- --------------------------------------------------------------------------------
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 [FEE REQUIRED]
For the fiscal year ended December 31, 1999
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
Commission File Number: 0-18587
HECTOR COMMUNICATIONS CORPORATION
(Exact name of registrant as specified in its charter)
Minnesota 41-1666660
- -------------------------------- -------------------
(State or other jurisdiction (Federal Employer
of incorporation or organization) Identification No.)
211 South Main Street
Hector, MN 55342
(Address of principal executive offices and zip code)
Registrant's telephone number, including area code: (320) 848-6611
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Common Stock, $.01 par value
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES X NO
--- ---
Indicate by a check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. (X)
The aggregate market value of the voting stock held by non-affiliates of the
Registrant was approximately $40,992,000 based upon the closing sale price of
the Company's common stock on the American Stock Exchange on March 17, 2000.
As of March 17, 2000 there were outstanding 3,555,454 shares of the Registrant's
common stock.
Documents Incorporated by Reference: The Company's Proxy Statement for its
Annual Meeting of Shareholders to be held on May 18, 2000 is incorporated by
reference into Part III of this Form 10-K.
- --------------------------------------------------------------------------------
<PAGE>
TABLE OF CONTENTS
Item Page
PART I
1. Business 3
2. Properties 14
3. Legal Proceedings 14
4. Submission of Matters to a Vote of Security Holders 14
PART II
5. Market for Company's Common Equity and Related
Stockholder Matters 15
6. Selected Financial Data 16
7. Management's Discussion and Analysis of Financial
Condition and Results of Operations 17
8. Financial Statements and Supplementary Data 26
9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure 42
PART III
10. Directors and Executive Officers of the Registrant 43
11. Executive Compensation 43
12. Security Ownership of Certain Beneficial
Owners and Management 43
13. Certain Relationships and Related Transactions 43
PART IV
14. Exhibits, Financial Statement Schedule and
Reports on Form 8-K 44
2
<PAGE>
PART I.
ITEM 1. BUSINESS
[a] GENERAL DEVELOPMENT OF BUSINESS
Hector Communications Corporation ("HCC" or "Company") is a
telecommunications holding company which, through its wholly-owned and
majority-owned subsidiaries, primarily provides local telephone and cable
television service. The Company also invests in other companies providing
wireless telephone and other telecommunications related services.
HCC operates five wholly-owned local exchange company subsidiaries
(generally referred to as "local exchange carriers" or "LECs") which served
7,200 access lines in 9 rural communities in Minnesota and Wisconsin at December
31, 1999. HCC, through its subsidiaries, also provides cable television service
to 4,900 subscribers in Minnesota and Wisconsin.
HCC's 68% owned subsidiary, Alliance Telecommunications Corporation, owns
and operates five additional LEC subsidiaries which served 28,600 access lines
in 26 rural communities in Minnesota, Iowa, North Dakota and South Dakota at
December 31, 1999. Alliance, through its subsidiaries, also served 8,200 cable
television subscribers in Minnesota, North Dakota and South Dakota. Golden West
Telecommunications Cooperative, Inc. of Wall, South Dakota, and Split Rock
Telecom Cooperative, Inc. of Garretson, South Dakota own the remaining interests
in Alliance.
[b] FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS
The Company is organized in two business segments, Hector Communications
Corporation and its wholly-owned subsidiaries, and Alliance Telecommunications
Corporation and its subsidiaries. Information regarding segment operations is
provided in Note 11 to the financial statements found under Item 8 of this
report.
[c] NARRATIVE DESCRIPTION OF BUSINESS
(1) Telephone
The Company's LEC subsidiaries provide basic local telephone services to
35,867 residential and business customers in Minnesota, Wisconsin, South Dakota,
North Dakota and Iowa. Basic local service enables customers to originate and
receive telephone calls within a defined exchange area. Approximately 81% of the
Company's customers are residential and approximately 19% are businesses. Most
customers pay a fixed monthly fee for service.
The following chart presents the number of access lines served by the
Company's LEC subsidiaries at December 31, 1999, 1998 and 1997:
3
<PAGE>
<TABLE>
<CAPTION>
Access Lines*
--------------------------------------------------
December 31
--------------------------------------------------
1999 1998 1997
----------- ---------- ------------
Hector Communications Corporation:
<S> <C> <C> <C>
Arrowhead Communications Corporation 817 780 749
Eagle Valley Telephone Company 734 676 685
Granada Telephone Company 289 274 275
Pine Island Telephone Company 3,154 3,019 2,919
Indianhead Telephone Company 2,234 2,109 2,076
Alliance Telecommunications Corporation:
Loretel Systems, Inc. 12,967 12,675 12,023
Sleepy Eye Telephone Company 6,467 6,197 5,998
Sioux Valley Telephone Company 5,756 5,679 5,457
Hills Telephone Company 2,706 2,618 2,545
Felton Telephone Company 743 735
----------- ---------- ----------
35,867 34,762 32,727
=========== ========== ==========
</TABLE>
* An "access line" is a single or multi-party circuit between the customer's
establishment and the central switching office.
The Company maintains a local presence in each of its LEC subsidiaries.
The Company provides its LEC subsidiaries with various services, including
finance, accounting and treasury services, marketing, customer service,
purchasing, engineering and construction, customer billing, rate administration,
credit and collection, and development of administrative and procedural
practices.
The Company's LEC subsidiaries also provide network access services,
which allow customers to originate and terminate long distance calls. Long
distance calls typically involve more than one company in providing service on
an end-to-end basis. Because long distance calls usually are billed to the
customer originating the call, mechanisms are required to compensate each
company providing services to complete the call. In the case of interstate
calls, access revenues are determined according to rules promulgated by the
Federal Communications Commission ("FCC") and administered by the National
Exchange Carriers Association ("NECA"), a not-for-profit membership corporation
of local exchange carriers. Interstate access revenues are received from NECA,
which collects payments from long distance service providers (also referred to
as interexchange carriers or "IXCs") and distributes payments to the member
LECs. In the case of intrastate calls, access revenues are determined by state
regulatory agencies. A portion of the Company's access revenues is received from
universal service funds based upon the high cost of providing service to rural
areas. Interstate universal service fund support accounted for $1,040,000,
$951,000 and $656,000 of the Company's network access revenues in 1999, 1998 and
1997, respectively. A small portion of access revenues are derived from
subscriber line fees determined by the FCC and billed directly to customers.
The Company's LEC subsidiaries offer their customers a number of enhanced
telecommunications services, including custom calling features like call
waiting, caller identification and voice mail. Charges for custom calling
services are generally billed monthly together with the customers' local service
bill. Internet access is also available, through local dial-up telephone
numbers, to all of the Company's local service customers. Digital subscriber
lines ("DSL") permit high-speed Internet access and are available in many of the
Company's service areas.
4
<PAGE>
(2) Cable Television
The Company, through its cable television and LEC subsidiaries, owns and
operates 46 cable television systems serving 13,100 subscribers in Minnesota,
North Dakota, South Dakota and Wisconsin. Cable television revenues are derived
almost exclusively from monthly fees for basic and premium programming. Fees for
basic services range from $14.95 to $26.28 per month. Basic service generally
includes the major television networks, non-network independent stations, sports
programming, news services and automated information channels, children's
programming, access channels for public, governmental, educational and leased
use, senior citizens' programming and religious programming. Premium programming
services, such as the HBO or ShowTime movie services, are provided to
subscribers for an additional fee of $6.95 to $10.95 per month per channel.
Approximately one-third of the Company's cable television customers subscribe to
a premium channel. Premium programming is obtained from suppliers for a flat
monthly fee per subscriber and/or a fee based on the monthly charge to
subscribers for the service.
(3) Investments
Wireless Telephone Services
The Company is the largest shareholder of Midwest Wireless
Communications, LLC, with a 10.69% ownership stake. Midwest Wireless serves five
rural service areas and one metropolitan service area in southern Minnesota.
Population of the service area is approximately 950,000. Midwest Wireless offers
complete wireless service, including custom calling features, facsimile and data
transmission and presently serves more than 100,000 customers. Midwest Wireless
is acquiring additional wireless operations in Wisconsin and Iowa. When
completed, these acquisitions would significantly increase Midwest Wireless'
service area, but would reduce the Company's percentage ownership of the
operation. The Company accounts for its investment in Midwest Wireless using the
equity method. Income recognized was $1,481,000, $1,508,000, and $1,210,000 in
1999, 1998 and 1997, respectively.
The Company owns 13.36% of Wireless North, which provides personal
communications services ("PCS") to parts of Minnesota, Wisconsin, Iowa, North
Dakota and South Dakota. Wireless North has secured FCC licenses to provide PCS
services in 13 basic trading areas in these states, encompassing 110,000 square
miles and a population of 2.4 million. Wireless North is in its start-up phase,
and is building infrastructure in four markets, where it presently serves 7,800
customers. Its operations have not been profitable to date. Losses recorded by
the Company on this investment were $1,597,000, $1,066,000 and $435,000 in 1999,
1998 and 1997, respectively. At December 31, 1999, the Company had invested
$2,303,000 of cash and had outstanding loan guarantees of $1,373,000 in Wireless
North.
The Company has had a significant investment in Rural Cellular
Corporation ("RCC"), a publicly traded company providing cellular telephone
services in Minnesota and New England. The Company obtained its investment in
RCC through its ownership interests in the RSAs serving northern Minnesota and
through the acquisitions of Ollig Utilities Company and Felton Telephone
Company. Company sales of RCC stock were 326,707 shares, 40,000 shares, and
161,469 shares in 1999, 1998 and 1997, respectively. Gains on sales of these
securities were $11,600,000, $179,000, and $1,464,000 in 1999, 1998 and 1997,
respectively. At December 31, 1999, the Company owned approximately 10,700
shares of RCC's common stock.
In December, 1998, an Alliance subsidiary sold its interest in a
cellular telephone partnership serving the Sioux Falls, South Dakota MSA.
Proceeds from the sale were $6,725,000. Gain on the sale was $4,817,000. Income
recognized from the Company's investment in this partnership was $334,000 and
$377,000 in 1998 and 1997, respectively.
5
<PAGE>
Onvoy, Inc.
The Company has a $1,276,000 investment in the common stock of Onvoy,
Inc. (formerly MEANS, or Minnesota Equal Access Network Services). Onvoy, Inc.,
a privately held company, is a competing local exchange carrier ("CLEC") that
provides integrated voice, data, and network services through its fiber optic
communications network linking communities throughout Minnesota, including all
major metropolitan areas. Onvoy, Inc. is also Minnesota's largest Internet
service provider and is a leading provider of long distance, video- conferencing
and high-speed data networking services. It serves the majority of
small-to-medium sized businesses and Minnesota based Fortune 500 companies, most
of the state's higher education institutions, nearly all of the state's K-12
schools, public libraries, state and county governments, more than 70 regional
Internet service providers and more than two-thirds of the state's independent
local telephone companies.
Fiber Optic Transport Facilities
The Company has invested approximately $1 million in five companies
that build and lease fiber optic transport facilities. These facilities afford
high-quality, high-capacity communications links and generally are used to carry
long-distance traffic. Through these investments, the Company owns pieces of
fiber routes serving the Twin Cities, Duluth-Superior, Sioux Falls,
Fargo-Moorhead, Rochester, St. Cloud and Grand Forks, and extending into Iowa
and Wisconsin.
Marketable Securities
Through its acquisitions of Ollig Utilities Company and Felton Telephone
Company, and due to the success of the Company's investments in
telecommunications ventures that were ultimately sold to the public, the Company
has acquired a portfolio of marketable securities. In addition to its holdings
in Rural Cellular Corporation, the Company presently has significant investments
in mutual funds, USWest Communications and Illuminet Holdings, Inc.
Bank Stocks
As part of its borrowing agreements, the Company has investments in
CoBank, Rural Telephone Finance Cooperative and the Rural Telephone Bank that
totaled $4,644,000 and $4,365,000 at December 31, 1999 and 1998, respectively.
Other Investments
The Company has a small ownership interest in South Dakota Network
Services and Iowa Network Services, each of which provide integrated voice, data
and network services within their respective states. The Company is also an
investor in Fibercom LLC, a CLEC that has been established to provide local
communications services to business customers in the Sioux City, Iowa area.
(4) Competition
Telephone
LECs may be subject to many forms of competition. Among potential
competitors are:
- Facilities-based competition from providers with their own local service
network;
- Resale competition from resale interconnection (providers who purchase
local services from the LEC at wholesale rates and resell the services to
their customers);
- Competition from unbundled network element interconnection (providers who
lease some of the network elements from the LEC) - Wireless providers who
may charge a competitive fee for services that could compete with
wireline based local service.
Rural areas like those served by the Company are less likely to
experience competition from facilities-based competitors due to the significant
investment in plant and equipment required in relation to the lower customer
density in rural markets. Competition from resale interconnection or unbundled
network element interconnection is more likely. Under the Telecommunications Act
of 1996, the Company's LECs are not currently required to lease facilities to
competitors seeking to interconnect with our network. However, there is no
assurance that Congress may not require interconnection in the future.
6
<PAGE>
Wireless telephone service is currently seen as a complementary service
to traditional wireline based local service. Wireless service does directly
compete with traditional local service among certain classes of customers,
principally customers with seasonal or lake homes. Developments in technology
related to cellular, PCS, digital microwave, coaxial cable, fiber optics and
other wireline or wireless services could also lead to greater competition for
traditional local services.
LECs are increasingly subject to competition from competing access
providers ("CAPs") which construct, modify or lease facilities that enable high
volume long distance users to bypass the local telephone network. Cable
television companies may also be able to modify their networks to carry
telephone messages that bypass the local telephone network. The Company believes
its LEC subsidiaries have experienced only a small loss of traffic due to
bypass.
Cable Television
In addition to competition from off-air television, other technologies
also supply services that compete with cable television. These include low power
television stations, multi-point distribution systems, over-the-air subscription
television and direct broadcast satellite ("DBS"). Cable television also
competes for customers in local markets with providers of other forms of
entertainment, news and information. These competitors include radio,
newspapers, magazines, motion picture theaters, video cassettes and Internet
service providers.
All of the Company's cable television franchises are non-exclusive. The
1992 Cable Act prohibits franchising authorities from unreasonably refusing to
grant franchises to competing cable television systems. The Company competes
with a municipally owned cable system in one community it serves. The degree of
competition from other cable providers will be dependent upon the state and
federal regulations concerning entry, interconnection requirements and the
degree of unbundling of the LECs' networks. Competition will be based upon
product, service quality, breadth of services offered and, to a lesser extent,
on price.
Maintaining and expanding the Company's cable television subscriber base
depends on numerous factors, including the quality and quantity of signals
available from "off-air" television stations, demand for satellite and premium
television channels and average household income in the cable service area.
Promotional efforts for cable television include telephone and door-to-door
selling and local media advertising.
(5) Regulation
The Company's LECs and cable television systems are subject to federal,
state and local regulation. The Communications Act of 1934 and the
Telecommunications Act of 1996 govern Federal regulations. Under these federal
statutes, the FCC exercises jurisdiction over all interstate telecommunications
activities. Intrastate activities are governed by rules and regulations set by
the respective state public utility commissions.
Federal Regulations
Under federal regulations, incumbent local exchange carriers ("ILECs")
are required to comply with the Communications Act of 1934 and rules issued by
the FCC. While the Telecommunications Act of 1996 amended the earlier law to
reduce regulatory burdens and promote competition, ILECs remain subject to
extensive regulatory requirements. ILECs are required to maintain accounting
records according to Uniform System of Accounts, to structure access charges
according to FCC rules and to reflect their charges for interstate services at a
rate of return prescribed by the FCC. The FCC also regulates transfer of control
and assignments of operating authorizations and construction licenses. The FCC
requires carriers providing access services to file tariffs with the FCC
reflecting rates, terms and conditions of the services. Tariffs filed are
subject to review and potential objection by third parties.
Regulation of Cost Recovery and Nonregulated Revenue Allocation
As a regulated common carrier, the Company's LEC subsidiaries can set
maximum rates at a level that allows recovery of reasonable costs incurred to
provide regulated service and earns a reasonable return on the investment
required to provide these services.
7
<PAGE>
Costs are recovered through:
- Monthly charges to end users for basic local telephone services and
enhanced services;
- Access charges to interexchange carriers for originating and terminating
interstate and intrastate interexchange calls; and
- Payments from the federal Universal Service Fund and the state universal
service funds (where applicable) that offset the high cost of providing
service in certain rural markets.
Rates for regulated services and the amount of universal service fund
support are set forth by the FCC with respect to interstate services and by
state regulatory agencies with respect to intrastate services.
In conjunction with the recovery of costs and establishment of rates, a
LEC must first determine its aggregate costs and then allocate those costs
between regulated and nonregulated services. After identifying the regulated
costs of providing local telephone service, a LEC must allocate those costs
among its various local exchange and interstate and intrastate interexchange
services and between state and federal jurisdictions. Allocating costs is
complicated because the same pieces of a LEC's plant and equipment are utilized
for different services, such as local telephone and interstate and intrastate
access services. The allocation process is called "separation" and is governed
primarily by FCC regulations. The purpose of separation is to determine how a
carrier's expenses are allocated and recovered from federal and state
jurisdictions. The FCC is considering whether to change or eliminate this
process. Any change in separation rules by the FCC could reduce or increase the
LEC's revenues.
Interstate End-User Rates
The part of the local telephone network running from the switching
facility to the customer is called the "local loop." Costs to construct, operate
and maintain the loop are among the most significant costs incurred by a local
exchange carrier. The FCC has established a rate structure that provides for the
recovery of a portion of the cost of the local loop allocated to interstate
jurisdiction directly from end-users through the assessment of a subscriber line
charge. The remaining portions of the interstate local loop costs are recovered
from interstate access charges to interexchange carriers.
Due to demographic and geographic conditions, costs to provide local loop
and switching services are often higher, on a per customer basis, in rural areas
compared to urban areas. Absent a regulatory framework to permit recovery of
these costs, rural LECs would be compelled to charge considerably higher rates
for local network services. Consequently, the FCC provides for additional
interstate recovery by eligible telecommunications carriers through the federal
Universal Service Fund. Funds from the federal Universal Service Fund are
available to local exchange carriers whose local loop costs are significantly
above the national average as determined by FCC rules.
Interstate Access Rates
Interstate access rates are developed on the basis of a LEC's measurement
of its interstate costs to provide access service to IXCs divided by its
projected demand for service. The resulting rates are published in the LEC's
interstate access tariff and filed with the FCC, at which time they are subject
to challenge by third parties and to review by the FCC.
The FCC recognized that the rate making and tariff filing process is
administratively burdensome for small local exchange carriers. In 1983, the FCC
established the National Exchange Carriers Association ("NECA") to develop and
administer interstate access service rates, terms and conditions. NECA develops
interstate access rates on the basis of data provided by participating local
exchange carriers and blended to yield average rates. These rates are intended
to generate revenue equal to the aggregate costs plus a return on the investment
of all of the participants.
Individual LECs are likely to have service costs that differ from the
revenues generated by applying the overall NECA tariff rates. To allow for this,
revenues generated by participating LECs are pooled and redistributed on the
basis of each individual company's costs. This process eliminates the burden of
individual tariff filing and produces a system in which small companies can
share and spread risk. For example, if a small local exchange carrier filed its
8
<PAGE>
own tariff and subsequently suffered the loss of major customers that utilize
interstate access service, the local exchange carrier could suffer significant
under-recovery of its costs. In the NECA pool environment, the impact of this
loss is reduced because it is spread over all of the pool participants.
NECA operates separate pools for traffic sensitive costs (primarily
switching costs) and non-traffic sensitive costs (primarily loop costs). LECs
can choose to develop and administer their own interstate access charges and not
participate in the NECA pools. All but one of HCC's LECs participates in the
traffic sensitive NECA pools. All of HCC's LECs participate in the non-traffic
sensitive NECA pools.
The FCC is reviewing its rates and policies governing interstate access
and the rate of return applicable to incumbent local exchange carriers who are
subject to rate-of-return, rather than price cap, regulation. The outcome of
this review could directly affect HCC's earnings. The outcome of this proceeding
cannot be predicted at this time.
The Telecommunications Act
The Telecommunications Act was enacted to promote competition without
jeopardizing the availability of nationwide universal service at affordable
rates. These two objectives have resulted in a complex set of rules intended to
promote competitive entry in the provision of local telephone services, except
where entry would adversely effect the provision of universal service or the
public interest.
- Promotion of Local Service Competition and the Rural Exemptions
The Telecommunications Act made competitive entry into the local
telephone business more attractive to other carriers by removing barriers to
competition. In order to promote competition the Telecommunications Act
established new interconnection rules, generally requiring local exchange
carriers to allow competing carriers to interconnect with their local networks.
Congress recognized, however, that the desire to promote competition conflicted
with the ability of some existing LECs to provide universal service to high cost
customers. Congress exempted these LECs (classified as "Rural Telephone
Companies") from interconnection requirements until the continuation of the
exemption was no longer required by the public interest, as defined in the
Telecommunications Act.
Under the Telecommunications Act, all local exchange carriers, including
both incumbent local exchange carriers and new competitive carriers, are
required to:
- Offer reasonable and nondiscriminatory resale of their
telecommunications services,
- Ensure that customers can keep their telephone numbers when changing
carriers,
- Ensure that competitors' customers can use the same number of digits
when dialing and receive nondiscriminatory access to telephone
numbers, operator service, directory assistance and directory listing,
- Ensure access to telephone poles, ducts, conduits and rights of way and
- Compensate competitors for the costs of terminating traffic.
The Telecommunications Act also requires incumbent local exchange
carriers to:
- Negotiate in good faith the terms and conditions of interconnection
with any competitive carrier making a bona fide request for same,
- Interconnect their facilities and equipment with any requesting
telecommunications carrier at any technically feasible point,
- Unbundle and provide nondiscriminatory access to unbundled network
elements, such as local loops, switches and transport facilities, at
nondiscriminatory rates and on nondiscriminatory terms and conditions,
- Offer resale interconnection at wholesale rates,
9
<PAGE>
- Provide reasonable notice of changes in the information necessary for
transmission and routing of services over the incumbent local exchange
carrier's facilities or in the information necessary for
interoperability and
- Provide for the physical collocation of equipment necessary for
interconnection or access to unbundled network elements at the premises
of the incumbent local exchange carrier, at rates, terms an conditions
that are just, reasonable and nondiscriminatory.
In order to implement interconnection requirements, local exchange
carriers generally enter into negotiated interconnection arrangements with
competing carriers. Local exchange carriers may also offer interconnection
tariffs, available to all competitors.
Competitors are required to compensate a local exchange carrier for the
cost of providing interconnection services. In the case of resale
interconnection, the rules provide that the rates charged should be on a
wholesale basis and reflect the current retail rates of the incumbent local
exchange carrier, excluding the portion of costs avoided by the incumbent local
exchange carrier. In the case of unbundled network element interconnection,
rates are based on costing methodologies that employ a forward-looking economic
cost pricing methodology known as total element long run incremental cost. The
Telecommunications Act specifies that resale and unbundled network element rates
are to be negotiated among the parties, or, if the parties fail to reach an
agreement, arbitrated by the relevant state regulatory authority. Once the
parties have come to agreement, the proposed rates are subject to final approval
by the state regulatory commission.
HCC's LEC subsidiaries are defined as "rural telephone companies" under
the Telecommunications Act. As rural telephone companies, they were granted
rural exemptions from the requirements relating to both resale interconnection
and unbundled network element interconnections. The rural exemptions are
continued until regulatory authorities determine that interconnection is
technically feasible, not unduly economically burdensome and consistent with the
Telecommunications Act's universal service provisions.
- Promotion of Universal Service
While the Telecommunications Act promoted Congress' policy of ensuring
that affordable service is provided to consumers universally in rural, high-cost
areas of the country, the Telecommunications Act altered the framework for
providing universal service by:
- Providing for the identification of those services eligible for
universal service support,
- Requiring the FCC to make implicit subsidies explicit,
- Expanding the types of communications carriers required to pay
universal service support and
- Allowing competitive local exchange carriers to be eligible for
funding.
These and other provisions were intended to make provision of universal
service support compatible with a competitive market.
Pursuant to the Telecommunications Act, federal Universal Service Fund
payments are only available to carriers that are designated as eligible
telecommunications carriers by a state public utilities commission. In areas
served by rural LECs, the Telecommunications Act provides that a state public
utilities commission may designate more than one eligible telecommunications
carrier, in addition to the incumbent local exchange carrier, only after
determining that the designation of an additional eligible telecommunications
carrier will serve the public interest. As a result, an incumbent rural LEC has
an opportunity to maintain its status as the sole recipient of federal Universal
Service Fund payments in its service area, even if it is subsequently subjected
to competition. HCC's rural LEC subsidiaries are currently the sole designated
eligible telecommunications carriers in their respective service areas. The
addition of a second eligible telecommunications carrier in these service areas
could have the effect of reducing the amount of funds available to HCC's LECs
10
<PAGE>
from the federal Universal Service Fund. Such a reduction could materially
adversely affect HCC's ability to achieve a reasonable rate of return on the
capital invested in its network.
In May 1997, the FCC implemented new rules for interstate universal
service support. The new rules provide for separate federal Universal Service
Fund programs for rural and non-rural telephone companies. The new rules for
non-rural companies base support upon "forward-looking costs" derived from cost
proxy models. It is uncertain whether these models will fully compensate local
exchange carriers for the cost of providing local service in high-cost areas.
The FCC set the implementation date for the new system as January 1, 1999, which
was postponed to January 1, 2000 for non-rural telephone companies. The FCC has
established a Rural Task Force, which will investigate how to adapt the proxy
cost models approved for larger carriers for rural telephone companies. The FCC
has indicated that it will not implement a new system for application to rural
telephone companies for an additional three years after the first step
implementation, or at least until January 1, 2001. In the interim, support
mechanisms for rural carriers remain unchanged. The FCC continues to refine the
cost proxy models to be applied to non-rural telephone companies.
State Regulation of Rural LECs
HCC's LEC subsidiaries are subject to regulation by Minnesota, South
Dakota, Iowa and Wisconsin regulatory agencies with respect to:
o Intrastate toll rates,
o Intrastate access charges billed to intrastate IXCs, o Service areas, o
Service standards, o Accounting and related matters, and o The use of
radio frequencies in telephone operations
In some cases state regulations also apply to local service rates, rate
of return, depreciation rates, construction plans and borrowings, and certain
other financial transactions.
Local service rates are not directly determined by regulatory
authorities, but are limited by regulation of these other areas. The Company has
sought appropriate increases in local and other service rates and approval for
changes in rate structures necessary to achieve reasonable rates and earnings.
The bulk of the Company's access lines are located in Minnesota. A bill
passed by the 1995 Minnesota legislature allows telephone companies serving
fewer than 50,000 access lines to elect to provide service under an alternate
form of regulation. Companies choosing alternative regulation agree not to
increase rates for two years, other than in extraordinary circumstances. These
companies are not subject to rate of return review by the Public Utilities
Commission for the same two years. All of HCC's Minnesota-based LEC subsidiaries
elected alternative rate regulation election effective January 1, 1996. Local
rate increases after January 1, 1998 are not subject to review by the Minnesota
Public Utilities Commission unless the lower of 500 or five percent of customers
file a petition requesting such review.
Where applicable, our HCC's LECs also participate in intrastate access
tariffs approved by state regulatory authorities for intrastate intra-LATA
(Local Access Transport Area) and inter-LATA services. These intrastate
arrangements are intended to compensate LECs for the costs, including a fair
rate of return, of facilities provided in originating and terminating intrastate
long distance services.
Cable Television System Regulation
The FCC regulates the providers of satellite communications services and
facilities for the transmission of programming services, the cable television
systems that carry such services, and, to some extent, the availability of the
programming services themselves through its regulation of program licensing.
Municipalities and other state and local government authorities also regulate
cable television systems. FCC regulations contain many detailed provisions
including:
11
<PAGE>
- "Must carry" rules regarding the broadcast television and translator
signals that must be included in channel offerings to subscribers,
- Exclusivity provisions which require the deletion of certain programming
carried by out-of-area stations where it would duplicate programming
carried by local stations,
- Technical standards and performance testing requirements, and - Franchise
fees applicable to state and local cable television franchises.
Thus far, HCC's cable systems have not experienced any difficulty in complying
with the FCC rules.
In Minnesota, the award of cable franchises and certain aspects of cable
operations are subject to rules of the Minnesota Cable Communications Board.
Cable television systems are operated under 15 year, non-exclusive franchises
granted by local government authorities. Franchises contain many conditions,
including time limitations on commencement or completion of construction,
approval of initial fees charged to subscribers for basic service, the number of
channels offered and the types of programming. HCC does not anticipate
difficulty in obtaining renewal of its franchises at the expiration of their
current terms.
The regulation of cable television at the federal, state and local levels
is subject to the political process and has been in constant flux over the past
decade. This process continues in the context of legislative proposals for new
laws and the adoption or deletion of administrative regulations and policies.
The Company anticipates further material developments in these areas, but cannot
anticipate their direction and impact on its cable television operations.
(6) Business Strategy
The Company is focused on business opportunities in rural
telecommunications. Its three-part strategy is to:
- Expand its existing operations through internal growth - Pursue
acquisitions of attractive properties, particularly the
acquisition of additional rural telephone exchanges and cable
television properties.
- Participate in opportunities afforded by new telecommunications
technologies
Future growth in existing telephone and cable operations is expected to
come from providing service to new or presently unserved homes and businesses,
from sales of enhanced services to existing customers and from providing new
services made possible by improvements in technology.
The Company continually assesses acquisition opportunities. Competition
to acquire attractive telephone or cable television properties is intense.
Acquisitions of rural telephone exchanges are subject to the approval of
regulatory agencies in some states and, in some cases, to federal waivers that
may affect the form of regulation or amount of interstate cost recovery of
acquired telephone exchanges. The Company will aggressively pursue acquisitions
of telephone exchanges, but there is no assurance that acquisitions can be made
on acceptable terms or that regulatory approval, where required, will be
received.
The Company has aggressively invested in new telecommunications
technologies, primarily through investments in partnerships and limited
liability companies. The Company has substantial investments in wireless
communications companies, fiber optic transport groups, CLECs and Internet
service providers. The Company intends to pursue additional investment
opportunities in the future.
(7) Employees
At March 1, 2000, the Company had 159 full-time and part-time employees,
of which 108 employees work in the Alliance operations and 51 work in Hector
operations. None of the Company's employees are represented under collective
bargaining agreements. HCC believes its employee relations to be good.
12
<PAGE>
(8) Executive Officers of Registrant
The executive officers of the Company and their ages at March 1, 2000
were as follows:
Name Age Position
Curtis A. Sampson 66 Chairman of the Board and Chief
Executive Officer
Steven H. Sjogren 57 President and Chief Operating Officer
Paul N. Hanson 53 Vice President and Treasurer
Charles A. Braun 42 Chief Financial Officer
Executive officers serve at the pleasure of the Board of Directors and
are elected annually for one-year terms. Each officer above has served the
Company in the indicated capacity since 1990.
Mr. Sjogren devotes his full time to the Company's business. Messrs.
Sampson, Hanson and Braun each devote approximately 40% of their working time to
the Company's business with the balance devoted to management responsibilities
at Communications Systems, Inc. ("CSI"), a diversified telecommunications
holding company also located in Hector, Minnesota, for which they are separately
compensated by CSI.
[d] FINANCIAL INFORMATION ABOUT FOREIGN AND DOMESTIC OPERATIONS AND
EXPORT SALES
Not Applicable.
13
<PAGE>
ITEM 2. PROPERTIES
The Company's telephone property consists mainly of central office
switching equipment, the land and buildings in which the equipment is housed,
and connecting lines consisting of aerial and underground cable, conduit, and
poles and wires which connect customers' premises with central offices.
Connecting lines are generally located under or above public rights of way or
land owned, for the most part, by others, pursuant to consents of various
governmental bodies or private leases, permits, easements, agreements or
licenses. The Company also owns customer-leased telephones and related terminal
equipment and a small amount of connecting lines that are located on customers'
premises.
The connecting lines constitute approximately 56% of the Company's
telephone property in service. Central office switching equipment represents
approximately 33%. Telephones and related equipment constitute approximately 1%.
Land, buildings, data processing equipment, service vehicles and construction
equipment constitute the remaining 10%. The Company owns substantially all the
land and buildings in which its central office equipment is located. HCC's
principal general offices, administrative services department and business
office are located in Hector, Minnesota and leased to HCC from CSI. Alliance
owns the building in Ada, Minnesota where its general offices are located.
The physical assets of the Company's cable television systems consist of
signal reception equipment and distribution electronics and cables. The
receiving equipment is comprised of a tower and antennas for reception of
broadcast television signals and one or more satellite dishes for reception of
satellite signals. The Company owns or leases the land on which the towers for
its cable systems and the buildings containing other receiving equipment are
located. Pole attachment space is leased from utilities serving the community.
See Note 6 of "Notes to Consolidated Financial Statements for additional
information regarding pledged assets.
ITEM 3. LEGAL PROCEEDINGS
No material litigation or other claims are presently pending against the
Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
14
<PAGE>
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS
[a] MARKET INFORMATION
The Company's common stock is currently being traded on the American
Stock Exchange. Prior to February 20, 1998, the Company's common stock traded on
the National Market System of the National Association of Securities Dealers
Automated Quotation System ("NASDAQ").
The table below presents the range of high and low trading prices for the
Company's stock for each period as reported by the respective exchanges.
1999 1998
------------------------ --------------------------
Quarter High Low High Low
First $ 9.63 $ 8.06 $ 12.63 $ 9.00
Second 11.13 8.00 12.25 10.50
Third 14.88 10.00 11.25 7.75
Fourth 17.25 12.00 9.00 7.38
[b] HOLDERS
At March 1, 2000 there were 565 holders of record of Hector
Communications Corporation common stock.
[c] DIVIDENDS
HCC has not paid cash dividends on its common stock or preferred stock
since it began operating as a public company in 1990, nor does HCC have any
obligations to pay dividends on its preferred stock. The financing agreements
between HCC's subsidiaries and their lenders, and HCC and its lenders restrict
the ability of HCC to pay dividends. At the present time, HCC intends to retain
earnings to finance the expansion of its business, and does not anticipate any
cash dividends will be paid in the foreseeable future. See Management's
Discussion and Analysis of Financial Condition and Results of Operations, and
also Note 6 to the Consolidated Financial Statements under Item 8 herein for a
description of restrictions on dividends.
15
<PAGE>
ITEM 6. SELECTED FINANCIAL DATA
<TABLE>
<CAPTION>
SELECTED CONSOLIDATED FINANCIAL INFORMATION
(in thousands except per share amounts)
Year Ended December 31
------------------------------------------------------------
1999 1998 1997 1996 1995
- --------------------------------------------------------------------------------------------------------------------------------
Selected Income Statement Information
<S> <C> <C> <C> <C> <C>
Revenues $ 34,117 $ 31,839 $ 28,866 $ 20,658 $ 5,844
Costs and Expenses 23,063 21,192 19,113 14,066 4,992
- --------------------------------------------------------------------------------------------------------------------------------
Operating Income 11,054 10,647 9,753 6,592 852
Other Income (Expenses), net 7,401 (40) (3,367) (3,518) (980)
- --------------------------------------------------------------------------------------------------------------------------------
Income (Loss) Before Income Taxes 18,455 10,606 6,386 3,074 (128)
Income Tax Expense (Benefit) 7,513 4,949 2,867 1,540 (51)
- --------------------------------------------------------------------------------------------------------------------------------
Income (Loss) Before Minority Interest 10,942 5,657 3,519 1,534 (77)
Minority Interest in Earnings of Alliance
Telecommunications Corporation 3,463 1,747 798 325
- --------------------------------------------------------------------------------------------------------------------------------
Net Income (Loss) $ 7,479 $ 3,910 $ 2,721 $ 1,209 $ (77)
================================================================================================================================
Basic Net Income (Loss) Per Common Share $ 2.42 $ 1.63 $ 1.44 $ .65 $ (.04)
Diluted Net Income (Loss) Per Common Share $ 1.96 $ 1.15 $ .93 $ .53 $ (.04)
Average Shares Outstanding:
Common shares only 3,095 2,403 1,893 1,870 1,866
Common and potential common shares 3,945 3,937 3,732 3,694 1,866
================================================================================================================================
Selected Balance Sheet Information
Working Capital $ 18,736 $ 6,554 $ 8,504 $ 1,307 $ 9,679
Property, Plant and Equipment, net 51,410 50,810 45,927 47,039 14,609
Excess of Cost Over Net Assets Acquired, net 51,405 53,004 51,170 52,510 907
Total Assets 166,797 150,680 139,291 137,348 33,518
Long-Term Debt 86,282 94,232 97,793 96,127 22,096
Stockholders' Equity 39,982 22,720 14,447 9,946 8,134
- --------------------------------------------------------------------------------------------------------------------------------
All potential common shares are anti-dilutive for 1995 and are excluded from calculation of net income per share
Operating results for 1996 include the operations of Ollig Utilities Company
from the April 25, 1996 purchase date.
</TABLE>
16
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Hector Communications Corporation ("HCC") owns a 100% interest in five
LEC subsidiaries and one cable television subsidiary. At December 31, 1999,
these subsidiaries provided telephone service to 7,228 customers in 9 rural
communities in Minnesota and Wisconsin. They also owned cable television systems
serving 4,934 customers in Minnesota and Wisconsin. HCC's 100%-owned
subsidiaries also have substantial investments in other telecommunications
ventures, including, Midwest Wireless Communications, LLC, Wireless North LLC
and Onvoy, Inc..
HCC also owns a 68% interest in Alliance Telecommunications Corporation
("Alliance"). At December 31, 1999, Alliance, through its five LEC subsidiaries,
provided telephone service to 28,639 customers in 26 rural communities in
Minnesota, South Dakota and Iowa. Alliance's subsidiaries also provided cable
television services to 8,186 subscribers in Minnesota, South Dakota and North
Dakota. Alliance's subsidiaries also own substantial investments in Midwest
Wireless Communications, LLC, Wireless North LLC and Onvoy, Inc., own marketable
securities portfolios with investments in telecommunications providers like U.S.
West Communications, Inc., Illuminet Holdings, Inc. and Rural Cellular
Corporation, and have other investments. The minority interest in Alliance is
owned by Golden West Telecommunications Cooperative and Split Rock Telecom
Cooperative.
Results of Operations
General
The Company's telephone revenues are principally derived from the local
service and access revenues received by its local exchange carrier ("LEC")
subsidiaries. Local service revenues are earned by providing customers with
local service to connecting points within the local exchange boundaries and, in
certain cases, to nearby local exchanges under extended area service ("EAS")
plans that eliminate long distance charges to the neighboring exchanges. Monthly
rates for telephone service differ among the LECs depending upon the cost of
providing service, the type and grade of service, the number of customers and
calling patterns within the toll free calling area and other factors.
Access revenues are received by LECs for intrastate and interstate
exchange services provided to long distance carriers (generally referred to as
interexchange carriers or "IXCs"). These services enable IXCs to provide long
distance service to end users in the local exchange network.
Access revenues are determined, in the case of interstate calls,
according to rules promulgated by the Federal Communications Commission ("FCC")
and administered by the National Exchange Carriers Association ("NECA"). In the
case of intrastate calls, access revenues are determined by state regulatory
agencies. A relatively small portion of the Company's access revenues are
derived from subscriber line fees determined by the FCC and billed directly to
end users for access to long distance carriers. The balance of the Company's
interstate access revenues is received from NECA, which collects payments from
IXCs and distributes settlement payments to LECs.
Settlement payments are based on a number of factors, including the cost
of providing service and the amount of time the local network is utilized to
provide long distance services. Since 1984, a variety of factors, including
increased subscriber counts, cultural and technological changes, and rate
reductions by IXCs, have resulted in a consistent pattern of increasing use of
the nation's telephone network. This growth has produced higher revenues for
NECA and increased settlements for its participating LECs. The Company's
settlements from NECA have increased every year since the pool was established
in 1984, but there can be no assurance that this trend will continue.
HCC's LECs also sell and lease customer premise telephone equipment,
provide inside wiring services and custom calling features, provide Internet
access and sell and lease other facilities for private line, teletype, data
transmission and other communications services. They also provide billing and
collection services for certain IXCs in lieu of such IXCs directly billing
customers within the LEC's service areas.
17
<PAGE>
The Company's cable television revenues are derived almost exclusively
from monthly fees for basic and premium services.
The following table presents the percentage of revenues derived from
local service revenues, access revenues, billing and collection services,
nonregulated telephone activities and cable television operations for the last
three years:
<TABLE>
<CAPTION>
Year Ended December 31
------------------------------------------------
1999 1998 1997
----------- ---------- ---------
<S> <C> <C> <C>
Local network 17.3% 16.6% 16.9%
Network access 56.9 55.6 58.0
Nonregulated telephone activities 12.3 15.0 13.3
Billing and collecting 2.4 2.7 3.5
Cable television 11.1 10.1 8.3
----------- ----------- ---------
100.0 % 100.0% 100.0%
=========== ========== ==========
</TABLE>
1999 Compared to 1998
Consolidated revenues increased 7% from $31,839,000 in 1998 to
$34,117,000 in 1999. The following table shows revenues by operating group for
1999 compared to 1998:
<TABLE>
<CAPTION>
Alliance Hector
Year Ended December 31 Year Ended December 31
1999 1998 1999 1998
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Local network $ 4,250,474 $ 3,730,079 $ 1,664,204 $ 1,560,732
Network access 14,587,083 13,480,391 4,831,878 4,229,530
Billing and collection 650,839 683,132 173,700 182,635
Nonregulated activities 3,527,645 4,283,839 647,415 489,528
Cable television 2,306,786 1,774,495 1,477,292 1,424,333
------------ ------------ ------------ ------------
$ 25,322,827 $ 23,951,936 $ 8,794,489 $ 7,886,758
============ ============ ============ ============
</TABLE>
Consolidated local service revenues grew from $5,291,000 in 1998 to
$5,915,000 in 1999, an increase of $624,000 or 12%. Revenue growth was due to:
- - Addition of extended area service to Sioux Falls from Alliance's South Dakota
telephone exchanges
- - Increased demand for telephone lines to provide advanced telecommunications
services such as Internet services
- - Increased development within the LECs' service areas, and - The full year
effect of Alliance's acquisition of Felton Telephone Company
("Felton").
The number of access lines served by the LECs increased 3% from 34,762 to
35,867.
Network access revenues rose from $17,710,000 in 1998 to $19,419,000 in
1999, an increase of $1,709,000 or 10%. The increase was chiefly due to
increased use of the telephone network by customers, increased settlements
payments from NECA and increased universal service support funds.
Nonregulated revenues fell from $4,773,000 in 1998 to $4,175,000 in 1999,
a decrease of $598,000 or 13%. Revenue decreases from equipment leases in 1999
more than offset increased Internet revenues. Cable television revenues rose
from $3,199,000 in 1998 to $3,784,000 in 1999, an increase of $585,000 or 18%
due to rate increases and the full-year effect of the June 1998 acquisition by
Alliance of additional cable systems from Spectrum Cablevision Limited
Partnership. Billing and collection revenues declined from $866,000 in 1998 to
$825,000 in 1999, a decrease of $41,000 or 5% as IXCs continued the trend toward
self-billing of customers.
Consolidated operating costs and expenses grew from $21,192,000 in 1998
to $23,063,000 in 1999, an increase of $1,871,000 or 9%. The following table
shows costs and expenses by operating group for 1999 compared to 1998:
18
<PAGE>
<TABLE>
<CAPTION>
Alliance Hector
Year Ended December 31 Year Ended December 31
1999 1998 1999 1998
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Plant operations $ 2,944,902 $ 2,821,318 $ 1,142,021 $ 933,994
Depreciation and amortization 5,930,740 5,712,509 2,616,879 2,068,701
Customer operations 1,583,327 1,549,019 329,191 254,649
General and administrative 3,149,918 2,575,215 1,544,670 1,375,954
Other operating expenses 2,295,122 2,646,862 1,526,310 1,253,586
------------ ------------ ------------ ------------
$ 15,904,009 $ 15,304,923 $ 7,159,071 $ 5,886,884
============ ============ ============ ============
</TABLE>
Consolidated plant operations expenses increased from $3,755,000 in 1998
to $4,087,000 in 1999, an increase of $332,000 or 9%, due to training and
maintenance contracts associated with new telephone switches and offerings of
enhanced telephone services. Depreciation and amortization increased from
$7,781,000 in 1998 to $8,548,000 in 1999, an increase of $767,000 or 10% due to
increased depreciation on new telephone switching equipment. Customer operations
expenses increased 6% from $1,804,000 in 1998 to $1,913,000 in 1999 due largely
to growth in the number of customers served. General and administrative expenses
increased from $3,951,000 in 1998 to $4,695,000 in 1999, an increase of $744,000
or 19% due to increased cable television selling and administrative expenses.
Other operating expenses decreased $79,000 or 2%.
Consolidated operating income increased $407,000 or 4% from $10,647,000
in 1998 to $11,054,000 in 1999.
Consolidated interest expenses decreased $732,000 from $7,315,000 in 1998
to $6,583,000 in 1999. The decrease was due to expense reductions on convertible
debentures that were retired or converted into common stock in 1998 and 1999.
In 1999, the Company had a consolidated loss from partnership and LLC
investments of $336,000 compared to consolidated income of $883,000 in 1998. The
Company's share of loss from its Wireless North PCS investment was $1,597,000 in
1999 compared to $1,066,000 in 1998. The Company and its partners are
negotiating with potential new investors to inject more investment capital into
Wireless North's operations in order make the operations large enough to be
financially viable. Income from Midwest Wireless Communications, LLC decreased
from $1,508,000 in 1998 to $1,481,000,in 1999. The decrease was due to price
competition from other wireless service providers. The Company had income in
1998 from the Sioux Falls, South Dakota MSA, prior to its sale by Alliance, of
$334,000 in 1998 compared to no income in 1999.
Alliance had gains on sales of marketable securities totaling $13,203,000
in 1999 compared to gains on sales of $965,000 in 1998. Most of the gains were
on sales of Rural Cellular Corporation stock that Alliance sold over the course
of 1999. Alliance continues to hold a significant portfolio of marketable
securities. Consolidated investment income increased $507,000 from $609,000 in
1998 to $1,116,000 in 1999 due to investments of the cash proceeds from the
marketable securities sales. Alliance's 1998 income included a gain before
income taxes of $4,817,000 from the sale of its 12.25% interest in a cellular
telephone partnership serving the Sioux Falls, South Dakota MSA to CommNet
Cellular, Inc.
Consolidated income before income taxes increased from $10,606,000 in
1998 to $18,455,000 in 1999. The Company's effective income tax rate of 40.7% is
higher than the standard U.S. tax rate due to state income taxes and because the
goodwill amortization expenses from the acquisition of Ollig Utilities cannot be
deducted. Income before the minority interest in Alliance's earnings increased
93% from $5,657,000 in 1998 to $10,942,000. Minority interest on earnings of
Alliance were $3,463,000 in 1999 compared to $1,747,000 in 1998. Net income
increased 91% to $7,479,000 in 1999 compared to $3,910,000 in 1998.
19
<PAGE>
1998 Compared to 1997
Consolidated revenues increased 10% from $28,866,000 in 1997 to
$31,839,000 in 1998. The following table shows revenues by operating group for
1998 compared to 1997:
<TABLE>
<CAPTION>
Alliance Hector
Year Ended December 31 Year Ended December 31
1998 1997 1998 1997
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Local network $ 3,730,079 $ 3,346,733 $ 1,560,732 $ 1,519,514
Network access 13,480,391 12,845,426 4,229,530 3,892,682
Billing and collection 683,132 820,540 182,635 209,642
Nonregulated activities 4,283,839 3,469,234 489,528 369,188
Cable television 1,774,495 1,027,602 1,424,333 1,365,804
------------ ------------ ------------ ------------
$ 23,951,936 $ 21,509,535 $ 7,886,758 $ 7,356,830
============ ============ ============ ============
</TABLE>
Consolidated local service revenues grew from $4,866,000 in 1997 to
$5,291,000 in 1998, an increase of $425,000 or 9%. Revenue growth was due to:
- - Alliance's acquisition of Felton Telephone Company ("Felton") - Increased
development within the LECs' service areas, and - Increased demand for telephone
lines to provide advanced telecommunications services such as Internet services.
The number of access lines served by the LECs increased 6% from 32,727 to
34,762.
Network access revenues rose from $16,738,000 in 1997 to $17,710,000 in
1998, an increase of $972,000 or 6%. Excluding Felton's revenues reduces the
increase to $581,000 or 3%. The increase was chiefly due to increased use of the
telephone network by customers and increased universal service support funds.
Access revenues in 1997 were higher than normal due to a one-time retroactive
tariff settlement received by an Alliance subsidiary.
Nonregulated revenues grew from $3,838,000 in 1997 to $4,773,000 in 1998,
an increase of $935,000 or 24%. Revenue increases in 1998 were due to increased
Internet revenues, commissions on sales of long distance services and leases of
fiber-optic transport facilities. Cable television revenues rose from $2,393,000
in 1997 to $3,199,000 in 1998, an increase of $806,000 or 34% due to the
acquisition by Alliance of additional cable systems from Spectrum Cablevision
Limited Partnership. Billing and collection revenues declined from $1,030,000 in
1997 to $866,000 in 1998, a decrease of $164,000 or 16% as IXCs continued the
trend toward self-billing of customers.
Consolidated operating costs and expenses grew from $19,113,000 in 1997
to $21,192,000 in 1998, an increase of $2,079,000 or 11%. The following table
shows costs and expenses by operating group for 1998 compared to 1997:
<TABLE>
<CAPTION>
Alliance Hector
Year Ended December 31 Year Ended December 31
1998 1997 1998 1997
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Plant operations $ 2,821,318 $ 2,714,192 $ 933,994 $ 916,638
Depreciation and amortization 5,712,509 5,336,031 2,068,701 1,973,699
Customer operations 1,549,019 1,430,676 254,649 243,435
General and administrative 2,575,215 2,324,079 1,375,954 1,269,042
Other operating expenses 2,646,862 1,830,921 1,253,586 1,074,244
------------ ------------ ------------ ------------
$ 15,304,923 $ 13,635,899 $ 5,886,884 $ 5,477,058
============ ============ ============ ============
</TABLE>
Consolidated plant operations expenses increased from $3,631,000 in 1997
to $3,755,000 in 1998, an increase of $124,000 or 3%, due primarily to
Alliance's acquisition of Felton. Depreciation and amortization increased from
$7,310,000 in 1997 to $7,781,000 in 1998, an increase of $471,000 or 6% due to
Alliance's acquisition of Felton and a group of cable television systems from
20
<PAGE>
Spectrum Cablevision ("Spectrum"). Customer operations expenses increased 7%
from $1,674,000 in 1997 to $1,804,000 in 1998 due largely to growth in the
number of customers served. General and administrative expenses increased from
$3,593,000 in 1997 to $3,951,000 in 1998, an increase of $358,000 or 10% due to
the Company's expanded operations. Other operating expenses increased $995,000
or 34% due mainly to increased cable television expenses from the Spectrum
systems.
Consolidated operating income increased $894,000 or 9% from $9,753,000 in
1997 to $10,647,000 in 1998.
Consolidated interest expenses increased $518,000 from $6,797,000 in 1997
to $7,315,000 in 1998. The biggest factor in the interest expense increase was
the lack of patronage dividends on interest paid to St. Paul Bank for
Cooperatives ("St. Paul Bank"). This dividend was $694,000 in 1997 compared to
no dividend in 1998. St. Paul Bank has substantial loan exposures in the
agricultural economy, and poor performance by that economy during the third and
fourth quarters of 1998 prevented the payment of patronage dividends at
anticipated rates. The Company also had interest expense on new borrowings to
finance the acquisitions of Felton and Spectrum. This was offset to some degree
by interest reductions on convertible debentures that were retired or converted
into common stock in the second and third quarters of 1998.
Consolidated income from partnership and LLC investments decreased
$425,000 from $1,308,000 in 1997 to $883,000 in 1998. Income from Midwest
Wireless Communications, LLC increased $298,000 from $1,210,000 in 1997 to
$1,508,000 in 1998. The increase was due to continuing growth in the number of
customers using cellular services. Income from the Sioux Falls, South Dakota MSA
prior to its sale by Alliance was $334,000 in 1998 compared to $377,000 for all
of 1997. Losses from the Company's Wireless North PCS investment totaled
$1,066,000 in 1998 compared to $435,000 in 1997. While the Company anticipated
substantial losses from this operation's start-up phase, it is concerned that
anticipated future capital investments may be inadequate to finance Wireless
North's expansion plans. Accordingly, the Company and its fellow investors are
reviewing Wireless North's business plans with the goal of reducing operating
losses and attracting more investment capital to the operation.
Consolidated investment income declined $17,000 from $626,000 in 1997 to
$609,000 in 1998. Alliance had gains on sales of marketable securities totaling
$965,000 in 1998. Alliance continues to hold a significant portfolio of
marketable securities. In December, 1998, Alliance sold its 12.25% interest in a
cellular telephone partnership serving the Sioux Falls, South Dakota MSA to
CommNet Cellular, Inc. for $6,725,000. Alliance's gain on the sale before income
taxes was $4,817,000. Hector had gains on marketable securities sales of
$1,496,000 in 1997.
Consolidated income before income taxes increased 66% to $10,606,000. The
Company's effective income tax rate of 46.7% is higher than the standard U.S.
tax rate due to state income taxes and because the goodwill amortization
expenses from the acquisition of Ollig Utilities cannot be deducted. Income
before the minority interest in Alliance's earnings increased 61% from
$3,519,000 in 1997 to $5,657,000 in 1998. Minority interest on earnings of
Alliance were $1,747,000 in 1998 compared to $798,000 in 1997. Net income
increased 44% to $3,910,000 in 1998 compared to $2,721,000 in 1997.
Liquidity and Capital Resources
Operations
Cash flows from consolidated operating activities were $6,693,000,
$9,623,000 and $8,365,000 in 1999, 1998, and 1997, respectively. The decrease in
cash flows from operations in 1999 was due to income tax payments on gains from
sales of marketable securities. At December 31, 1999, the Company's cash, cash
equivalents and marketable securities totaled $39,274,000 compared to
$23,241,000 at December 31, 1998. Alliance's cash and securities were
$33,027,000 of this total at December 31, 1999. Working capital at December 31,
1999 was $18,736,000 compared to $6,554,000 at December 31, 1998. The current
ratio was 2.3 to 1 at December 31, 1999 compared to 1.5 to 1 at December 31,
1998.
21
<PAGE>
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 1999, 1998 and 1997 were $2,902,000, $2,652,000 and
$2,316,000, respectively. Alliance's plant additions in 1999, 1998 (excluding
the acquisitions of Felton and Spectrum) and 1997 were $4,640,000, $5,163,000
and $2,379,000, respectively. Plant additions for 2000 for Hector and Alliance
are expected to total $1,894,000 and $5,500,000, respectively. These plant
additions will provide customers with additional advanced telecommunications
services and expand usage of high capacity fiber optics in the telephone
network.
Investments
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 1999, Alliance received $18,920,000 from sales of marketable securities,
principally Rural Cellular Corporation common stock. In 1998, Alliance received
$1,820,000 from sales of interests in Rural Cellular Corporation, MediaOne
Group, Inc., Comnet Cellular, Inc. and Illuminet Holdings, Inc. In 1997, Hector
sold 161,469 shares of Rural Cellular Corporation for $1,728,000. At December
31, 1999, Alliance continued to maintain a significant marketable securities
portfolio consisting primarily of shares of Illuminet Holdings, Inc., U.S. West
Communications, Inc. and Rural Cellular Corporation.
The Company is an investor in Wireless North LLC, a limited liability
corporation that has licenses to operate PCS systems in 13 markets in Minnesota,
Wisconsin, North Dakota and South Dakota. The Company invested cash of
$1,032,000 and $761,000 in Wireless North in 1999 and 1998, respectively.
Investments in Wireless North prior to 1998 consisted of $510,000 of cash and
debt guarantees of $1,373,000. The PCS systems are in start-up mode and have
incurred significant losses to date. The Company cannot predict how much
additional capital might be required beyond amounts already invested.
The Company continued to maintain its ownership in Midwest Wireless
Communications, LLC through acquisition of additional partnership interests.
Cash expended to purchase Midwest Wireless Communications, LLC interests was
$380,000 in 1998. At December 31, 1999, the Company's ownership percentage was
10.69%. In December, 1998, the Company sold its 12.25% interest in Sioux Falls
Cellular, Ltd., which provides cellular service in the Sioux Falls, South Dakota
MSA to CommNet Cellular, Inc. for $6,725,000.
Debt and Loan Commitments
As part of financing its 68% ownership interest in Alliance, the Company
borrowed $6,000,000 from CoBank (St. Paul Bank for Cooperatives before its 1999
merger with CoBank). In 1997, the Company repaid principal of $2,000,000 on the
loan and converted the remaining balance into a five-year term loan. In 1998,
the Company replaced the loan with a 15-year term loan from Rural Telephone
Finance Cooperative ("RTFC"). The interest rate on the loan varies according to
the rate RTFC charges for similar loans. The interest rate was 6.95% at December
31, 1999.
The Company carries a significant amount of debt due to Alliance`s
borrowing to finance the acquisition of Ollig Utilities Company. Interest rates
on Alliance's acquisition loan from CoBank have been locked for periods of one
to ten years at rates averaging 7.5%. The outstanding balance on this loan at
December 31, 1999 was $47,580,800. 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. As a
condition of maintaining the loan, Alliance invested $344,000 and $509,000 of
cash in the bank in 1999 and 1998, respectively. The Company recorded a loss of
$200,000 in 1999 due to writedown of the value of this bank stock in the merger
between CoBank and St. Paul Bank for Cooperatives.
In 1995 the Company made a public offering of 8.5% convertible
subordinated debentures. Value of the offering was $12,650,000. Proceeds to the
Company, after underwriting, accounting and legal expenses were $11,300,000.
During 1999 and 1998, the Company issued calls to retire the debentures, which
resulted in $10,757,000 of debentures being converted into stock and $1,893,000
of debentures being purchased and retired.
22
<PAGE>
The Company's LEC subsidiaries borrow 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 $6,156,000, $737,000,
and $2,026,000 in 1999, 1998 and 1997, respectively. The average interest rate
on outstanding RUS and RTB loans is 5.6%. At December 31, 1999 unadvanced loan
commitments from the RUS and RTB to Hector's and Alliance's LEC subsidiaries
totaled $11,655,000.
The Company's loan agreements place significant restrictions on cash
distributions from the subsidiaries to the parent company. Substantially all of
the LEC's assets are pledged or are subject to mortgages to secure obligations
to the RUS and RTB. Alliance's loan covenants with CoBank also restrict dividend
payments at the Alliance level. A portion of any dividend payment from Alliance
to Hector would also be subject to federal and state income taxes. It is the
Company's plan, in so far as possible, to maintain its cash balances at the
subsidiary level to support their operations.
By utilizing cash flow from operations, current cash and investment
balances, and other available financing sources, the Company feels it has
adequate resources to meet its anticipated operating, debt service and capital
expenditure requirements.
Acquisitions
Effective April 1, 1998, Alliance acquired all the outstanding common
stock of Felton Telephone Company ("Felton"); a rural telephone company located
in northwestern Minnesota adjacent to areas already served by the Company's
telephone subsidiaries. Felton serves approximately 700 access lines and held a
significant portfolio of marketable securities, including investments in Rural
Cellular Corporation, U.S. West Communications, Inc. and MediaOne Group, Inc.
Purchase price was $3,650,000, which includes a cash downpayment and seller
financing of the balance through a $3,149,000 note payable bearing interest at
8.25%. The note matures April 1, 2005.
Effective June 9, 1998, Alliance acquired the assets of 8 cable
television systems serving 4,000 customers in 19 rural communities in Minnesota
and North Dakota from Spectrum Cablevision Limited Partnership ("Spectrum").
Several of these communities are also served by Alliance's telephone
subsidiaries. Purchase price was approximately $4,559,000. Financing for this
purchase included $2,000,000 from a new line of credit arrangement with Rural
Telephone Finance Cooperative. In 1997, Alliance acquired one small system for
$120,000.
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.
In 1999, the Company was a member of investor groups that sought unsuccessfully
to acquire rural telephone properties offered for sale by GTE and U.S. West
Communications. The Company cannot predict if it will be successful in acquiring
additional properties and does not currently have financing plans in place to
pay for possible acquisitions.
Effects of Inflation
The Company's local exchange telephone companies are subject to the
jurisdiction of Minnesota, Iowa, South Dakota and Wisconsin regulatory
authorities with respect to a variety of matters, including rates for intrastate
access services, the conditions and quality of service, issuance of debt,
depreciation rates and accounting methods. Rates for local telephone service are
not established directly by regulatory authorities, but their authority over
other matters limits the Company's ability to implement rate increases. In
addition, the regulatory process inherently restricts the Company's ability to
immediately pass cost increases along to customers unless the cost increases are
anticipated and the rate increases implemented prospectively.
Year 2000
In 1999 the Company contracted with Nortel, Inc. to upgrade its central
office switching equipment to Year 2000 compliance. Cost of the upgrades was
$658,000. The Company completed installation and testing of the new equipment in
November 1999. The Company is not aware of any disruptions of telephone service
to its customers due to Year 2000 problems.
23
<PAGE>
New Accounting Standards
In June 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative
Instruments and Hedging Activities" which was to be effective January 1, 2000.
SFAS 133 requires companies to record derivatives on the balance sheet as assets
or liabilities, measured at fair value. Gains or losses resulting from changes
in the values of those derivatives would be accounted for depending on the use
of the derivative and whether it qualifies for hedge accounting. SFAS No. 137,
an amendment of SFAS No. 133, was issued in June of 1999 and defers the
effective date of SFAS No. 133 to fiscal years beginning after June 15, 2000.
The Company has not yet determined the impact of this pronouncement on its
financial statements.
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101, (SAB 101), "Revenue Recognition in Financial
Statements". SAB 101 summarizes certain of the staff's views regarding generally
accepted accounting principles for revenue recognition and deferred costs in the
financial statements. The Company does not believe SAB 101 will have a material
effect on its financial statements.
Factors Affecting Future Performance
From time to time in reports filed with the Securities and Exchange
Commission, in press releases, and in other communications to shareholders and
the investing public, the Company may make statements regarding the Company's
future financial performance. Such forward looking statements are subject to
risks and uncertainties, including but not limited to, the effects of the
Telecommunications Act, new technological developments which may reduce barriers
for competitors entering the Company's local exchange or cable television
markets, higher than expected expenses and other risks involving the
telecommunications industry generally. All such forward-looking statements
should be considered in light of such risks and uncertainties.
24
<PAGE>
REPORT OF MANAGEMENT
The management of Hector Communications Corporation and its subsidiary companies
is responsible for the integrity and objectivity of the financial statements and
other financial information contained in the annual report. The financial
statements and related information were prepared in accordance with generally
accepted accounting principles and include amounts that are based on
management's informed judgments and estimates.
In fulfilling its responsibilities for the integrity of financial information,
management maintains accounting systems and related controls. These controls
provide reasonable assurance, at appropriate costs, that assets are safeguarded
against losses and that financial records are reliable for use in preparing
financial statements. Management recognizes its responsibility for conducting
the Company's affairs according to the highest standards of personal and
corporate conduct.
The Audit Committee of the Board of Directors, composed solely of outside
directors, meets with the independent auditors and management periodically to
review accounting, auditing, financial reporting and internal control matters.
The independent auditors have free access to this committee, without management
present to discuss the results of their audit work and their opinion on the
adequacy of internal financial controls and the quality of financial reporting.
/s/ Curtis A. Sampson
------------------------------------
Curtis A. Sampson
Chairman and Chief Executive Officer
/s/ Charles A. Braun
------------------------------------
Charles A. Braun
March 28, 2000 Chief Financial Officer
25
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
(a) FINANCIAL STATEMENTS
INDEPENDENT AUDITORS' REPORT
Shareholders and Board of Directors
Hector Communications Corporation
We have audited the accompanying consolidated balance sheets of Hector
Communications Corporation and subsidiaries as of December 31, 1999 and 1998 and
the related consolidated statements of income and comprehensive income,
stockholders' equity, and cash flows for each of the three years in the period
ended December 31, 1999. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Hector
Communications Corporation and subsidiaries as of December 31, 1999 and 1998 and
the results of their operations and their cash flows for each of the three years
in the period ended December 31, 1999 in conformity with generally accepted
accounting principles.
/s/ Olsen Thielen & Co., Ltd.
Olsen Thielen & Co., Ltd.
February 16, 2000
St. Paul, Minnesota
26
<PAGE>
<TABLE>
<CAPTION>
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
ASSETS
December 31
-----------------------------------
1999 1998
-------------- --------------
CURRENT ASSETS:
<S> <C> <C>
Cash and cash equivalents $ 27,055,772 $ 14,686,034
Construction fund (Note 6) 283,604 200,491
Accounts receivable (net of allowance for doubtful accounts of
$447,000 and $234,000, respectively) 4,854,365 4,140,992
Materials, supplies and inventories, at average cost 616,985 528,839
Prepaid expenses 171,432 180,134
-------------- --------------
TOTAL CURRENT ASSETS 32,982,158 19,736,490
PROPERTY, PLANT AND EQUIPMENT,net (Notes 1 and 5) 51,410,033 50,810,464
OTHER ASSETS:
Excess of cost over net assets acquired, less amortization
of $6,473,000 and $4,890,000 (Note 1) 51,405,010 53,003,560
Marketable securities (Note 3) 12,218,303 8,555,336
Wireless telephone investments (Note 4) 9,688,981 9,482,902
Other investments (Notes 1 and 6) 8,768,797 8,259,419
Deferred debenture issue costs (Note 6) 371,311
Other assets (Note 1) 323,405 460,305
-------------- --------------
TOTAL OTHER ASSETS 82,404,496 80,132,833
-------------- --------------
TOTAL ASSETS $ 166,796,687 $ 150,679,787
============== ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Notes payable and current portion of long-term debt (Note 6) $ 5,607,100 $ 6,808,500
Accounts payable (Note 10) 2,481,507 2,473,526
Accrued expenses 2,184,626 1,945,687
Income taxes payable 3,973,019 1,955,153
-------------- --------------
TOTAL CURRENT LIABILITES 14,246,252 13,182,866
LONG-TERM DEBT, less current portion (Note 6) 86,281,656 94,232,389
DEFERRED INVESTMENT TAX CREDITS (Note 7) 140,386 252,601
DEFERRED INCOME TAXES (Note 7) 9,435,515 8,510,637
DEFERRED COMPENSATION (Note 9) 897,113 990,155
COMMITMENTS AND CONTINGENCIES (Note 4)
MINORITY INTEREST IN ALLIANCE TELECOMMUNICATIONS, CORP. 15,813,847 10,790,818
STOCKHOLDERS' EQUITY: (Notes 1, 6 and 8)
Preferred stock, par value $1.00 per share; 3,000,000 shares authorized:
Convertible Series A, 229,300 and 342,800 shares issued and outstanding 229,300 342,800
Common stock, par value $.01 per share; 10,000,000 shares authorized;
3,574,712 and 2,661,062 shares issued and outstanding 35,747 26,611
Additional paid-in capital 13,274,444 6,326,441
Retained earnings 23,115,945 15,636,764
-------------- --------------
36,655,436 22,332,616
Accumulated other comprehensive income (Note 3) 3,326,482 387,705
-------------- --------------
TOTAL STOCKHOLDERS' EQUITY 39,981,918 22,720,321
-------------- --------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 166,796,687 $ 150,679,787
============== ==============
See notes to consolidated financial
statements.
</TABLE>
27
<PAGE>
<TABLE>
<CAPTION>
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
Year Ended December 31
------------------------------------------------
1999 1998 1997
------------- ------------- -------------
REVENUES:
<S> <C> <C> <C>
Local network $ 5,914,678 $ 5,290,811 $ 4,866,247
Network access 19,418,961 17,709,921 16,738,108
Billing and collection 824,539 865,767 1,030,182
Nonregulated activities 4,175,060 4,773,367 3,838,422
Cable television revenues 3,784,078 3,198,828 2,393,406
------------- ------------- -------------
TOTAL REVENUES 34,117,316 31,838,694 28,866,365
COSTS AND EXPENSES:
Plant operations 4,086,923 3,755,312 3,630,830
Depreciation and amortization 8,547,619 7,781,210 7,309,730
Customer operations 1,912,518 1,803,668 1,674,111
General and administrative 4,694,588 3,951,169 3,593,121
Other operating expenses 3,821,432 3,900,448 2,905,165
------------- ------------- -------------
TOTAL COSTS AND EXPENSES 23,063,080 21,191,807 19,112,957
------------- ------------- -------------
OPERATING INCOME 11,054,236 10,646,887 9,753,408
OTHER INCOME (EXPENSES):
Interest expense (6,582,536) (7,315,153) (6,797,354)
Partnership and LLC income (loss) (Note 4) (335,537) 883,096 1,308,346
Interest and dividend income 1,116,098 609,071 625,582
Gain on sale of marketable securities (Note 3) 13,203,062 965,069 1,495,999
Gain on sale of cellular partnership (Note 4) 4,817,498
------------- ------------- -------------
OTHER INCOME (EXPENSES), net 7,401,087 (40,419) (3,367,427)
------------- ------------- -------------
INCOME BEFORE INCOME TAXES 18,455,323 10,606,468 6,385,981
INCOME TAX EXPENSE (Note 7) 7,513,000 4,949,000 2,867,000
------------- ------------- -------------
INCOME BEFORE MINORITY INTEREST 10,942,323 5,657,468 3,518,981
MINORITY INTEREST IN EARNINGS OF
ALLIANCE TELECOMMUNICATIONS CORPORATION 3,463,142 1,747,225 798,228
------------- ------------- -------------
NET INCOME 7,479,181 3,910,243 2,720,753
------------- ------------- -------------
OTHER COMPREHENSIVE INCOME:
Unrealized holding gains on marketable securities 20,784,075 492,287 1,754,213
Reclassification adjustment for gains included in net income (13,203,062) (965,069) (1,495,999)
------------- ------------- -------------
OTHER COMPREHENSIVE INCOME (LOSS) BEFORE
INCOME TAXES 7,581,013 (472,782) 258,214
------------- ------------- -------------
Income tax expense related to unrealized holding gains
on marketable securities 8,450,555 189,519 752,667
Income tax benefit related to reclassification adjustment for
gains included in net income (5,368,207) (371,529) (641,877)
------------- ------------- -------------
Income tax expense (benefit) related to items of other
comprehensive income 3,082,348 (182,010) 110,790
Minority interest in other comprehensive income of
Alliance Telecommunications Corporation 1,559,887
------------- ------------- -------------
Other Comprehensive Income (Loss) 2,938,778 (290,772) 147,424
------------- ------------- -------------
COMPREHENSIVE INCOME $ 10,417,959 $ 3,619,471 $ 2,868,177
============= ============= =============
BASIC NET INCOME PER COMMON SHARE (Note 1) $ 2.42 $ 1.63 $ 1.44
============= ============= =============
DILUTED NET INCOME PER COMMON SHARE (Note 1) $ 1.96 $ 1.15 $ .93
============= ============= =============
AVERAGE SHARES OUTSTANDING (Notes 1 and 8):
Common shares only 3,095,000 2,403,000 1,893,000
Common and potential common shares 3,945,000 3,937,000 3,732,000
See notes to consolidated financial
statements.
</TABLE>
28
<PAGE>
<TABLE>
<CAPTION>
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Unearned Accumulated
Employee
Additional Stock Other
Preferred Stock Common Stock Paid-in Retained Ownership Comprehensive
Shares Amount Shares Amount Capital Earnings Shares Income Total
------- -------- --------- ------- ----------- ----------- ---------- ---------- -----------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
BALANCE AT DECEMBER 31, 1996 389,487 $389,487 1,883,857 $18,839 $ 102,003 $ 9,005,768 $(101,312) $ 531,053 $ 9,945,838
Net income 2,720,753 2,720,753
Issuance of common stock 171,425 1,714 1,488,255 1,489,969
Issuance of common stock under
Employee Stock Purchase Plan 3,695 37 23,126 23,163
Issuance of common stock under
Employee Stock Option Plan 9,000 90 61,885 61,975
Issuance of common stock in
exchange for preferred stock (11,387) (11,387) 11,387 114 11,273 0
ESOP Shares Allocated 26,412 31,588 58,000
Change in unrealized gains on
marketable securities, net
of deferred taxes 147,424 147,424
------- ------- --------- ------- ----------- ----------- ---------- ---------- -----------
BALANCE AT DECEMBER 31, 1997 378,100 378,100 2,079,364 20,794 1,712,954 11,726,521 (69,724) 678,477 14,447,122
Net income 3,910,243 3,910,243
Issuance of common stock under
Employee Stock Purchase Plan 10,753 107 73,013 73,120
Issuance of common stock under
Employee Stock Option Plan 48,200 482 354,931 355,413
Issuance of common stock in
exchange for preferred stock (35,300) (35,300) 35,300 353 34,947 0
Issuance of common stock from
exercise of outstanding warrants 7,876 79 61,091 61,170
Conversion of convertible
debentures into common stock 479,569 4,796 4,096,134 4,100,930
ESOP Shares Allocated (6,629) 69,724 63,095
Change in unrealized gains on
marketable securities, net of
deferred taxes (290,772) (290,772)
------- -------- --------- ------- ----------- ----------- ---------- ---------- -----------
BALANCE AT DECEMBER 31, 1998 342,800 342,800 2,661,062 $26,611 6,326,441 15,636,764 - 387,705 22,720,321
Net income 7,479,181 7,479,181
Issuance of common stock under
Employee Stock Purchase Plan 14,890 149 104,267 104,416
Issuance of common stock under
Employee Stock Option Plan 43,675 437 361,475 361,912
Issuance of common stock in
exchange for preferred stock (113,500) (113,500) 113,500 1,135 112,365 0
Issuance of common stock from
exercise of outstanding warrants 8,742 87 (87) 0
Conversion of convertible
debenturex into common stock 730,438 7,304 6,350,007 6,357,311
Issuance of common stock to ESOP 2,405 24 19,976 20,000
Change in unrealized gains on
marketable securities, net of
deferred taxes 2,938,777 2,938,777
------- -------- --------- ------- ----------- ----------- ---------- ---------- -----------
BALANCE AT DECEMBER 31, 1999 229,300 $229,300 3,574,712 $35,747 $13,274,444 $23,115,945 $ - $3,326,482 $39,981,918
======= ======== ========= ======= =========== =========== ========== ========== ===========
See notes to consolidated
financial statements.
</TABLE>
29
<PAGE>
<TABLE>
<CAPTION>
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31
------------------------------------------------
1999 1998 1997
-------------- ------------- -------------
CASH FLOWS FROM OPERATING ACTIVITIES:
<S> <C> <C> <C>
Net Income $ 7,479,181 $ 3,910,243 $ 2,720,753
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 8,663,181 7,957,527 7,500,078
Minority stockholders' interest in earnings
of Alliance Telecommunications Corporation 3,463,142 1,747,225 798,228
Gain on sales of marketable securities (13,203,062) (965,069) (1,495,999)
Gain on sale of wireless partnership investment (4,817,498)
Loss (income) from partnership and LLC investments 335,537 (883,096) (1,308,346)
Proceeds from wireless telephone investments 709,668 1,206,505 792,622
Noncash patronage refunds (12,569) (661,923)
Changes in assets and liabilities net of effects from
the purchase of Felton Telephone Company:
Increase in accounts receivable (727,508) (37,845) (37,430)
Decrease (increase) in materials, supplies and inventories (88,146) 21,188 (30,567)
Decrease (increase) in prepaid expenses 8,702 46,455 (56,060)
Increase (decrease) in accounts payable 7,981 866,321 (269,033)
Increase (decrease) in accrued expenses 477,147 (193,287) 157,333
Increase in income taxes payable 1,942,370 1,455,010 422,816
Decrease in deferred investment tax credits (112,215) (136,016) (145,167)
Increase (decrease) in deferred income taxes (2,157,467) (604,706) 25,394
Increase (decrease) in deferred compensation (93,042) 49,730 (47,519)
------------- ------------- -------------
Net cash provided by operating activities 6,692,900 9,622,687 8,365,180
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property, plant and equipment (7,541,926) (9,716,135) (4,695,301)
Sales of temporary cash investments 300,000 779,900
Sales of marketable securities 18,920,352 1,819,653 1,728,115
Purchases of marketable securities (1,768,648)
Purchases of wireless telephone investments (1,031,587) (1,140,457) (98,933)
Increase in construction fund (83,113) (122,801) (3,353)
Purchases of other investments (1,052,230) (1,083,592) (1,193,105)
Proceeds from other investments 463,734 114,536 27,667
Proceeds from sale of wireless partnership investment 6,725,140
Decrease (increase) in excess of cost over net assets acquired 15,170 (2,797,123) (61,107)
Decrease (increase) in other assets (52,109) (62,012) 12,534
Increase in cash from purchase of Felton Telephone Company 196,500
------------- ------------- -------------
Net cash provided by (used in) investing activities 7,869,643 (5,766,291) (3,503,583)
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of notes payable and long-term debt (8,815,220) (8,911,738) (5,637,184)
Proceeds from issuance of notes payable and long-term debt 6,156,087 6,733,179 2,026,000
Issuance of common stock 466,328 489,703 1,575,107
ESOP shares allocated 63,095 58,000
------------- ------------- -------------
Net cash used in financing activities (2,192,805) (1,625,761) (1,978,077)
------------- ------------- -------------
NET INCREASE IN CASH AND CASH EQUIVALENTS 12,369,738 2,230,635 2,883,520
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 14,686,034 12,455,399 9,571,879
------------- ------------- -------------
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 27,055,772 $ 14,686,034 $ 12,455,399
============= ============= =============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Interest paid $ 6,700,250 $ 7,096,930 $ 7,316,215
Income taxes paid 7,840,312 4,262,666 2,564,157
See notes to consolidated financial
statements.
</TABLE>
30
<PAGE>
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Description of business: Hector Communications Corporation owns a 100% interest
in five local exchange telephone subsidiaries and one cable television
subsidiary. The Company also owns a 68% interest in Alliance Telecommunications
Corporation, which owns and operates five local exchange telephone companies,
two cable television companies, an engineering company, and a credit card
communications company. At December 31, 1999, the Company's wholly and majority
owned subsidiaries provided telephone service to 35,867 access lines in 35 rural
communities in Minnesota, Wisconsin, South Dakota and Iowa. Its cable television
operations provided cable television services to 13,100 subscribers in
Minnesota, South Dakota and Wisconsin. The Company is also an investor in
partnerships and corporations providing wireless telephone and other
telecommunications related services.
Principles of consolidation: The consolidated financial statements include the
accounts of Hector Communications Corporation and its wholly and majority owned
subsidiaries ("HCC" or the "Company"). All material intercompany transactions
and accounts have been eliminated.
Regulatory accounting: Accounting practices prescribed by regulatory authorities
have been considered in the preparation of the financial statements and
formulation of accounting policies for telephone subsidiaries. These policies
conform to generally accepted accounting principles as applied to regulated
public utilities in accordance with Statement of Financial Accounting Standards
No. 71, "Accounting for the Effects of Certain Types of Regulation" (SFAS 71).
Accounting estimates: The presentation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets,
liabilities, and disclosure of contingent assets and liabilities at the balance
sheet date, and the reported amounts of revenues and expenses during the
reporting period. The estimates and assumptions used in the accompanying
consolidated financial statements are based upon management's evaluation of the
relevant facts and circumstances as of the time of the financial statements.
Actual results could differ from those estimates. The Company's financial
statements are also affected by depreciation rates prescribed by regulators,
which may result in different depreciation rates than for an unregulated
enterprise.
Property, plant and equipment: Property, plant and equipment is recorded at
cost. Depreciation is computed using principally the straight-line method.
Depreciation included in costs and expenses was $6,942,357, $6,260,624 and
$5,807,103 for 1999, 1998 and 1997, respectively. Maintenance and repairs are
charged to operations and additions or improvements are capitalized. Items of
property sold, retired or otherwise disposed of in the ordinary course of
business are removed from assets and any gains or losses are included in
accumulated depreciation.
Wireless telephone investments: The Company has significant investments in
Midwest Wireless Communications, LLC and Wireless North, LLC. The Company is the
second largest shareholder of Midwest Wireless Communications, LLC and Wireless
North, LLC and has the ability to influence the operating and financial policies
of these companies. The Company recognizes income and losses from these
investments on the equity method of accounting. Income and losses recognized
from these investments are material to the Company's operating results.
Other assets: The excess of cost over net assets of subsidiaries acquired in
purchase transactions is being amortized on the straight-line method over
periods ranging from fifteen to forty years. Amortization included in costs and
expenses was $1,583,380, $1,499,456 and $1,401,889 in 1999, 1998 and 1997,
respectively.
Deferred debenture issue costs are the underwriting, legal and accounting fees
incurred by the Company in completing its February, 1995 public offering of
convertible subordinated debentures. The debenture issue costs were amortized
over the expected life of the debentures (Note 6). Amortization cost included in
interest expense was $115,562, $176,317 and $189,112 in 1999, 1998 and 1997,
respectively. When the debentures were converted into common stock, the
remaining issue costs were charged to capital. $256,151 and $233,549 of
debenture issue costs were charged to capital in 1999 and 1998, respectively.
None of the convertible debentures remained outstanding at December 31, 1999.
Accumulated amortization was $460,425 at December 31, 1998.
31
<PAGE>
Other investments consist of Rural Telephone Bank stock, Onvoy, Inc. stock,
CoBank stock, and investments in stock companies and partnerships of other
telecommunications service providers. Long-term investments in companies that
are not intended for resale or are not readily marketable are valued at cost,
which does not exceed net realizable value. Investments in joint ventures,
partnerships and limited liability companies are recorded on the equity method
of accounting, which reflects original cost and recognition of the Company's
share of operating income or losses from the respective operations.
Other assets are cable television franchises owned by the Company and other
deferred charges. Amortization included in expenses was $21,882, $21,130 and
$100,738 for 1999, 1998 and 1997, respectively.
Financial instruments: The fair value of the Company's financial instruments
approximates carrying value except for long-term investments in other companies
and long-term debt payable to the Rural Utilities Service ("RUS") and Rural
Telephone Bank ("RTB"). Other long-term investments are not intended for resale
and not readily marketable, thus a reasonable estimate of fair value is not
practicable. The fair value of long-term debt owed to RUS and RTB was
$34,117,000 and $31,183,000 at December 31, 1999 and 1998, respectively. Fair
values were estimated based on current rates offered to the Company for debt
with similar terms and maturities.
Revenue recognition: Revenues are recognized when earned, regardless of the
period in which they are billed. Network access revenues are furnished in
conjunction with interexchange carriers and are determined by cost separation
studies and nationwide average schedules. Revenues include estimates pending
finalization of cost studies. Network access revenues are based upon interstate
tariffs filed with the Federal Communications Commission by the National
Exchange Carriers Association and state tariffs filed with state regulatory
agencies. Management believes recorded revenues are reasonable based on
estimates of final cost separation studies, which are typically settled within
two years.
Income taxes and investment tax credits: The provision for income taxes consists
of an amount for taxes currently payable and a provision for tax consequences
deferred to future periods. For financial statement purposes, deferred
investment tax credits are being amortized as a reduction of the provision for
income taxes over the estimated useful lives of the related property, plant and
equipment.
Net income per share: Basic net income per common share is based on the weighted
average number of common shares outstanding during each year. Diluted net income
per common share takes into effect the dilutive effect of potential common
shares outstanding. The Company's potential common shares outstanding include
preferred stock, stock options, warrants and convertible debentures. The
calculation of the Company's net income per share is included in Exhibit 11 of
this form 10-K.
Statement of cash flows: The Company considers temporary cash investments with
an original maturity of three months or less to be cash equivalents. During 1999
and 1998, the Company issued calls to retire outstanding convertible debentures.
As a result of these calls, $6,493,000 and $4,264,000 of debentures were
converted into common stock in noncash transactions in 1999 and 1998,
respectively.
New accounting principles: In June 1998, the Financial Accounting Standards
Board issued Statement of Financial Accounting Standards (SFAS) No. 133,
"Accounting for Derivative Instruments and Hedging Activities" which was to be
effective January 1, 2000. SFAS 133 requires companies to record derivatives on
the balance sheet as assets or liabilities, measured at fair value. Gains or
losses resulting from changes in the values of those derivatives would be
accounted for depending on the use of the derivative and whether it qualifies
for hedge accounting. SFAS No. 137, an amendment of SFAS No. 133, was issued in
June of 1999 and defers the effective date of SFAS No. 133 to fiscal years
beginning after June 15, 2000. The Company has not yet determined the impact of
this pronouncement on its financial statements.
Basis of presentation: Certain amounts in the 1997 and 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.
32
<PAGE>
NOTE 2 - ACQUISITIONS.
Effective April 1, 1998, Alliance Telecommunications Corporation acquired all
the outstanding common stock of Felton Telephone Company ("Felton"); a rural
telephone company located in northwestern Minnesota adjacent to areas already
served by the Company's telephone subsidiaries. Felton serves approximately 700
access lines and held a significant portfolio of marketable securities,
including investments in Rural Cellular Corporation, U.S. West Communications,
Inc. and MediaOne Group, Inc. Purchase price was $3,650,000, which includes a
cash downpayment and seller financing of the balance through a $3,149,000 note
payable bearing interest at 8.25%. The note matures April 1, 2005. The
acquisition is being accounted for as a purchase. Excess of cost over net assets
acquired in the transaction was $536,000, which is being amortized on a
straight-line basis over 40 years. The operations of Felton, which were not
material to the Company's financial statements, are included in the Company's
financial results from the purchase date. In the acquisition, the following
assets were acquired and liabilities assumed:
Property, plant and equipment $ 1,427,800
Excess of cost over net assets acquired 536,215
Marketable securities 4,363,854
Long-term debt (1,770,895)
Deferred taxes and credits (1,709,976)
Other assets and liabilities 803,002
-------------
Total purchase price 3,650,000
Less notes payable issued to seller (3,149,358)
Less cash and cash equivalents acquired (590,944)
Less deposits and acquisition costs paid in 1997 (106,198)
-------------
Increase in cash from purchase of Felton
Telephone Company $ 196,500
=============
Effective June 9, 1998, Alliance acquired the assets of 8 cable television
systems from Spectrum Cablevision Limited Partnership ("Spectrum"). These
systems serve 4,000 cable television customers in 19 rural communities in
Minnesota and North Dakota, including several communities also served by the
Company's telephone subsidiaries. Purchase price was approximately $4,559,000.
The acquisition is being accounted for as a purchase. Excess of cost over net
assets acquired in the transaction was $2,784,000, which is being amortized over
15 years on a straight-line basis. The operations of the cable systems, which
were not material to the Company's financial statements, are included in the
Company's financial results from the purchase date.
NOTE 3 - MARKETABLE SECURITIES AND GAINS ON SALES OF INVESTMENTS
Marketable securities consist principally of equity securities of other
telecommunications companies obtained by the Company's subsidiaries in sales of
investments in wireless telephone partnerships. The acquisition of Felton
Telephone Company included a substantial portfolio of marketable securities of
this type. The Company's marketable securities portfolio was classified as
available-for-sale at December 31, 1999 and December 31, 1998. The cost and fair
values of available-for-sale investment securities was as follows:
Gross Gross
Unrealized Unrealized Fair
Cost Gains Losses Value
December 31, 1999 $4,074,353 $ 8,174,811 $ (30,861) $12,218,303
December 31, 1998 7,792,397 1,949,794 (1,386,855) 8,555,336
Net unrealized gains on marketable securities, net of related deferred taxes and
minority interest, are included in stockholders' equity as accumulated other
comprehensive income at December 31, 1999 and 1998 as follows:
Net Deferred Accumulated
Unrealized Income Minority Comprehensive
Gains Taxes Interest Income
December 31, 1999 $8,143,950 $(3,257,581) $(1,559,887) $ 3,326,482
December 31, 1998 562,939 (175,234) - 387,705
33
<PAGE>
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 $18,920,000,
$1,820,000 and $1,728,000 in 1999, 1998 and 1997, respectively. Gross realized
gains on sales of these securities were $13,203,000, $965,000 and $1,496,000 in
1999, 1998 and 1997, respectively. Realized gains on sales are based on the
difference between net sales proceeds and the book value of the securities sold,
using the specific identification method.
NOTE 4 - WIRELESS TELEPHONE INVESTMENTS
Investments in wireless telephone partnerships and limited liability companies
are recorded on the equity method of accounting, which reflects original cost
and recognition of the Company's share of income or losses. At December 31,
1999, the Company owned 10.69% of Midwest Wireless Communications LLC, which
provides cellular service to the former RSA partnership areas in southern
Minnesota and the Rochester, Minnesota MSA. Income from this investment, net of
associated amortization expense, was $1,481,000, $1,508,000 and $1,210,000 in
1999, 1998 and 1997, respectively. Cash distributions received from Midwest
Wireless were $710,000, $848,000 and $397,000 in 1999, 1998 and 1997,
respectively. The excess of cost over the Company's share of equity in Midwest
Wireless, net of amortization reserves, was $6,897,000 and $5,990,000 at
December 31, 1999 and 1998, respectively. Excess cost is being amortized on the
straight-line method over forty years. Amortization expense was $183,000,
$158,000 and $151,000 in 1999, 1998 and 1997, respectively. At December 31,
1999, the Company's cumulative share of income from Midwest Wireless was
$5,070,000, of which $3,108,000 was undistributed.
The Company owns 13.36% of Wireless North, LLC which has licenses to provide
personal communications services in Minnesota, Wisconsin, North Dakota and South
Dakota. At December 31, 1999, the Company had invested $2,303,000 of cash and
guaranteed debt of $1,373,000 in Wireless North. Its PCS systems have not been
profitable to date. The Company's share of Wireless North's losses was
$1,597,000, $1,066,000 and $435,000 in 1999, 1998 and 1997, respectively. The
Company cannot predict if it will be necessary to provide additional capital to
Wireless North.
Summarized audited financial information for these companies for 1999, 1998 and
1997 is as follows:
Year Ended December 31
1999 1998 1997
------------ ------------ ------------
Current assets $ 11,602,675 $ 14,894,978 $ 14,361,193
Noncurrent assets 94,755,699 84,844,144 68,816,885
Current liabilities 13,815,844 14,856,061 10,796,036
Noncurrent liabilities 66,079,559 51,090,911 43,117,318
Members' equity 26,462,971 33,792,150 29,264,724
Revenues 60,228,148 50,268,747 40,330,759
Expenses 55,910,186 41,649,381 30,581,537
Net income 4,317,962 8,619,366 9,749,222
In December, 1998, the Company sold its 12.25% interest in Sioux Falls Cellular,
Ltd., which provides cellular service in the Sioux Falls, South Dakota MSA for
$6,725,000 of cash. Gain on the sale was $4,817,000. Income from this investment
prior to the sale, net of associated amortization expense, was $334,000 and
$377,000 in 1998 and 1997, respectively. Amortization expense was $29,000 and
$36,000 in 1998 and 1997, respectively.
34
<PAGE>
NOTE 5 - PROPERTY, PLANT AND EQUIPMENT
The cost of property, plant and equipment and the estimated useful lives are as
follows:
Estimated December 31
useful life 1999 1998
----------- ------------ -------------
Land $ 606,397 $ 589,560
Buildings 5-40 years 5,562,920 5,379,836
Machinery and equipment 3-15 years 2,016,253 1,238,040
Furniture and fixtures 5-10 years 2,142,535 2,129,062
Telephone plant 5-33 years 64,107,388 57,385,560
Cable television plant 10-15 years 8,948,737 8,495,861
Construction in progress 1,236,205 1,027,314
------------ -------------
84,620,435 76,245,233
Less accumulated depreciation 33,210,402 25,434,769
------------ -------------
$ 51,410,033 $ 50,810,464
============ =============
NOTE 6 - NOTES PAYABLE AND LONG-TERM DEBT
<TABLE>
<CAPTION>
December 31
--------------------------------
1999 1998
------------ ------------
Notes payable to CoBank, payable by Alliance
Telecommunications Corporation in monthly installments,
<S> <C> <C>
average interest rate of 7.5%, due 2000 to 2011 $ 47,580,800 $ 50,524,700
Rural Utilities Service ("RUS") and Rural Telephone Bank ("RTB") mortgage notes,
payable by telephone company
subsidiaries in monthly and quarterly installments,
average rate of 5.6%, due 2000 to 2026 38,041,254 33,761,429
Notes payable to Rural Telephone Finance Cooperative
in quarterly installments, interest rate of 6.95%, due 2013 3,743,712 3,914,852
Notes payable on line of credit from Rural Telephone
Finance Cooperative 2,000,000
Notes payable to former owners of Felton Telephone
Company, payable by a subsidiary of Alliance Tele-
communications Corporation in monthly installments,
interest rate of 8.25%, due 2005 2,522,990 2,891,908
Convertible subordinated debentures, payable to
debentureholders, interest rate of 8.5% 7,948,000
------------ ------------
91,888,756 101,040,889
Less current portion 5,607,100 6,808,500
------------ ------------
$ 86,281,656 $ 94,232,389
============ ============
</TABLE>
In 1996, the Company's 68% owned subsidiary, Alliance Telecommunications
Corporation negotiated a term loan agreement with the St. Paul Bank for
Cooperatives ("St. Paul Bank") to provide financing for the acquisition of Ollig
Utilities Company. As a condition to receiving the loans, Alliance purchased
stock in the bank. Alliance's investment in St. Paul Bank stock at December 31,
1998 was $3,095,000. In 1999, St. Paul Bank merged with CoBank. As part of the
merger, Alliance's St. Paul Bank stock was revalued. Alliance recorded a loss of
$199,995 in 1999 due to this revaluation. At December 31, 1999, Alliance's
investment in CoBank stock was $3,239,000.
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. Patronage refund received from the
bank was $694,000 in 1997; approximately 30% was received in cash, with the
balance in the bank. The patronage refund was shown in the Company's operating
statement as a reduction of interest expense. No patronage refund was accrued
for 1998 or 1999. The Company cannot predict what patronage refunds might be in
future years.
35
<PAGE>
Alliance's loan from CoBank is secured by a pledge of substantially all
the assets of Alliance and its subsidiaries. The loan covenants also restrict
Alliance's ability to pay dividends to its shareholders. Interest rates on the
loan are fixed for periods ranging from one to ten years at rates averaging
approximately 7.5%. Principal payments began in January 1997 and will continue
until March 2011.
The Rural Utilities Service (RUS) and the Rural Telephone Bank (RTB) are
the Company's primary sources of long-term financing for additions to telephone
plant and equipment. The RUS has made long-term loans to telephone companies
since 1949, at interest rates of 2% and 5%, for the purpose of improving
telephone service in rural areas. The RUS is also authorized to make hardship
loans at a 5% interest rate and cost-of-money loans at a rate reflecting the
government's cost of money for a like term. The RTB advances funds at the
average U.S. government cost-of-money for the year for like maturities. In some
cases RTB loans are made concurrently with RUS loans. At December 31, 1999, the
Company's local exchange carrier subsidiaries had unadvanced loan commitments
under the RUS and RTB programs aggregating approximately $11,655,000 to finance
specific construction activities in future years.
Substantially all of the telephone plant of the LEC subsidiaries is
pledged or is subject to mortgages to secure obligations to the RUS and RTB. In
addition, the amount of dividends on common stock that may be paid by the LEC
subsidiaries to the Company is limited by certain financial covenants set forth
in the mortgages. At December 31, 1999, $8,099,000 of retained earnings of these
subsidiaries was available for dividend payments to HCC.
The Company is continuing its construction program to upgrade its
telephone and cable television properties. Planned expenditures for HCC and
Alliance properties in 2000 are $1,894,000 and $5,500,000, respectively. The
Company intends to use RUS and RTB loan funds to help finance these projects.
Loan funds received are deposited in construction fund accounts and
disbursements are restricted, subject to RUS approval, to construction costs
authorized by the loan agreements.
The Company has a term loan and a $5,000,000 revolving line of credit
from Rural Telephone Financing Cooperative ("RTFC"). The interest rate on the
term loan varies according to the rate charged by the Lender for similar loans
(6.95% at December 31, 1999). Interest on borrowings against the credit line is
at the bank's prime rate plus 1.5%. The Company borrowed $2,000,000 against the
credit line in 1998 to help finance the purchase of additional cable television
systems from Spectrum Cablevision Limited Partnership. The credit line was
repaid in 1999. Both the credit line and the term loan are secured by a pledge
of the stock of HCC's wholly owned subsidiaries.
In February 1995 the Company completed a public offering of 8.5%
convertible subordinated debentures. During 1999 and 1998, the Company issued
calls to retire the debentures, which resulted in $10,757,000 of debentures
being converted into stock and $1,893,000 of debentures being purchased and
retired.
The annual requirements for principal payments on notes payable and
long-term debt are as follows:
2000 $ 5,607,100
2001 5,955,100
2002 6,321,900
2003 6,707,200
2004 7,098,400
NOTE 7 - INCOME TAXES
Hector Communications Corporation and its wholly owned subsidiaries file
a consolidated tax return separate from the consolidated return for Alliance
Telecommunications Corporation and its subsidiaries. Income tax expenses
(benefits) consist of the following:
36
<PAGE>
<TABLE>
<CAPTION>
Year Ended December 31
--------------------------------------------------------
1999 1998 1997
----------------- ------------------ -----------------
Currently payable taxes:
<S> <C> <C> <C>
Federal $ 8,120,000 $ 4,445,000 $ 2,305,000
State 1,662,000 1,244,000 682,000
----------------- ------------------ -----------------
9,782,000 5,689,000 2,987,000
Deferred income taxes (benefit) (2,157,000) (604,000) 25,000
Deferred investment tax credits (112,000) (136,000) (145,000)
------------------ ------------------- ------------------
$ 7,513,000 $ 4,949,000 $ 2,867,000
================== =================== ==================
</TABLE>
Deferred tax assets and (liabilities) as of December 31 related to the
following:
1999 1998
--------------- ---------------
Accelerated depreciation $ (6,012,515) $ (6,291,637)
Alternative minimum tax credits 28,000 69,000
Marketable securities (4,073,000) (2,947,000)
Deferred compensation 363,000 400,000
Other 259,000 259,000
--------------- ---------------
$ (9,435,515) $ (8,510,637)
=============== ===============
The provision for income taxes varied from the federal statutory tax rate
as follows:
Year Ended December 31
-------------------------------
1999 1998 1997
--------- --------- ---------
Tax at U.S. statutory rate 35.0% 35.0% 35.0%
Surtax exemption - (1.0) (1.0)
State income taxes, net of federal benefit 3.8 7.8 7.4
Excess of cost over net assets acquired 3.0 5.1 8.3 .
Investment tax credits ( .6) (1.3) (2.3)
Other ( .5) 1.1 (2.5)
--------- --------- ---------
Effective tax rate 40.7% 46.7% 44.9%
========= ========= =========
NOTE 8 - STOCKHOLDERS' EQUITY
Preferred stock is entitled to share ratably with common shareholders in
any dividends or distributions paid by the Company, but are not entitled to any
dividend distribution separate from common shareholders. Preferred shareholders
have no voting rights. Each share of preferred stock is convertible into one
share of common stock.
Common shares are reserved for issuance in connection with stock option
plans under which 800,000 shares may be issued pursuant to stock options, stock
appreciation rights, restricted stock or deferred stock granted to officers and
key employees. Exercise prices of stock options under the plan cannot be less
than fair market value of the stock on the date of grant. Rules and conditions
governing awards of stock options, stock appreciation rights and restricted or
deferred stock are determined by the Compensation Committee of the Board of
Directors, subject to certain limitations incorporated into the plan. Another
provision of the plans automatically grants 2,000 shares of nonqualified stock
options per year to each nonemployee director. Options issued under this
provision have a ten-year term and an exercise price not less than fair market
value at date of grant. At December 31, 1999, 388,675 shares remained available
to be issued under the plans.
Changes in outstanding employee and director stock options during the
three years ended December 31, 1999 is as follows:
37
<PAGE>
Average
Number of exercise price
shares per share
----------- ----------
Outstanding at December 31, 1996 212,175 $ 7.12
Granted 69,775 7.87
Exercised (9,000) 6.89
Canceled (33,200) 7.69
----------- ----------
Outstanding at December 31, 1997 239,750 7.27
Granted 74,775 11.50
Exercised (48,200) 6.75
Canceled (300) 7.50
----------- ----------
Outstanding at December 31, 1998 266,025 8.55
Granted 91,400 8.80
Exercised (43,675) 7.93
Canceled (6,100) 8.44
----------- ----------
Outstanding at December 31, 1999 307,650 $ 8.72
=========== ==========
Options issued to officers and key employees are subject to vesting. Options are
vested and become exercisable one-third at the date of issue, one-third one year
from date of issue and one-third two years from date of issue. At December 31,
1999, 232,958 stock options are currently exercisable at an average price of
$8.47 per share. The following table summarizes the status of stock options
outstanding at December 31, 1999:
Weighted Average Weighted
Remaining Average
Range of Exercise Prices Shares Option Life Exercise Price
- ------------------------ --------- ----------- --------------
$ 6.50 to $ 8.50 216,375 2.6 years $ 7.69
$ 8.51 to $10.93 20,000 6.8 years 9.86
$10.94 to $12.51 71,275 3.7 years 11.50
Effective August 1, 1990, the 1990 Employee Stock Purchase Plan ("ESPP") was
adopted, for which 100,000 shares were reserved. Under terms of the plan,
eligible employees may acquire shares of common stock through payroll deductions
of not more than 10% of compensation. The price of shares purchased by the
employees is 85% of the lower of fair market value for such shares on one of two
specified dates in each plan year. A participant is limited to the acquisition
in any plan year to the number of shares which their payroll deductions for the
year would purchase based on the market price on the first day of the year or
$25,000, whichever is less. Shares issued to employees under the plan were
14,890, 10,753 and 3,695 for the plan years ended August 31, 1999, 1998 and
1997, respectively. At December 31, 1999 employees had subscribed to purchase an
additional 11,300 shares in the current plan cycle ending August 31, 2000.
The Company has adopted the disclosure provisions of SFAS No. 123, "Accounting
for Stock-Based Compensation", but applies APB Opinion No. 25, "Accounting for
Stock Issued to Employees" for measurement and recognition of stock-based
transactions with its employees. If the Company had elected to recognize
compensation cost for its stock based transactions using the method prescribed
by SFAS No. 123, net income and earnings per share would have been as follows:
Year Ended December 31
-----------------------------------------
1999 1998 1997
----------- ----------- -----------
Net income $ 7,211,118 $ 3,709,988 $ 2,579,427
Basic net income per share $ 2.33 $ 1.54 $ 1.36
Diluted net income per share $ 1.90 $ 1.10 $ .89
The fair value of the Company's stock options and Employee Stock Purchase
Plan transactions used to compute pro forma net income and net income per share
disclosures is the estimated present value at grant date using the Black-Scholes
option-pricing model. The following table displays the assumptions used in the
model.
38
<PAGE>
Year Ended December 31
---------------------------------------
1999 1998 1997
-------- -------- --------
Expected volatility 28.2% 23.3% 21.4%
Risk free interest rate 5.3% 5.6% 6.5%
Expected holding period - employees 4 years 4 years 4 years
Expected holding period - directors 7 years 7 years 7 years
Dividend yield 0% 0% 0%
Pro forma stock-based compensation cost was $268,063, $200,255 and
$141,326 in 1999, 1998 and 1997, respectively. Fair value of all options issued
was $286,529, $271,770 and $180,134, in 1999, 1998 and 1997, respectively.
In 1995 the Company issued $12,650,000 (par value) of convertible
subordinated debentures. The debentures were convertible into common stock of
the Company at a rate of 112.5 common shares per $1,000 par value debenture.
During 1998 and 1999 the Company issued calls retiring the debentures;
$10,757,000 of debentures being converted into common stock and $1,893,000 of
debentures being retired for cash. The underwriters of the debenture offering
also received warrants to purchase shares of the Company's common stock at a
price of $8.70 per share. 8,742 shares and 7,876 shares were issued upon
exercise of warrants in 1999 and 1998, respectively. At December 31, 1999,
warrants for 91,046 shares remain outstanding. All of the outstanding warrants
were exercised in February 2000.
Effective August 1, 1990, the Board of Directors adopted a leveraged
employee stock ownership plan ("ESOP"). Contributions to the ESOP are determined
by the Board on an annual basis and can be made in cash or by issuing shares of
the Company's common stock. ESOP expense reflects the market value of company
stock contributed to the accounts of eligible employees at the time of the
contribution. ESOP expense was $97,000, $83,000 and $60,000 for 1999, 1998 and
1997, respectively. At December 31, 1998, the ESOP held 57,205 shares of the
Company's common stock, all of which had been allocated to the accounts of
participating employees. All eligible employees of Hector Communications
Corporation participate in the plan after completing one year of service.
Employees of Alliance Telecommunications Corporation do not participate in the
plan. Contributions are allocated to each participant based on compensation and
vest 30% after three years of service and incrementally thereafter, with full
vesting after seven years.
On July 28, 1999 the Board of Directors adopted a shareholders' rights
plan. Under this plan, the Board of Directors declared a distribution of one
right per share of common stock. Each right entitles the holder to purchase
1/100th of a share of a new series of Junior Participating Preferred Stock of
the Company at an initial exercise price of $65. The rights expire on July 27,
2009. The rights will become exercisable only following the acquisition by a
person or group, without the prior consent of the Board of Directors, of 15% or
more of the Company's voting stock, or following the announcement of a tender
offer or exchange offer to acquire an interest of 15% or more. If the rights
become exercisable, each rightholder will be entitled to purchase, at the
exercise price, common stock with a market value equal to twice the exercise
price. Should the Company be acquired, each right would entitle the holder to
purchase, at the exercise price, common stock of the acquiring company with a
market value equal to twice the exercise price. Any rights owned by the
acquiring person or group would become void.
NOTE 9 - EMPLOYEE BENEFIT PLANS
The Company has 401(k) savings plans for its employees. Employees who
meet certain age and service requirements may contribute up to 10% of their
salaries to the plan on a pretax basis. The Company matches a portion of
employee contributions. Contributions to the plan by the Company for 1999, 1998
and 1997 were approximately $152,000, $135,000 and $121,000, respectively.
Employees of Alliance Telecommunications Corporation who meet certain age
and service requirements are eligible to participate in a profit sharing plan.
Contributions are determined annually by Alliance's Board of Directors and are
allocated proportionately to the participants in each allocation group.
Contributions to the plan by the Company in 1999, 1998 and 1997 were $224,000,
$177,000 and $166,000, respectively.
39
<PAGE>
Ollig Utilities Company had a deferred compensation agreement with two of its
former officers that the Company has assumed. Under the agreement, the salaries
of these officers were continued after their retirement based on a formula
stated in the agreement. The Company incurred no expense under this agreement in
1999 or 1997. The Company's 1998 expense under the plan was $143,000. Payments
made under the agreement in 1999, 1998 and 1997 were $93,000, $93,000 and
$47,500, respectively.
NOTE 10 - TRANSACTIONS WITH COMMUNICATIONS SYSTEMS, INC.
Transactions between the Company and Communications Systems, Inc. (CSI), the
Company's former parent, are based on a distribution agreement, which provides
for the Company's use of certain of CSI's staff and facilities, with related
costs paid by the Company. Services provided by CSI aggregated approximately
$270,000, $300,000 and $264,000 in 1999, 1998 and 1997, respectively.
Employees of the Company also participated in a joint self-funded medical
insurance program with employees of CSI through August, 1999. Costs paid by the
Company into this program were $429,000, $595,000, and $535,000 in 1999, 1998
and 1997, respectively.
Costs of services from CSI may not be indicative of the costs of such services
had they been obtained from a different party. Intercompany accounts with CSI
are handled on an open account basis. Outstanding amounts payable to CSI were
$428,000 and $645,000 at December 31, 1999 and 1998, respectively.
NOTE 11 - SEGMENT INFORMATION
The Company is organized into two business segments: Hector Communications
Corporation and its wholly owned subsidiaries, and Alliance Telecommunications
Corporation and its subsidiaries. No single customer accounted for a material
portion of the Company's revenues in any of the last three years. Segment
information is as follows:
<TABLE>
<CAPTION>
Hector Alliance Consolidated
------------ ------------ ------------
Year Ended December 31, 1999
<S> <C> <C> <C>
Revenues $ 8,794,489 $ 25,322,827 $ 34,117,316
Costs and expenses 7,159,071 15,904,009 23,063,080
------------ ------------- ------------
Operating income 1,635,418 9,418,818 11,054,236
Interest expense (1,279,386) (5,303,150) (6,582,536)
Partnership and LLC loss (259,588) (75,949) (335,537)
Interest and dividend income 198,559 917,539 1,116,098
Gain on sale of marketable securities 13,203,062 13,203,062
------------ ------------ ------------
Income before income taxes $ 295,003 $ 18,160,320 $ 18,455,323
============ ============ ============
Depreciation and Amortization $ 2,616,879 $ 5,930,740 $ 8,547,619
============ ============ ============
Total Assets $ 29,141,485 $137,655,202 $166,796,687
============ ============ ============
Capital Expenditures $ 2,901,944 $ 4,639,982 $ 7,541,926
============ ============ ============
</TABLE>
40
<PAGE>
<TABLE>
<CAPTION>
Hector Alliance Consolidated
------------ ------------ ------------
Year Ended December 31, 1998
<S> <C> <C> <C>
Revenues $ 7,886,758 $ 23,951,936 $ 31,838,694
Costs and expenses 5,886,884 15,304,923 21,191,807
------------ ------------ ------------
Operating income 1,999,874 8,647,013 10,646,887
Interest expense (1,835,244) (5,479,909) (7,315,153)
Partnership and LLC income 60,665 822,431 883,096
Investment income 199,094 409,977 609,071
Gain on sale of marketable securities 965,069 965,069
Gain on sale of cellular partnership 4,817,498 4,817,498
------------ ------------ ------------
Income before income taxes $ 424,389 $ 10,182,079 $ 10,606,468
============ ============ ============
Depreciation and Amortization $ 2,068,701 $ 5,712,509 $ 7,781,210
============ ============ ============
Total Assets $ 26,215,059 $124,464,728 $150,679,787
============ ============ ============
Capital Expenditures $ 2,651,776 $ 7,064,359 $ 9,716,135
============ ============ ============
Hector Alliance Consolidated
------------ ------------ ------------
Year Ended December 31, 1997
Revenues $ 7,356,830 $ 21,509,535 $ 28,866,365
Costs and expenses 5,477,058 13,635,899 19,112,957
------------ ------------ ------------
Operating income 1,879,772 7,873,636 9,753,408
Interest expense (2,059,948) (4,737,406) (6,797,354)
Partnership and LLC income 259,050 1,049,296 1,308,346
Investment income 169,878 455,704 625,582
Gain on sale of marketable securities 1,495,999 1,495,999
------------ ------------ ------------
Income before income taxes $ 1,744,751 $ 4,641,230 $ 6,385,981
============ ============ ============
Depreciation and Amortization $ 1,973,699 $ 5,336,031 $ 7,309,730
============ ============ ============
Total Assets $ 25,917,132 $113,373,824 $139,290,956
============ ============ ============
Capital Expenditures $ 2,316,025 $ 2,379,276 $ 4,695,301
============ ============ ============
</TABLE>
41
<PAGE>
(b) SUPPLEMENTAL FINANCIAL INFORMATION
Unaudited Quarterly Operating Results
(in thousands except per share amounts)
Quarter Ended
March 31 June 30 Sept 30 Dec 31
- --------------------------------------------------------------------------------
1999
Revenues $ 8,319 $ 8,724 $ 8,935 $ 8,139
Operating income 2,826 3,347 3,130 1,752
Net income 755 719 2,232 3,773
Basic net income per share $ .28 $ .26 $ .65 $ 1.07
Diluted net income per share $ .22 $ .22 $ .57 $ .95
1998
Revenues $ 7,249 $ 8,023 $ 8,027 $ 8,539
Operating income 2,449 2,928 2,992 2,278
Net income 434 778 874 1,824
Basic net income per share $ .21 $ .34 $ .34 $ .69
Diluted net income per share $ .16 $ .25 $ .26 $ .50
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE
Not applicable.
42
<PAGE>
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information called for by paragraphs (a), (c), (d), (e), and (f) of Item 401
under Regulation S-K, to the extent applicable, will be set forth under the
caption "Election of Directors" in the Company's definitive proxy material for
its May 18, 2000 Annual Meeting of Shareholders to be filed within 120 days from
the end of the Registrant's fiscal year, which information is expressly
incorporated by reference herein. The information called for by paragraph (b) of
Item 401 is set forth under Item 1(c) herein. The information called for by Item
405 under Regulation S-K, to the extent applicable, will be set forth under the
caption "Certain Transactions" in the Company's above referenced definitive
proxy material.
ITEM 11. EXECUTIVE COMPENSATION
The information called for by Item 402 under Regulation S-K to the extent
applicable, will be set forth under the caption "Executive Compensation" in the
Company's definitive proxy materials for its May 18, 2000 Annual Meeting to be
filed within 120 days from the end of the Registrant's fiscal year, which
information is expressly incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information called for by Item 403 under Regulation S-K will be set forth
under the captions "Security Ownership of Certain Beneficial Owners and
Management" and "Election of Directors" in the Company's definitive proxy
materials for its May 18, 2000 Annual Meeting to be filed within 120 days from
the end of the Registrant's fiscal year, which information is expressly
incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information called for by Item 404 under Regulation S-K will be set forth
under the caption "Certain Transactions" in the Company's definitive proxy
materials for its May 18, 2000 Annual Meeting to be filed within 120 days from
the end of the Registrant's fiscal year, which information is expressly
incorporated herein by reference.
43
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE, AND REPORTS ON FORM 8-K
(a) (1) Consolidated Financial Statements
The following Consolidated Financial Statements of Hector
Communications Corporation and subsidiaries appear at pages 26 to 42 herein:
Independent Auditors' Report for the years ended
December 31, 1999, 1998 and 1997
Consolidated Balance Sheets as of December 31, 1999 and 1998
Consolidated Statements of Income and Comprehensive Income for the
years ended December 31, 1999, 1998 and 1997
Consolidated Statements of Stockholders' Equity for the years ended
December 31, 1999, 1998 and 1997
Consolidated Statements of Cash Flows for the years ended
December 31, 1999, 1998 and 1997
Notes to Consolidated Financial Statements
(a) (2) Financial Statement Schedule Page Herein
---------------------------- -----------
The following financial statement schedule is being filed as part of
this Form 10-K Report:
Independent Auditors' Report on financial statement
schedule for the years ended December 31, 1999,
1998 and 1997 47
Schedule I - Condensed Financial Information of Registrant 48-51
All other schedules are omitted as the required information is inapplicable or
the information is presented in the financial statements or related notes.
Separate financial statements of Midwest Wireless Communications LLC, a
50 percent or less owned equity method investment, included as this
entity constitutes a "significant subsidiary" pursuant to the
provisions of Regulation S-X, Article 3-09. 52-65
(a) (3) Exhibits
The exhibits which accompany or are incorporated by reference in this
report, including all exhibits required to be filed with this report, are
described on the Exhibit Index, which begins on page 67 of the sequential
numbering system used in this report.
(b) REPORTS ON FORM 8-K FILED DURING THE THREE MONTHS ENDED DECEMBER 31, 1999
Not Applicable.
44
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
HECTOR COMMUNICATIONS CORPORATION
Dated: March 28, 2000 /s/ Curtis A. Sampson
----------------------------------------
Curtis A. Sampson, Chairman of the Board
of Directors and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant in the capacities and on the dates indicated:
Each person whose signature appears below constitutes and appoints
CURTIS A. SAMPSON and PAUL N. HANSON as his true and lawful attorneys-in-fact
and agents, each acting alone, with full power of substitution and
resubstitution, for him and in his name, place and stead, in any and all
capacities, to sign any or all amendments to this Annual Report on Form 10-K and
to file the same, with all exhibits thereto, and other documents in connection
therewith, with the Securities and Exchange Commission, granting unto said
attorneys-in-fact and agents, each acting alone, full power and authority to do
and perform each and every act and thing requisite and necessary to be done in
and about the premises, as fully to all intents and purposes as he might or
could do in person, hereby ratifying and confirming all said attorneys-in-fact
and agents, each acting alone, or his substitute or substitutes, may lawfully do
or cause to be done by virtue thereof.
Signature Title Date
/s/Curtis A. Sampson Chairman of the Board of Directors, March 28, 2000
- ----------------------- Chief Executive Officer and Director
Curtis A. Sampson
/s/Steven H. Sjogren President, Chief Operating Officer, March 28, 2000
- ---------------------- and Director
Steven H. Sjogren
/s/Paul N. Hanson Vice President, Treasurer and March 28, 2000
- ----------------------- Director
Paul N. Hanson
/s/Charles A. Braun Chief Financial Officer and March 28, 2000
- ----------------------- Principal Accounting Officer
Charles A. Braun
/s/Charles R. Dickman Director March 28, 2000
- -----------------------
Charles R. Dickman
/s/Jjames O. Ericson Director March 28, 2000
- -----------------------
James O. Ericson
/s/Paul A. Hoff Director March 28, 2000
- -----------------------
Paul A. Hoff
/s/Wayne E. Sampson Director March 28, 2000
- -----------------------
Wayne E. Sampson
/s/Edward E. Strickland Director March 28, 2000
- -----------------------
Edward E. Strickland
45
<PAGE>
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
OF
HECTOR COMMUNICATIONS CORPORATION
FOR
YEAR ENDED DECEMBER 31, 1999
--------------------------------
FINANCIAL STATEMENT SCHEDULE
- --------------------------------------------------------------------------------
46
<PAGE>
INDEPENDENT AUDITORS' REPORT ON FINANCIAL STATEMENT SCHEDULE
Shareholders and Board of Directors
Hector Communications Corporation
The audit of the consolidated financial statements of Hector Communications
Corporation and subsidiaries referred to in our opinion dated February 16, 2000,
included the related financial statement schedule as listed in item 14(a)2. In
our opinion, this financial statement schedule, when considered in relation to
the basic consolidated financial statements, presents fairly in all material
respects the information set forth therein.
/s/ Olsen Thielen and Co., Ltd.
- -------------------------------
Olsen Thielen and Co., Ltd.
St. Paul, Minnesota
February 16, 2000
47
<PAGE>
<TABLE>
<CAPTION>
HECTOR COMMUNICATIONS CORPORATION
SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
HECTOR COMMUNICATIONS CORPORATION (PARENT COMPANY)
BALANCE SHEETS
December 31
-------------------------------
1999 1998
------------- -------------
Assets:
<S> <C> <C>
Cash $ 8,024
Investment in subsidiaries $ 41,255,044 30,297,399
Other current assets 464,374 159,219
Property, plant and equipment, net 92,548 88,603
Accounts with subsidiaries 2,157,388 5,809,257
Other investments 449,582 616,286
Deferred debenture issue costs 371,311
Other assets 25,000
------------- -------------
Total Assets $ 44,443,936 $ 37,350,099
============= =============
Liabilities and Stockholders' Equity:
Cash overdraft $ 29,931
Accounts payable 257,787 $ 387,242
Other current liabilities 430,588 379,684
Current portion of long-term debt 183,000 2,171,000
Long-term debt 3,560,712 11,691,852
Stockholders' equity:
Preferred stock, par value $1.00 per share; 3,000,000 shares authorized:
Convertible Series A, 229,300 and 342,800
shares issued and outstanding 229,300 342,800
Common stock, par value $.01 per share;
10,000,000 shares authorized; 3,574,712 and
2,661,062 shares issued and outstanding 35,747 26,611
Additional paid-in capital 13,274,444 6,326,441
Retained earnings 23,115,945 15,636,764
Accumulated other comprehensive income 3,326,482 387,705
------------- -------------
Total Liabilities and Stockholders' Equity $ 44,443,936 $ 37,350,099
============= =============
</TABLE>
48
<PAGE>
<TABLE>
<CAPTION>
HECTOR COMMUNICATIONS CORPORATION
SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
HECTOR COMMUNICATIONS CORPORATION (PARENT COMPANY)
STATEMENT OF INCOME AND COMPREHENSIVE INCOME
Year Ended December 31
--------------------------------------------------
1999 1998 1997
------------- ------------- -------------
Revenues:
<S> <C> <C> <C>
Sales $ 303,779 $ 286,569 $ 287,345
Expenses:
Operating expenses 116,466 103,164 90,464
Amortization of goodwill 34,721 41,245 52,126
Gain on sale of marketable securities (1,464,409)
Interest expense, net 719,739 1,329,491 1,571,655
Income tax expense (benefit) (170,504) (412,835) 24,315
------------- ------------- -------------
Total expenses 700,422 1,061,065 274,151
Income (loss) before equity in earnings of
subsidiaries (396,643) (774,496) 13,194
Equity in earnings of subsidiaries 7,875,824 4,684,739 2,707,559
------------- ------------- -------------
Net income 7,479,181 3,910,243 2,720,753
Other comprehensive income (loss):
Unrealized holding gains of subsidiaries on marketable
securities 20,784,075 492,287 1,754,213
Reclassification adjustment for gains of subsidiaries
included in net income (13,203,062) (965,069) (1,495,999)
------------- ------------- -------------
Other comprehensive income (loss) before
income taxes 7,581,013 (472,782) 258,214
------------- ------------- -------------
Income tax expense related to unrealized holding gains
of subsidiaries on marketable securities 8,450,555 189,519 752,667
Income tax benefit related to reclassification adjustment for
gains of subsidiaries included in net income (5,368,207) (371,529) (641,877)
------------- ------------- -------------
Income tax expense (benefit) related to items of other
comprehensive income 3,082,348 (182,010) 110,790
Minority interest in other comprehensive income
of subsidiaries 1,559,887
------------- ------------- -------------
Other comprehensive income (loss) 2,938,778 (290,772) 147,424
------------- ------------- -------------
Comprehensive income $ 10,417,959 $ 3,619,471 $ 2,868,177
============= ============= =============
</TABLE>
49
<PAGE>
<TABLE>
<CAPTION>
HECTOR COMMUNICATIONS CORPORATION
SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
HECTOR COMMUNICATIONS CORPORATION (PARENT COMPANY)
--------------------------------------------------
STATEMENTS OF CASH FLOWS
Year Ended December 31
--------------------------------------------------
1999 1998 1997
------------- ------------- -------------
Cash flows from operating activities:
<S> <C> <C> <C>
Net income $ 7,479,181 $ 3,910,243 $ 2,720,753
Adjustments to reconcile net income to net cash provided by operating
activities:
Gain on sale of marketable securities (1,464,409)
Noncash patronage refund (12,569)
Equity in earnings of subsidiaries (7,875,824) (4,684,739) (2,707,559)
Dividends from subsidiaries 1,671,639 527,444
Depreciation and amortization 190,151 272,326 304,700
Changes in assets and liabilities:
Decrease (increase) in other current assets (310,195) (90,163) 186,866
Decrease (increase) in accounts with subsidiaries 3,651,869 (2,935,762) (428,294)
Increase in cash overdraft 29,931
Increase (decrease) in accounts payable (129,455) 240,890 (19,803)
Increase (decrease) in other current liabilities 213,616 (103,691) (166,479)
------------- ------------- -------------
Net cash provided by (used in) operating activities 3,236,705 (1,719,257) (1,046,781)
Cash flows from investing activities:
Purchases of property, plant and equipment (44,214) (10,167) (71,485)
Cash investments in affiliates (18,600)
Purchases of other investments (342,171) (169,737)
Cash proceeds from other investments 2,897 1,646,900
Purchases of other assets (25,000)
------------- ------------- -------------
Net cash provided by (used in) investing activities (84,917) (352,338) 1,405,678
Cash flows from financing activities:
Issuance of debt 5,996,281
Repayment of long-term debt (3,626,140) (4,519,429) (2,000,000)
Issuance of common stock 466,328 489,703 1,575,107
ESOP shares allocated 63,095 58,000
------------- ------------- -------------
Net cash provided by (used in) financing activities (3,159,812) 2,029,650 (366,893)
------------- ------------- -------------
Net decrease in cash and cash equivalents (8,024) (41,945) (7,996)
Beginning cash and cash equivalents 8,024 49,969 57,965
------------- ------------- -------------
Ending cash and cash equivalents $ - $ 8,024 $ 49,969
============= ============= =============
Supplemental disclosures of cash flow information:
Interest paid $ 890,545 $ 1,231,676 $ 1,420,884
Income taxes paid 168,500 45,000 450,000
</TABLE>
50
<PAGE>
NOTES TO CONDENSED FINANCIAL STATEMENT OF REGISTRANT
Note 1 - Basis of Presentation
Pursuant to the rules and regulations of the Securities and Exchange Commission,
the Condensed Financial Statements of the Registrant do not include all of the
information and notes normally included in financial statements prepared in
accordance with generally accepted accounting principles. It is suggested that
these Condensed Financial Statements be read in conjunction with the
Consolidated Financial Statements and Notes thereto included in the Registrant's
Annual Report as referenced in Form 10-K, Part II, Item 8.
Note 2 - Cash Dividends from Subsidiaries
The Registrant received dividends from its subsidiaries of $1,671,639 and
$527,444 in 1998 and 1997, respectively. No dividends were received in 1999.
Note 3 - Long Term Debt
December 31
--------------------------
1999 1998
----------- -----------
Notes payable to Rural Telephone
Finance Cooperative, in quarterly installments,
interest rate of 6.95%, due 2013 $ 3,743,712 $ 3,914,852
Convertible subordinated debentures, payable to
debentureholders, interest rate of 8.5% 7,948,000
Notes payable on line of credit from Rural
Telephone Finance Cooperative 2,000,000
----------- -----------
3,743,712 13,862,852
Less current portion 183,000 2,171,000
----------- -----------
$ 3,560,712 $11,691,852
=========== ===========
The annual requirements for principal payments on notes payable and long-term
debt are as follows:
2000 $ 183,000
2001 195,000
2002 209,000
2003 223,000
2004 238,000
51
<PAGE>
MIDWEST WIRELESS COMMUNICATIONS L.L.C.
REPORT ON AUDIT OF CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1999 AND 1998
52
<PAGE>
Report of Independent Accountants
To the Board of Managers
Midwest Wireless Communications L.L.C.:
In our opinion, the accompanying consolidated statements of financial position
and the related consolidated statements of operations, changes in members'
equity and cash flows present fairly, in all material respects, the financial
position of Midwest Wireless Communications L.L.C. (a subsidiary of Midwest
Wireless Holdings L.L.C.) (the Company) and subsidiary at December 31, 1999 and
1998, and the consolidated results of their operations and their cash flows for
the years then ended in conformity with accounting principles generally accepted
in the United States. These financial statements are the responsibility of the
Company's management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
statements in accordance with auditing standards generally accepted in the
United States, which require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.
PRICEWATERHOUSECOOPERS LLP
February 4, 2000
53
<PAGE>
<TABLE>
<CAPTION>
Midwest Wireless Communications L.L.C.
(A Subsidiary of Midwest Wireless Holdings, L.L.C.)
Consolidated Statements of Financial Position
At December 31, 1999 and 1998
Assets 1999 1998
------------------ ------------------
Current assets:
<S> <C> <C>
Cash and cash equivalents $ 1,378,350 $ 3,147,979
Restricted cash 1,000,000
Marketable securities 3,946,270
Accounts receivable, less allowance for doubtful accounts of
$258,120 and $282,287in 1999 and 1998, respectively 4,326,962 4,228,358
Due from Parent 321,218
Inventories 2,519,796 1,624,026
Other 527,482 352,624
------------------ ------------------
Total current assets 10,073,808 13,299,257
Property, cellular plant and equipment, net 43,997,663 34,078,742
FCC licenses, net 16,514,927 16,736,528
Investments in cooperatives 2,201,408 1,548,287
Deferred acquisition costs 1,046,824 125,000
------------------ ------------------
Total assets $ 73,834,630 $ 65,787,814
================== ==================
Liabilities and Members' Equity
Current liabilities:
Current portion of long-term debt $ 2,426,350 $ 1,279,048
Accounts payable 3,029,225 6,212,502
Accrued commissions 818,592 615,757
Accrued liabilities 3,862,594 3,676,552
------------------ ------------------
Total current liabilities 10,136,761 11,783,859
Other liabilities 1,156,949 517,491
Revolving loan 2,000,000
Long-term debt 26,334,775 15,648,092
------------------ ------------------
Total liabilities 39,628,485 27,949,442
Commitments
Members' equity 34,206,145 37,838,372
------------------ ------------------
Total liabilities and members' equity $ 73,834,630 $ 65,787,814
================== ==================
The accompanying notes are an integral part of the
financial statements.
</TABLE>
54
<PAGE>
Midwest Wireless Communications L.L.C.
(A Subsidiary of Midwest Wireless Holdings, L.L.C.)
Consolidated Statements of Operations
For the Years Ended December 31, 1999 and 1998
1999 1998
--------------------------------
Operating revenues:
Retail service $40,009,007 $33,403,860
Roamer service 11,671,572 12,393,902
Equipment sales 5,651,878 3,321,271
------------- -------------
57,332,457 49,119,033
------------- -------------
Operating expenses:
Operations and maintenance 10,636,197 10,054,893
Cost of equipment sold 5,683,363 3,897,151
Depreciation 7,528,105 4,707,905
Amortization 494,381 481,392
Selling, general and administrative 14,314,802 11,024,317
Home roamer costs 1,699,261 1,353,930
------------- -------------
40,356,109 31,519,588
------------- -------------
Operating income 16,976,348 17,599,445
------------- -------------
Other income (expense):
Equity loss on Switch 2000 (710,330)
Interest expense (1,291,817) (890,930)
Interest and dividend income 230,760 711,388
Other 46,733 262,375
------------- -------------
(1,014,324) (627,497)
------------- -------------
Net income $ 15,962,024 $ 16,971,948
============= =============
The accompanying notes are an integral part of the financial statements.
55
<PAGE>
Midwest Wireless Communications, L.L.C.
(A Subsidiary of Midwest Wireless Holdings, L.L.C.)
Consolidated Statement of Changes in Members' Equity
For the Years Ended December 31, 1999 and 1998
Total
Capital Accumulated Members'
Contributions Income Equity
Balance, December 31, 1997 $15,748,194 $13,855,048 $29,603,242
Redemption of units (11,416) (119,438) (130,854)
Distributions to members (8,605,964) (8,605,964)
Net income 16,971,948 16,971,948
------------- ------------- -------------
Balance, December 31, 1998 15,736,778 22,101,594 37,838,372
Redemption of units (1,012,261) (11,751,826) (12,764,087)
Distributions to members (6,830,164) (6,830,164)
Net income 15,962,024 15,962,024
------------- ------------- -------------
Balance, December 31, 1999 $14,724,517 $19,481,628 $34,206,145
============= ============= =============
The accompanying notes are an integral part of the financial statements.
56
<PAGE>
<TABLE>
<CAPTION>
(A Subsidiary of Midwest Wireless Holdings, L.L.C.)
Consolidated Statements of Cash Flows
For the Years Ended December 31, 1999 and 1998
1999 1998
--------------------------------
Cash flows from operating activities:
<S> <C> <C>
Net income $ 15,962,024 $ 16,971,948
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for bad debts 58,775 266,901
Management fee to Parent 396,033
Depreciation 7,582,105 4,707,905
Amortization 494,381 481,392
Loss on disposal of equipment 390,567
Equity loss on investment in Switch 2000 710,330
Appreciation rights 639,458 322,244
Accretion of discount on marketable securities (124,204) (210,403)
Changes in assets and liabilities:
Accounts receivable (157,379) 53,732
Due from Parent (717,251)
Inventories (895,770) (853,409)
Accounts payable (4,479,112) (994,241)
Accrued liabilities 388,877 761,884
Other (174,858) (25,207)
------------- -------------
Net cash provided by operating activities 19,363,646 22,193,076
------------- -------------
Cash flows from investing activities:
Payments for property, cellular plant and equipment (16,581,238) (11,514,175)
Purchases of marketable securities (6,679,526) (12,794,926)
Proceeds received upon maturity of marketable securities 10,750,000 14,970,930
Purchase of Switch 2000 interests (383,330)
Purchase of FCC licenses (287,300) (385,696)
Purchases of cooperative stock (653,121) (1,150,092)
Payments for deferred acquisition costs (921,824) (125,000)
Restriction of cash (1,000,000)
------------- -------------
Net cash used in investing activities (15,373,009) (11,382,289)
------------- -------------
Cash flows from financing activities:
Proceeds on revolving loan 2,000,000
Proceeds on long-term debt borrowings 13,368,420 16,372,239
Payments on long-term debt (1,534,435) (17,361,509)
Distributions to members (6,830,164) (8,605,964)
Redemption of units (12,764,087) (130,854)
------------- -------------
Net cash used in financing activities (5,760,266) (9,726,088)
------------- -------------
Net change in cash and cash equivalents (1,769,629) 1,084,699
Cash and cash equivalents, beginning of year 3,147,979 2,063,280
------------- -------------
Cash and cash equivalents, end of year $ 1,378,350 $ 3,147,979
============= =============
Supplemental disclosure:
Cash paid during the year for interest $ 1,156,323 $ 1,015,834
The accompanying notes are an integral part of the financial statements.
</TABLE>
57
<PAGE>
Midwest Wireless Communications L.L.C.
(A Subsidiary of Midwest Wireless Holdings L.L.C.)
Notes to Consolidated Financial Statements
1. Organization and Significant Accounting Policies
Organization and Basis of Consolidation
Midwest Wireless Communications L.L.C. (the Company) is a Delaware
limited liability company organized to provide cellular communications
services in certain service areas within the State of Minnesota. The
latest date the Company may be dissolved is December 31, 2034.
On November 29, 1999, certain members which held an 86% interest in the
Company exchanged their interests for a 100% interest in Midwest Wireless
Holdings L.L.C. (the Parent).
Consolidation
The consolidated financial statements of the Company include its
subsidiary, Switch 2000 L.L.C. (Switch 2000) as of December 31, 1999, and
from the date of acquisition (October 1, 1998) to December 31, 1998 (see
Note 2). All significant intercompany balances and transactions have been
eliminated in consolidation.
Revenue Recognition
Service revenue consists of the base monthly service fee and airtime
revenue. Base monthly service fees are billed one month in advance and
are recognized in the month earned. Airtime and roamer revenue is
recognized when the service is provided. The Company recognizes other
service revenues from equipment installations, equipment sales and
connection fees when earned.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles in the United States requires management
to make estimates and assumptions that affect the reported amounts of
assets and liabilities at the date of the financial statements and
disclosure of contingent assets and liabilities at the date of the
financial statements. Estimates also affect the reported amounts of
revenues and expenses during the periods reported. Actual results could
differ from those estimates.
Concentration of Credit Risk
The Company provides cellular service and cellular telephones to a
diversified group of consumers within a concentrated geographical area.
The Company performs credit evaluations of its customers and requires a
deposit when deemed necessary. Receivables are generally due within 30
days. Credit losses related to customers have been within management's
expectations.
Cash and Cash Equivalents
For the purpose of the statements of cash flows, the Company considers
all investments purchased with original maturities of three months or
less to be cash equivalents.
58
<PAGE>
Midwest Wireless Communications L.L.C.
(A Subsidiary of Midwest Wireless Holdings L.L.C.)
Notes to Consolidated Financial Statements
Marketable Securities
Marketable securities which the Company has the positive intent and
ability to hold to maturity are stated at cost adjusted for the accretion
of discounts computed under a method which approximates the interest
method. The market value approximated amortized cost at December 31,
1998. Unrealized gains and losses were not significant.
Cellular Telephone Inventories
Inventories consist primarily of cellular phones and accessories held for
resale with cost determined using the specific identification method.
Consistent with industry practice, losses on sales of cellular phones are
recognized in the period in which sales are made as a cost of acquiring
subscribers.
Property, Cellular Plant and Equipment
Property, cellular plant and equipment is stated at its original cost.
Depreciation is provided on a straight-line basis over the estimated
useful lives of the cellular plant and equipment, which range from one to
fifteen years.
Major renewals or betterments are capitalized, while repair and
maintenance expenditures are charged to operations as incurred. The cost
and accumulated depreciation of property, cellular plant and equipment
disposed of or sold are eliminated from their respective accounts, and
the resulting gain or loss is recorded in operations.
Income Taxes
No provision for income taxes has been recorded since all income, losses
and tax credits are allocated to the members for inclusion in their
respective income tax returns.
Advertising
Advertising costs are expensed as incurred. Total advertising expenses
were $1,754,394 and $1,412,628 for the years ended December 31, 1999 and
1998, respectively.
Federal Communications Commission (FCC) Licenses
FCC licenses are recorded at fair market value and are amortized on a
straight-line basis over lives ranging from 10 to 39 years.
59
<PAGE>
Midwest Wireless Communications L.L.C.
(A Subsidiary of Midwest Wireless Holdings L.L.C.)
Notes to Consolidated Financial Statements
2. Select Account Information
Restricted Cash
At June 29, 1999, the Company signed a letter of intent to acquire
certain cellular properties. In connection with the pending acquisition,
the Company deposited $1,000,000 into an escrow account. Currently, other
subsidiaries of the Company's Parent are expected to complete the
acquisitions in the first quarter of 2000. Upon closing of the
acquisition or in the event that the acquisition fails to occur on or
before June 30, 2000, the restricted funds will be released to the
Company. If the Company materially breaches the acquisition agreement,
the restricted cash will be released to the seller.
Deferred Acquisition Costs
During 1999, the Company paid certain external deferred acquisition costs
of $1,046,824 on behalf of the Parent in connection with the pending
acquisition of certain cellular properties. Upon closing of the
acquisitions, these costs will be allocated to the Parent and the Company
will record a receivable due from the Parent.
Property, Cellular Plant and Equipment
1999 1998
------------- ------------
Lnnd $ 1,696,989 $ 1,442,308
Plant in service 56,271,401 49,641,677
Plant under construction 8,453,176 3,112,679
------------- ------------
66,421,566 54,196,664
less accumulated depreciation (22,423,903) (20,117,922)
------------- ------------
$43,997,663 $34,078,742
============= ============
At December 31, 1999 and 1998, accounts payable includes $1,295,835 and
$5,100,282, respectively, related to the purchase of property, cellular
plant and equipment. The Company capitalized interest in the amount of
$243,973 and $248,377 for the years ended December 31, 1999 and 1998,
respectively.
FCC Licenses
1999 1998
------------- ------------
Cellular license $17,505,700 $17,505,700
LMDS licenses 357,696 357,696
PCS licenses 287,300
Other 28,000
------------- ------------
18,150,696 17,891,396
Less accumulated amortization (1,635,769) (1,154,868)
------------- ------------
$16,514,927 $16,736,528
============= ============
60
<PAGE>
Midwest Wireless Communications L.L.C.
(A Subsidiary of Midwest Wireless Holdings L.L.C.)
Notes to Consolidated Financial Statements
3. Investment in Switch 2000
Switch 2000 provided switching and interconnection services to the
Company through December 31, 1998. During the period January 1, 1998,
through September 30, 1998, the Company had ownership and voting
interests in Switch 2000 of 45.55%. Accordingly, during this period, this
investment was accounted for using the equity method of accounting.
During September and October of 1998, the Company gained 100% ownership
interest in Switch 2000 by acquiring the remaining equity interest in
Switch 2000 for a purchase price of $383,330 in cash and equipment with a
fair market value of $700,277. The acquisition was accounted for under
the purchase method of accounting; accordingly, the assets and
liabilities of Switch 2000, principally cellular plant and equipment,
were recorded at fair value. The cellular plant and equipment acquired is
being depreciated over a period of two years.
Effective June 30, 1997, Switch 2000 and the Company entered into a
Management Agreement which expired on December 31, 1997. The Company
continued to provide management services to Switch 2000 through September
30, 1998. Under the terms of the Management Agreement, Switch 2000
retained the services of the Company to manage the operations of Switch
2000, including administration of transport and switching services and
other general business operations. Switch 2000 was required to pay a
management fee equal to the total costs incurred by the Company related
to the management of Switch 2000. Total management fees paid to the
Company during 1998 were $196,000.
Switch 2000, in turn, allocated management fees and certain other
expenses, primarily network costs, to its owners, which included the
Company. Amounts billed to the Company totaled approximately $1,802,000
for the period from January 1, 1998, to September 30, 1998.
61
<PAGE>
Midwest Wireless Communications L.L.C.
(A Subsidiary of Midwest Wireless Holdings L.L.C.)
Notes to Consolidated Financial Statements
4. Members' Capital
Members' capital includes capital contributions made by the members and
the accumulated income resulting from operations. Company income or loss
is allocated to the individual members based upon their ownership
percentage, as defined in the Limited Liability Company Agreement (the
Agreement). Pursuant to the Agreement, members are not obligated for the
debts and obligations of the Company, including accumulated losses in
excess of capital contributions.
Under the Agreement, no member may transfer or sell any units unless the
board of managers approves the terms of such transfer or sale. Upon
receipt of a bona fide offer in writing from a third party, the other
members and then the Company have the right to purchase all, but not less
than all, of the units at the bona fide offer price within a specified
time frame.
The Agreement also contains the right of co-sale under which no member
may transfer its units to an acquiring person, as defined in the
Agreement, who after such transfer would be an acquiring person without
assuring that each of the other members may participate in the transfer
of units under the same terms and conditions. The right of co-sale would
terminate in the event the Company completes a sale of securities
pursuant to a securities act or if the Company's market capitalization
would exceed $200,000,000.
Each member is entitled to one vote for each unit owned. Certain
restrictions on voting rights exist when units are sold to an acquiring
person.
5. Debt
Effective July 29, 1998, the Company entered into an agreement (the
Agreement) with the Rural Telephone Finance Cooperative (the Cooperative)
to refinance the indebtedness of the Company. Proceeds in the amount of
$16,372,239 received under the Agreement were used to pay the entire
outstanding principal balance on the previous debt.
62
<PAGE>
Midwest Wireless Communications L.L.C.
(A Subsidiary of Midwest Wireless Holdings L.L.C.)
Notes to Consolidated Financial Statements
The Agreement includes a term note with principal and interest payable in
quarterly installments beginning October 31, 1998, with final maturity in
2008. The Agreement provides the Company the option to fix the interest
rate on borrowings (or portions thereof) through the maturity date. The
variable rate is based on the Cooperative's cost of capital and is
adjusted monthly. At December 31, 1999, the Company had borrowings of
$7,476,259 outstanding that accrue interest at a variable rate and
$8,171,831 outstanding but accrue interest at a fixed rate of 5.75%. The
variable rate was 6.95% at December 31, 1999.
In addition, the Agreement provides for an acquisition note of up to
$36,842,105. Advances under the acquisition note are subject to the
Cooperative's review and of the Company's acquisition plan and any
regulatory approval required to accomplish the contemplated acquisition.
Borrowings under the acquisition note are subject to the same interest
rate terms as the term note. The acquisition note becomes due ten years
after the date of the initial borrowing, at which time the outstanding
principal and interest are due. At December 31, 1999, $13,113,035 was
outstanding under the acquisition note at the variable rate of 6.95%.
The Agreement also provides for a revolving loan of up to $10,000,000.
Borrowings under the revolving loan bear interest at the prime rate plus
one and one-half percent. The revolving loan expires on July 29, 2003, at
which time the outstanding principal and interest are due. At December
31, 1999 and 1998, there were $2,000,000 of outstanding borrowings under
the revolving loan. The prime rate was 8.5% at December 31, 1999.
The Agreement requires the Company to maintain an investment in the
Cooperative in the amount of at least 5% of the outstanding debt balance.
The Agreement also contains covenants that restrict distributions to
members and require the Company to maintain a debt coverage service ratio
of not less than 1.25. Substantially all assets of the Company are
pledged as collateral under the Agreement.
Maturities of long-term debt are as follows:
2000 $ 2,426,350
2001 2,583,994
2002 2,571,912
2003 5,110,777
2004 3,121,304
Thereafter 14,946,788
-------------
$ 30,761,125
=============
63
<PAGE>
Midwest Wireless Communications L.L.C.
(A Subsidiary of Midwest Wireless Holdings L.L.C.)
Notes to Consolidated Financial Statements
6. Commitments
Future minimum rental payments required under operating leases,
principally for real estate related to tower sites, and other contractual
commitments that have initial or remaining noncancellable terms in excess
of one year as of December 31, 1999, are as follows:
2000 $ 622,932
2001 368,874
2002 275,101
2003 172,839
2004 140,943
Thereafter 1,566,101
-------------
$ 3,146,790
=============
Rental expense was $666,765 and $433,550 for the years ended December 31,
1999 and 1998, respectively.
7. Cell Site Sharing Agreements
The Company is subject to an agreement with a partnership located in
Wisconsin, to jointly operate common cellular base station facilities
(Cell Sites) in Nelson and Fountain City, Wisconsin and Red Wing,
Minnesota. Under the agreement, both parties agreed to share: the costs
to construct the Cell Sites, selected ongoing costs of operation, and
roamer revenues attributable to the Cell Sites.
The Company has included its proportionate share of the assets,
liabilities, revenues and expenses of the Cell Sites in its financial
statements. As of December 31, 1999 and 1998, these assets were
approximately $1,161,000 and $769,000 and liabilities were approximately
$-0- and $800, respectively. For the years ended December 31, 1999 and
1998, revenues were approximately $557,000 and $573,000 and operating
expenses were approximately $78,000 and $275,000, respectively.
8. Due from Parent
During 1999, the Company entered into a services agreement with its
Parent. Under the terms of the Agreement, the Parent provides certain
services to the Company including consulting, constructing cell sites,
switching and billing services. During the year ended December 31, 1999,
the Company was charged $396,033 for these services. In addition, the
Company advanced $717,251 to the Parent for initial funding of the
Parent's operations. The net $321,218 is reflected as due from the Parent
on the statement of financial position as of December 31, 1999.
64
<PAGE>
Midwest Wireless Communications L.L.C.
(A Subsidiary of Midwest Wireless Holdings L.L.C.)
Notes to Consolidated Financial Statements
9. Employee Benefits
The Company established the Midwest Wireless Communications L.L.C. 401(k)
Profit Sharing Plan and Trust (the 401(k) Plan) for all employees who
meet certain service and age requirements. The 401(k) Plan is comprised
of an employer matching contribution component and a profit sharing
component. Employer matching contributions to this component of the plan
were $185,909 and $128,219 for the years ended December 31, 1999 and
1998, respectively. Profit sharing contributions are 100% vested after
five years of employment. Profit sharing contribution expenses were
$210,606 and $155,286 for the years ended December 31, 1999 and 1998,
respectively.
Effective January 1, 1997, the Company established the Midwest Wireless
Communications L.L.C. Appreciation Rights Plan (the Plan) for certain key
employees. The Plan is designed to create two classes of appreciation
rights, Class A and Class B, which become fully vested three years and
five years after the first day of the year the rights are granted,
respectively. Participants in the Plan are eligible to receive awards
based on the change in members' equity from the date of grant through the
end of the vesting period. The Board of Managers granted both Class A and
Class B appreciation rights in 1997. Under the terms of the Plan, no
additional Class B appreciation rights will be granted, and additional
Class A appreciation rights will be granted at the discretion of the
Board of Managers. The Company recognized $639,458 and $322,244 in
compensation expense related to the Plan for the years ended December 31,
1999 and 1998, respectively.
65
<PAGE>
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
OF
HECTOR COMMUNICATIONS CORPORATION
FOR
YEAR ENDED DECEMBER 31, 1999
--------------------------
EXHIBITS
- --------------------------------------------------------------------------------
66
<PAGE>
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
Exhibit Index To
Form 10-K for the Year Ended December 31, 1999
Regulation S-K Location in Consecutive Numbering
Exhibit Table System as Filed With the
Reference Title of Document Securities and Exchange Commission
3.1 Articles of Incorporation, Filed as Exhibit 3.1 to the Form 10
as amended of the Company, File No. 0-18587
(the "Form 10") and incorporated
hereby by reference
3.2 Bylaws, as amended Filed as Exhibit 3.2 to the Form 10
of the Company and incorporated
hereby by reference.
4.1 Indenture dated Filed as Exhibit 4.1 to the
February 24, 1995 between Company's Registration Statement on
Hector Communications Corp. Form S-2 File No. 33-87888 and
and National City Bank of incorporated herein by reference
Minneapolis, trustee
10.1 1990 Stock Plan Filed as Exhibit 10.1 to the Form 10
of the Company and incorporated
herein by reference.
10.2 Employee Stock Purchase Plan Filed as Exhibit 10.2 to the Form 10
of the Company and incorporated
herein by reference.
10.3 Employee Stock Ownership Plan Filed as Exhibit 10.3 to the Form 10
of the Company and incorporated
herein by reference.
10.4 Employee Savings Plan and Trust Filed as Exhibit 10.4 to the Form 10
of the Company and incorporated
herein by reference.
10.5 Distribution Agreement Filed as Exhibit 10.5 to the Form 10
of the Company and incorporated
herein by reference.
10.7 Flexible Benefit Plan Filed as Exhibit 10.7 to the 1993
Form 10-K and incorporated herein
by reference.
10.8 Form of Rights Agreement dated Filed as Exhibit 1 to the Company's
as of July 27, 1999 between the Form 8-A on August 9, 1999 and
Company and Norwest Bank, incorporated herein by reference.
Minnesota, National Association
10.9 1999 Stock Plan Filed by the Company on Form S-8 on
December 3, 1999 and incorporated
herein by reference.
11 Calculation of Earnings Filed herewith at page 68.
Per Share
21 Subsidiaries of the Registrant Filed herewith at page 69.
23 Independent Auditors' Consent Filed herewith at page 70.
24 Power of Attorney Included in signatures at page 45.
The exhibits referred to in this Exhibit Index will be supplied to a shareholder
at a charge of $.25 per page upon written request directed to HCC's Assistant
Secretary at the executive offices of the Company.
<PAGE>
67
<TABLE>
<CAPTION>
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
EXHIBIT 11
CALCULATION OF EARNINGS PER SHARE
Year Ended December 31
------------------------------------------------
Basic: 1999 1998 1997
- ------- ----------- ----------- -----------
<S> <C> <C> <C>
Net income $ 7,479,181 $ 3,910,243 $ 2,720,753
=========== =========== ===========
Common shares:
Weighted average number of common shares outstanding 3,095,028 2,402,794 1,901,508
Number of unallocated shares held by ESOP 0 0 (8,930)
----------- ----------- -----------
3,095,028 2,402,794 1,892,578
=========== =========== ===========
Net income per common share $ 2.42 $ 1.63 $ 1.44
=========== =========== ===========
Diluted:
- -------------
Net income $ 7,479,181 $ 3,910,243 $ 2,720,753
Interest on convertible debentures, net of tax 265,783 620,594 758,616
----------- ----------- -----------
Adjusted net income $ 7,744,964 $ 4,530,837 $ 3,479,369
=========== =========== ===========
Common and common equivalent shares:
Weighted average number of common shares outstanding 3,095,028 2,402,794 1,901,508
Assumed conversion of convertible
debentures into common stock 431,152 1,119,683 1,423,125
Dilutive effect of convertible preferred shares outstanding 321,961 352,867 378,100
Dilutive effect of stock options outstanding after
application of treasury stock method 73,965 45,441 36,130
Dilutive effect of Employee Stock
Purchase Plan shares subscribed 688 4,664 2,455
Dilutive effect of warrants outstanding 21,734 11,623
Weighted average number of
unallocated shares held by ESOP (8,930)
----------- ----------- -----------
3,944,528 3,937,072 3,732,388
=========== =========== ===========
Diluted net income per share $ 1.96 $ 1.15 $ .93
=========== =========== ===========
</TABLE>
68
<PAGE>
SUBSIDIARIES OF HECTOR COMMUNICATIONS CORPORATION
EXHIBIT 21
Subsidiaries Jurisdiction of Incorporation
Arrowhead Communications Corporation Minnesota
Eagle Valley Telephone Company Minnesota
Granada Telephone Company Minnesota
Indianhead Telephone Company Wisconsin
North American Communications Corporation Minnesota
Pine Island Telephone Company Minnesota
Indianhead Communications Corporation Wisconsin
Alliance Telecommunications Corporation Minnesota
Ollig Utilities Company Minnesota
Felton Telephone Company Minnesota
Loretel Systems, Inc. Minnesota
Sleepy Eye Telephone Company Minnesota
Sioux Valley Telephone Company South Dakota
Hills Telephone Company Minnesota
OU Connection, Inc. Minnesota
Aurora Cable TV, Inc. South Dakota
Loretel Financial Systems, Inc. Minnesota
Hastad Engineering Co. Minnesota
Valley Cablevision of SD, Inc. South Dakota
Arrowhead Communications Corporation, Eagle Valley Telephone Company, Granada
Telephone Company, Indianhead Telephone Company, North American Communications
Corporation and Indianhead Communications Corporation are 100% owned by Hector
Communications Corporation. Pine Island Telephone Company is 69% owned by Hector
Communications Corporation and 31% owned by Indianhead Telephone Company.
Alliance Telecommunications Corporation is 68% owned by Hector Communications
Corporation, 20% owned by Golden West Telecommunications Cooperative, Inc. of
Wall, South Dakota and 12% owned by Split Rock Telecom Cooperative of Garretson,
South Dakota.
Loretel Systems, Inc., Sleepy Eye Telephone Company, Sioux Valley Telephone
Company, Hills Telephone Company, Felton Telephone Company, Ollig Utilities
Company, OU Connection, Inc., Aurora Cable TV, Inc., Loretel Financial Systems,
Inc., Hastad Engineering Co. and Valley Cablevision of SD, Inc. are 100% owned
by Alliance Telecommunications Corporation.
The financial statements of these subsidiaries are included in the Consolidated
Financial Statements of Hector Communications Corporation.
69
<PAGE>
EXHIBIT 23
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in Registration Statements No.
33-39865, 33-39866, 3-65176, 33-87888, 333-45971, 333-45975 and 333-92063 of
Hector Communications Corporation of our report dated February 16, 2000,
appearing in this Annual Report on Form 10-K of Hector Communications
Corporation and its subsidiaries for the year ended December 31, 1999.
/s/ Olsen Thielen and Co., Ltd.
- --------------------------------
Olsen Thielen and Co., Ltd.
March 28, 2000
St. Paul, Minnesota
<TABLE> <S> <C>
<ARTICLE> 5
<CIK> 0000863437
<NAME> HECTOR COMMUNICATIONS CORPORATION
<MULTIPLIER> 1
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> DEC-31-1999
<EXCHANGE-RATE> 1
<CASH> 27,055,772
<SECURITIES> 0
<RECEIVABLES> 4,854,365
<ALLOWANCES> 0
<INVENTORY> 616,985
<CURRENT-ASSETS> 32,982,158
<PP&E> 84,620,435
<DEPRECIATION> 33,210,402
<TOTAL-ASSETS> 166,796,687
<CURRENT-LIABILITIES> 14,246,252
<BONDS> 86,281,656
0
229,300
<COMMON> 35,747
<OTHER-SE> 39,716,871
<TOTAL-LIABILITY-AND-EQUITY> 166,796,687
<SALES> 34,117,316
<TOTAL-REVENUES> 34,117,316
<CGS> 23,063,080
<TOTAL-COSTS> 23,063,080
<OTHER-EXPENSES> (13,983,623)
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 6,582,536
<INCOME-PRETAX> 18,455,323
<INCOME-TAX> 7,513,000
<INCOME-CONTINUING> 10,942,323
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 7,479,181
<EPS-BASIC> 2.42
<EPS-DILUTED> 1.96
</TABLE>
