E> 81,696,542
<DEPRECIATION> 30,285,255
<TOTAL-ASSETS> 157,532,326
<CURRENT-LIABILITIES> 12,093,509
<BONDS> 86,112,950
0
340,300
<COMMON> 34,562
<OTHER-SE> 34,772,362
<TOTAL-LIABILITY-AND-EQUITY> 157,532,326
<SALES> 25,977,752
<TOTAL-REVENUES> 25,977,752
<CGS> 16,675,362
<TOTAL-COSTS> 16,675,362
<OTHER-EXPENSES> (5,151,858)
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 4,943,817
<INCOME-PRETAX> 9,510,431
<INCOME-TAX> 4,065,000
<INCOME-CONTINUING> 5,445,431
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 3,705,919
<EPS-BASIC> 1.26
<EPS-DILUTED> 1.01
</TABLE>
