- --------------------------------------------------------------------------------
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended SEPTEMBER 30, 1998
-------------------------------------------------
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR
15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number: 0-18587
HECTOR COMMUNICATIONS CORPORATION
................................................................................
(Exact name of registrant as specified in its charter)
MINNESOTA 41-1666660
................................................................................
(State or other jurisdiction of (Federal Employer
incorporation or organization) Identification No.)
211 South Main Street, Hector, MN 55342
................................................................................
(Address of principal executive offices) (Zip Code)
(320) 848-6611
................................................................................
Registrant's telephone number, including area code
................................................................................
(Former name, address, and fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. YES X NO
--- ---
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS:
Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Sections 12, 13, or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court. YES ___ NO ___
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuers classes of
common stock, as of the latest practicable date.
CLASS Outstanding at October 31, 1998
- --------------------------- -------------------------------
Common Stock, par value 2,661,062
$.01 per share
Total Pages (16) Exhibit at Page 16
- --------------------------------------------------------------------------------
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
INDEX
Page No.
Part I. Financial Information
Item 1. Financial Statements
Consolidated Balance Sheets 3
Consolidated Statements of Income and
Comprehensive Income 4
Consolidated Statements of Stockholders' Equity 5
Consolidated Statements of Cash Flows 6
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 9
Part II. Other Information 15
2
PART I. FINANCIAL INFORMATION
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
Item 1. Financial Statements
CONSOLIDATED BALANCE SHEETS
(unaudited)
September 30 December 31
Assets: 1998 1997
------------ ------------
Current assets:
Cash and cash equivalents $ 7,671,813 $ 12,455,399
Temporary cash investments 300,000
Construction fund 77,773 77,690
Accounts receivable, net 5,040,856 4,003,184
Materials, supplies and inventories 1,415,867 542,681
Prepaid expenses 174,454 216,351
------------ ------------
Total current assets 14,380,763 17,595,305
Property, plant and equipment 72,522,021 65,794,563
less accumulated depreciation (23,013,251) (19,867,410)
------------ ------------
Net property, plant and equipment 49,508,770 45,927,153
Other assets:
Excess of cost over net assets acquired, net 51,597,593 51,169,677
Marketable securities 8,351,395 5,485,698
Wireless telephone investments 11,734,159 10,680,655
Other investments 8,316,336 7,231,868
Deferred debenture issue costs, net 414,057 780,089
Other assets 2,575,104 420,511
------------ ------------
Total other assets 82,988,644 75,768,498
------------ ------------
Total Assets $146,878,177 $139,290,956
============ ============
Liabilities and Stockholders' Equity:
Current liabilities:
Notes payable and current portion of
long-term debt $ 5,044,800 $ 4,770,000
Accounts payable 2,913,323 1,591,546
Accrued expenses 1,670,232 2,247,972
Income taxes payable 627,394 481,831
------------ ------------
Total current liabilities 10,255,749 9,091,349
Long-term debt, less current portion 96,407,909 97,793,195
Deferred investment tax credits 262,232 381,180
Deferred income taxes 8,409,851 7,594,092
Deferred compensation 870,643 940,425
Minority stockholders interest in Alliance
Telecommunications Corp. 9,983,506 9,043,593
Stockholders' Equity 20,688,287 14,447,122
------------ ------------
Total Liabilities and Stockholders' Equity $146,878,177 $139,290,956
============ ============
See notes to consolidated financial statements.
3
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
(unaudited)
Three Months Ended September 30 Nine Months Ended September 30
------------------------------- ------------------------------
1998 1997 1998 1997
------------- ------------ ------------ ------------
Revenues:
Local network $ 1,394,487 $ 1,290,906 $ 3,943,825 $ 3,649,860
Network access 4,345,230 4,748,418 13,288,966 12,496,118
Billing and collection 235,933 267,868 634,453 797,270
Nonregulated activities 1,098,334 1,060,338 3,197,310 2,978,456
Cable television revenues 953,475 607,145 2,235,044 1,790,275
------------- ------------ ------------ ------------
Total revenues 8,027,459 7,974,675 23,299,598 21,711,979
Costs and expenses:
Plant operations 679,988 891,070 2,592,470 2,710,598
Depreciation and amortization 1,973,826 1,818,967 5,730,237 5,462,917
Customer operations 508,550 424,667 1,448,027 1,361,913
General and administrative 1,176,784 1,069,093 3,375,799 3,313,798
Other operating expenses 696,017 527,392 1,783,816 1,449,424
------------- ------------ ------------ ------------
Total costs and expenses 5,035,165 4,731,189 14,930,349 14,298,650
Operating income 2,992,294 3,243,486 8,369,249 7,413,329
Other income and (expenses):
Investment income 186,439 182,521 582,333 519,733
Interest expense (1,843,504) (1,879,565) (5,388,494) (5,478,030)
Gain on sales of marketable securities 517,826 947,295 1,495,999
Partnership and LLC income 390,283 410,096 895,096 640,387
------------- ------------ ------------ ------------
Other expense, net (748,956) (1,286,948) (2,963,770) (2,821,911)
Income before income taxes 2,243,338 1,956,538 5,405,479 4,591,418
Income tax expense 984,000 945,000 2,379,000 2,170,000
------------- ------------ ------------ ------------
Income before minority interest 1,259,338 1,011,538 3,026,479 2,421,418
Minority interest in earnings of
Alliance Telecommunications Corporation 384,853 315,772 939,913 514,815
------------- ------------ ------------ ------------
Net income $ 874,485 $ 695,766 $ 2,086,566 $ 1,906,603
------------- ------------ ------------ ------------
Other comprehensive income:
Unrealized holding gains (losses)
on marketable securities (555,106) 408,434 270,571 911,906
Less: reclassification adjustment for gains
included in net income (517,826) (947,295) (1,495,999)
------------- ------------ ------------ ------------
Other comprehensive income (loss) before income taxe(1,072,932) 408,434 (676,724) (584,093)
Income tax expense (benefit) related to items of other
comprehensive income (429,173) 163,376 (270,690) (233,637)
------------- ------------ ------------ ------------
Other comprehensive income (loss) (643,759) 245,058 (406,034) (350,456)
------------- ------------ ------------ ------------
Comprehensive income $ 230,726 $ 940,824 $ 1,680,532 $ 1,556,147
============= ============ ============ ============
Basic net income per share $ .34 $ .37 $ .90 $ 1.01
Diluted net income per share $ .26 $ .24 $ .71 $ .67
See notes to consolidated financial statements.
4
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(unaudited)
Accumulated
Other
Preferred Stock Common Stock Additional Unearned Compre-
----------------- -------------------- Paid-in Retained ESOP hensive
Shares Amount Shares Amount Capital Earnings Shares Income Total
-------- -------- ---------- -------- ---------- ----------- --------- ---------- -----------
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 Option Plan 9,000 90 61,885 61,975
Issuance of common stock under
Employee Stock Purchase Plan 3,695 37 23,126 23,163
Conversion of preferred stock into
common stock (11,387) (11,387) 11,387 114 11,273 0
ESOP Shares Allocated 26,412 31,588 58,000
Change in unrealized gains and
losses 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 2,086,566 2,086,566
Issuance of common stock under
Employee Stock Option Plan 48,200 482 324,931 325,413
Issuance of common stock under
Employee Stock Purchase Plan 10,753 107 73,013 73,120
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
Conversion of preferred stock into
common stock (35,300) (35,300) 35,300 353 34,947 0
Change in unrealized gains and
losses on marketable securities,
net of deferred taxes (406,034) 406,034)
-------- -------- ---------- -------- ---------- ----------- --------- ---------- -----------
BALANCE at September 30, 1998 342,800 $342,800 2,661,062 $ 26,611 $6,303,070 $13,813,087 $ (69,724) $ 272,443 $20,688,287
======== ======== ========== ======== ========== =========== ========= ========== ===========
5
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
Nine Months Ended September 30
------------------------------
1998 1997
----------- -----------
Cash Flows from Operating Activities:
Net income $ 2,086,566 $ 1,906,603
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization 5,862,719 5,604,751
Minority stockholders' interest in earnings of Alliance
Telecommunications Corporation 939,913 514,815
Gain on sales of marketable securities (947,295) (1,495,999)
Income from partnership and LLC investments (895,096) (640,387)
Changes in assets and liabilities:
Increase in accounts receivable (936,502) (650,594)
Increase in materials, supplies and inventories (846,755) (472,589)
Decrease in prepaid expenses 51,251 35,632
Increase in accounts payable 1,313,719 863,795
Decrease in accrued expenses (469,795) (352,145)
Increase in income taxes payable 100,699 656,202
Decrease in deferred investment credits (126,451) (132,382)
Decrease in deferred taxes (615,270) (44,019)
Decrease in deferred compensation (69,782) (35,639)
----------- -----------
Net cash provided by operating activities 5,447,921 5,758,044
Cash Flows from Investing Activities:
Capital expenditures, net (6,754,582) (2,904,056)
Sales of temporary cash investments 300,000 779,900
Sales of marketable securities 1,801,879 1,728,115
Increase in construction fund (83) (85,450)
Purchases of wireless telephone investments (644,882)
Proceeds from wireless telephone investments 486,474 326,985
Purchases of other investments (578,979) (1,320,349)
Increase in excess of cost over net assets acquired (952,650)
Increase in other assets (2,207,899) (175,635)
Payment for purchase of Felton Telephone Company, (3,523,107)
net of cash acquired
----------- -----------
Net cash used in investing activities (12,073,829) (1,650,490)
Cash Flows from Financing Activities:
Repayment of long-term debt (3,766,739) (4,711,656)
Proceeds from issuance of notes payable and long-term debt 5,149,358 1,530,000
Issuance of common stock 459,703 85,137
----------- -----------
Net cash provided by (used in) financing activities 1,842,322 (3,096,519)
----------- -----------
Net Increase (Decrease) in Cash and Cash Equivalents (4,783,586) 1,011,035
Cash and Cash Equivalents at Beginning of Period 12,455,399 9,571,879
----------- -----------
Cash and Cash Equivalents at End of Period $ 7,671,813 $ 10,582,914
=========== ===========
Supplemental disclosures of cash flow information:
Interest paid during the period $ 5,536,402 $ 5,653,724
Income taxes paid during the period 2,400,544 1,690,331
See notes to consolidated financial statements.
6
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
NOTE 1 - CONSOLIDATED FINANCIAL STATEMENTS
The balance sheet and statement of stockholders' equity as of September 30,
1998, the statements of income and comprehensive income for the three and nine
month periods ended September 30, 1998 and 1997 and the statements of cash flows
for the nine month periods ended September 30, 1998 and 1997 have been prepared
by the Company without audit. In the opinion of management, all adjustments
(which include only normal recurring adjustments) necessary to present fairly
the financial position, results of operations, and changes in cash flows at
September 30, 1998 and 1997 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, 1997 Annual Report to
Shareholders. The results of operations for the periods ended September 30 are
not necessarily indicative of the operating results for the entire year.
Certain amounts in the 1997 financial statements have been reclassified to
conform to the 1998 financial statement presentation. These reclassifications
had no effect on net income or stockholders equity as previously reported.
NOTE 2 - MARKETABLE SECURITIES AND GAINS ON SALES OF INVESTMENTS
Marketable securities consist principally of equity securities of other
telecommunications companies. The Company's marketable securities portfolio is
classified as available-for-sale. The cost and fair value of available-for-sale
investment securities was as follows:
Gross Gross
Unrealized Unrealized Fair
Cost Gains Losses Value
September 30, 1998 $ 7,992,397 $ 1,275,728 $ (916,730) $ 8,351,395
December 31, 1997 4,449,976 1,035,722 -- 5,485,698
Net unrealized gains on marketable securities, net of related deferred taxes,
are included in accumulated other comprehensive income as follows:
Accumulated
Net Deferred Other
Unrealized Income Comprehensive
Gains Taxes Income
September 30, 1998 $ 358,998 $ (86,555) $ 272,443
December 31, 1997 1,035,722 (357,245) 678,477
These amounts have no cash effect and are not included in the statement of cash
flows.
Gross proceeds from sales of available-for-sale securities were $1,802,000 and
$1,728,000 in 1998 and 1997, respectively. Gross realized gains on sales of
these securities were $947,000 and $1,496,000 in 1998 and 1997, respectively.
Income tax expense related to these gains was $379,000 and $598,000 in 1998 and
1997, respectively. Realized gains on sales are based on the difference between
net sales proceeds and the book value of securities sold, using the specific
identification method.
7
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
NOTE 3 - WIRELESS TELEPHONE INVESTMENTS
The Company's investments in wireless telephone partnerships and limited
liability companies are recorded on the equity method of accounting which
reflects original cost and recognition of the Company's share of income or
losses. At September 30, 1998, the Company owned 10.0% of Midwest Wireless
Communications LLC, 12.25% of Sioux Falls Cellular, Ltd., and 13.7% of Wireless
North LLC.
Income recognized on cellular telephone investments, net of amortization, was
$1,537,000 and $640,000 for the nine-month periods ended September 30, 1998 and
1997 respectively. Losses from PCS investments were $772,000 for the nine-month
period ended September 30, 1998. Income from other equity method investments was
$130,000 for the nine-month period ended September 30, 1998.
The Company made additional cash investments of $645,000 in the 1998 period to
support the operations of its wireless investments. Cash distributions received
from cellular telephone investments were $486,000 and $327,000 in 1998 and 1997,
respectively.
NOTE 4 - INCOME TAXES AND INVESTMENT CREDITS
Income taxes have been calculated in proportion to the earnings and tax credits
generated by operations. Investment tax credits have been deferred and are
included in income over the estimated useful lives of the related assets. The
Company's effective income tax rate is higher than the U.S. rate due to the
effect of state income taxes and non-deductible expenses.
NOTE 5 - ACQUISITIONS
Effective April 1, 1998, the Company's 68% owned subsidiary, Alliance
Telecommunications Corporation, acquired all of the outstanding common stock of
Felton Telephone Company, Inc. for $3,650,000 in cash and notes. The acquisition
is being accounted for as a purchase. The excess of cost over net assets
acquired in the transaction was $536,000 which is being amortized on a
straight-line basis over forty years.
Effective June 9, 1998, the Company acquired cable television systems serving 20
rural communities in Minnesota and North Dakota from Spectrum Cablevision
Limited Partnership ("Spectrum") for $5,300,000 in cash. The acquisition is
being accounted for as a purchase. The excess of cost over net assets acquired
in the transaction was $952,650, which is being amortized on a straight-line
basis over fifteen years. Subsequent to the acquisition, the Company sold one of
the acquired systems in exchange for a note receivable of $602,000.
The results of the operations of these acquisitions have been included in the
Company's operating results as of their respective acquisition dates. These
acquisitions were not material to the Company's financial statements.
8
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations
Nine Months Ended September 30, 1998 Compared to
Nine Months Ended September 30, 1997
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 companies, an
engineering company, and a credit card communications company. At September 30,
1998, the Company's wholly and majority owned subsidiaries provided telephone
service to 34,600 access lines in 35 rural communities in Minnesota, Wisconsin,
South Dakota and Iowa. Its cable television operations provided cable television
services to approximately 13,000 subscribers in Minnesota, North Dakota, South
Dakota and Wisconsin. The Company is also an investor in partnerships and
corporations providing wireless telephone and other telecommunications related
services.
Revenues from the Company's Hector and Alliance operations for the respective
nine-month periods ending September 30 were as follows:
Alliance Alliance Hector Hector
1998 1997 1998 1997
------------ ------------ ------------ ------------
Revenues:
Local network $ 2,776,230 $ 2,516,377 $ 1,167,595 $ 1,133,483
Network access 10,161,677 9,668,809 3,127,289 2,827,309
Billing and collection 501,524 647,405 132,929 149,865
Nonregulated activities 2,825,657 2,735,177 371,653 243,279
Cable television revenues 1,172,688 764,600 1,062,356 1,025,675
------------ ------------ ------------ ------------
Total revenues $ 17,437,776 $ 16,332,368 $ 5,861,822 $ 5,379,611
Revenues from the Company's 68% owned Alliance Telecommunications Corporation
("Alliance") operations increased $1,105,000 or 7%. Local network revenues
increased $260,000 or 10% due to increases in the number of access lines served
by the Company. Network access revenues increased $493,000 or 5% due to
increased interstate access settlements from NECA. Alliance's 1997 revenues
included a one-time retroactive network access settlement of $560,000. Cable
television revenues increased $408,000 or 53% due to the acquisition of the
Spectrum cable systems. Billing and collection revenues declined $146,000 or 23%
due to reduced payments from interexchange carriers ("IXCs") associated with
Company efforts to resell long distance services directly to customers. Revenues
from nonregulated activities increased $90,000 or 3% due to increased revenues
from internet customers.
Revenues from the Company's 100% owned Hector Communications Corporation
("Hector") operations increased $482,000 or 9%. Local network revenues increased
$34,000 or 3% due to increases in the number of access lines served by the
Company. Network access revenues increased $300,000 or 11%. The increase was
principally due to increased interstate access settlements from NECA. Cable
television revenues increased $37,000 or 4%. Billing and collection revenues
declined $17,000 or 11%. Revenues from nonregulated activities increased
$128,000 or 53% due to increased revenues from internet customers.
Operating costs and administrative expenses for 1998 increased $632,000 or 4%
from the 1997 period. Operating costs and administrative expenses for Alliance's
operations and Hector's operations for the respective nine-month periods ended
September 30 were as follows:
9
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
Alliance Alliance Hector Hector
1998 1997 1998 1997
------------ ------------ ------------ ------------
Costs and expenses:
Plant operations $ 1,910,781 $ 2,015,574 $ 681,689 $ 695,024
Depreciation and amortization 4,197,482 3,994,888 1,532,755 1,468,029
Customer operations 1,175,826 1,174,701 272,201 187,212
General and administrative 2,302,511 2,289,344 1,073,288 1,024,454
Nonregulated and miscellaneous 886,592 701,918 897,224 747,506
------------ ------------ ------------ ------------
Total costs and expenses: $ 10,473,192 $ 10,176,425 $ 4,457,157 $ 4,122,225
============ ============ ============ ============
Operating costs and expenses for Alliance operations increased $297,000 or 3%.
Plant operations expenses decreased $105,000 or 5%. Depreciation and
amortization expenses increased $203,000 or 5% due to expenses associated with
new acquisitions. Customer operations expenses decreased $1,000 due to
consolidation of certain job functions with Hector. General and administrative
expenses increased $13,000 or 1%. Nonregulated expenses increased $185,000 or
26% due to increased cable television expenses associated with acquisitions.
Operating income from Alliance's operations increased $809,000 or 13%.
Operating costs and expenses for Hector operations increased $335,000 or 8%.
Plant operations expenses decreased $13,000 or 2%. Depreciation and amortization
expenses increased $65,000 or 4%. Customer operations expenses increased $85,000
or 45% due to expenses incurred in integrating Hector's customer service system
with Alliance and upgrading to Year 2000 compliance. General and administrative
expenses increased $49,000 or 5%. Nonregulated expenses increased $150,000 or
20% due to increased cable television maintenance expenses and increased
internet service expenses. Operating income from Hector operations increased
$147,000 or 12%. Consolidated operating income increased $956,000 or 13%.
Consolidated interest expense, net of investment income decreased $152,000 due
to principal payments made on outstanding borrowings and conversions of
outstanding convertible debentures into common stock. Income from investments in
partnerships and LLCs increased $255,000 due to above plan performance by
investments in Midwest Wireless LLC, which offset start-up losses on the
Company's personal communications services ("PCS") partnership investments.
Gains on sales of marketable securities held by Alliance were $947,000 in the
1998 period. Gains on sales of marketable securities held by Hector were
$1,496,000 in 1997.
Consolidated income before income taxes was $5,405,000 up 18% from $4,591,000 in
1997. Income tax expense was $2,379,000 in the 1998 period compared to
$2,170,000 in 1997. The Company's effective tax rate of 44% in 1998 is higher
than the standard tax rate because the amortization expenses associated with
excess of cost over net assets acquired in Alliance's 1996 purchase of Ollig
Utilities Company are not tax deductible. The 32% minority shareholders'
interest in earnings of Alliance was $940,000 in the 1998 period compared to
$515,000 in 1997. Net income was $2,087,000 compared to $1,907,000 in 1997.
Three Months Ended September 30, 1998 Compared to
Three Months Ended September 30, 1997
Revenues from the Company's Hector and Alliance operations for the respective
three-month periods ending September 30 were as follows:
10
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
Alliance Alliance Hector Hector
1998 1997 1998 1997
------------ ------------ ------------ ------------
Revenues:
Local network $ 991,742 $ 902,044 $ 402,745 $ 388,862
Network access 3,289,146 3,733,510 1,056,084 1,014,908
Billing and collection 190,807 214,171 45,126 53,697
Nonregulated activities 988,452 978,810 109,882 81,528
Cable television revenues 597,872 259,386 355,603 347,759
------------ ------------ ------------ ------------
Total revenues $ 6,058,019 $ 6,087,921 $ 1,969,440 $ 1,886,754
============ ============ ============ ============
Revenues from Alliance operations decreased $30,000. Excluding the acquisition
of Felton Telephone Company and the Spectrum cable television systems, revenues
decreased $690,000 or 12%. Local network revenues increased $90,000 or 10% due
to increases in the number of access lines served by the Company. Network access
revenues decreased $444,000 or 12%. . Alliance's 1997 revenues included a
one-time retroactive network access settlement of $560,000. Cable television
revenues increased $338,000 or 130% due to the acquisition of additional cable
systems. Billing and collection revenues declined $23,000 or 11% due to reduced
payments from IXCs associated with Company efforts to resell long distance
services directly to customers. Revenues from nonregulated activities increased
$10,000 or 1% due to increased revenues from internet customers.
Revenues from Hector operations increased $83,000 or 4%. Local network revenues
increased $14,000 or 4% due to increases in the number of access lines served by
the Company. Network access revenues increased $41,000 or 4%. The increase was
principally due to increased cost-basis interstate access settlements from NECA.
Cable television revenues increased $8,000 or 2%. Billing and collection
revenues declined $9,000 or 16%. Revenues from nonregulated activities increased
$28,000 or 35% due to increased revenues from internet customers.
Operating costs and administrative expenses for 1998 increased $304,000 or 6%
from the 1997 period. Operating costs and administrative expenses for Alliance's
operations and Hector's operations for the respective three-month periods ended
September 30 were as follows:
Alliance Alliance Hector Hector
1998 1997 1998 1997
------------ ------------ ------------ ------------
Costs and expenses:
Plant operations $ 457,454 $ 648,251 $ 222,534 $ 242,819
Depreciation and amortization 1,462,931 1,331,665 510,895 487,302
Customer operations 422,524 359,236 86,026 65,431
General and administrative 821,386 699,770 355,398 369,323
Nonregulated and miscellaneous 354,442 269,837 341,575 257,555
------------ ------------ ------------ ------------
Total costs and expenses: $ 3,518,737 $ 3,308,759 $ 1,516,428 $ 1,422,430
============ ============ ============ ============
Operating costs and expenses for Alliance operations increased $210,000 or 6%.
Plant operations expenses decreased $191,000 or 29%. Depreciation and
amortization expenses increased $131,000 or 10% due to expenses associated with
new acquisitions. Customer operations expenses increased $63,000 or 18%. General
and administrative expenses increased $122,000 or 17%. Nonregulated expenses
increased $85,000 or 31% due to increased cable television expenses associated
with acquisitions. Operating income from Alliance's operations decreased
$240,000 or 9%.
11
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
Operating costs and expenses for Hector operations increased $94,000 or 7%.
Plant operations expenses decreased $20,000 or 8%. Depreciation and amortization
expenses increased $24,000 or 5%. Customer operations expenses increased $21,000
or 31% due to expenses incurred in integrating Hector's customer service system
with Alliance and upgrading to Year 2000 compliance. General and administrative
expenses decreased $14,000 or 4% due to cost sharing with Alliance. Nonregulated
expenses increased $84,000 or 33% due to increased cable television maintenance
expenses and increased internet service expenses. Operating income from Hector
operations decreased $11,000 or 2%. Consolidated operating income decreased
$251,000 or 8%.
Consolidated interest expense, net of investment income decreased $40,000 due to
principal payments made on outstanding borrowings and reduced interest charges
on convertible debentures redeemed or converted into common stock in the period.
Income from investments in partnerships and LLCs decreased $20,000 due to
start-up losses on the Company's personal communications services ("PCS")
partnership investments, which offset above plan performance by investments in
Midwest Wireless LLC. Gains on sales of marketable securities held by Alliance
were $518,000 in the 1998 period.
Consolidated income before income taxes was $2,243,000 compared to $1,957,000 in
1997. Income tax expense was $984,000 in the 1998 period compared to $945,000 in
1997. The Company's effective tax rate of 44% in 1998 is higher than the
standard tax rate because the amortization expenses associated with excess of
cost over net assets acquired in the Alliance's 1996 purchase of Ollig Utilities
Company are not tax deductible. The 32% minority shareholders' interest in
earnings of Alliance was $385,000 in the 1998 period compared to $315,000 in
1997. Net income was $874,000 compared to $696,000 in 1997.
Liquidity and Capital Resources
The Company produced cash from operating activities of $5,448,000 in the first
nine months of 1998 compared to $5,758,000 in the 1997 period. The decrease was
primarily due to the timing of accounts receivable collections from IXCs and
increases in materials, supplies and inventories on hand. At September 30, 1998,
the Company's cash, cash equivalents, temporary cash investments and marketable
securities totaled $16,023,000 compared to $18,241,000 at December 31, 1997.
Working capital at September 30, 1998 was $4,125,000 compared to $8,504,000 at
December 31, 1997.
The Company continues to carry a significant amount of debt associated with
Alliance's 1996 acquisition of Ollig Utilities Company. The Company owns 68% of
Alliance with the remaining interest owned by Golden West Telecommunications
Cooperative, Inc. of Wall, South Dakota and Split Rock Telecom Cooperative, Inc.
of Garretson, South Dakota. Alliance financed the acquisition using the combined
equity investments of its shareholders and $55,250,000 of long-term debt
financing provided by St. Paul Bank for Cooperatives ("St. Paul Bank"). The
Company has locked in the interest rates on this debt for periods of 1 - 10
years at rates averaging 7.4%. The outstanding balance on this loan at September
30, 1998 was $51,163,000.
The Company's cash investment in Alliance is approximately $16,903,000, which
included $6,000,000 of borrowing by the Company from St. Paul Bank. The Company
repaid $2,000,000 of this debt in 1997 and paid down an additional $286,000 in
the first quarter of 1998. In April, 1998, the Company refinanced the remaining
debt through a fifteen-year term loan from Rural Telephone Financing Corporation
("RTFC").
12
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
Effective April 1, 1998, Alliance Telecommunications Corporation purchased all
the outstanding common stock of Felton Telephone Company, Inc., a rural
telephone company located in northwestern Minnesota adjacent to areas already
served by the Company's telephone subsidiaries. Felton serves approximately 700
access lines and holds a significant portfolio of marketable securities,
including investments in Rural Cellular Corporation, U.S. West Communications,
Inc. and Media One Group, Inc. Purchase price was $3,650,000, which includes a
cash downpayment and a seller financed note payable of $3,149,000.
Effective June 9, 1998, Alliance purchased cable television systems serving
4,600 customers in 20 communities in Minnesota and North Dakota (including
several communities also served by the Company's telephone subsidiaries) from
Spectrum Cablevision Limited Partnership. Purchase price was approximately
$5,235,000. The Company used its cash reserves and funds from its line of credit
with RTFC to make this purchase. Subsequent to the acquisition, the Company sold
one of the acquired systems in exchange for a note receivable of $602,000.
In 1998 the Company issued two calls totaling $4,000,000 of its outstanding 8.5%
convertible subordinated debentures. Of these called debentures, $193,000 worth
were ultimately redeemed for cash and the balance was converted into common
stock. In separate transactions, additional debentures totaling $702,000 have
been redeemed for cash or converted to stock in the 1998 period. Outstanding
convertible debentures totaled $7,948,000 at September 30, 1998. The Company
believed that because its common stock was trading at a considerable premium to
the conversion price available to debenture holders and the Company had sources
of funds available at lower interest rates than carried by the debentures, it
was in the best interest of both the Company and the debenture holders that the
debentures be replaced with cheaper debt or converted to stock. The Company
expects to continue to redeem debentures as market conditions and funds
availability permit.
The Company finances its telephone asset additions from internally generated
funds and drawdowns of Rural Utilities Service ("RUS") and Rural Telephone Bank
("RTB") loan funds. At September 30, 1998, the Company's local exchange carrier
("LEC") subsidiaries had unadvanced loan commitments from RUS and RTB totaling
$17,478,000. Alliance's LEC subsidiaries are in the process of applying for
additional loans. Expected telephone and cable television plant additions for
1998, excluding the acquisition of the Spectrum cable systems, are $5,621,000 of
which $4,979,000 has been spent to date.
The Company's investment income has been derived almost exclusively from
interest earned on its cash and cash equivalents. Interest income earned by the
Company has fluctuated in relation to changes in interest rates and availability
of cash for investment.
The Company has also derived substantial amounts of net income from sales of
securities held in its marketable securities portfolio, which appreciated
significantly in value in the first half of 1998 before declining in the third
quarter. In the first nine months of 1998, the Company received $1,802,000 from
the sales of marketable securities. Proceeds from securities sales totaled
$1,728,000 in 1997 and $2,053,000 in 1996. The Company believes sales of
marketable securities will continue to be a significant cash source in future
periods. At September 30, 1998, the Company's marketable securities portfolio
consisted primarily of shares of Rural Cellular Corp., U.S. West Communications,
Inc. and Media One Group, Inc. owned by Ollig Utilities Company and Felton
Telephone Company, Inc. prior to their acquisition.
13
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
The Company is an investor in Wireless North LLC, a consortium of three limited
partnerships and one limited liability corporation which have acquired licenses
to operate PCS systems in 13 markets in Minnesota, Wisconsin, North Dakota and
South Dakota. The Company invested $510,000 of cash and guaranteed debt of
$1,373,000 in these entities through December 31, 1997. Capital contributions in
1998 to date total $573,000. The PCS systems are in start-up mode and have not
been profitable to date. Losses accrued on this investment were $772,000 before
income tax benefits in the first nine months of 1998. The Company has committed
to providing $913,000 of additional capital to these entities. It cannot predict
if additional funding beyond this amount will be required.
By utilizing cash flow from operations, current cash and investment balances,
and other available financing sources, the Company feels it has adequate
resources to meet its anticipated operating, debt service and capital
expenditure requirements.
Year 2000 Issues
The software used by the Company's data processing and central office equipment
was originally designed to use references to calendar dates on an abbreviated
basis. Under this system, references to the calendar year are abbreviated to the
last two digits of the year, i.e. 1998 is abbreviated as "98". Most software
using this system does not recognize that the year 2000, abbreviated as "00",
follows 1999. This causes computing errors in date sensitive processes. The
Company has surveyed its central office and data processing systems to locate
computer systems which may be subject to this error.
The Company has determined that the central office switching equipment
used in its local telephone exchanges to connect customer calls and record
telephone usage is not Year 2000 compliant. If not corrected, this could
interrupt telephone services for customers, interrupt connections between the
Company's telephone system and the national and worldwide telephone networks,
and make the Company unable to accurately bill customers for telephone usage.
The Company's system may also be vulnerable to Year 2000 problems in other
telephone networks with which it interconnects. The Company cannot estimate what
its liability to customers and regulators from such a loss of service might be.
The Company will be upgrading its central office equipment and related software
in the third and fourth quarters of 1998 to attain Year 2000 compliance. The
Company relies on switching equipment and software provided by Nortel, Inc. and
does not itself have the technical expertise required to make the necessary
hardware and software corrections. It is the Company's understanding that
Nortel, Inc. has completed testing of the new software and that no additional
action related to this problem will be required when installation is complete.
Estimated cost is $658,000. No retirements of equipment currently in service
will be required.
The Company's billing, accounting and management information systems utilize
software provided by Martin and Associates. The Company believes this software
to be Year 2000 compliant.
At the present time, the Company does not expect Year 2000 problems to cause any
interruption of service to customers or cause material disruptions to its own
operations. However, it will continue to monitor the situation and modify its
business plans and procedures as the situation warrants.
- --------------------------------------------------------------------------------
Statements regarding the Company's anticipated performance in future periods are
forward looking and involve risks and uncertainties, including but not limited
to: changes in government rules and regulations, new technological developments,
and other risks involving the telecommunications industry generally.
- --------------------------------------------------------------------------------
14
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
PART II. OTHER INFORMATION
Items 1 - 5. Not Applicable
Item 6(a). Exhibits
Exhibit 11, "Calculation of Earnings Per Share" is attached to this Form 10-Q.
Item 6(b). Not Applicable.
Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereto duly authorized.
Hector Communications Corporation
By /s/Charles A. Braun
Charles A. Braun
Chief Financial Officer
Date: November 13, 1998
15
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
EXHIBIT 11
CALCULATION OF EARNINGS PER SHARE
Three Months Ended Sept 30 Nine Months Ended Sept 30
-------------------------- --- ---------------------
Basic: 1998 1997 1998 1997
- ------- ---------- ---------- ---------- ----------
Net income $ 874,485 $ 695,766 $2,086,566 $1,906,603
========== ========== ========== ==========
Common shares:
Weighted average number of common shares outstanding 2,586,476 1,904,900 2,315,763 1,898,713
Number of unallocated shares held by ESOP (6,042) (11,817) (6,042) (11,817)
---------- ---------- ---------- ----------
2,580,434 1,893,083 2,309,721 1,886,896
========== ========== ========== ==========
Net income per common share $ .34 $ .37 $ .90 $ 1.01
========== ========== ========== ==========
Diluted:
- -------------
Net income $ 874,485 $ 695,766 $2,086,566 $1,906,603
Interest on convertible debentures, net of tax 135,028 189,654 502,233 568,962
---------- ---------- ---------- ----------
Adjusted net income $1,009,513 $ 885,420 $2,588,799 $2,475,565
========== ========== ========== ==========
Common and common equivalent shares:
Weighted average number of common shares
outstanding 2,586,476 1,904,900 2,315,763 1,898,713
Assumed conversion of convertible
debentures into common stock 894,150 1,423,125 894,150 1,423,125
Dilutive effect of convertible preferred shares
outstanding 342,800 378,100 356,256 378,100
Dilutive effect of stock options outstanding after
application of treasury stock method 41,868 40,581 52,921 30,004
Dilutive effect of Employee Stock
Purchase Plan shares subscribed 4,379 5,302
Dilutive effect of warrants outstanding 9,162 1,236 16,781
Weighted average number of
unallocated shares held by ESOP (6,042) (11,817) (6,042) (11,817)
---------- ---------- ---------- ----------
3,872,793 3,736,125 3,635,131 3,718,125
========== ========== ========== ==========
Diluted net income per share $ .26 $ .24 $ .71 $ .67
========== ========== ========== ==========
16