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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, 1999
-------------------------------------------------
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR
15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from .................... to .........................
Commission File Number: 0-18587
HECTOR COMMUNICATIONS CORPORATION
................................................................................
(Exact name of registrant as specified in its charter)
MINNESOTA 41-1666660
................................................................................
(State or other jurisdiction of (Federal Employer
incorporation or organization) Identification No.)
211 South Main Street, Hector, MN 55342
................................................................................
(Address of principal executive offices) (Zip Code)
(320) 848-6611
................................................................................
Registrant's telephone number, including area code
................................................................................
(Former name, address, and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. YES X NO
--- ---
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
CLASS Outstanding at April 30, 1999
Common Stock, par value 2,666,967
$.01 per share
Total Pages (15) Exhibit at Page 15
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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 14
2
PART I. FINANCIAL INFORMATION
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
Item 1. Financial Statements
CONSOLIDATED BALANCE SHEETS
(unaudited)
March 31 December 31
Assets: 1999 1998
------------ ------------
Current assets:
Cash and cash equivalents $ 11,833,424 $ 14,686,034
Construction fund 3,054,610 200,491
Accounts receivable, net 5,395,038 4,140,992
Materials, supplies and inventories 580,821 528,839
Prepaid expenses 144,877 180,134
------------ ------------
Total current assets 21,008,770 19,736,490
Property, plant and equipment 76,901,754 76,245,233
less accumulated depreciation (27,008,106) (25,434,769)
------------ ------------
Net property, plant and equipment 49,893,648 50,810,464
Other assets:
Excess of cost over net assets acquired, net 52,612,568 53,003,560
Marketable securities 8,459,657 8,555,336
Wireless telephone investments 9,824,903 9,482,902
Other investments 8,865,279 8,259,419
Deferred debenture issue costs, net 341,606 371,311
Other assets 564,564 460,305
------------ ------------
Total other assets 80,668,577 80,132,833
------------ ------------
Total Assets $ 151,570,995 $ 150,679,787
============ ============
Liabilities and Stockholders' Equity:
Current liabilities:
Notes payable and current portion of long-term debt $ 4,802,400 $ 6,808,500
Accounts payable 3,239,285 2,473,526
Accrued expenses 1,935,665 1,945,687
Income taxes payable 753,457 1,955,153
------------ ------------
Total current liabilities 10,730,807 13,182,866
Long-term debt, less current portion 96,281,994 94,232,389
Deferred investment tax credits 212,308 252,601
Deferred income taxes 8,567,190 8,510,637
Deferred compensation 966,894 990,155
Minority stockholders interest in Alliance
Telecommunications Corp. 11,171,575 10,790,818
Stockholders' Equity 23,640,227 22,720,321
-------------- --------------
Total Liabilities and Stockholders' Equity $ 151,570,995 $ 150,679,787
============== ==============
See notes to consolidated financial statements.
3
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
(unaudited)
Three Months Ended March 31
---------------------------------
1999 1998
------------- ------------
Revenues:
Local network $ 1,345,549 $ 1,199,969
Network access 4,879,818 4,259,695
Billing and collection 193,898 194,562
Nonregulated activities 972,915 981,281
Cable television revenues 927,379 613,295
------------- ------------
Total revenues 8,319,559 7,248,802
Costs and expenses:
Plant operations 1,104,755 876,931
Depreciation and amortization 1,993,646 1,823,323
Customer operations 478,250 454,256
General and administrative 1,222,519 1,084,030
Other operating expenses 694,262 521,775
------------- ------------
Total costs and expenses 5,493,432 4,760,315
Operating income 2,826,127 2,488,487
Other income and (expenses):
Investment income 194,426 191,962
Interest expense (1,672,708) (1,735,305)
Gain on sales of marketable securities 803,364 91,854
Partnership and LLC income (loss) (165,028) 175,912
------------- ------------
Other expense, net (839,946) (1,275,577)
Income before income taxes 1,986,181 1,212,910
Income tax expense 850,000 551,000
------------- ------------
Income before minority interest 1,136,181 661,910
Minority interest in earnings of
Alliance Telecommunications Corporation 380,757 227,952
------------- ------------
Net income $ 755,424 $ 433,958
------------- ------------
Other comprehensive income:
Unrealized holding gains
on marketable securities 1,037,917 1,376,813
Less: reclassification adjustment for gains
included in net income (803,364) (91,854)
------------- ------------
Other comprehensive income before income taxes 234,553 1,284,959
Income tax expense related to items of other
comprehensive income 93,821 513,983
------------- ------------
Other comprehensive income 140,732 770,976
------------- ------------
Comprehensive income $ 896,156 $ 1,204,934
============= ============
Basic net income per share $ .28 $ .21
Diluted net income per share $ .22 $ .16
See notes to consolidated financial statements.
4
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Unearned Accumulated
Preferred Stock Common Stock Additional Employee Other
----------------- ------------------ Paid-in Retained Stock Owner- Comprehensive
Shares Amount Shares Amount Capital Earnings ship Shares Income Total
-------- -------- --------- --------- ----------- ------------ ----------- ---------- -----------
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 755,424 755,424
Issuance of common stock to
ESOP 2,405 24 19,976 20,000
Issuance of common stock under
Employee Stock Option Plan 500 5 3,745 3,750
Change in unrealized gains on
marketable securities, net of
deferred taxes 140,732 140,732
-------- -------- --------- --------- ----------- ------------ ----------- ---------- -----------
BALANCE AT MARCH 31, 1999 342,800 $342,800 2,663,967 $ 26,640 $6,350,162 $ 16,392,188 $ - $ 528,437 $23,640,227
======== ======== ========= ========= =========== ============ =========== ========== ===========
See notes to consolidated financial statements.
5
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
Three Months Ended March 31
-----------------------------
1999 1998
----------- -----------
Cash Flows from Operating Activities:
Net income $ 755,424 $ 433,958
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 2,023,351 1,870,570
Minority stockholders' interest in earnings of Alliance
Telecommunications Corporation 380,757 227,952
Gain on sales of marketable securities (803,364) (91,854)
Loss (income) from partnership and LLC investments 165,028 (175,912)
Proceeds from wireless telephone investments 160,924 285,222
Changes in assets and liabilities:
Increase in accounts receivable (1,254,046) (509,961)
Increase in materials, supplies and inventories (51,982) (29,583)
Decrease in prepaid expenses 35,257 84,307
Increase in accounts payable 765,759 543,951
Increase (decrease) in accrued expenses 9,978 (582,582)
Increase (decrease) in income taxes payable (1,201,696) 17,299
Decrease in deferred investment credits (40,293) (42,786)
Decrease in deferred taxes (37,269) (16,594)
Decrease in deferred compensation (23,261) (23,261)
----------- -----------
Net cash provided by operating activities 884,567 1,990,726
Cash Flows from Investing Activities:
Capital expenditures, net (681,368) (704,486)
Sales of marketable securities 1,133,597 336,854
Increase in construction fund (2,854,119) (115)
Purchases of wireless telephone investments (667,953) (470,391)
Purchases of other investments (605,860) (638,681)
Increase in other assets (108,729) (147,003)
----------- -----------
Net cash used in investing activities (3,784,432) (1,623,822)
Cash Flows from Financing Activities:
Repayment of long-term debt (3,198,129) (1,248,189)
Proceeds from issuance of notes payable and long-term debt 3,241,634
Issuance of common stock 3,750 121,900
----------- -----------
Net cash provided by (used in) financing activities 47,255 (1,126,289)
----------- -----------
Net Decrease in Cash and Cash Equivalents (2,852,610) (759,385)
Cash and Cash Equivalents at Beginning of Period 14,686,034 12,455,399
----------- -----------
Cash and Cash Equivalents at End of Period $ 11,833,424 $ 11,696,014
=========== ===========
Supplemental disclosures of cash flow information:
Interest paid during the period $ 1,743,968 $ 1,964,199
Income taxes paid during the period 2,101,550 556,596
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 March 31, 1999,
and the statements of income and comprehensive income and the statements of cash
flows for the three month periods ended March 31, 1999 and 1998 have been
prepared by the Company without audit. In the opinion of management, all
adjustments (which include only normal recurring adjustments) necessary to
present fairly the financial position, results of operations, and changes in
cash flows at March 31, 1999 and 1998 have been made.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted. It is suggested these condensed financial
statements be read in conjunction with the financial statements and notes
thereto included in the Company's December 31, 1998 Annual Report to
Shareholders. The results of operations for the periods ended March 31 are not
necessarily indicative of the operating results for the entire year.
Certain amounts in the 1998 financial statements have been reclassified to
conform to the 1999 financial statement presentation. These reclassifications
had no effect on net income or stockholders' equity as previously reported.
NOTE 2 - MARKETABLE SECURITIES AND GAINS ON SALES OF INVESTMENTS
Marketable securities consist principally of equity securities of other
telecommunications companies. The Company's marketable securities portfolio is
classified as available-for-sale. The cost and fair value of available-for-sale
investment securities was as follows:
Gross Gross
Unrealized Unrealized Fair
Cost Gains Losses Value
March 31, 1999 $7,662,164 $1,428,983 $ 631,490) $8,459,657
December 31, 1998 7,992,397 1,949,794 (1,386,855) 8,555,336
Net unrealized gains on marketable securities, net of related deferred taxes,
are included in accumulated other comprehensive income as follows:
Accumulated
Net Deferred Other
Unrealized Income Comprehensive
Gains Taxes Income
March 31, 1999 $797,493 $(269,056) $528,437
December 31, 1998 562,939 (175,235) 387,705
These amounts have no cash effect and are not included in the statement of cash
flows.
Gross proceeds from sales of available-for-sale securities were $1,134,000 and
$337,000 in the three-month periods ended March 31, 1999 and 1998, respectively.
Gross realized gains on sales of these securities were $803,000 and $92,000 in
the respective 1999 and 1998 periods. Realized gains on sales are based on the
difference between net sales proceeds and the book value of securities sold,
using the specific identification method.
7
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 March 31, 1999, the Company owned 10.0% of Midwest Wireless
Communications LLC and 14.3% of Wireless North LLC.
Income recognized on cellular telephone investments, net of amortization, was
$265,000 and $379,000 for the three-month periods ended March 31, 1999 and 1998
respectively. The 1998 period included income from a 12.25% interest in Sioux
Falls Cellular, Ltd. which the Company sold in December 1998. Losses from PCS
investments were $446,000 and $236,000 for the three-month periods ended March
31, 1999 and 1998, respectively.
The Company made additional cash investments of $668,000 and $470,000 in the
respective 1999 and 1998 periods to support the operations of its wireless
investments. Cash distributions received from cellular telephone investments
were $161,000 and $285,000 in 1999 and 1998, respectively.
NOTE 4 - INCOME TAXES AND INVESTMENT CREDITS
Income taxes have been calculated in proportion to the earnings and tax credits
generated by operations. Investment tax credits have been deferred and are
included in income over the estimated useful lives of the related assets. The
Company's effective income tax rate is higher than the U.S. rate due to the
effect of state income taxes and non-deductible expenses.
NOTE 5 - SEGMENT INFORMATION
The Company is organized into two business segments: Hector Communications
Corporation and its wholly owned subsidiaries, and Alliance Telecommunications
Corporation and its subsidiaries. Segment information is as follows:
Hector Alliance Consolidated
Three Months Ended March 31, 1999
Revenues $ 2,005,440 $ 6,314,119 $ 8,319,559
Costs and expenses 1,637,751 3,855,681 5,493,432
------------ ------------ ------------
Operating income 367,689 2,458,438 2,826,127
Interest expense (396,006) (1,276,702) (1,672,708)
Partnership and LLC loss (92,228) (72,800) (165,028)
Investment income 40,874 153,552 194,426
Gain on sale of marketable securities 803,364 803,364
------------ ------------ ------------
Income (loss) before income taxes (79,671) 2,065,852 1,986,181
============ ============ ============
Depreciation and Amortization $ 607,805 $ 1,385,841 $ 1,993,646
============ ============ ============
Total Assets $ 26,186,764 $125,384,231 $151,570,995
============ ============ ============
Capital Expenditures $ 255,530 $ 425,838 $ 681,368
============ ============ ============
8
Hector Alliance Consolidated
Three Months Ended March 31, 1998
Revenues $ 1,835,635 $ 5,413,167 $ 7,248,802
Costs and expenses 1,432,097 3,328,218 4,760,315
------------ ------------ ------------
Operating income 403,538 2,084,949 2,488,487
Interest expense (527,250) (1,208,055) (1,735,305)
Partnership and LLC income (loss) (612) 176,524 175,912
Investment income 50,628 141,334 191,962
Gain on sale of marketable securities 91,854 91,854
------------ ------------ ------------
Income (loss) before income taxes (73,696) 1,286,606 1,212,910
============ ============ ============
Depreciation and Amortization $ 510,702 $ 1,312,621 $ 1,823,323
============ ============ ============
Total Assets $ 25,311,374 $114,694,709 $140,006,083
============ ============ ============
Capital Expenditures $ 378,138 $ 326,348 $ 704,486
============ ============ ============
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Three Months Ended March 31, 1999 Compared to
Three Months Ended March 31, 1998
Hector Communications Corporation ("HCC") owns a 100% interest in five local
exchange telephone subsidiaries and one cable television subsidiary. At March
31, 1999, these subsidiaries provided telephone service to 7,039 customers in 9
rural communities in Minnesota and Wisconsin. They also owned 30 cable
television systems serving 4,857 customers in 36 communities in Minnesota and
Wisconsin. HCC also directly owns substantial investments in other
telecommunications ventures, including, Midwest Wireless LLC, Wireless North LLC
and MEANS.
HCC owns a 68% interest in Alliance Telecommunications Corporation ("Alliance").
At March 31, 1999, Alliance, through its five local exchange telephone
subsidiaries, provided telephone service to 28,172 customers in 26 rural
communities in Minnesota, South Dakota and Iowa. Alliance's 16 cable television
systems provided cable television services to approximately 8,160 subscribers in
Minnesota, South Dakota and North Dakota. Alliance's subsidiaries also own
substantial investments in Midwest Wireless LLC, Wireless North LLC and MEANS,
own marketable securities portfolios with investments in telecommunications
providers like U.S. West Communications, Inc., MediaOne Group, Inc. and Rural
Cellular Corporation, and has other investments.
Consolidated revenues increased 15% to $8,320,000. The revenue breakdown by
operating group was as follows:
9
Alliance Hector
Three Months Ended March 31 Three Months Ended March 31
1999 1998 1999 1998
------------ ------------ ------------ ------------
Local Network $ 954,762 $ 828,405 $ 390,787 $ 371,564
Network Access 3,766,263 3,296,393 1,113,555 963,302
Billing and Collection 153,874 149,142 40,024 45,420
Nonregulated activities 863,882 875,448 109,033 105,833
Cable Television 575,338 263,779 352,041 349,516
------------ ------------ ------------ ------------
$ 6,314,119 $ 5,413,167 $ 2,005,440 $ 1,835,635
Consolidated local service revenues increased $146,000 or 12%. The increase was
due to increases in access lines served, which increased 11% to 35,211. Growth
was due to increased development within the Company's service areas, increased
demand for telephone lines to provide advanced telephone services such as
internet services, and the acquisition by Alliance of Felton Telephone Company
effective March 31, 1998. Network access revenues increased $620,000 or 15%. The
increase was chiefly due to increased use of the telephone network by customers
and increased universal service support funds.
Nonregulated revenues decreased $8,000 or 1%. Cable television revenues
increased $314,000 or 51% due to the acquisition by Alliance of additional cable
systems from Spectrum Cablevision Limited Partnership in June 1998. Billing and
collection revenues declined $1,000.
Consolidated operating costs and expenses increased $733,000 or 15%. Costs and
expenses by operating group were as follows:
Alliance Hector
Three Months Ended March 31 Three Months Ended March 31
1999 1998 1999 1998
------------ ------------ ------------ ------------
Plant operations $ 827,573 $ 651,812 $ 277,182 $ 225,119
Depreciation and amortization 1,385,841 1,312,621 607,805 510,702
Customer operations 401,323 379,949 76,927 74,307
General and administrative 856,571 735,780 365,948 348,250
Other operating expenses 384,373 248,056 309,889 273,719
------------ ------------ ------------ ------------
$ 3,855,681 $ 3,328,218 $ 1,637,751 $ 1,432,097
- -
Consolidated plant operations expenses increased $228,000 or 26%, due to
increases in the Company's customer base and the acquisition of Felton.
Depreciation and amortization increased $170,000 or 9% due to the acquisitions
of Felton and the Spectrum cable television systems and increased depreciation
on telephone switching equipment. Customer operations expenses increased
$24,000, or 5% due largely to growth in the number of customers served. General
and administrative expenses increased $138,000 or 13% due to the Company's
expanded operations. Other operating expenses increased $172,000 or 33% due to
increased cable television expenses from the Spectrum systems. Consolidated
operating income increased $338,000 or 14%.
Interest expenses decreased $63,000 due to interest reductions on convertible
debentures that were retired or converted into common stock in the second and
third quarters of 1998. This reduction was partially offset by the reduced
accruals of patronage dividends on interest paid to St. Paul Bank. The Company
also incurred interest expense on 1998 borrowings to finance the acquisitions of
Felton and the Spectrum cable systems.
10
The Company recorded a loss from partnership and LLC investments of $165,000 for
the 1999 period compared to income of $176,000 in 1998. Income from Midwest
Wireless LLC was $265,000 compared to $279,000 in the 1998 period. Losses from
the Company's Wireless North PCS investment totaled $446,000 compared to
$236,000 in 1998. The Company and its fellow investors are reviewing Wireless
North's business plans with the goal of reducing operating losses and attracting
more investment capital to the operation. First quarter 1998 income from the
Sioux Falls, South Dakota MSA in 1998 was $100,000. The Company sold its
interest in the MSA in December 1998.
Investment income increased $2,000. Alliance had gains on sales of marketable
securities of $803,000 and $92,000 in 1999 and 1998, respectively. Alliance
continues to hold a significant portfolio of marketable securities.
Income before income taxes increased 64% to $1,986,000. The Company's effective
income tax rate of 43% is higher than the standard U.S. tax rate due to state
income taxes and the effect of nondeductible amortization expenses. Income
before minority interest increased 72% to $1,136,000. Minority interest on
earnings of Alliance were $381,000 compared to $228,000 in 1998. Net income
increased 74% to $755,000.
Liquidity and Capital Resources
Cash flows from consolidated operating activities for the three-month periods
were $885,000 and $1,991,000 in 1999 and 1998, respectively. The decrease in
operating cash flow was due to increases in receivables from interexchange
carriers and increased income tax payments. At March 31, 1999, the Company's
total cash, cash equivalents, temporary cash investments and marketable
securities totaled $20,293,000 compared to $23,241,000 at December 31, 1998.
Alliance's cash and securities were $15,908,000 of this total. Working capital
at March 31, 1999 was $10,278,000 compared to $6,554,000 at December 31, 1998.
The current ratio was 2.0 to 1 at March 31, 1999.
The Company makes periodic improvements to its facilities to provide up-to-date
services to its telephone and cable television customers. Hector's plant
additions in the 1999 and 1998 three-month periods were $256,000 and $378,000,
respectively. Alliance's plant additions in the same periods were $426,000 and
$326,000, respectively. Plant additions for 1999 for Hector and Alliance are
expected to total $3,237,000 and $3,245,000, respectively, and will provide
customers with additional advanced switching services, upgrade the telephone
switching system to Year 2000 compliance and expand usage of high capacity fiber
optics in the telephone network.
Investment income has been derived almost exclusively from interest earned on
the Company's cash and cash equivalents. Interest income has fluctuated in
relation to changes in interest rates and availability of cash for investment.
In the 1999 period, Alliance received $1,134,000 from sales of a portion of its
investment in MediaOne Group, Inc. Alliance's proceeds from sales of marketable
securities were $337,000 in the 1998 period. At March 31, 1999, Alliance
continued to maintain a significant marketable securities portfolio consisting
primarily of shares of Rural Cellular Corporation, U.S. West Communications,
Inc. and MediaOne Group, Inc. owned by Ollig Utilities Company and Felton
Telephone Company prior to their acquisition by Alliance.
The Company is an investor in Wireless North, 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 cash of $761,000 in Wireless North in 1998
and an additional $668,000 in the first three months of 1999. Investments in
Wireless North in 1997 and 1996 consisted of $510,000 of cash and debt
guarantees of $1,373,000. The Company cannot predict if additional funding
beyond this amount will be required. The PCS systems are in start-up mode and
11
have incurred significant losses to date. The Company and its fellow investors
are reviewing Wireless North's business plans with the goal of reducing
operating losses and attracting more investment capital to the operation. The
Company continues to maintain its ownership in cellular telephone systems
through its 10.0% interest in Midwest Wireless LLC. In December, 1998, the
Company sold its 12.25% interest in Sioux Falls Cellular, Ltd., which provides
cellular service in the Sioux Falls, South Dakota MSA.
The Company continues to carry a significant amount of debt associated with
Alliance's 1996 acquisition of Ollig Utilities Company. HCC owns 68% of Alliance
with the remaining interest owned by Golden West Telecommunications Cooperative,
Inc. of Wall, South Dakota and Split Rock Telecom Cooperative, Inc. of
Garretson, South Dakota. To finance its equity investment in Alliance, HCC
borrowed $6,000,000 from St. Paul Bank (since refinanced through Rural Telephone
Finance Cooperative) and used part of the proceeds from its 1995 convertible
debenture offering. The Company called some of the outstanding debentures in
1998, and is currently exploring alternatives to refinance the remaining
debentures.
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"). Interest rates on this debt have been
locked for periods of one to ten years at rates averaging 7.5%. The outstanding
balance on this loan at March 31, 1999 was $49,857,000. St. Paul Bank is a
cooperative, owned and controlled by its customers. Each customer borrowing from
the bank on a patronage basis shares in the bank's net income through payment of
patronage refunds. The Company accrued for a patronage refund in the 1998 period
but, due to losses at the Bank on its agricultural loans, did not do so in 1999.
The Company's LEC subsidiaries use loans from the Rural Utilities Service
("RUS") and the Rural Telephone Bank ("RTB") to help finance asset additions.
Proceeds from long-term borrowings from RUS and RTB were $3,242,000 in the first
three months of 1999. Substantially all of the LEC's assets are pledged or are
subject to mortgages to secure obligations to the RUS and RTB. In addition, the
amount of dividends on common stock that may be paid to the Company by the LEC
subsidiaries is limited by covenants in the mortgages. At March 31, 1999
unadvanced loan commitments from the RUS and RTB to the LEC subsidiaries totaled
$14,310,000.
The Company is always looking to acquire properties that advance its plan to be
a provider of top quality telecommunications services to rural customers. In
1998, the Company acquired Felton Telephone Company and eight cable television
systems from Spectrum Cablevision Limited Partnership. The Company is currently
a member of investor groups seeking to acquire rural telephone properties
expected to be offered for sale by GTE and U.S. West Communications in 1999. The
Company cannot predict if it will be successful in acquiring additional
properties and does not have financing plans in place to pay for possible
acquisitions.
By utilizing cash flow from operations, current cash and investment balances,
and other available financing sources, the Company feels it has adequate
resources to meet its anticipated operating, debt service and capital
expenditure requirements.
Year 2000 Issues
The software used by the Company's data processing and 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 that may be subject to this error.
12
The Company's survey determined that the central office switching equipment used
in its local telephone exchanges to connect customer calls and record telephone
usage was not Year 2000 compliant. If not corrected, this could interrupt
telephone services for customers, interrupt connections between the Company's
telephone systems and the national and worldwide telephone networks, and make
the Company unable to accurately bill customers for telephone usage. The
Company's systems may also be vulnerable to Year 2000 problems in other
telephone networks with which it interconnects. The Company cannot estimate what
its liability to customers and regulators from such a loss of service might be.
The Company relies on switching equipment and software provided by Nortel, Inc.
and does not itself have the technical expertise required to make all the
necessary hardware and software corrections required to bring its systems into
Year 2000 compliance. It has contracted with Nortel, Inc. to upgrade its
equipment to Year 2000 compliance. It is the Company's understanding that
Nortel, Inc. has completed testing of the new software and hardware and that no
additional action related to this problem will be required when installation is
complete. Estimated cost is $658,000. The Company began upgrading its central
office equipment and related software to Year 2000 compliance in the third
quarter of 1998. Installation of all the new hardware will be completed in May
1999. Testing of software interconnections is scheduled to be completed in
November 1999.
The Company's billing, accounting and management information systems utilize
software provided by Martin and Associates. The Company believes this software
to be Year 2000 compliant.
At the present time, the Company does not expect Year 2000 problems to cause any
interruption of local telephone services to customers or cause material
disruptions to its own operations. It is possible that customers will have
difficulty making telephone connections through certain interexchange carriers
or to certain foreign countries, depending on the respective carriers and
countries' state of Year 2000 readiness. Customers could also be vulnerable to
Year 2000 problems within their own internal telephone networks. The Company is
in constant contact with its equipment supplier and with management and service
personnel of other telephone service providers and affected customers as the
upgrade and integration process moves forward. The Company also plans to have
additional personnel available as required to address any new Year 2000 problems
that arise. The Company does not expect Year 2000 problems to cause any loss of
service to customers, but will continue to monitor the situation and modify its
business plans and procedures as the situation warrants.
- --------------------------------------------------------------------------------
Statements regarding the Company's anticipated performance in future periods are
forward looking and involve risks and uncertainties, including but not limited
to: changes in government rules and regulations, new technological developments,
and other risks involving the telecommunications industry generally.
- --------------------------------------------------------------------------------
13
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 Charles A. Braun
----------------------------------
Charles A. Braun
Chief Financial Officer
Date: May 14, 1999
14
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
EXHIBIT 11
CALCULATION OF EARNINGS PER SHARE
Three Months Ended March 31
-----------------------------
Basic: 1999 1998
- ------- ---------- ----------
Net income $ 755,424 $ 433,958
========== ==========
Common shares:
Weighted average number of common
shares outstanding 2,662,756 2,092,212
Number of unallocated shares held by ESOP (6,042)
---------- ----------
2,662,756 2,086,170
========== ==========
Net income per common share $ .28 $ .21
========== ==========
Diluted:
- -------------
Net income $ 755,424 $ 433,958
Interest on convertible debentures, net of tax 119,160 189,529
---------- ----------
Adjusted net income $ 874,584 $ 623,487
========== ==========
Common and common equivalent shares:
Weighted average number of common
shares outstanding 2,662,756 2,092,212
Assumed conversion of convertible
debentures into common stock 894,150 1,420,313
Dilutive effect of convertible preferre
shares outstanding 342,800 374,556
Dilutive effect of stock options outstanding
after application of treasury stock method 32,577 63,262
Dilutive effect of Employee Stock
Purchase Plan shares subscribed 3,402 4,001
Dilutive effect of warrants outstanding 1,173 18,467
Weighted average number of
unallocated shares held by ESOP 0 (6,042)
---------- ----------
3,936,858 3,966,769
========== ==========
Diluted net income per share $ .22 $ .16
========== ==========
15