UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One) | | | | |
x | | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) | | |
| | OF THE SECURITIES EXCHANGE ACT OF 1934 | | |
| | | | |
For the quarterly period ended March 31, 2006 | | |
| | | | |
| | OR | | |
o | | TRANSITION REPORT PURSUANT TO SECTION 13 OR | | |
| | 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | | |
For the transition period from to
Commission File Number: 001-13891
HECTOR COMMUNICATIONS CORPORATION
(Exact name of registrant as specified in its charter)
MINNESOTA | | 41-1666660 |
(State or other jurisdiction of | | (Federal Employer |
incorporation or organization) | | Identification No.) |
| | |
211 South Main Street, Hector, MN | | 55342 |
(Address of principal executive offices) | | (Zip Code) |
(320) 848-6611
Registrant’s telephone number, including area code
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES x NO o
Indicate by a check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer (as defined by Rule 12b-2 of the Exchange Act).
Large Accelerated Filer o Accelerated Filer o Non-accelerated filer x
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act. YES o NO x
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
| | Name of Exchange | | |
Class | | On Which Registered | | Outstanding at April 30, 2006 |
Common Stock, par value | | American Stock Exchange | | 4,044,384 |
$.01 per share | | | | |
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
INDEX
2
Item 1. Financial Statements
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(unaudited)
| | March 31 | | December 31 | |
Assets: | | 2005 | | 2005 | |
Current assets: | | | | | |
Cash and cash equivalents | | $ | 26,961,080 | | $ | 25,245,358 | |
Construction fund | | 1,009,525 | | 756,260 | |
Accounts receivable, net | | 1,959,800 | | 2,678,690 | |
Materials, supplies and inventories | | 825,706 | | 795,181 | |
Other current assets | | 136,484 | | 247,182 | |
Total current assets | | 30,892,595 | | 29,722,671 | |
| | | | | |
Property, plant and equipment | | 106,482,367 | | 105,320,975 | |
less accumulated depreciation | | (69,757,459 | ) | (67,939,405 | ) |
Net property, plant and equipment | | 36,724,908 | | 37,381,570 | |
| | | | | |
Other assets: | | | | | |
Excess of cost over net assets acquired | | 30,921,094 | | 30,921,094 | |
Investment in Midwest Wireless Holdings, LLC | | 18,825,636 | | 18,067,471 | |
Investment in other unconsolidated affiliates | | 3,238,214 | | 3,307,593 | |
Other investments | | 7,653,248 | | 8,037,986 | |
Other assets | | 300,020 | | 315,906 | |
Total other assets | | 60,938,212 | | 60,650,050 | |
Total Assets | | $ | 128,555,715 | | $ | 127,754,291 | |
| | | | | |
Liabilities and Stockholders’ Equity: | | | | | |
| | | | | |
Current liabilities: | | | | | |
Notes payable and current portion of long-term debt | | $ | 6,491,000 | | $ | 6,527,400 | |
Accounts payable | | 1,785,912 | | 1,287,547 | |
Accrued expenses | | 1,596,302 | | 1,873,656 | |
Income taxes payable | | 973,582 | | 1,052,944 | |
Total current liabilities | | 10,846,796 | | 10,741,547 | |
| | | | | |
Long-term debt, less current portion | | 48,146,191 | | 49,456,138 | |
Deferred investment tax credits | | 0 | | 2,638 | |
Deferred income taxes | | 5,260,718 | | 5,306,152 | |
Deferred compensation | | 797,482 | | 802,116 | |
| | | | | |
Stockholders’ Equity | | 63,504,528 | | 61,445,700 | |
Total Liabilities and Stockholders’ Equity | | $ | 128,555,715 | | $ | 127,754,291 | |
See the notes to the consolidated financial statements.
3
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(unaudited)
| | Three Months Ended March 31 | |
| | 2006 | | 2005 | |
Revenues: | | | | | |
Local network | | $ | 1,459,268 | | $ | 1,427,164 | |
Network access | | 3,645,899 | | 3,718,411 | |
Nonregulated services: | | | | | |
Video services | | 790,010 | | 782,943 | |
Internet services | | 1,049,109 | | 903,664 | |
Other nonregulated services | | 809,905 | | 816,815 | |
Total revenues | | 7,754,191 | | 7,648,997 | |
| | | | | |
Costs and expenses: | | | | | |
Plant operations, excluding depreciation | | 1,164,675 | | 1,111,912 | |
Customer operations | | 397,122 | | 463,483 | |
General and administrative | | 953,700 | | 842,659 | |
Depreciation and amortization | | 1,878,437 | | 1,915,635 | |
Other operating expenses: | | | | | |
Operating taxes | | 102,826 | | 124,886 | |
Video service expenses | | 787,558 | | 756,726 | |
Internet expenses | | 226,546 | | 281,277 | |
Other | | 374,565 | | 339,108 | |
Total costs and expenses | | 5,885,429 | | 5,835,686 | |
| | | | | |
Operating income | | 1,868,762 | | 1,813,311 | |
| | | | | |
Other income and (expenses): | | | | | |
Interest expense | | (726,289 | ) | (730,172 | ) |
Interest and dividend income | | 228,684 | | 184,781 | |
Income from investment in Midwest Wireless Holdings, LLC | | 1,566,365 | | 1,070,343 | |
Income (loss) from investments in other unconsolidated affiliates | | (49,898 | ) | (2,201 | ) |
Other income (expense), net | | 1,018,862 | | 522,751 | |
| | | | | |
Income before income taxes | | 2,887,624 | | 2,336,062 | |
| | | | | |
Income tax expense | | 1,189,000 | | 950,000 | |
| | | | | |
Net income | | $ | 1,698,624 | | $ | 1,386,062 | |
| | | | | |
Basic net income per share | | $ | .42 | | $ | .37 | |
Diluted net income per share | | $ | .41 | | $ | .34 | |
Dividends per share | | $ | .10 | | $ | .05 | |
See the notes to the consolidated financial statements.
4
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY
(unaudited)
| | Common Stock | | Additional
Paid-in | | Retained | | Accumulated
Other
Comprehensive | | | |
| | Shares | | Amount | | Capital | | Earnings | | Income | | Total | |
BALANCE AT DECEMBER 31, 2005 | | 3,982,789 | | $ | 39,828 | | $ | 17,138,826 | | $ | 43,794,447 | | $ | 472,599 | | $ | 61,445,700 | |
Net income | | | | | | | | 1,698,624 | | | | 1,698,624 | |
Stock based compensation | | | | | | 44,128 | | | | | | 44,128 | |
Cash dividends | | | | | | | | (402,182 | ) | | | (402,182 | ) |
Issuance of common stock to Employee Stock Ownership Plan | | 10,220 | | 102 | | 289,124 | | | | | | 289,226 | |
Issuance of common stock under Employee Stock Option Plan | | 47,013 | | 470 | | 497,337 | | | | | | 497,807 | |
Purchase and retirement of common stock | | (22 | ) | | | (98 | ) | (527 | ) | | | (625 | ) |
Change in unrealized gains on marketable securities, net of deferred taxes | | | | | | | | | | (68,150 | ) | (68,150 | ) |
BALANCE AT MARCH 31, 2006 | | 4,040,000 | | $ | 40,400 | | $ | 17,969,317 | | $ | 45,090,362 | | $ | 404,449 | | $ | 63,504,528 | |
See notes to consolidated financial statements.
5
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
| | Three Months Ended March 31 | |
| | 2006 | | 2005 | |
CASH FLOWS FROM OPERATING ACTIVITIES: | | | | | |
Net Income | | $ | 1,698,624 | | $ | 1,386,062 | |
Adjustments to reconcile net income to net cash
provided by operating activities: | | | | | |
Depreciation and amortization | | 1,882,842 | | 1,920,040 | |
Stock based compensation | | 44,128 | | | |
Income from Midwest Wireless Holdings LLC | | (1,566,365 | ) | (1,070,343 | ) |
Loss from other unconsolidated affiliates | | 49,898 | | 2,201 | |
Cash distributions from Midwest Wireless Holdings LLC | | 808,200 | | 460,634 | |
Cash distributions from other unconsolidated affiliates | | 19,481 | | 37,707 | |
Noncash investment income | | (6,580 | ) | (20,781 | ) |
Changes in assets and liabilities: | | | | | |
Accounts receivable | | 718,890 | | 811,784 | |
Materials, supplies and inventories | | (30,525 | ) | 7,945 | |
Other current assets | | 110,698 | | 106,191 | |
Accounts payable | | 498,365 | | (237,165 | ) |
Accrued expenses | | 11,872 | | 58,378 | |
Income taxes payable | | (79,362 | ) | 798,622 | |
Deferred investment tax credits | | (2,638 | ) | (223 | ) |
Deferred compensation | | (4,634 | ) | (2,928 | ) |
Net cash provided by operating activities | | 4,152,894 | | 4,258,124 | |
| | | | | |
CASH FLOWS FROM INVESTING ACTIVITIES: | | | | | |
Purchases of property, plant and equipment | | (1,210,294 | ) | (421,996 | ) |
Increase in construction fund | | (253,265 | ) | (1,480,658 | ) |
Purchases of other investments | | (1,065 | ) | (756,989 | ) |
Proceeds from other investments | | 278,799 | | 63,745 | |
Net cash used in investing activities | | (1,185,825 | ) | (2,595,898 | ) |
| | | | | |
CASH FLOWS FROM FINANCING ACTIVITIES: | | | | | |
Repayment of notes payable and long-term debt | | (1,599,609 | ) | (1,710,955 | ) |
Proceeds from issuance of notes payable and long-term debt | | 253,262 | | 1,769,118 | |
Issuance of common stock | | 497,807 | | 69,051 | |
Cash dividends | | (402,182 | ) | (194,666 | ) |
Purchase of stock | | (625 | ) | | |
Net cash used in financing activities | | (1,251,347 | ) | (67,452 | ) |
| | | | | |
NET INCREASE IN CASH AND CASH EQUIVALENTS | | 1,715,722 | | 1,594,774 | |
| | | | | |
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR | | 25,245,358 | | 19,980,506 | |
| | | | | |
CASH AND CASH EQUIVALENTS AT END OF PERIOD | | $ | 26,961,080 | | $ | 21,575,280 | |
| | | | | |
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: | | | | | |
Interest paid | | $ | 782,765 | | $ | 776,000 | |
Income taxes paid | | 1,271,000 | | 151,601 | |
See the notes to the consolidated financial statements.
6
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The consolidated financial statements include the accounts of Hector Communications Corporation (“HCC” or “Company”) and its subsidiaries. All material intercompany transactions and accounts have been eliminated. 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).
The balance sheet and statement of stockholders’ equity as of March 31, 2006 and the statements of income and cash flows for the periods ended March 31, 2006 and 2005 have been prepared by the Company without audit. In the opinion of management, all adjustments (which include only normal recurring adjustments) necessary to present fairly the financial position, results of operations, and changes in cash flows at March 31, 2006 and 2005 have been made.
Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted. It is suggested these condensed financial statements be read in conjunction with the financial statements and notes thereto included in the Company’s December 31, 2005 Annual Report to Shareholders. The results of operations for the periods ended March 31 are not necessarily indicative of the operating results for the entire year.
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.
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 cost separation studies, which are typically settled within two years.
Income taxes have been calculated in proportion to the earnings and tax credits generated by operations. The Company’s effective income tax rate is higher than the U.S. rate due to the effect of state income taxes.
Certain other amounts in the 2005 financial statements have been reclassified to conform to the 2006 financial statement presentation. These reclassifications had no effect on net income or stockholders’ equity as previously reported.
7
COMPREHENSIVE INCOME
The Company’s comprehensive income includes net income and unrealized gains and losses on investments in marketable securities, net of deferred taxes. Comprehensive income for the three months ended March 31, 2006 and 2005 was $1,630,474 and $1,378,182, respectively.
STOCK-BASED COMPENSATION
The company adopted Statement of Financial Accounting Standards (SFAS) No. 123R, “Share-Based Payment”, on January 1, 2006. This statement requires Hector to recognize the cost of employee and director services received in exchange for the stock options it has awarded. Under SFAS 123R, Hector is required to recognize compensation expense over an award’s vesting period based on the award’s fair value at the date of grant. Hector has elected to adopt SFAS 123R on a modified prospective basis; accordingly the financial statements for periods prior to January 1, 2006 do not include stock-based compensation costs calculated under the fair value method.
The Company uses the Black-Scholes option pricing model to value its stock option grants. The Company did not issue any new stock option awards in the first quarter of 2006. Stock based compensation expense recognized in the period for previously issued awards was $44,000.
Prior to January 1, 2006 Hector applied APB Opinion No. 25, “Accounting for Stock Issued to Employees” for measurement and recognition of stock-based transactions with its employees and directors. If Hector had recognized compensation cost for its stock-based transactions based on the fair value of the options method prescribed by SFAS No. 123R, net income and net income per share for the first quarter of 2005 would have been as follows:
Net income as reported | | $ | 1,386,062 | |
Less: Total stock-based employee compensation expense determined under the fair value method for all awards | | (186,770 | ) |
Pro forma net income | | $ | 1,199,292 | |
| | | |
Basic net income per share: | | | |
As reported | | $ | .37 | |
Pro forma | | $ | .34 | |
Diluted net income per share: | | | |
As reported | | $ | .32 | |
Pro forma | | $ | .30 | |
MARKETABLE SECURITIES
Marketable securities consist principally of equity securities of other telecommunications companies. The Company’s marketable securities portfolio is classified as available-for-sale. The cost and fair value of available-for-sale investment securities was as follows:
| | Cost | | Gross
Unrealized
Gains | | Gross
Unrealized
Losses | | Fair
Value | |
March 31, 2006 | | $ | 1,102,009 | | $ | 716,975 | | $ | (42,893 | ) | $ | 1,776,091 | |
December 31, 2005 | | 1,102,009 | | 844,188 | | (56,522 | ) | 1,889,675 | |
| | | | | | | | | | | | | |
8
Net unrealized gains on marketable securities, net of related deferred taxes, are included in accumulated other comprehensive income as follows:
| | Net
Unrealized
Gains | | Deferred
Income
Taxes | | Accumulated
Comprehensive
Income | |
March 31, 2006 | | $674,082 | | $(269,633 | ) | $404,449 | |
December 31, 2005 | | 787,666 | | (315,067 | ) | 472,599 | |
These amounts have no cash effect and are not included in the statement of cash flows.
OTHER INVESTMENTS — RURAL TELEPHONE BANK STOCK
As part of its borrowing agreements, the Company has stock investments in CoBank, Rural Telephone Finance Cooperative and the Rural Telephone Bank (“RTB”). In 2005, the Board of Directors of the RTB approved resolutions to liquidate the bank and redeem its stock. Congress removed legal restrictions on the redemption of RTB stock in 2005. In April 2006 the RTB was dissolved and outstanding RTB stock was redeemed at par value. The Company received the par value of its RTB stock, which was $11,610,000. The carrying value of the stock was $1,269,000 at March 31, 2006.
GOODWILL AND INTANGIBLE ASSETS
The Company accounts for goodwill and other intangible assets under SFAS No. 142, “Goodwill and Other Intangible Assets”. Under the provisions of this accounting standard, goodwill and intangible assets with indefinite useful lives are no longer amortized but are instead tested for impairment on at least an annual basis and when changes in circumstances indicate that the value of goodwill may be below its carrying value.
For 2005, the Company performed its annual impairment test of goodwill during the third quarter. The determined fair value of the reporting units was sufficient to pass the first step impairment test, and no impairment was recorded.
The carrying value of HCC’s goodwill was $30,921,000 at March 31, 2006 and December 31, 2005; $29,586,000 of goodwill is related to the Company’s telephone operations and $1,335,000 of goodwill is related to other operations.
Changes in the Company’s intangible and other assets are as follows:
| | Intangible
Assets | | Other
Assets | | Consolidated | |
Balance December 31, 2005 | | $ | 163,868 | | $ | 152,038 | | $ | 315,906 | |
Capitalization of prepaid engineering fees | | | | (5,731 | ) | (5,731 | ) |
Amortization | | (10,155 | ) | | | (10,155 | ) |
Balance March 31, 2006 | | $ | 153,713 | | $ | 146,307 | | $ | 300,020 | |
| | | | | | | | | | | | |
9
MIDWEST WIRELESS HOLDINGS, LLC
Midwest Wireless Holdings LLC (“Midwest Wireless”) provides wireless telecommunications services to 449,000 customers in fourteen rural service areas and one metropolitan service area in Minnesota, Wisconsin and Iowa. Population of the service areas is approximately 1,910,000. Midwest Wireless offers a complete package of services, including custom calling features, facsimile and data transmission.
Midwest Wireless is owned by telecommunications companies (principally ILECs) located within Midwest Wireless’ operating footprint in southern Minnesota, northern Iowa and southeastern Wisconsin. HCC is presently the second largest member of Midwest Wireless Holdings LLC, with an 8.0% ownership stake. HCC accounts for its investment in Midwest Wireless using the equity method. Income from this investment included in continuing operations was $1,566,000 and $1,070,000 in the three-month periods ended March 31, 2006 and 2005, respectively. Cash distributions received by continuing operations from Midwest Wireless were $808,000 and $461,000 in the same respective periods.
Income statement information for Midwest Wireless Holdings, LLC for the periods ended March 31, 2006 and 2005 was as follows:
| | Three Months Ended March 31 | |
| | 2006 | | 2005 | |
Revenues | | $ | 69,380,612 | | $ | 60,197,675 | |
Operating income | | 22,688,359 | | 16,506,888 | |
Net income | | 19,549,422 | | 13,379,293 | |
| | | | | | | |
On November 17, 2005 Midwest Wireless and Alltel Corporation (“Alltel”) entered into a definitive agreement for Alltel to purchase Midwest Wireless. Compensation paid by Alltel would total $1.075 billion, including payments to Midwest Wireless shareholders, payments to minority interest holders in certain Midwest properties and assumption of Midwest Wireless’ outstanding debt. The Company estimates its pretax share of the proceeds will be $64,900,000. U.S. Cellular Corporation has initiated proceedings at the FCC and in Delaware State court contesting the definitive agreement. Midwest Wireless expects to close the transaction in 2006, subject to settlement of U.S. Cellular’s claims, satisfaction of customary conditions and receipt of regulatory approvals.
SEGMENT INFORMATION
The Company operates in two business segments. The majority of the Company’s operations consist of providing basic telephone services (often referred to as “plain old telephone service” or “POTS”) to residential and business customers within its service territories. POTS revenues consist mainly of fees for local service which are billed directly to customers and access revenues which are received for intrastate and interstate exchange services provided to long distance carriers. POTS revenues are subject to regulation by a number of state and federal government agencies.
The Company also provides a number of nonregulated telecommunications services to customers. These services include cable television or video service, internet access services, lease of fiber optic transport facilities, billing and collection services to long distance carriers, telephone directory services and equipment rental. The Company also makes retail sales of consumer telecommunications equipment and sells wireless telephone services on a commission basis.
10
Segment information is as follows:
| | POTS | | Other Services | | Total | |
Three Months Ended March 31, 2006 | | | | | | | |
Revenues | | $ | 5,105,167 | | $ | 2,649,024 | | $ | 7,754,191 | |
Costs and expenses | | 3,899,140 | | 1,986,289 | | 5,885,429 | |
Operating income | | 1,206,027 | | 662,735 | | 1,868,762 | |
Depreciation and amortization | | $ | 1,503,346 | | $ | 375,091 | | $ | 1,878,437 | |
Total assets | | $ | 92,695,162 | | $ | 35,860,553 | | $ | 128,555,715 | |
Capital expenditures | | $ | 1,023,778 | | $ | 186,516 | | $ | 1,210,294 | |
| | | | | | | |
| | POTS | | Other Services | | Total | |
Three Months Ended March 31, 2005 | | | | | | | |
Revenues | | $ | 5,145,575 | | $ | 2,503,422 | | $ | 7,648,997 | |
Costs and expenses | | 3,920,301 | | 1,915,385 | | 5,835,686 | |
Operating income | | 1,225,274 | | 588,037 | | 1,813,311 | |
Depreciation and amortization | | $ | 1,513,319 | | $ | 402,316 | | $ | 1,915,635 | |
Total assets | | $ | 95,819,344 | | $ | 31,025,662 | | $ | 126,845,006 | |
Capital expenditures | | $ | 308,599 | | $ | 113,397 | | $ | 421,996 | |
| | | | | | | | | | | | | | |
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Hector Communications Corporation (“Hector” or “Company”) is a telecommunications holding company which, through its subsidiaries, primarily provides local telephone and cable television service. The Company also invests in other companies providing wireless telephone and other telecommunications related services.
At March 31, 2006 Hector operated nine wholly-owned local exchange company subsidiaries (generally referred to as “local exchange carriers” or “LECs”) serving 29,422 access lines in 28 rural communities in Minnesota, Wisconsin and North Dakota. HCC, through its subsidiaries, also provides cable television service to 7,979 subscribers in Minnesota.
Midwest Wireless Holdings LLC, which is expected to be sold in 2006, has been the driver for the Company’s increases in net income and per share earnings in recent years. The Company also expects its core wireline telephone business to face significant challenges in the future including but not limited to: the loss of access revenue due to the impact of the dramatic growth in wireless telephony, possible changes to the level of regulatory support for rural telecommunications and the emergence of Voice over Internet Protocol (VoIP). The management and Board of Directors of the Company have retained the investment-banking firm of Stifel Nicolaus for assistance in assessing available strategic options for maximizing value to shareholders.
11
Three Months Ended March 31, 2006 Compared to Three Months Ended March 31, 2005
Revenues increased 1% to $7,754,000 in 2006 from $7,649,000 in 2005. The revenue breakdown was as follows:
| | Three Months Ended March 31 | |
| | 2006 | | 2005 | |
Plain old telephone service (“POTS”): | | | | | |
Local network | | $ | 1,459,268 | | $ | 1,427,164 | |
Network access revenues: | | | | | |
Long distance providers - interstate | | 745,257 | | 717,474 | |
Long distance providers — intrastate | | 1,127,451 | | 1,081,816 | |
Subscriber line charge revenue | | 585,132 | | 601,161 | |
High cost and universal service fund support | | 1,188,059 | | 1,317,960 | |
Total network access revenues | | 3,645,899 | | 3,718,411 | |
Total POTS revenues | | 5,105,167 | | 5,145,575 | |
Other services: | | | | | |
Video services | | 790,010 | | 782,943 | |
Internet services | | 1,049,109 | | 903,664 | |
Other nonregulated services: | | | | | |
Fiber leases | | 165,362 | | 162,621 | |
Cellular sales commissions | | 84,985 | | 82,454 | |
Directory revenues | | 134,105 | | 132,932 | |
Retail sales | | 108,307 | | 85,112 | |
Long distance resale | | 121,141 | | 107,759 | |
Customer equipment installation and repair | | 91,626 | | 87,101 | |
All other revenues | | 104,379 | | 158,836 | |
Total nonregulated services revenue | | 809,905 | | 816,815 | |
Total other service revenues | | 2,649,024 | | 2,503,422 | |
Total revenue | | $ | 7,754,191 | | $ | 7,648,997 | |
Total POTS revenues decreased $40,000 or 1%. Local network revenues increased $32,000 or 2%. Access lines served were 29,422 at March 31, 2006, an increase of 53 lines from March 2005.
Total network access revenues decreased $73,000 or 2%. The revenue decrease was primarily due to lower high cost and universal service support payments from USAC and NECA.
Total revenues from other services increased $146,000 or 6%. Revenues from video (cable television) services increased $7,000. Increases in video revenues in areas where the Company offers digital video services were offset by declines in revenues from older analog based systems. Revenues from internet services increased $145,000 or 16%, due to a 32% increase in the number of DSL customers. At March 31, 2006 the Company had 5,599 digital subscriber line (“DSL”) customers and 5,691 dial-up internet customers, compared to 4,240 DSL customers and 6,504 dial-up customers in March 2005. The DSL customer growth was facilitated by the deployment of broadband equipment manufactured by Next Level Communications, Inc. in the Company’s Sleepy Eye, MN exchange in 2002 and 2003. This equipment makes it possible to deliver voice, video and high speed internet services to the customer over the same circuit. Revenues from other nonregulated services declined $7,000.
Operating costs and expenses increased 1% to $5,885,000 in 2006 from $5,836,000 in 2005. The breakdown of costs and expenses was as follows:
12
| | Three Months Ended March 31 | |
| | 2006 | | 2005 | |
Plain old telephone service (“POTS”): | | | | | |
Plant operations, excluding depreciation | | $ | 1,164,083 | | $ | 1,111,326 | |
Customer operations | | 354,795 | | 415,734 | |
General and administrative | | 774,090 | | 755,036 | |
Depreciation and amortization | | 1,503,346 | | 1,513,319 | |
Operating taxes | | 102,826 | | 124,886 | |
Total POTS costs and expenses | | 3,899,140 | | 3,920,301 | |
Other services: | | | | | |
Plant operations | | 592 | | 586 | |
Customer operations | | 42,327 | | 47,749 | |
General and administrative | | 179,610 | | 87,623 | |
Depreciation and amortization | | 375,091 | | 402,316 | |
Other costs and expenses: | | | | | |
Video service expenses | | 787,558 | | 756,726 | |
Internet expenses | | 226,546 | | 281,277 | |
Other | | 374,565 | | 339,108 | |
Total other service costs and expenses | | 1,986,289 | | 1,915,385 | |
Total costs and expenses | | $ | 5,885,429 | | $ | 5,835,686 | |
Total POTS costs and expenses decreased $21,000 or 1%. Plant operations expenses increased $53,000 or 5% due to increased labor and overhead costs. Customer operations expenses decreased $61,000 or 15% due to decreased marketing expenses. General and administrative expenses increased $19,000 or 3%. Operating income in 2006 from POTS was $1,207,000, a decrease of 2% from $1,225,000 in 2005.
Total costs and expenses for other services increased $71,000 or 4%. Video service expenses increased $31,000 or 4% due to higher fee payments to programming providers. Internet expenses decreased $55,000 or 20%. General and administrative expenses increased $92,000 from 2005 due to the cost of expensing employee and director stock options in accordance with SFAS 123R ($44,000) and legal and consulting costs associated with the Company’s shareholder value initiative. Depreciation and amortization expenses decreased $27,000 because a substantial amount of the Company’s cable television plant was fully depreciated at the end of 2005. Operating income in 2006 from other services was $663,000, an increase of 13% from $588,000 in 2005. Total operating income increased 3% to $1,869,000.
Interest expenses for 2006 decreased $4,000. Decreases in the Company’s outstanding debt were offset by increases in the rates the Company pays on its floating debt at CoBank. Interest and dividend income increased $45,000 due to higher interest rates earned on invested cash balances.
Income from the Company’s investment in Midwest Wireless Holdings, LLC was $1,566,000 in 2006 an increase of 46% from $1,070,000 in 2005. At March 31, 2006 Midwest Wireless had 448,756 wireless customers, a 9% increase from 2005.
Income before income taxes increased 24% to $2,888,000. Income tax expense increased to $1,189,000 in 2006 from $950,000 in 2005. The Company had net income of $1,699,000 in 2006 compared to $1,386,000 in 2005.
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Liquidity and Capital Resources
Cash flows from operating activities for the three-month periods were $4,153,000 and $4,258,000 in 2006 and 2005, respectively. At March 31, 2006, the Company’s cash and cash equivalents totaled $26,961,000 compared to $25,245,000 at December 31, 2005. Working capital at March 31, 2006 was $20,046,000 compared to $18,981,000 at December 31, 2005. The current ratio was 2.8 to 1 at March 31, 2006.
Plant additions in the 2006 and 2005 periods were $1,210,000 and $422,000, respectively. Plant additions in the 2006 period went primarily to increase the use of fiberoptic technology in the Company’s Loretel Systems subsidiary. The OC-192 ring installed at Loretel will serve as the platform to for the Company’s “Triple Play” offering of voice, video and high speed internet to a new group of customers. Plant additions for 2006 are expected to total $4,234,000. These plant additions will upgrade the Company’s telephone equipment to allow advanced telecommunications services, expand telecommunications services into new construction developments and increase usage of broadband equipment and high capacity fiber optics in the telephone network.
In addition to cashflow from operations, the Company’s working capital position benefited from debt and equity issuances. Borrowings from the Rural Utilities Service and Rural Telephone Bank totaled $253,000 and $1,769,000 in the respective 2006 and 2005 periods. Loan funds are utilized to finance plant additions. At March 31, 2006, construction funds on hand totaled $1,010,000. The Company received $498,000 and $69,000 during the respective 2006 and 2005 from employee stock option exercises.
The Company’s long-term debt includes a term loan provided to Hector by CoBank. The loan is secured by a pledge of the stock of Hector’s subsidiary companies. Interest rates on long-term portions of the loan are fixed through 2007, while the non-fixed portion floats at short-term market rates. The average rate on the total loan was approximately 6.9% at March 31, 2006. Principal payments are made quarterly and will continue until April 2013. The outstanding balance on this loan at March 31, 2006 was $19,938,000.
The Company’s Board of Directors has initiated a policy of paying regular cash dividends. Cash dividends of $.10 and $.05 per share were paid to shareholders in March 2006 and March, 2005, respectively. The Board of Directors has also authorized the purchase and retirement, from time to time, of shares of the Company’s stock on the open market, or in private transactions consistent with overall market and financial conditions. At March 31, 2006, 214,000 shares could be repurchased under outstanding Board authorizations.
Midwest Wireless Holdings LLC (“Midwest Wireless’) is owned by telecommunications companies (principally LECs) located within Midwest Wireless’ operating footprint in southern Minnesota, northern Iowa and west central Wisconsin. Hector is presently the third largest member of Midwest Wireless Holdings LLC, with an 8.0% ownership stake. On November 17, 2005 Midwest Wireless and Alltel Corporation (“Alltel”) entered into a definitive agreement for Alltel to purchase Midwest Wireless. Compensation paid by Alltel would total $1.075 billion, including payments to Midwest Wireless shareholders, payments to minority interest holders in certain Midwest properties and assumption of Midwest Wireless’ outstanding debt. The Company estimates its pretax share of the proceeds will be $64,900,000. U.S. Cellular Corporation has initiated proceedings at the FCC and in Delaware State court contesting the definitive agreement. Midwest Wireless expects to close the transaction in 2006, subject to settlement of U.S. Cellular’s claims, satisfaction of customary conditions and receipt of regulatory approvals.
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As part of its borrowing agreements, the Company has stock investments in CoBank, Rural Telephone Finance Cooperative and the Rural Telephone Bank (“RTB”). In 2005, the Board of Directors of the RTB approved resolutions to liquidate the bank and redeem its stock. Congress removed legal restrictions on the redemption of RTB stock in 2005. In April 2006 the RTB was dissolved and outstanding RTB stock was redeemed at par value. The Company received the par value of its RTB stock, which was $11,610,000. The carrying value of the stock was $1,269,000 at March 31, 2006.
The Company is always looking to acquire properties that advance its plan to be a provider of top quality telecommunications services to rural customers. However, competition for properties that become available remains intense. The Company cannot predict if it will be successful in acquiring additional properties in the future and does not currently have financing plans in place to pay for possible acquisitions.
By utilizing cash flow from operations, current cash and investment balances, and other available financing sources, the Company feels it has adequate resources to meet its anticipated operating, debt service and capital expenditure requirements.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
The Company does not use derivative financial instruments in its operations or investment portfolio. Its operations are not subject to risks associated with changes in the value of foreign currencies. Portions of the Company’s long-term debt have variable interest rates based on the lenders’ cost of money. The Company has investments in money market funds that earn interest at prevailing market rates. In the opinion of management, the Company does not have a material exposure to loss caused by market risk.
Item 4. Controls and Procedures
Under the supervision and with the participation of our management, including our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), we evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”)). Based on that evaluation, our CEO and CFO have concluded that, as of the end of the period covered by this report, our disclosure controls and procedures are operating effectively and are adequately designed to ensure that information required to be disclosed by us in the reports we file or submit under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the applicable rules and forms and is accumulated and communicated to our management, including the CEO and CFO, as appropriate to allow timely decisions regarding required disclosure. During the period covered by this Report there was no change in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) that materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
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.
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PART II. OTHER INFORMATION
Item 1 – Not applicable.
Item 1A. Risk Factors
There have been no material changes to the Company’s risk factors from those disclosed in the Company’s 2005 Annual Report on Form 10-K.
Items 2 – 4. Not Applicable
Item 5. Other Information
On May 10, 2006, the Company reported its financial results for its first quarter ended March 31, 2006. The Company’s press release is furnished as Exhibit 99 to this quarterly report.
Item 6(a). Exhibits
11 | | Calculation of Earnings Per Share |
31.1 | | Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (Rules 13a-14 and 15d-14 of the Exchange Act) |
31.2 | | Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (Rules 13a-14 and 15d-14 of the Exchange Act) |
32 | | Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 USC §1350). |
99 | | Press Release dated May 10, 2006. |
Item 6(b). Reports on Form 8-K.
On March 7, 2006, the Company filed a current report on Form 8-K with the Securities and Exchange Commission, reporting under Items 2.02 and 9.01 its fourth quarter 2005 earnings release to shareholders.
Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereto duly authorized.
| | Hector Communications Corporation |
| | | |
| | By | /s/Curtis A. Sampson |
Date: May 10, 2006 | | | Chief Executive Officer |
| | | |
| | By | /s/Charles A. Braun |
Date: May 10, 2006 | | | Chief Financial Officer |
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