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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 [FEE REQUIRED]
For the fiscal year ended December 31, 2000
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
Commission File Number: 0-18587
HECTOR COMMUNICATIONS CORPORATION
(Exact name of registrant as specified in its charter)
Minnesota 41-1666660
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(State or other jurisdiction (Federal Employer
of incorporation or organization) Identification No.)
211 South Main Street
Hector, MN 55342
(Address of principal executive offices and zip code)
Registrant's telephone number, including area code: (320) 848-6611
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
----------------------------
Common Stock, $.01 par value
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES X NO
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Indicate by a check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. (X)
The aggregate market value of the voting stock held by non-affiliates of the
Registrant was approximately $27,836,000 based upon the closing sale price of
the Company's common stock on the American Stock Exchange on March 23, 2001.
As of March 23, 2001 there were outstanding 3,494,962 shares of the Registrant's
common stock.
Documents Incorporated by Reference: The Company's Proxy Statement for its
Annual Meeting of Shareholders to be held on May 17, 2001 is incorporated by
reference into Part III of this Form 10-K.
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TABLE OF CONTENTS
Item Page
PART I
1. Business 3
2. Properties 14
3. Legal Proceedings 14
4. Submission of Matters to a Vote of Security Holders 14
PART II
5. Market for Company's Common Equity and Related
Stockholder Matters 15
6. Selected Financial Data 16
7. Management's Discussion and Analysis of Financial Condition
and Results of Operations 17
8. Financial Statements and Supplementary Data 25
9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure 41
PART III
10. Directors and Executive Officers of the Registrant 42
11. Executive Compensation 42
12. Security Ownership of Certain Beneficial Owners and Management 42
13. Certain Relationships and Related Transactions 42
PART IV
14. Exhibits, Financial Statement Schedule and Reports on Form 8-K 43
2
PART I.
ITEM 1. BUSINESS
[a] GENERAL DEVELOPMENT OF BUSINESS
Hector Communications Corporation ("HCC" or "Company") is a
telecommunications holding company which, through its wholly-owned and
majority-owned subsidiaries, primarily provides local telephone and cable
television service. The Company also invests in other companies providing
wireless telephone and other telecommunications related services.
HCC operates five wholly-owned local exchange company subsidiaries
(generally referred to as "local exchange carriers" or "LECs") which served
7,422 access lines in 9 rural communities in Minnesota and Wisconsin at December
31, 2000. HCC, through its subsidiaries, also provides cable television service
to 4,853 subscribers in Minnesota and Wisconsin.
HCC's 68% owned subsidiary, Alliance Telecommunications Corporation, owns
and operates six additional LEC subsidiaries which served 31,323 access lines in
28 rural communities in Minnesota, Wisconsin, Iowa and South Dakota at December
31, 2000. Alliance, through its subsidiaries, also served 8,318 cable television
subscribers in Minnesota, North Dakota and South Dakota. Golden West
Telecommunications Cooperative, Inc. of Wall, South Dakota, and Split Rock
Telecom Cooperative, Inc. of Garretson, South Dakota own the remaining interests
in Alliance.
Effective June 9, 2000, Alliance acquired all the outstanding common
stock of Hager TeleCom, Inc. ("Hager"); a rural telephone company located in
southwestern Wisconsin. Hager serves approximately 2,100 access lines, provides
internet service to 2,700 customers in Hager, WI and Red Wing, MN and has an
ownership interest in Midwest Wireless Holdings, LLC. Purchase price was
$9,124,500 of cash plus acquisition costs.
[b] FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS
The Company is organized in two business segments, Hector Communications
Corporation and its wholly-owned subsidiaries, and Alliance Telecommunications
Corporation and its subsidiaries. Information regarding segment operations is
provided in Note 11 to the financial statements found under Item 8 of this
report.
[c] NARRATIVE DESCRIPTION OF BUSINESS
(1) Telephone
The Company's LEC subsidiaries provide basic local telephone services to
residential and business customers in Minnesota, Wisconsin, South Dakota, North
Dakota and Iowa. Local service revenues are earned by providing customers with
local service to connecting points within the local exchange boundaries and, in
certain cases, to nearby local exchanges under extended area service ("EAS")
plans that eliminate long distance charges to the neighboring exchanges. Monthly
rates for telephone service differ among the LECs depending upon the cost of
providing service, the type and grade of service, the number of customers and
calling patterns within the toll free calling area and other factors. The
following chart presents the number of access lines served by Hector's and
Alliance's LEC subsidiaries at December 31, 2000, 1999 and 1998:
Access Lines*
---------------------------------------------------------
December 31
--------------------------------------------------
2000 1999 1998
----------- ----------- -----------
Hector Communications Corporation:
Arrowhead Communications Corporation 806 817 780
Eagle Valley Telephone Company 731 734 676
Granada Telephone Company 288 289 274
Pine Island Telephone Company 3,263 3,154 3,019
Indianhead Telephone Company 2,334 2,234 2,109
---------- ---------- ----------
Total Hector Access Lines 7,422 7,228 6,858
---------- ---------- ----------
3
Access Lines*
---------------------------------------------------------
December 31
--------------------------------------------------
2000 1999 1998
----------- ----------- -----------
Alliance Telecommunications Corporation:
Loretel Systems, Inc. 13,234 12,967 12,675
Sleepy Eye Telephone Company 6,511 6,467 6,197
Sioux Valley Telephone Company 5,939 5,756 5,679
Hills Telephone Company 2,788 2,706 2,618
Felton Telephone Company 764 743 735
Hager TeleCom, Inc. 2,087
---------- ---------- ----------
Total Alliance Access Lines 31,323 28,639 27,904
---------- ---------- ----------
Total Access Lines 38,745 35,867 34,762
========== ========== ==========
* An "access line" is a single or multi-party circuit between the customer's
establishment and the central switching office.
The Company's LEC subsidiaries offer their customers a number of enhanced
telecommunications services, including custom calling features like call
waiting, caller identification and voice mail. Charges for custom calling
services are generally billed monthly together with the customers' local service
bill. Internet access is also available, through local dial-up telephone
numbers, to all of the Company's local service customers. The Company provided
internet services to 7,876 customers at December 31, 2000. Digital subscriber
lines ("DSL") permit high-speed Internet access and are available in many of the
Company's service areas.
The Company maintains a local presence in each of its LEC subsidiaries.
The Company provides its LEC subsidiaries with various services, including
finance, accounting and treasury services, marketing, customer service,
purchasing, engineering and construction, customer billing, rate administration,
credit and collection, and development of administrative and procedural
practices.
Access revenues are received by LECs for intrastate and interstate
exchange services provided to long distance carriers (generally referred to as
interexchange carriers or "IXCs"). These services enable IXCs to provide long
distance service to end users in the local exchange network.
Access revenues are determined, in the case of interstate calls,
according to rules promulgated by the Federal Communications Commission ("FCC")
and administered by the National Exchange Carriers Association ("NECA"). In the
case of intrastate calls, access revenues are determined by state regulatory
agencies. A relatively small portion of the Company's access revenues are
derived from subscriber line fees determined by the FCC and billed directly to
end users for access to long distance carriers. The balance of the Company's
interstate access revenues is received from NECA, which collects payments from
IXCs and distributes settlement payments to LECs.
Settlement payments are based on a number of factors, including the cost
of providing service and the amount of time the local network is utilized to
provide long distance services. Since 1984, a variety of factors, including
increased subscriber counts, cultural and technological changes, and rate
reductions by IXCs, have resulted in a consistent pattern of increasing use of
the nation's telephone network. This growth has produced higher revenues for
NECA and increased settlements for its participating LECs. The Company's
settlements from NECA have increased every year since the pool was established
in 1984, but there can be no assurance that this trend will continue.
A portion of the Company's access revenues is received from universal
service funds based upon the high cost of providing service to rural areas.
Interstate universal service fund support accounted for $1,264,000, $1,040,000
and $951,000 of the Company's network access revenues in 2000, 1999 and 1998,
respectively.
HCC's LECs also sell and lease customer premise telephone equipment,
provide inside wiring services and custom calling features, provide Internet
access and sell and lease other facilities for private line, teletype, data
transmission and other communications services. They also provide billing and
collection services for certain IXCs in lieu of such IXCs directly billing
customers within the LEC's service areas.
4
The following table presents the percentage of revenues derived from
local service revenues, access revenues, billing and collection services,
nonregulated telephone activities and cable television operations for the last
three years:
Year Ended December 31
--------------------------------
2000 1999 1998
------- ------- -------
Local network 17.6% 17.3% 16.6%
Network access 55.1 56.9 55.6
Billing and collection 1.8 2.4 2.7
Nonregulated telephone activities 15.0 12.3 15.0
Cable television 10.5 11.1 10.1
------- ------- -------
100.0% 100.0% 100.0%
======= ======= =======
(2) Cable Television
The Company, through its cable television and LEC subsidiaries, owns and
operates 45 cable television systems serving 13,171 subscribers in Minnesota,
North Dakota, South Dakota and Wisconsin. Cable television revenues are derived
almost exclusively from monthly fees for basic and premium programming. Fees for
basic services range from $9.75 to $26.50 per month. Basic service generally
includes the major television networks, non-network independent stations, sports
programming, news services and automated information channels, children's
programming, access channels for public, governmental, educational and leased
use, senior citizens' programming and religious programming. Premium programming
services, such as the HBO or ShowTime movie services, are provided to
subscribers for an additional fee of $1.75 to $11.00 per month per channel.
Approximately one-third of the Company's cable television customers subscribe to
a premium channel. Premium programming is obtained from suppliers for a flat
monthly fee per subscriber and/or a fee based on the monthly charge to
subscribers for the service.
(3) Investments in Unconsolidated Affiliates
Wireless Telephone Services
- ---------------------------
The Company is the largest shareholder of Midwest Wireless Holdings, LLC,
with a 10.4% ownership stake. Midwest Wireless acquired additional wireless
operations in Wisconsin and Iowa in 2000, which significantly increased Midwest
Wireless' service area, but reduced the Company's percentage ownership of the
operation. Midwest Wireless now serves eleven rural service areas and one
metropolitan service area in Minnesota, Wisconsin and Iowa. Population of the
service areas is approximately 1,590,000. Midwest Wireless offers complete
wireless service, including custom calling features, facsimile and data
transmission and presently has 200,000 customers. The Company accounts for its
investment in Midwest Wireless using the equity method. Income recognized was
$1,248,000, $1,481,000, and $1,508,000 in 2000, 1999 and 1998, respectively.
The Company owns 10.4% of Wireless North, which provides personal
communications services ("PCS") to parts of Minnesota, Wisconsin, Iowa, North
Dakota and South Dakota. Wireless North has secured FCC licenses to provide PCS
services in 13 basic trading areas in these states, encompassing 110,000 square
miles and a population of 2.4 million. Wireless North is in its start-up phase,
and is building infrastructure in four markets, where it presently serves 11,000
customers. Its operations have not been profitable to date. Losses recorded by
the Company on this investment were $1,597,000 and $1,066,000 in 1999 and 1998,
respectively. At December 31, 2000, the Company had invested $2,073,000 of cash
and had outstanding loan guarantees of $1,091,000 in Wireless North.
The Company has had a significant investment in Rural Cellular
Corporation ("RCC"), a publicly traded company providing cellular telephone
services in Minnesota and New England. The Company obtained its investment in
RCC through its ownership interests in the RSAs serving northern Minnesota and
through the acquisitions of Ollig Utilities Company and Felton Telephone
Company. Company sales of RCC stock were 326,707 shares and 40,000 shares in
1999 and 1998, respectively. Gains on sales of these securities were $11,600,000
and $179,000 in 1999 and 1998, respectively. At December 31, 2000, the Company
owned approximately 10,700 shares of RCC's common stock.
5
In December 1998, an Alliance subsidiary sold its interest in a cellular
telephone partnership serving the Sioux Falls, South Dakota MSA. Proceeds from
the sale were $6,725,000. Gain on the sale was $4,817,000. Income recognized
from the Company's investment in this partnership was $334,000 in 1998.
Onvoy, Inc.
- -----------
Onvoy, Inc. is a privately held company that provides integrated voice,
data, and network services through its fiber optic communications network
linking communities throughout Minnesota, including all major metropolitan
areas. Onvoy, Inc. is also Minnesota's largest Internet service provider and is
a leading provider of long distance, video- conferencing and high-speed data
networking services. Onvoy's customers include the majority of Minnesota based
Fortune 500 companies and many small-to-medium sized businesses. Onvoy also
serves most of the state's higher education institutions, nearly all of the
state's K-12 schools, public libraries, state and county governments, more than
70 regional Internet service providers and more than two-thirds of the state's
independent local telephone companies.
The Company is presently the second largest common shareholder of
Onvoy. During 2000 the Company also purchased $446,000 of debt issued by Onvoy
to provide additional working capital to Onvoy's operations. However, at the end
of 2000 the Company determined that due to losses incurred by Onvoy's
operations, the value of the Company's investment in Onvoy's common stock was
impaired. Accordingly, the Company established a valuation reserve of $1,273,000
against its investment in Onvoy common stock during the fourth quarter of 2000.
Fiber Optic Transport Facilities
- --------------------------------
The Company has invested approximately $1,341,000 in five companies that
build and lease fiber optic transport facilities. These facilities afford
high-quality, high-capacity communications links and generally are used to carry
long-distance traffic. Through these investments, the Company owns pieces of
fiber routes serving the Twin Cities, Duluth-Superior, Sioux Falls,
Fargo-Moorhead, Rochester, St. Cloud and Grand Forks, and extending into Iowa
and Wisconsin.
Bank Stocks
- -----------
As part of its borrowing agreements, the Company has investments in
CoBank, Rural Telephone Finance Cooperative and the Rural Telephone Bank that
totaled $4,694,000, $4,644,000 and $4,365,000 at December 31, 2000, 1999 and
1998, respectively.
Other Investments
- -----------------
The Company has a small ownership interest in South Dakota Network
Services and Iowa Network Services, each of which provide integrated voice, data
and network services within their respective states. The Company is also an
investor in Fibercom LLC, a CLEC that has been established to provide local
communications services to business customers in the Sioux City, Iowa area.
(4) Competition
Telephone
- ---------
LECs may be subject to many forms of competition. Among potential
competitors are:
- - Facilities-based competition from providers with their own local service
network;
- - Resale competition from resale interconnection (providers who purchase local
services from the LEC at wholesale rates and resell the services to their
customers);
- - Competition from unbundled network element interconnection (providers who
lease some of the network elements from the LEC)
- - Wireless providers who may charge a competitive fee for services that could
compete with wireline based local service.
6
Rural areas like those served by the Company are less likely to
experience competition from facilities-based competitors due to the significant
investment in plant and equipment required in relation to the lower customer
density in rural markets. Competition from resale interconnection or unbundled
network element interconnection is more likely. Under the Telecommunications Act
of 1996, the Company's LECs are not currently required to lease facilities to
competitors seeking to interconnect with our network. However, there is no
assurance that interconnection may not be required in the future.
Most customers currently see wireless telephone service as a
complementary service to traditional wireline based local service. Wireless
service does directly compete with traditional local service among certain
classes of customers, principally customers with seasonal or lake homes.
Developments in technology related to cellular, PCS, digital microwave, coaxial
cable, fiber optics and other wireline or wireless services could also lead to
greater competition for traditional local services.
LECs are increasingly subject to competition from competing access
providers ("CAPs") which construct, modify or lease facilities that enable high
volume long distance users to bypass the local telephone network. Cable
television companies may also be able to modify their networks to carry
telephone messages that bypass the local telephone network. The Company believes
its LEC subsidiaries have experienced only a small loss of traffic due to
bypass.
Cable Television
- ----------------
In addition to competition from off-air television, other technologies
also supply services that compete with cable television. These include low power
television stations, multi-point distribution systems, over-the-air subscription
television and direct broadcast satellite ("DBS"). Cable television also
competes for customers in local markets with providers of other forms of
entertainment, news and information. These competitors include radio,
newspapers, magazines, motion picture theaters, video cassettes and Internet
service providers.
All of the Company's cable television franchises are non-exclusive. The
1992 Cable Act prohibits franchising authorities from unreasonably refusing to
grant franchises to competing cable television systems. The Company competes
with a municipally owned cable system in one community it serves. The degree of
competition from other cable providers will be dependent upon the state and
federal regulations concerning entry, interconnection requirements and the
degree of unbundling of the LECs' networks. Competition will be based upon
product, service quality, breadth of services offered and, to a lesser extent,
on price.
Maintaining and expanding the Company's cable television subscriber base
depends on numerous factors, including the quality and quantity of signals
available from "off-air" television stations, demand for satellite and premium
television channels and average household income in the cable service area.
Promotional efforts for cable television include telephone and door-to-door
selling and local media advertising.
(5) Regulation
The Company's LECs and cable television systems are subject to federal,
state and local regulation. The Communications Act of 1934 and the
Telecommunications Act of 1996 govern Federal regulations. Under these federal
statutes, the FCC exercises jurisdiction over all interstate telecommunications
activities. Intrastate activities are governed by rules and regulations set by
the respective state public utility commissions.
Federal Regulations
- -------------------
Under federal regulations, incumbent local exchange carriers ("ILECs")
are required to comply with the Communications Act of 1934 and rules issued by
the FCC. While the Telecommunications Act of 1996 amended the earlier law to
reduce regulatory burdens and promote competition, ILECs remain subject to
extensive regulatory requirements. ILECs are required to maintain accounting
records according to Uniform System of Accounts, to structure access charges
according to FCC rules and to reflect their charges for interstate services at a
rate of return prescribed by the FCC. The FCC also regulates transfer of control
and assignments of operating authorizations and construction licenses. The FCC
requires carriers providing access services to file tariffs with the FCC
reflecting rates, terms and conditions of the services. Tariffs filed are
subject to review and potential objection by third parties.
7
Regulation of Cost Recovery and Nonregulated Revenue Allocation
- ---------------------------------------------------------------
As a regulated common carrier, the Company's LEC subsidiaries can set
maximum rates at a level that allows recovery of reasonable costs incurred to
provide regulated service and earns a reasonable return on the investment
required to provide these services.
Costs are recovered through:
- - Monthly charges to end users for basic local telephone services and enhanced
services;
- - Access charges to interexchange carriers for originating and terminating
interstate and intrastate interexchange calls; and
- - Payments from the federal Universal Service Fund and the state universal
service funds (where applicable) that offset the high cost of providing
service in certain rural markets.
Rates for regulated services and the amount of universal service fund
support are set forth by the FCC with respect to interstate services and by
state regulatory agencies with respect to intrastate services.
In conjunction with the recovery of costs and establishment of rates, a
LEC must first determine its aggregate costs and then allocate those costs
between regulated and nonregulated services. After identifying the regulated
costs of providing local telephone service, a LEC must allocate those costs
among its various local exchange and interstate and intrastate interexchange
services and between state and federal jurisdictions. Allocating costs is
complicated because the same pieces of a LEC's plant and equipment are utilized
for different services, such as local telephone and interstate and intrastate
access services. The allocation process is called "separation" and is governed
primarily by FCC regulations. The purpose of separation is to determine how a
carrier's expenses are allocated and recovered from federal and state
jurisdictions. The FCC is considering whether to change or eliminate this
process. Any change in separation rules by the FCC could reduce or increase the
LEC's revenues.
Interstate End-User Rates
- -------------------------
The part of the local telephone network running from the switching
facility to the customer is called the "local loop." Costs to construct, operate
and maintain the loop are among the most significant costs incurred by a local
exchange carrier. The FCC has established a rate structure that provides for the
recovery of a portion of the cost of the local loop allocated to interstate
jurisdiction directly from end-users through the assessment of a subscriber line
charge. The remaining portions of the interstate local loop costs are recovered
from interstate access charges to interexchange carriers.
Due to demographic and geographic conditions, costs to provide local loop
and switching services are often higher, on a per customer basis, in rural areas
compared to urban areas. Absent a regulatory framework to permit recovery of
these costs, rural LECs would be compelled to charge considerably higher rates
for local network services. Consequently, the FCC provides for additional
interstate recovery by eligible telecommunications carriers through the federal
Universal Service Fund. Funds from the federal Universal Service Fund are
available to local exchange carriers whose local loop costs are significantly
above the national average as determined by FCC rules.
Interstate Access Rates
- -----------------------
Interstate access rates are developed on the basis of a LEC's measurement
of its interstate costs to provide access service to IXCs divided by its
projected demand for service. The resulting rates are published in the LEC's
interstate access tariff and filed with the FCC, at which time they are subject
to challenge by third parties and to review by the FCC.
The FCC recognized that the rate making and tariff filing process is
administratively burdensome for small local exchange carriers. In 1983, the FCC
established the National Exchange Carriers Association ("NECA") to develop and
administer interstate access service rates, terms and conditions. NECA develops
interstate access rates on the basis of data provided by participating local
exchange carriers and blended to yield average rates. These rates are intended
to generate revenue equal to the aggregate costs plus a return on the investment
of all of the participants.
8
Individual LECs are likely to have service costs that differ from the
revenues generated by applying the overall NECA tariff rates. To allow for this,
revenues generated by participating LECs are pooled and redistributed on the
basis of each individual company's costs. This process eliminates the burden of
individual tariff filing and produces a system in which small companies can
share and spread risk. For example, if a small local exchange carrier filed its
own tariff and subsequently suffered the loss of major customers that utilize
interstate access service, the local exchange carrier could suffer significant
under-recovery of its costs. In the NECA pool environment, the impact of this
loss is reduced because it is spread over all of the pool participants.
NECA operates separate pools for traffic sensitive costs (primarily
switching costs) and non-traffic sensitive costs (primarily loop costs). LECs
can choose to develop and administer their own interstate access charges and not
participate in the NECA pools. HCC's LECs located in Minnesota and Wisconsin
participate in the traffic sensitive NECA pools. HCC's LECs located in Iowa and
South Dakota do not participate in the traffic sensitive NECA pools. All of
HCC's LECs participate in the non-traffic sensitive NECA pools.
The FCC is reviewing its rates and policies governing interstate access
and the rate of return applicable to incumbent local exchange carriers who are
subject to rate-of-return, rather than price cap, regulation. The outcome of
this review could directly affect HCC's earnings. The outcome of this proceeding
cannot be predicted at this time.
The Telecommunications Act
- --------------------------
The Telecommunications Act was enacted to promote competition without
jeopardizing the availability of nationwide universal service at affordable
rates. These two objectives have resulted in a complex set of rules intended to
promote competitive entry in the provision of local telephone services, except
where entry would adversely effect the provision of universal service or the
public interest.
- Promotion of Local Service Competition and the Rural Exemptions
---------------------------------------------------------------
The Telecommunications Act made competitive entry into the local
telephone business more attractive to other carriers by removing barriers to
competition. In order to promote competition the Telecommunications Act
established new interconnection rules, generally requiring local exchange
carriers to allow competing carriers to interconnect with their local networks.
Congress recognized, however, that the desire to promote competition conflicted
with the ability of some existing LECs to provide universal service to high cost
customers. Congress exempted these LECs (classified as "Rural Telephone
Companies") from interconnection requirements until the continuation of the
exemption was no longer required by the public interest, as defined in the
Telecommunications Act.
Under the Telecommunications Act, all local exchange carriers, including
both incumbent local exchange carriers and new competitive carriers, are
required to:
- - Offer reasonable and nondiscriminatory resale of their telecommunications
services,
- - Ensure that customers can keep their telephone numbers when changing carriers,
- - Ensure that competitors' customers can use the same number of digits when
dialing and receive nondiscriminatory access to telephone numbers, operator
service, directory assistance and directory listing,
- - Ensure access to telephone poles, ducts, conduits and rights of way and
- - Compensate competitors for the costs of terminating traffic.
The Telecommunications Act also requires incumbent local exchange
carriers to:
- - Negotiate in good faith the terms and conditions of interconnection with any
competitive carrier making a bona fide request for same,
9
- - Interconnect their facilities and equipment with any requesting
telecommunications carrier at any technically feasible point,
- - Unbundle and provide nondiscriminatory access to unbundled network elements,
such as local loops, switches and transport facilities, at nondiscriminatory
rates and on nondiscriminatory terms and conditions,
- - Offer resale interconnection at wholesale rates,
- - Provide reasonable notice of changes in the information necessary for
transmission and routing of services over the incumbent local exchange
carrier's facilities or in the information necessary for interoperability and
- - Provide for the physical collocation of equipment necessary for
interconnection or access to unbundled network elements at the premises of
the incumbent local exchange carrier, at rates, terms and conditions that are
just, reasonable and nondiscriminatory.
In order to implement interconnection requirements, local exchange
carriers generally enter into negotiated interconnection arrangements with
competing carriers. Local exchange carriers may also offer interconnection
tariffs, available to all competitors.
Competitors are required to compensate a local exchange carrier for the
cost of providing interconnection services. In the case of resale
interconnection, the rules provide that the rates charged should be on a
wholesale basis and reflect the current retail rates of the incumbent local
exchange carrier, excluding the portion of costs avoided by the incumbent local
exchange carrier. In the case of unbundled network element interconnection,
rates are based on costing methodologies that employ a forward-looking economic
cost pricing methodology known as total element long run incremental cost. The
Telecommunications Act specifies that resale and unbundled network element rates
are to be negotiated among the parties, or, if the parties fail to reach an
agreement, arbitrated by the relevant state regulatory authority. Once the
parties have come to agreement, the proposed rates are subject to final approval
by the state regulatory commission.
The Company's LEC subsidiaries are defined as "rural telephone companies"
under the Telecommunications Act. As rural telephone companies, they were
granted rural exemptions from the requirements relating to both resale
interconnection and unbundled network element interconnections. The rural
exemptions are continued until regulatory authorities determine that
interconnection is technically feasible, not unduly economically burdensome and
consistent with the Telecommunications Act's universal service provisions.
- Promotion of Universal Service
------------------------------
While the Telecommunications Act promoted Congress' policy of ensuring
that affordable service is provided to consumers universally in rural, high-cost
areas of the country, the Telecommunications Act altered the framework for
providing universal service by:
- - Providing for the identification of those services eligible for universal
service support,
- - Requiring the FCC to make implicit subsidies explicit,
- - Expanding the types of communications carriers required to pay universal
service support and
- - Allowing competitive local exchange carriers to be eligible for funding.
These and other provisions were intended to make provision of universal
service support compatible with a competitive market.
10
Pursuant to the Telecommunications Act, federal Universal Service Fund
payments are only available to carriers that are designated as eligible
telecommunications carriers by a state public utilities commission. In areas
served by rural LECs, the Telecommunications Act provides that a state public
utilities commission may designate more than one eligible telecommunications
carrier, in addition to the incumbent local exchange carrier, only after
determining that the designation of an additional eligible telecommunications
carrier will serve the public interest. As a result, an incumbent rural LEC has
an opportunity to maintain its status as the sole recipient of federal Universal
Service Fund payments in its service area, even if it is subsequently subjected
to competition. HCC's rural LEC subsidiaries are currently the sole designated
eligible telecommunications carriers in their respective service areas except in
one area where a wireless competitor was approved as an eligible provider. The
addition of a second eligible telecommunications carrier in these service areas
could have the effect of reducing the amount of funds available to HCC's LECs
from the federal Universal Service Fund. Such a reduction could materially
adversely affect HCC's ability to achieve a reasonable rate of return on the
capital invested in its network.
In May 1997, the FCC implemented new rules for interstate universal
service support. The new rules provide for separate federal Universal Service
Fund programs for rural and non-rural telephone companies. The new rules for
non-rural companies base support upon "forward-looking costs" derived from cost
proxy models. It is uncertain whether these models will fully compensate local
exchange carriers for the cost of providing local service in high-cost areas.
The FCC set the implementation date for the new system as January 1, 1999, which
was postponed to January 1, 2000 for non-rural telephone companies. The FCC
established a Rural Task Force, which investigated how to adapt the proxy cost
models approved for larger carriers for rural telephone companies. The Rural
Task Force has proposed that revenues for small rural telephone companies be
based on embedded costs rather than forward looking costs. Such a plan has been
proposed by a multi-association group ("MAG"). The MAG plan is currently in the
comment phase and has not been agreed to by any of the interested parties. The
Company does not expect a new plan to be put in effect before January 1, 2002
and cannot predict the effect of any new plan on operations. In the interim,
support mechanisms for rural carriers remain unchanged.
State Regulation of Rural LECs
- ------------------------------
HCC's LEC subsidiaries are subject to regulation by Minnesota, South
Dakota, Iowa and Wisconsin regulatory agencies with respect to:
- - Intrastate toll rates,
- - Intrastate access charges billed to intrastate IXCs, - Service areas, -
Service standards, - Accounting and related matters, and - The use of radio
frequencies in telephone operations
In some cases state regulations also apply to local service rates, rate
of return, depreciation rates, construction plans and borrowings, and certain
other financial transactions.
Local service rates are not directly determined by regulatory
authorities, but are limited by regulation of these other areas. The Company has
sought appropriate increases in local and other service rates and approval for
changes in rate structures necessary to achieve reasonable rates and earnings.
The bulk of the Company's access lines are located in Minnesota. A bill
passed by the 1995 Minnesota legislature allows telephone companies serving
fewer than 50,000 access lines to elect to provide service under an alternate
form of regulation. Companies choosing alternative regulation agree not to
increase rates for two years, other than in extraordinary circumstances. These
companies are not subject to rate of return review by the Public Utilities
Commission for the same two years. All of HCC's Minnesota-based LEC subsidiaries
elected alternative rate regulation election effective January 1, 1996. Local
rate increases after January 1, 1998 are not subject to review by the Minnesota
Public Utilities Commission unless the lower of 500 or five percent of customers
file a petition requesting such review.
The Minnesota Public Utilities Commission is investigating intrastate
access rates charged by local telephone companies to IXCs. The commission has
proposed a plan reducing intrastate access charges and implementing a state
universal service fund to compensate high cost companies. The Company cannot
predict the outcome of the rate investigation or if any part of the proposed
plan will be adopted.
11
Where applicable, HCC's LECs also participate in intrastate access
tariffs approved by state regulatory authorities for intrastate intra-LATA
(Local Access Transport Area) and inter-LATA services. These intrastate
arrangements are intended to compensate LECs for the costs, including a fair
rate of return, of facilities provided in originating and terminating intrastate
long distance services.
Cable Television System Regulation
- ----------------------------------
The FCC regulates the providers of satellite communications services and
facilities for the transmission of programming services, the cable television
systems that carry such services, and, to some extent, the availability of the
programming services themselves through its regulation of program licensing.
Municipalities and other state and local government authorities also regulate
cable television systems. FCC regulations contain many detailed provisions
including:
o "Must carry" rules regarding the broadcast television and translator signals
that must be included in channel offerings to subscribers, o Exclusivity
provisions which require the deletion of certain programming carried by
out-of-area stations where it would duplicate programming
carried by local stations,
o Technical standards and performance testing requirements, and o
Franchise fees applicable to state and local cable television franchises.
Thus far, HCC's cable systems have not experienced any difficulty in complying
with the FCC rules.
In Minnesota, the award of cable franchises and certain aspects of cable
operations are subject to rules of the Minnesota Cable Communications Board.
Cable television systems are operated under 15 year, non-exclusive franchises
granted by local government authorities. Franchises contain many conditions,
including time limitations on commencement or completion of construction,
approval of initial fees charged to subscribers for basic service, the number of
channels offered and the types of programming. HCC does not anticipate
difficulty in obtaining renewal of its franchises at the expiration of their
current terms.
The regulation of cable television at the federal, state and local levels
is subject to the political process and has been in constant flux over the past
decade. This process continues in the context of legislative proposals for new
laws and the adoption or deletion of administrative regulations and policies.
The Company anticipates further material developments in these areas, but cannot
anticipate their direction and impact on its cable television operations.
(6) Business Strategy
The Company is focused on business opportunities in rural
telecommunications. Its three-part strategy is to:
- - Expand its existing operations through internal growth
- - Pursue acquisitions of attractive properties, particularly the acquisition of
additional rural telephone exchanges and cable television properties
- - Participate in opportunities afforded by new telecommunications technologies
Future growth in existing telephone and cable operations is expected to
come from providing service to new or presently unserved homes and businesses,
from sales of enhanced services to existing customers and from providing new
services made possible by improvements in technology.
The Company continually assesses acquisition opportunities. Competition
to acquire attractive telephone or cable television properties is intense.
Acquisitions of rural telephone exchanges are subject to the approval of
regulatory agencies in some states and, in some cases, to federal waivers that
may affect the form of regulation or amount of interstate cost recovery of
acquired telephone exchanges. The Company will aggressively pursue acquisitions
of telephone exchanges, but there is no assurance that acquisitions can be made
on acceptable terms or that regulatory approval, where required, will be
received.
12
The Company has aggressively invested in new telecommunications
technologies, primarily through investments in partnerships and limited
liability companies. The Company has substantial investments in wireless
communications companies, fiber optic transport groups, CLECs and Internet
service providers. The Company intends to pursue additional investment
opportunities in the future.
(7) Employees
At March 1, 2001, the Company had 168 full-time and part-time employees,
of which 118 employees work in the Alliance operations and 50 work in Hector
operations. None of the Company's employees are represented under collective
bargaining agreements. HCC believes its employee relations to be good.
(8) Executive Officers of Registrant
The executive officers of the Company and their ages at March 1, 2001
were as follows:
Name Age Position
Curtis A. Sampson 67 Chairman of the Board and Chief
Executive Officer
Steven H. Sjogren 58 President and Chief Operating
Officer
Paul N. Hanson 54 Vice President and Treasurer
Charles A. Braun 43 Chief Financial Officer
Executive officers serve at the pleasure of the Board of Directors and
are elected annually for one-year terms. Each officer above has served the
Company in the indicated capacity since 1990.
Mr. Sjogren devotes his full time to the Company's business. Messrs.
Sampson, Hanson and Braun each devote approximately 40% of their working time to
the Company's business with the balance devoted to management responsibilities
at Communications Systems, Inc. ("CSI"), a diversified telecommunications
holding company also located in Hector, Minnesota, for which they are separately
compensated by CSI.
[d] FINANCIAL INFORMATION ABOUT FOREIGN AND DOMESTIC OPERATIONS AND
EXPORT SALES
Not Applicable.
13
ITEM 2. PROPERTIES
The Company's telephone property consists mainly of central office
switching equipment, the land and buildings in which the equipment is housed,
and connecting lines consisting of aerial and underground cable, conduit, and
poles and wires which connect customers' premises with central offices.
Connecting lines are generally located under or above public rights of way or
land owned, for the most part, by others, pursuant to consents of various
governmental bodies or private leases, permits, easements, agreements or
licenses. The Company also owns customer-leased telephones and related terminal
equipment and a small amount of connecting lines that are located on customers'
premises.
The connecting lines constitute approximately 56% of the Company's
telephone property in service. Central office switching equipment represents
approximately 33%. Telephones and related equipment constitute approximately 1%.
Land, buildings, data processing equipment, service vehicles and construction
equipment constitute the remaining 10%. The Company owns substantially all the
land and buildings in which its central office equipment is located. HCC's
principal general offices, administrative services department and business
office are located in Hector, Minnesota and leased to HCC from CSI. Alliance
owns the building in Ada, Minnesota where its general offices are located.
The physical assets of the Company's cable television systems consist of
signal reception equipment and distribution electronics and cables. The
receiving equipment is comprised of a tower and antennas for reception of
broadcast television signals and one or more satellite dishes for reception of
satellite signals. The Company owns or leases the land on which the towers for
its cable systems and the buildings containing other receiving equipment are
located. Pole attachment space is leased from utilities serving the community.
See Note 6 of "Notes to Consolidated Financial Statements" for additional
information regarding pledged assets.
ITEM 3. LEGAL PROCEEDINGS
No material litigation or other claims are presently pending against the
Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
14
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS
[a] MARKET INFORMATION
The Company's common stock is traded on the American Stock Exchange
("AMEX"). The table below presents the range of high and low trading prices for
the Company's stock for each period as reported by AMEX:
2000 1999
------------------------ -------------------------
Quarter High Low High Low
First $ 15.75 $ 11.63 $ 9.63 $ 8.06
Second 14.88 11.38 11.13 8.00
Third 14.25 12.38 14.88 10.00
Fourth 13.25 10.00 17.25 12.00
[b] HOLDERS
At March 1, 2001 there were 561 holders of record of Hector
Communications Corporation common stock.
[c] DIVIDENDS
HCC has not paid cash dividends on its common stock or preferred stock
since it began operating as a public company in 1990, nor does HCC have any
obligations to pay dividends on its preferred stock. The financing agreements
between HCC's subsidiaries and their lenders, and HCC and its lenders restrict
the ability of HCC to pay dividends. At the present time, HCC intends to retain
earnings to finance the expansion of its business, and does not anticipate any
cash dividends will be paid in the foreseeable future. See Management's
Discussion and Analysis of Financial Condition and Results of Operations, and
also Note 6 to the Consolidated Financial Statements under Item 8 herein for a
description of restrictions on dividends.
15
ITEM 6. SELECTED FINANCIAL DATA
SELECTED CONSOLIDATED FINANCIAL INFORMATION
(in thousands except per share amounts)
Year Ended December 31
------------------------------------------------------------
2000 1999 1998 1997 1996
- --------------------------------------------------------------------------------------------------------------------------------
Selected Income Statement Information
Revenues $ 37,790 $ 34,117 $ 31,839 $ 28,866 $ 20,658
Costs and Expenses 26,799 23,063 21,192 19,113 14,066
- --------------------------------------------------------------------------------------------------------------------------------
Operating Income 10,991 11,054 10,647 9,753 6,592
Other Income (Expenses), net (2,471) 7,401 (40) (3,367) (3,518)
- --------------------------------------------------------------------------------------------------------------------------------
Income Before Income Taxes 8,520 18,455 10,606 6,386 3,074
Income Tax Expense 4,207 7,513 4,949 2,867 1,540
- --------------------------------------------------------------------------------------------------------------------------------
Income Before Minority Interest 4,313 10,942 5,657 3,519 1,534
Minority Interest in Earnings of Alliance
Telecommunications Corporation 1,004 3,463 1,747 798 325
- --------------------------------------------------------------------------------------------------------------------------------
Net Income $ 3,309 $ 7,479 $ 3,910 $ 2,721 $ 1,209
================================================================================================================================
Basic Net Income Per Common Share $ .93 $ 2.42 $ 1.63 $ 1.44 $ .65
Diluted Net Income Per Common Share $ .86 $ 1.96 $ 1.15 $ .93 $ .53
Average Shares Outstanding:
Common shares only 3,544 3,095 2,403 1,893 1,870
Common and potential common shares 3,851 3,945 3,937 3,732 3,694
===============================================================================================================================
Selected Balance Sheet Information
Working Capital $ 8,960 $ 18,736 $ 6,554 $ 8,504 $ 1,307
Property, Plant and Equipment, net 56,227 51,410 50,810 45,927 47,039
Excess of Cost Over Net Assets Acquired, net 55,475 51,405 53,004 51,170 52,510
Total Assets 158,678 166,797 150,680 139,291 137,348
Long-Term Debt 84,378 86,282 94,232 97,793 96,127
Stockholders' Equity 39,108 39,982 22,720 14,447 9,946
- --------------------------------------------------------------------------------------------------------------------------------
Operating results for 1996 include the operations of Ollig Utilities Company
from the April 25, 1996 purchase date.
16
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Hector Communications Corporation ("HCC") owns a 100% interest in five
LEC subsidiaries and one cable television subsidiary. At December 31, 2000,
these subsidiaries provided telephone service to 7,422 customers in 9 rural
communities in Minnesota and Wisconsin. They also owned cable television systems
serving 4,853 customers in Minnesota and Wisconsin. HCC's 100%-owned
subsidiaries also have substantial investments in other telecommunications
ventures, including, Midwest Wireless Holdings, LLC and Wireless North LLC.
HCC also owns a 68% interest in Alliance Telecommunications Corporation
("Alliance"). At December 31, 2000, Alliance, through its six LEC subsidiaries,
provided telephone service to 31,323 customers in 28 rural communities in
Minnesota, Wisconsin, South Dakota and Iowa. Alliance's subsidiaries also
provided cable television services to 8,318 subscribers in Minnesota, South
Dakota and North Dakota. Alliance's subsidiaries also own substantial
investments in Midwest Wireless Holdings, LLC, and Wireless North LLC, own
marketable securities portfolios with investments in telecommunications
providers Illuminet Holdings, Inc. and Rural Cellular Corporation, and have
other investments. The minority interest in Alliance is owned by Golden West
Telecommunications Cooperative and Split Rock Telecom Cooperative.
Results of Operations
- ---------------------
2000 Compared to 1999
- ---------------------
Consolidated revenues increased 11% to $37,790,000 in 2000 from
$34,117,000 in 1999. The following table shows revenues by operating group for
2000 compared to 1999:
Alliance Hector
Year Ended December 31 Year Ended December 31
2000 1999 2000 1999
Local network $ 4,934,548 $ 4,250,474 $ 1,715,694 $ 1,664,204
Network access 15,299,095 14,587,083 5,513,268 4,831,878
Billing and collection 527,740 650,839 166,431 173,700
Nonregulated activities 4,879,785 3,527,645 800,130 647,415
Cable television 2,469,407 2,306,786 1,484,004 1,477,292
--------------- ---------------- ---------------- -----------------
$ 28,110,575 $ 25,322,827 $ 9,679,527 $ 8,794,489
--------------- ---------------- ---------------- -----------------
Consolidated local service revenues grew to $6,650,000 in 2000 from
$5,915,000 in 1999, an increase of $735,000 or 12%. Revenue growth was due to
the acquisition of Hager TeleCom, Inc. in June 2000, which added $348,000 to
local service revenues in 2000 and also due to increased demand for telephone
lines to provide advanced telecommunications services such as Internet services.
Network access revenues rose to $20,812,000 in 2000 from $19,419,000 in
1999, an increase of $1,393,000 or 7%. The acquisition of Hager TeleCom, Inc.
accounted for $523,000 of the increase. Increased universal service support
payments accounted for $224,000. The balance was due to increased use of the
telephone network by customers and increased settlements payments from NECA.
Nonregulated revenues grew to $5,680,000 in 2000 from $4,175,000 in 1999,
an increase of $1,505,000 or 36%. The acquisition of Hager TeleCom, Inc.
accounted for $762,000 of the increase. The Company's deregulated revenues
consist mainly of internet service fees, rents from leased of fiber-optic cable
facilities, sales of telecommunications equipment, engineering fees, directory
revenues and sales commissions. Cable television revenues rose to $3,953,000 in
2000 from $3,784,000 in 1999, an increase of $169,000 or 4% due to increased
customer service rates. Billing and collection revenues declined to $694,000 in
2000 from $825,000 in 1999, a decrease of $131,000 or 16% as IXCs continued the
trend toward self-billing of customers.
17
Consolidated operating costs and expenses grew to $26,799,000 in 2000
from $23,063,000 in 1999, an increase of $3,736,000 or 16%. The acquisition of
Hager TeleCom, Inc. accounted for $1,265,000 of the increase. The following
table shows costs and expenses by operating group for 2000 compared to 1999:
Alliance Hector
Year Ended December 31 Year Ended December 31
2000 1999 2000 1999
Plant operations $ 3,586,255 $ 2,944,902 $ 1,224,546 $ 1,142,021
Depreciation and amortization 7,354,503 5,930,740 2,821,781 2,616,879
Customer operations 1,641,054 1,583,327 310,304 329,191
General and administrative 3,842,955 3,149,918 1,772,180 1,544,670
Other operating expenses 2,791,331 2,295,122 1,454,337 1,526,310
--------------- ---------------- ---------------- -----------------
$ 19,216,098 $ 15,904,009 $ 7,583,148 $ 7,159,071
--------------- ---------------- ---------------- -----------------
Consolidated plant operations expenses increased to $4,811,000 in 2000
from $4,087,000 in 1999, an increase of $724,000 or 18% due to the acquisition
of Hager, increased labor costs and increased charges from suppliers.
Depreciation and amortization increased to $10,176,000 in 2000 from $8,548,000
in 1999, an increase of $1,628,000 or 19% due to increased depreciation on new
telephone switching equipment and the acquisition of Hager. Customer operations
expenses increased 2% to $1,951,000 in 2000 from $1,913,000 in 1999 due largely
to growth in the number of customers served. General and administrative expenses
increased to $5,615,000 in 2000 from $4,695,000 in 1999, an increase of $920,000
or 20% due to the acquisition of Hager and increased cable television
administrative fees. Other operating expenses increased $424,000 or 11%.
Consolidated operating income decreased $63,000 or 1% to $10,991,000 in
2000 from $11,054,000 in 1999.
Consolidated interest expenses decreased $628,000 to $5,955,000 in 2000
from $6,583,000 in 1999. The decrease was due to expense reductions on
convertible debentures that were retired or converted into common stock in 1999.
In 2000, the Company had income from unconsolidated affiliates of
$611,000 compared to a loss of $336,000 in 1999. The Company recorded income on
its Wireless North PCS investment (due to adjustments in its debt guarantee) of
$15,000 in 2000 compared to a loss of $1,597,000 in 1999. Income from the
Company's investments in Northern Transport Group and South Dakota Networks
totaled $535,000 in the 2000 period. The Company took a charge against earnings
of $1,273,000 in 2000 based on its revaluation of its investment in Onvoy, Inc.
Income from Midwest Wireless Holdings, LLC decreased to $1,248,000 in 2000 from
$1,481,000,in 1999. The decrease was due to price competition from other
wireless service providers and costs associated with its acquisition of
additional service areas in Iowa and Wisconsin.
Alliance had gains on sales of marketable securities totaling $1,622,000
in 2000 compared to gains on sales of $13,203,000 in 1999. Most of the gains
were on sales of US West (now Qwest) stock sold in 2000 and sales of Rural
Cellular Corporation in 1999. Alliance continues to hold a significant portfolio
of marketable securities. Interest and dividend income increased to $1,251,000
in 2000 from $1,116,000 in 1999 due to investments of the cash proceeds from the
marketable securities sales.
Consolidated income before income taxes decreased to $8,520,000 in 2000
from $18,455,000 in 1999. The Company's effective income tax rate of 49.4% is
higher than the standard U.S. tax rate due to state income taxes and because the
goodwill amortization expenses from the Company's acquisitions cannot be
deducted. Income before the minority interest in Alliance's earnings decreased
to $4,313,000 in 2000 from $10,942,000 in 1999. Minority interest on earnings of
Alliance was $1,004,000 in 2000 compared to $3,463,000 in 1999. Net income
decreased to $3,309,000 in 2000 compared to $7,479,000 in 1999.
18
1999 Compared to 1998
- ---------------------
Consolidated revenues increased 7% from $31,839,000 in 1998 to
$34,117,000 in 1999. The following table shows revenues by operating group for
1999 compared to 1998:
Alliance Hector
Year Ended December 31 Year Ended December 31
1999 1998 1999 1998
Local network $ 4,250,474 $ 3,730,079 $ 1,664,204 $ 1,560,732
Network access 14,587,083 13,480,391 4,831,878 4,229,530
Billing and collection 650,839 683,132 173,700 182,635
Nonregulated activities 3,527,645 4,283,839 647,415 489,528
Cable television 2,306,786 1,774,495 1,477,292 1,424,333
--------------- ---------------- ---------------- -----------------
$ 25,322,827 $ 23,951,936 $ 8,794,489 $ 7,886,758
--------------- ---------------- ---------------- -----------------
Consolidated local service revenues grew from $5,291,000 in 1998 to
$5,915,000 in 1999, an increase of $624,000 or 12%. Revenue growth was due to:
- - Addition of extended area service to Sioux Falls from Alliance's South Dakota
telephone exchanges
- - Increased demand for telephone lines to provide advanced telecommunications
services such as Internet services
- - Increased development within the LECs' service areas, and - The full year
effect of Alliance's acquisition of Felton Telephone Company
("Felton").
The number of access lines served by the LECs increased 3% from 34,762 to
35,867.
Network access revenues rose from $17,710,000 in 1998 to $19,419,000 in
1999, an increase of $1,709,000 or 10%. The increase was chiefly due to
increased use of the telephone network by customers, increased settlements
payments from NECA and increased universal service support funds.
Nonregulated revenues fell from $4,773,000 in 1998 to $4,175,000 in 1999,
a decrease of $598,000 or 13%. Revenue decreases from equipment leases in 1999
more than offset increased Internet revenues. Cable television revenues rose
from $3,199,000 in 1998 to $3,784,000 in 1999, an increase of $585,000 or 18%
due to rate increases and the full-year effect of the June 1998 acquisition by
Alliance of additional cable systems from Spectrum Cablevision Limited
Partnership. Billing and collection revenues declined from $866,000 in 1998 to
$825,000 in 1999, a decrease of $41,000 or 5% as IXCs continued the trend toward
self-billing of customers.
Consolidated operating costs and expenses grew from $21,192,000 in 1998
to $23,063,000 in 1999, an increase of $1,871,000 or 9%. The following table
shows costs and expenses by operating group for 1999 compared to 1998:
Alliance Hector
Year Ended December 31 Year Ended December 31
1999 1998 1999 1998
Plant operations $ 2,944,902 $ 2,821,318 $ 1,142,021 $ 933,994
Depreciation and amortization 5,930,740 5,712,509 2,616,879 2,068,701
Customer operations 1,583,327 1,549,019 329,191 254,649
General and administrative 3,149,918 2,575,215 1,544,670 1,375,954
Other operating expenses 2,295,122 2,646,862 1,526,310 1,253,586
--------------- ---------------- ---------------- -----------------
$ 15,904,009 $ 15,304,923 $ 7,159,071 $ 5,886,884
--------------- ---------------- ---------------- -----------------
Consolidated plant operations expenses increased from $3,755,000 in 1998
to $4,087,000 in 1999, an increase of $332,000 or 9%, due to training and
maintenance contracts associated with new telephone switches and offerings of
enhanced telephone services. Depreciation and amortization increased from
$7,781,000 in 1998 to $8,548,000 in 1999, an increase of $767,000 or 10% due to
increased depreciation on new telephone switching equipment. Customer operations
expenses increased 6% from $1,804,000 in 1998 to $1,913,000 in 1999 due largely
to growth in the number of customers served. General and administrative expenses
increased from $3,951,000 in 1998 to $4,695,000 in 1999, an increase of $744,000
or 19% due to increased cable television selling and administrative expenses.
Other operating expenses decreased $79,000 or 2%.
19
Consolidated operating income increased $407,000 or 4% from $10,647,000
in 1998 to $11,054,000 in 1999.
Consolidated interest expenses decreased $732,000 from $7,315,000 in 1998
to $6,583,000 in 1999. The decrease was due to expense reductions on convertible
debentures that were retired or converted into common stock in 1998 and 1999.
In 1999, the Company had a loss from investments in unconsolidated
affiliates of $336,000 compared to income of $883,000 in 1998. The Company's
share of loss from its Wireless North PCS investment was $1,597,000 in 1999
compared to $1,066,000 in 1998. Income from Midwest Wireless Holdings, LLC
decreased from $1,508,000 in 1998 to $1,481,000,in 1999. The decrease was due to
price competition from other wireless service providers. The Company had income
in 1998 from the Sioux Falls, South Dakota MSA, prior to its sale by Alliance,
of $334,000 in 1998 compared to no income in 1999.
Alliance had gains on sales of marketable securities totaling $13,203,000
in 1999 compared to gains on sales of $965,000 in 1998. Most of the gains were
on sales of Rural Cellular Corporation stock that Alliance sold over the course
of 1999. Alliance continues to hold a significant portfolio of marketable
securities. Consolidated investment income increased $507,000 from $609,000 in
1998 to $1,116,000 in 1999 due to investments of the cash proceeds from the
marketable securities sales. Alliance's 1998 income included a gain before
income taxes of $4,817,000 from the sale of its 12.25% interest in a cellular
telephone partnership serving the Sioux Falls, South Dakota MSA to CommNet
Cellular, Inc.
Consolidated income before income taxes increased from $10,606,000 in
1998 to $18,455,000 in 1999. The Company's effective income tax rate of 40.7% is
higher than the standard U.S. tax rate due to state income taxes and because the
goodwill amortization expenses from the acquisition of Ollig Utilities cannot be
deducted. Income before the minority interest in Alliance's earnings increased
93% from $5,657,000 in 1998 to $10,942,000. Minority interest on earnings of
Alliance were $3,463,000 in 1999 compared to $1,747,000 in 1998. Net income
increased 91% to $7,479,000 in 1999 compared to $3,910,000 in 1998.
Liquidity and Capital Resources
- -------------------------------
Operations
----------
Cash flows from consolidated operating activities were $7,981,000,
$6,693,000 and $9,623,000 in 2000, 1999 and 1998, respectively. The increase in
cash flows from operations in 2000 was due to higher levels of noncash expenses
in 2000. At December 31, 2000, the Company's cash, cash equivalents and
marketable securities totaled $16,729,000 compared to $39,274,000 at December
31, 1999. Alliance's cash and securities were $10,225,000 of this total at
December 31, 2000. Working capital at December 31, 2000 was $8,960,000 compared
to $18,736,000 at December 31, 1999. The current ratio was 1.8 to 1 at December
31, 2000 compared to 2.3 to 1 at December 31, 1999. Most of the decrease in
working capital was due to cash payments made to acquire Hager TeleCom, Inc.
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 2000, 1999 and 1998 were $3,111,000, $2,902,000 and
$2,652,000, respectively. Alliance's plant additions in 2000 (excluding the
acquisition of Hager TeleCom, Inc.), 1999 and 1998 (excluding the acquisitions
of Felton and Spectrum) were $6,335,000, $4,640,000 and $5,163,000,
respectively. Plant additions for 2001 for Hector and Alliance are expected to
total $4,530,000 and $7,109,000, respectively. These plant additions will
provide customers with additional advanced telecommunications services and
expand usage of high capacity fiber optics in the telephone network. The Company
has contracted with Next Level Communications to provide $1,433,000 of broadband
equipment as part of these additions.
20
Investments
-----------
Investment income has been derived almost exclusively from interest
earned on the Company's cash and cash equivalents. Interest income has
fluctuated in relation to changes in interest rates and availability of cash for
investment. In 2000, Alliance received $5,421,000 from sales of marketable
securities, principally USWest common stock. In 1999, Alliance received
$18,920,000 from sales of marketable securities, principally Rural Cellular
Corporation common stock. In 1998, Alliance received $1,820,000 from sales of
interests in Rural Cellular Corporation, MediaOne Group, Inc., Comnet Cellular,
Inc. and Illuminet Holdings, Inc. At December 31, 2000, Alliance continued to
maintain a significant marketable securities portfolio consisting primarily of
shares of Illuminet Holdings, Inc. and Rural Cellular Corporation.
The Company is an investor in Wireless North LLC, a limited liability
corporation that has licenses to operate PCS systems in 13 markets in Minnesota,
Wisconsin, North Dakota and South Dakota. The Company invested cash of $183,000,
$1,032,000 and $761,000 in Wireless North in 2000, 1999 and 1998, respectively.
Cash received as return of capital in 2000 due to investment by Touch America,
Inc. in Wireless North were $409,000. Investments in Wireless North prior to
1998 consisted of $510,000 of cash and debt guarantees which have been reduced
by $282,000 to $1,091,000. The PCS systems are in start-up mode and continue to
incur significant losses. Wireless North is currently up for sale and
expressions of interest have been received from other investors. The Company has
accrued losses on Wireless North up to the total of its cash investments and
loan guarantees. It cannot predict the effect a sale of Wireless North would
have on its future financial results.
The Company continues to maintain its ownership in Midwest Wireless
Holdings, LLC through acquisition of additional partnership interests. The
acquisition of Hager TeleCom, Inc. added .8% to the Company's ownership
interest. Cash expended to purchase Midwest Wireless Holdings, LLC interests was
$380,000 in 1998. At December 31, 2000, the Company's ownership percentage
totaled 10.4%. In December, 1998, the Company sold its 12.25% interest in Sioux
Falls Cellular, Ltd., which provides cellular service in the Sioux Falls, South
Dakota MSA to CommNet Cellular, Inc. for $6,725,000.
The Company's Alliance subsidiary has committed to invest $600,000 in
2001 to support the CLEC operations in Breckenridge, MN and Wahpeton, ND of 702
Communications (Val Ed Co.). The Company cannot predict if additional funds
beyond this amount will be required.
Debt and Loan Commitments
-------------------------
As part of financing its 68% ownership interest in Alliance, the Company
borrowed $6,000,000 from CoBank (St. Paul Bank for Cooperatives before its 1999
merger with CoBank). In 1998, the Company replaced the loan with a 15-year term
loan from Rural Telephone Finance Cooperative ("RTFC"). The interest rate on the
loan varies according to the rate RTFC charges for similar loans. The interest
rate was 8.4% at December 31, 2000.
The Company carries a significant amount of debt due to Alliance`s
borrowing to finance the acquisition of Ollig Utilities Company. Interest rates
on Alliance's acquisition loan from CoBank have been locked for periods of one
to ten years at rates averaging 7.5%. The outstanding balance on this loan at
December 31, 2000 was $44,902,300. CoBank is a cooperative, owned and controlled
by its customers. Each customer borrowing from the bank on a patronage basis
shares in the bank's net income through payment of patronage refunds. As a
condition of maintaining the loan, Alliance invested $344,000 and $509,000 of
cash in the bank in 1999 and 1998, respectively. The Company recorded a loss of
$200,000 in 1999 due to writedown of the value of this bank stock in the merger
between CoBank and St. Paul Bank for Cooperatives.
In 1995 the Company made a public offering of 8.5% convertible
subordinated debentures. Value of the offering was $12,650,000. Proceeds to the
Company, after underwriting, accounting and legal expenses were $11,300,000.
During 1999 and 1998, the Company issued calls to retire the debentures, which
resulted in $10,757,000 of debentures being converted into stock and $1,893,000
of debentures being purchased and retired.
21
The Company's LEC subsidiaries borrow from the Rural Utilities Service
("RUS") and the Rural Telephone Bank ("RTB") to help finance asset additions.
Proceeds from long-term borrowings from RUS and RTB were $700,000, $6,156,000
and $737,000 in 2000, 1999 and 1998, respectively. The average interest rate on
outstanding RUS and RTB loans is 5.5%. At December 31, 2000 unadvanced loan
commitments from the RUS and RTB to Hector's and Alliance's LEC subsidiaries
totaled $11,498,000. Subsequent to year end, an Alliance subsidiary received
preliminary commitments from RUS & RTB for a new $13,000,000 loan.
The Company's loan agreements place significant restrictions on cash
distributions from the subsidiaries to the parent company. Substantially all of
the LEC's assets are pledged or are subject to mortgages to secure obligations
to the RUS and RTB. Alliance's loan covenants with CoBank also restrict dividend
payments at the Alliance level. A portion of any dividend payment from Alliance
to Hector would also be subject to federal and state income taxes. It is the
Company's plan, in so far as possible, to maintain its cash balances at the
subsidiary level to support their operations.
By utilizing cash flow from operations, current cash and investment
balances, and other available financing sources, the Company feels it has
adequate resources to meet its anticipated operating, debt service and capital
expenditure requirements.
Acquisitions
------------
Effective June 9, 2000, Alliance acquired all the outstanding common
stock of Hager TeleCom, Inc. ("Hager"); a rural telephone company located in
southwestern Wisconsin. Hager serves approximately 2,100 access lines, provides
internet service to 2,700 customers in Hager, WI and Red Wing, MN and has an
ownership interest in Midwest Wireless Holdings, LLC. Purchase price was
$9,124,500 of cash plus acquisition costs.
Effective April 1, 1998, Alliance acquired all the outstanding common
stock of Felton Telephone Company ("Felton"); a rural telephone company located
in northwestern Minnesota adjacent to areas already served by the Company's
telephone subsidiaries. Felton serves approximately 700 access lines and held a
significant portfolio of marketable securities, including investments in Rural
Cellular Corporation, U.S. West Communications, Inc. and MediaOne Group, Inc.
Purchase price was $3,650,000, which includes a cash downpayment and seller
financing of the balance through a $3,149,000 note payable bearing interest at
8.25%. The note matures April 1, 2005.
Effective June 9, 1998, Alliance acquired the assets of 8 cable
television systems serving 4,000 customers in 19 rural communities in Minnesota
and North Dakota from Spectrum Cablevision Limited Partnership ("Spectrum").
Several of these communities are also served by Alliance's telephone
subsidiaries. Purchase price was approximately $4,559,000. Financing for this
purchase included $2,000,000 from a new line of credit arrangement with Rural
Telephone Finance Cooperative. In 1997, Alliance acquired one small system for
$120,000.
The Company is always looking to acquire properties that advance its plan
to be a provider of top quality telecommunications services to rural customers.
In the past, the Company has been a member of investor groups that sought
unsuccessfully to acquire rural telephone properties offered for sale by GTE and
Qwest. The Company cannot predict if it will be successful in acquiring
additional properties and does not currently have financing plans in place to
pay for possible acquisitions.
Effects of Inflation
- --------------------
The Company's local exchange telephone companies are subject to the
jurisdiction of Minnesota, Iowa, South Dakota and Wisconsin regulatory
authorities with respect to a variety of matters, including rates for intrastate
access services, the conditions and quality of service, issuance of debt,
depreciation rates and accounting methods. Rates for local telephone service are
not established directly by regulatory authorities, but their authority over
other matters limits the Company's ability to implement rate increases. In
addition, the regulatory process inherently restricts the Company's ability to
immediately pass cost increases along to customers unless the cost increases are
anticipated and the rate increases implemented prospectively.
22
New Accounting Standards
- ------------------------
In June 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative
Instruments and Hedging Activities" (as amended) which was to be effective
January 1, 2000 but was deferred to fiscal years beginning after June 15, 2000.
The Company has not yet determined the impact of this pronouncement on its
financial statements.
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101, (SAB 101), "Revenue Recognition in Financial
Statements". SAB 101 summarizes certain of the staff's views regarding generally
accepted accounting principles for revenue recognition and deferred costs in the
financial statements. SAB 101 did not have a material effect on the Company's
financial statements.
Factors Affecting Future Performance
- ------------------------------------
From time to time in reports filed with the Securities and Exchange
Commission, in press releases, and in other communications to shareholders and
the investing public, the Company may make statements regarding the Company's
future financial performance. Such forward looking statements are subject to
risks and uncertainties, including but not limited to, the effects of the
Telecommunications Act, new technological developments which may reduce barriers
for competitors entering the Company's local exchange or cable television
markets, higher than expected expenses and other risks involving the
telecommunications industry generally. All such forward-looking statements
should be considered in light of such risks and uncertainties.
23
REPORT OF MANAGEMENT
The management of Hector Communications Corporation and its subsidiary companies
is responsible for the integrity and objectivity of the financial statements and
other financial information contained in the annual report. The financial
statements and related information were prepared in accordance with generally
accepted accounting principles and include amounts that are based on
management's informed judgments and estimates.
In fulfilling its responsibilities for the integrity of financial information,
management maintains accounting systems and related controls. These controls
provide reasonable assurance, at appropriate costs, that assets are safeguarded
against losses and that financial records are reliable for use in preparing
financial statements. Management recognizes its responsibility for conducting
the Company's affairs according to the highest standards of personal and
corporate conduct.
The Audit Committee of the Board of Directors, composed solely of outside
directors, meets with the independent auditors and management periodically to
review accounting, auditing, financial reporting and internal control matters.
The independent auditors have free access to this committee, without management
present to discuss the results of their audit work and their opinion on the
adequacy of internal financial controls and the quality of financial reporting.
/s/ Curtis A. Sampson
-----------------------------------
Curtis A. Sampson
Chairman and Chief Executive Officer
/s/ Charles A. Braun
-----------------------------------
Charles A. Braun
March 29, 2001 Chief Financial Officer
24
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
(a) FINANCIAL STATEMENTS
INDEPENDENT AUDITORS' REPORT
Shareholders and Board of Directors
Hector Communications Corporation
We have audited the accompanying consolidated balance sheets of Hector
Communications Corporation and subsidiaries as of December 31, 2000 and 1999 and
the related consolidated statements of income and comprehensive income,
stockholders' equity, and cash flows for each of the three years in the period
ended December 31, 2000. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Hector
Communications Corporation and subsidiaries as of December 31, 2000 and 1999 and
the results of their operations and their cash flows for each of the three years
in the period ended December 31, 2000 in conformity with accounting principles
generally accepted in the United States.
/s/ Olsen Thielen & Co., Ltd.
- -----------------------------
Olsen Thielen & Co., Ltd.
February 14, 2001
St. Paul, Minnesota
25
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
ASSETS
December 31
----------------------------------
2000 1999
------------- -------------
CURRENT ASSETS:
Cash and cash equivalents $ 13,834,110 $ 27,055,772
Construction fund (Note 6) 317,837 283,604
Accounts receivable (net of allowance for doubtful accounts of
$360,000 and $447,000, respectively) 5,548,622 4,854,365
Materials, supplies and inventories, at average cost 825,673 616,985
Other current assets 302,704 171,432
------------- -------------
TOTAL CURRENT ASSETS 20,828,946 32,982,158
PROPERTY, PLANT AND EQUIPMENT,net (Notes 1 and 5) 56,226,525 51,410,033
OTHER ASSETS:
Excess of cost over net assets acquired, less amortization
of $8,212,000 and $6,473,000 (Note 1) 55,475,430 51,405,010
Marketable securities (Note 3) 2,895,272 12,218,303
Wireless telephone investments (Note 4) 12,509,975 9,688,981
Other investments (Notes 1 and 6) 10,527,727 8,768,797
Other assets (Note 1) 214,106 323,405
------------- -------------
TOTAL OTHER ASSETS 81,622,510 82,404,496
------------- -------------
TOTAL ASSETS $ 158,677,981 $ 166,796,687
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Notes payable and current portion of long-term debt (Note 6) $ 6,337,200 $ 5,607,100
Accounts payable (Note 10) 2,664,520 2,481,507
Accrued expenses 2,479,779 2,184,626
Income taxes payable 387,100 3,973,019
------------- -------------
TOTAL CURRENT LIABILITES 11,868,599 14,246,252
LONG-TERM DEBT, less current portion (Note 6) 84,378,149 86,281,656
DEFERRED INVESTMENT TAX CREDITS (Note 7) 79,668 140,386
DEFERRED INCOME TAXES (Note 7) 6,603,310 9,435,515
DEFERRED COMPENSATION (Note 9) 904,071 897,113
COMMITMENTS AND CONTINGENCIES (Note 4)
MINORITY INTEREST IN ALLIANCE TELECOMMUNICATIONS, CORP. 15,736,317 15,813,847
STOCKHOLDERS' EQUITY: (Notes 1, 6 and 8)
Preferred stock, par value $1.00 per share; 3,000,000 shares authorized:
Convertible Series A, 221,300 and 229,300 shares issued and outstanding 221,300 229,300
Common stock, par value $.01 per share; 10,000,000 shares authorized;
3,504,363 and 3,574,712 shares issued and outstanding 35,044 35,747
Additional paid-in capital 12,844,776 13,274,444
Retained earnings 24,945,512 23,115,945
------------- -------------
38,046,632 36,655,436
Accumulated other comprehensive income (Note 3) 1,061,235 3,326,482
------------- -------------
TOTAL STOCKHOLDERS' EQUITY 39,107,867 39,981,918
------------- -------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 158,677,981 $ 166,796,687
============= =============
See notes to consolidated financial statements.
26
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
Year Ended December 31
------------------------------------------------
2000 1999 1998
------------- ------------- -------------
REVENUES:
Local network $ 6,650,242 $ 5,914,678 $ 5,290,811
Network access 20,812,363 19,418,961 17,709,921
Billing and collection 694,171 824,539 865,767
Nonregulated activities 5,679,915 4,175,060 4,773,367
Cable television revenues 3,953,411 3,784,078 3,198,828
------------- ------------- -------------
TOTAL REVENUES 37,790,102 34,117,316 31,838,694
COSTS AND EXPENSES:
Plant operations 4,810,801 4,086,923 3,755,312
Depreciation and amortization 10,176,284 8,547,619 7,781,210
Customer operations 1,951,358 1,912,518 1,803,668
General and administrative 5,615,135 4,694,588 3,951,169
Other operating expenses 4,245,668 3,821,432 3,900,448
------------- ------------- -------------
TOTAL COSTS AND EXPENSES 26,799,246 23,063,080 21,191,807
------------- ------------- -------------
OPERATING INCOME 10,990,856 11,054,236 10,646,887
OTHER INCOME (EXPENSES):
Interest expense (5,954,603) (6,582,536) (7,315,153)
Income (loss) from investments in unconsolidated
affiliates (Note 4) 610,846 (335,537) 883,096
Interest and dividend income 1,250,748 1,116,098 609,071
Gain on sale of marketable securities (Note 3) 1,622,226 13,203,062 965,069
Gain on sale of cellular partnership (Note 4) 4,817,498
------------- ------------- -------------
OTHER INCOME (EXPENSES), net (2,470,783) 7,401,087 (40,419)
------------- ------------- -------------
INCOME BEFORE INCOME TAXES 8,520,073 18,455,323 10,606,468
INCOME TAX EXPENSE (Note 7) 4,207,000 7,513,000 4,949,000
------------- ------------- -------------
INCOME BEFORE MINORITY INTEREST 4,313,073 10,942,323 5,657,468
MINORITY INTEREST IN EARNINGS OF
ALLIANCE TELECOMMUNICATIONS CORPORATION 1,003,650 3,463,142 1,747,225
------------- ------------- -------------
NET INCOME 3,309,423 7,479,181 3,910,243
------------- ------------- -------------
OTHER COMPREHENSIVE INCOME (LOSS):
Unrealized holding gains (losses) on marketable securities (3,903,896) 20,784,075 492,287
Reclassification adjustment for gains included in net income (1,622,226) (13,203,062) (965,069)
------------- ------------- -------------
OTHER COMPREHENSIVE INCOME (LOSS) BEFORE
INCOME TAXES (5,526,122) 7,581,013 (472,782)
------------- ------------- -------------
Income tax expense (benefit) related to unrealized
holding gains and losses on marketable securities (1,539,833) 8,450,555 189,519
Income tax benefit related to reclassification adjustment for
gains included in net income (639,862) (5,368,207) (371,529)
------------- ------------- -------------
Income tax expense (benefit) related to items of other
comprehensive income (loss) (2,179,695) 3,082,348 (182,010)
Minority interest in other comprehensive income (loss) of
Alliance Telecommunications Corporation (1,081,180) 1,559,887
------------- ------------- -------------
Other Comprehensive Income (Loss) (2,265,247) 2,938,778 (290,772)
------------- ------------- -------------
COMPREHENSIVE INCOME $ 1,044,176 $ 10,417,959 $ 3,619,471
============= ============= =============
BASIC NET INCOME PER COMMON SHARE (Note 1) $ .93 $ 2.42 $ 1.63
============= ============= =============
DILUTED NET INCOME PER COMMON SHARE (Note 1) $ .86 $ 1.96 $ 1.15
============= ============= =============
AVERAGE SHARES OUTSTANDING (Notes 1 and 8):
Common shares only 3,544,000 3,095,000 2,403,000
Common and potential common shares 3,851,000 3,945,000 3,937,000
See notes to consolidated financial statements.
27
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Unearned
Employee Accumulated
Additional Stock Other
Preferred Stock Common Stock Paid-in Retained Ownership Comprehensive
Shares Amount Shares Amount Capital Earnings 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 7,479,181 7,479,181
Issuance of common stock under
Employee Stock Purchase Plan 14,890 149 104,267 104,416
Issuance of common stock under
Employee Stock Option Plan 43,675 437 361,475 361,912
Issuance of common stock in
exchange for preferred stock (113,500) (113,500) 113,500 1,135 112,365 0
Issuance of common stock from
exercise of outstanding warrants 8,742 87 (87) 0
Conversion of convertible
debenturex into common stock 730,438 7,304 6,350,007 6,357,311
Issuance of common stock to ESOP 2,405 24 19,976 20,000
Change in unrealized gains on
marketable securities, net of
deferred taxes 2,938,777 2,938,777
------- -------- --------- ------- ----------- ----------- ---------- ---------- -----------
BALANCE AT DECEMBER 31, 1999 229,300 229,300 3,574,712 35,747 13,274,444 23,115,945 - 3,326,482 39,981,918
Net income 3,309,423 3,309,423
Issuance of common stock under
Employee Stock Purchase Plan 10,742 108 115,167 115,275
Issuance of common stock under
Employee Stock Option Plan 37,620 376 266,813 267,189
Issuance of common stock in
exchange for preferred stock (8,000) (8,000) 8,000 80 7,920 0
Issuance of common stock from
exercise of outstanding warrants 88,311 883 756,417 757,300
Issuance of common stock to ESOP 6,928 69 96,923 96,992
Purchase and retirement of
common stock (221,950) (2,219) (1,672,908) (1,479,856) (3,154,983)
Change in unrealized gains on
marketable securities, net of
deferred taxes (2,265,247) (2,265,247)
------- -------- --------- ------- ----------- ----------- ---------- ---------- -----------
BALANCE AT DECEMBER 31, 2000 221,300 $221,300 3,504,363 $35,044 $12,844,776 $24,945,512 $ - $1,061,235 $39,107,867
======= ======== ========= ======= =========== =========== ========== ========== ===========
See notes to consolidated financial statements.
28
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31
------------------------------------------------
2000 1999 1998
------------- ------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income $ 3,309,423 $ 7,479,181 $ 3,910,243
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 10,177,520 8,663,181 7,957,527
Minority stockholders' interest in earnings
of Alliance Telecommunications Corporation 1,003,650 3,463,142 1,747,225
Gain on sales of marketable securities (1,622,226) (13,203,062) (965,069)
Gain on sale of wireless partnership investment (4,817,498)
Loss (income) from unconsolidated affiliates (610,846) 335,537 (883,096)
Proceeds from wireless cellular investments 716,653 709,668 1,206,505
Noncash patronage refunds (8,780) (12,569)
Changes in assets and liabilities net of effects from
the purchase of Hager Telecom, Inc. and Felton Telephone Company:
Increase in accounts receivable (566,951) (727,508) (37,845)
Decrease (increase) in materials, supplies and inventories (172,847) (88,146) 21,188
Decrease in other current assets 111,795 8,702 46,455
Increase (decrease) in accounts payable (62,254) 7,981 866,321
Increase (decrease) in accrued expenses 121,137 477,147 (193,287)
Increase (decrease) in income taxes payable (3,426,965) 1,942,370 1,455,010
Decrease in deferred investment tax credits (60,718) (112,215) (136,016)
Decrease in deferred income taxes (934,383) (2,157,467) (604,706)
Increase (decrease) in deferred compensation 6,958 (93,042) 49,730
------------- ------------- -------------
Net cash provided by operating activities 7,981,166 6,692,900 9,622,687
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property, plant and equipment (9,446,190) (7,541,926) (9,716,135)
Sales of temporary cash investments 300,000
Sales of marketable securities 5,420,957 18,920,352 1,819,653
Purchases of marketable securities (1,768,648)
Investments in wireless telephone (183,276) (1,031,587) (1,140,457)
Proceeds from wireless PCS investments 408,846
Decrease (increase) in construction fund 8,169 (83,113) (122,801)
Purchases of other investments (2,393,458) (1,052,230) (1,083,592)
Proceeds from other investments 205,584 463,734 114,536
Proceeds from sale of wireless partnership investment 6,725,140
Decrease (increase) in excess of cost over net assets acquired 15,170 (2,797,123)
Decrease (increase) in other assets 109,954 (52,109) (62,012)
Increase in cash from purchase of Felton Telephone Company 196,500
Payments for purchase of Hager Telecom, Inc., net of cash acquired (8,532,392)
------------- ------------- -------------
Net cash provided by (used in) investing activities (14,401,806) 7,869,643 (5,766,291)
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of notes payable and long-term debt (5,485,803) (8,815,220) (8,911,738)
Proceeds from issuance of notes payable and long-term debt 700,000 6,156,087 6,733,179
Issuance of common stock 1,139,764 466,328 489,703
Purchase of stock (3,154,983)
ESOP shares allocated 63,095
------------- ------------- -------------
Net cash used in financing activities (6,801,022) (2,192,805) (1,625,761)
------------- ------------- -------------
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (13,221,662) 12,369,738 2,230,635
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 27,055,772 14,686,034 12,455,399
------------- ------------- -------------
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 13,834,110 $ 27,055,772 $ 14,686,034
============= ============= =============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Interest paid $ 6,189,304 $ 6,700,250 $ 7,096,930
Income taxes paid 8,639,597 7,840,312 4,262,666
See notes to consolidated inancial statements.
29
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
- ---------------------------------------------------
Description of business: Hector Communications Corporation owns a 100% interest
in five local exchange telephone subsidiaries and one cable television
subsidiary. The Company also owns a 68% interest in Alliance Telecommunications
Corporation, which owns and operates six local exchange telephone companies, two
cable television companies, an engineering company, and a credit card
communications company. At December 31, 2000, the Company's wholly and majority
owned subsidiaries provided telephone service to 38,745 access lines in 37 rural
communities in Minnesota, Wisconsin, South Dakota and Iowa. Its cable television
operations provided cable television services to 13,171 subscribers in
Minnesota, South Dakota and Wisconsin. The Company is also an investor in
partnerships and corporations providing wireless telephone and other
telecommunications related services.
Principles of consolidation: The consolidated financial statements include the
accounts of Hector Communications Corporation and its wholly and majority owned
subsidiaries ("HCC" or the "Company"). All material intercompany transactions
and accounts have been eliminated.
Regulatory accounting: Accounting practices prescribed by regulatory authorities
have been considered in the preparation of the financial statements and
formulation of accounting policies for telephone subsidiaries. These policies
conform to generally accepted accounting principles as applied to regulated
public utilities in accordance with Statement of Financial Accounting Standards
No. 71, "Accounting for the Effects of Certain Types of Regulation" (SFAS 71).
Accounting estimates: The presentation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets,
liabilities, and disclosure of contingent assets and liabilities at the balance
sheet date, and the reported amounts of revenues and expenses during the
reporting period. The estimates and assumptions used in the accompanying
consolidated financial statements are based upon management's evaluation of the
relevant facts and circumstances as of the time of the financial statements.
Actual results could differ from those estimates. The Company's financial
statements are also affected by depreciation rates prescribed by regulators,
which may result in different depreciation rates than for an unregulated
enterprise.
Property, plant and equipment: Property, plant and equipment is recorded at
cost. Depreciation is computed using principally the straight-line method.
Depreciation included in costs and expenses was $8,415,178, $6,942,357 and
$6,260,624 for 2000, 1999 and 1998, respectively. Maintenance and repairs are
charged to operations and additions or improvements are capitalized. Items of
property sold, retired or otherwise disposed of in the ordinary course of
business are removed from assets and any gains or losses are included in
accumulated depreciation.
Wireless telephone investments: The Company has significant investments in
Midwest Wireless Holdings, LLC and Wireless North, LLC. The Company is the
largest shareholder of Midwest Wireless Holdings, LLC and the fourth largest
shareholder of Wireless North, LLC and has the ability to influence the
operating and financial policies of these companies. The Company recognizes
income and losses from these investments on the equity method of accounting.
Income and losses recognized from these investments are material to the
Company's operating results.
Other assets: The excess of cost over net assets of subsidiaries acquired in
purchase transactions is being amortized on the straight-line method over
periods ranging from fifteen to forty years. Amortization included in costs and
expenses was $1,739,225, $1,583,380 and $1,499,456 in 2000, 1999 and 1998,
respectively.
30
In 1999 and 1998 the Company amortized debenture issue incurred in completing
its February, 1995 public offering of convertible subordinated debentures. The
debenture issue costs were amortized over the expected life of the debentures
(Note 6). Amortization cost included in interest expense was $115,562 and
$176,317 in 1999 and 1998, respectively. When the debentures were converted into
common stock, the remaining issue costs were charged to capital. $256,151 and
$233,549 of debenture issue costs were charged to capital in 1999 and 1998,
respectively. None of the convertible debentures remain outstanding.
Other investments consist of Rural Telephone Bank stock, CoBank stock, long-term
certificates of deposit, and investments in stock companies and partnerships of
other telecommunications service providers. Long-term investments in companies
that are not intended for resale or are not readily marketable are valued at
cost, which does not exceed net realizable value. During the fourth quarter of
2000, the Company established a valuation reserve of $1,273,000 against its
investment in Onvoy, Inc. common stock. Investments in joint ventures,
partnerships and limited liability companies are recorded on the equity method
of accounting, which reflects original cost and recognition of the Company's
share of operating income or losses from the respective operations.
Other assets are cable television franchises owned by the Company and other
deferred charges. Amortization included in expenses was $21,881, $21,882 and
$21,130 for 2000, 1999 and 1998, respectively.
Financial instruments: The fair value of the Company's financial instruments
approximates carrying value except for long-term investments in other companies
and long-term debt payable to the Rural Utilities Service ("RUS") and Rural
Telephone Bank ("RTB"). Other long-term investments are not intended for resale
and not readily marketable, thus a reasonable estimate of fair value is not
practicable. The fair value of long-term debt owed to RUS and RTB was
$37,162,000 and $34,117,000 at December 31, 2000 and 1999, respectively. Fair
values were estimated based on current rates offered to the Company for debt
with similar terms and maturities.
Revenue recognition: Revenues are recognized when earned, regardless of the
period in which they are billed. Network access revenues are furnished in
conjunction with interexchange carriers and are determined by cost separation
studies and nationwide average schedules. Revenues include estimates pending
finalization of cost studies. Network access revenues are based upon interstate
tariffs filed with the Federal Communications Commission by the National
Exchange Carriers Association and state tariffs filed with state regulatory
agencies. Management believes recorded revenues are reasonable based on
estimates of final cost separation studies, which are typically settled within
two years.
Income taxes and investment tax credits: The provision for income taxes consists
of an amount for taxes currently payable and a provision for tax consequences
deferred to future periods. For financial statement purposes, deferred
investment tax credits are being amortized as a reduction of the provision for
income taxes over the estimated useful lives of the related property, plant and
equipment.
Net income per share: Basic net income per common share is based on the weighted
average number of common shares outstanding during each year. Diluted net income
per common share takes into effect the dilutive effect of potential common
shares outstanding. The Company's potential common shares outstanding include
preferred stock, stock options, warrants and convertible debentures. The
calculation of the Company's net income per share is included in Exhibit 11 of
this form 10-K.
Statement of cash flows: The Company considers temporary cash investments with
an original maturity of three months or less to be cash equivalents. During 1999
and 1998, the Company issued calls to retire outstanding convertible debentures.
As a result of these calls, $6,493,000 and $4,264,000 of debentures were
converted into common stock in noncash transactions in 1999 and 1998,
respectively.
New accounting principles: In June 1998, the Financial Accounting Standards
Board issued Statement of Financial Accounting Standards (SFAS) No. 133,
"Accounting for Derivative Instruments and Hedging Activities" (as amended)
which was to be effective January 1, 2000 but subsequently deferred to fiscal
years beginning after June 15, 2000. The Company has not yet determined the
impact of this pronouncement on its financial statements.
31
Basis of presentation: Certain amounts in the 1998 and 1999 financial statements
have been reclassified to conform to the 2000 financial statement presentation.
These reclassifications had no effect on net income or stockholders' equity as
previously reported.
NOTE 2 - ACQUISITIONS.
Effective June 9, 2000, Alliance Telecommunications Corporation acquired all the
outstanding common stock of Hager TeleCom, Inc. ("Hager"); a rural telephone
company located in southwestern Wisconsin. Hager serves approximately 2,100
access lines, provides internet service to 2,700 customers in Hager, WI and Red
Wing, MN and has an ownership interest in Midwest Wireless Holdings, LLC.
Purchase price was $9,124,500 of cash plus acquisition costs. The acquisition is
being accounted for as a purchase. Excess of cost over net assets acquired in
the transaction was $5,810,000, which is being amortized on a straight-line
basis over 25 years. The operations of Hager, which were not material to the
Company's financial statements, are included in the Company's financial results
from the purchase date. In the acquisition, the following assets were acquired
and liabilities assumed:
Property, plant and equipment $ 3,819,916
Excess of cost over net assets acquired 5,809,643
Investment in Midwest Wireless Holdings, LLC 2,500,000
Long-term debt (3,612,396)
Deferred taxes (281,872)
Other assets and liabilities 978,961
--------------
Total purchase price 9,214,252
Less cash and cash equivalents acquired (681,860)
--------------
Payment for purchase of Hager TeleCom, Inc.,
net of cash acquired $ 8,532,392
==============
Effective April 1, 1998, Alliance Telecommunications Corporation acquired all
the outstanding common stock of Felton Telephone Company ("Felton"); a rural
telephone company located in northwestern Minnesota adjacent to areas already
served by the Company's telephone subsidiaries. Felton serves approximately 700
access lines and held a significant portfolio of marketable securities,
including investments in Rural Cellular Corporation, U.S. West Communications,
Inc. and MediaOne Group, Inc. Purchase price was $3,650,000, which includes a
cash downpayment and seller financing of the balance through a $3,149,000 note
payable bearing interest at 8.25%. The note matures April 1, 2005. The
acquisition is being accounted for as a purchase. Excess of cost over net assets
acquired in the transaction was $536,000, which is being amortized on a
straight-line basis over 40 years. The operations of Felton, which were not
material to the Company's financial statements, are included in the Company's
financial results from the purchase date. In the acquisition, the following
assets were acquired and liabilities assumed:
Property, plant and equipment $ 1,427,800
Excess of cost over net assets acquired 536,215
Marketable securities 4,363,854
Long-term debt (1,770,895)
Deferred taxes and credits (1,709,976)
Other assets and liabilities 803,002
--------------
Total purchase price 3,650,000
Less notes payable issued to seller (3,149,358)
Less cash and cash equivalents acquired (590,944)
Less deposits and acquisition costs paid in 1997 (106,198)
--------------
Increase in cash from purchase of Felton
Telephone Company $ 196,500
==============
Effective June 9, 1998, Alliance acquired the assets of 8 cable television
systems from Spectrum Cablevision Limited Partnership ("Spectrum"). These
systems serve 4,000 cable television customers in 19 rural communities in
Minnesota and North Dakota, including several communities also served by the
Company's telephone subsidiaries. Purchase price was approximately $4,559,000.
The acquisition is being accounted for as a purchase. Excess of cost over net
assets acquired in the transaction was $2,784,000, which is being amortized over
15 years on a straight-line basis. The operations of the cable systems, which
were not material to the Company's financial statements, are included in the
Company's financial results from the purchase date.
32
NOTE 3 - MARKETABLE SECURITIES AND GAINS ON SALES OF INVESTMENTS
Marketable securities consist principally of equity securities of other
telecommunications companies obtained by the Company's subsidiaries in sales of
investments in wireless telephone partnerships. The acquisition of Felton
Telephone Company included a substantial portfolio of marketable securities of
this type. The Company's marketable securities portfolio was classified as
available-for-sale at December 31, 2000 and December 31, 1999. The cost and fair
values of available-for-sale investment securities was as follows:
Gross Gross
Unrealized Unrealized Fair
Cost Gains Losses Value
-------------- ------------- ------------- -------------
December 31, 2000 $ 277,444 $ 2,630,212 $ (12,384) $ 2,895,272
December 31, 1999 4,074,353 8,174,811 (30,861) 12,218,303
Net unrealized gains on marketable securities, net of related deferred taxes and
minority interest, are included in stockholders' equity as accumulated other
comprehensive income at December 31, 2000 and 1999 as follows:
Net Deferred Accumulated
Unrealized Income Minority Comprehensive
Gains Taxes Interest Income
-------------- ------------- ------------- -------------
December 31, 2000 $ 2,617,828 $ (1,077,886) $ (478,707) $ 1,061,235
December 31, 1999 8,143,950 (3,257,581) (1,559,887) 3,326,482
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 $5,421,000,
$18,920,000 and $1,820,000 in 2000, 1999 and 1998 respectively. Gross realized
gains on sales of these securities were $1,622,000, $13,203,000 and $965,000 in
2000, 1999 and 1998, respectively. Realized gains on sales are based on the
difference between net sales proceeds and the book value of the securities sold,
using the specific identification method.
NOTE 4 - WIRELESS TELEPHONE INVESTMENTS
Investments in wireless telephone partnerships and limited liability companies
are recorded on the equity method of accounting, which reflects original cost
and recognition of the Company's share of income or losses. At December 31,
2000, the Company owned 10.4% of Midwest Wireless Holdings LLC, which provides
cellular service to rural service areas in Minnesota, Wisconsin and Iowa and the
Rochester, Minnesota MSA. Income from this investment, net of associated
amortization expense, was $1,248,000, $1,481,000 and $1,508,000 in 2000, 1999
and 1998, respectively. Cash distributions received from Midwest Wireless were
$717,000, $710,000 and $848,000 in 2000, 1999 and 1998, respectively. The excess
of cost over the Company's share of equity in Midwest Wireless at the time of
acquisition, net of amortization reserves, was $8,821,000 and $6,897,000 at
December 31, 2000 and 1999, respectively. Excess cost is being amortized on the
straight-line method over periods ranging from twenty-five to forty years.
Amortization expense was $249,000, $183,000 and $158,000 in 2000, 1999 and 1998,
respectively. At December 31, 2000, the Company's cumulative share of income
from Midwest Wireless was $6,567,000, of which $3,889,000 was undistributed.
The Company owns 10.4% of Wireless North, LLC which has licenses to provide
personal communications services in Minnesota, Wisconsin, North Dakota and South
Dakota. At December 31, 2000, the Company had invested $2,073,000 of cash and
guaranteed debt of $1,091,000 in Wireless North. Its PCS systems have not been
profitable to date. The Company's share of Wireless North's losses was
$1,597,000 and $1,066,000 in 1999 and 1998, respectively. The Company suspended
use of the equity method of accounting when its recorded losses equaled the
total of its cash investments and loan guarantees. As a result, the Company has
unrecorded losses of $1,400,000 on its investment. The Company cannot predict if
it will be necessary to provide additional capital to Wireless North.
33
Summarized audited financial information for these companies for 2000, 1999 and
1998 is as follows:
Year Ended December 31
2000 1999 1998
------------- ------------ ------------
Current assets $ 16,817,981 $ 1,602,675 $ 14,894,978
Noncurrent assets 283,197,391 94,755,699 84,844,144
Current liabilities 32,891,714 13,815,844 14,856,061
Noncurrent liabilities 172,488,204 66,079,559 51,090,911
Minority interest 5,844,777
Members' equity 88,790,677 26,462,971 33,792,150
Revenues 107,527,471 60,228,148 50,268,747
Expenses 106,571,860 55,910,186 41,649,381
Net income 955,611 4,317,962 8,619,366
In December, 1998, the Company sold its 12.25% interest in Sioux Falls Cellular,
Ltd., which provides cellular service in the Sioux Falls, South Dakota MSA for
$6,725,000 of cash. Gain on the sale was $4,817,000. Income from this investment
prior to the sale (net of associated amortization expense of $29,000) was
$334,000 in 1998.
NOTE 5 - PROPERTY, PLANT AND EQUIPMENT
The cost of property, plant and equipment and the estimated useful lives are as
follows:
December 31
Estimated -------------------------------
useful life 2000 1999
------------ -------------- -------------
Land $ 630,750 $ 606,397
Buildings 5-40 years 6,314,045 5,562,920
Machinery and equipment 3-15 years 2,754,648 2,016,253
Furniture and fixtures 5-10 years 2,208,319 2,142,535
Telephone plant 5-33 years 74,408,575 64,107,388
Cable television plant 10-15 years 9,436,721 8,948,737
Construction in progress 1,558,474 1,236,205
-------------- -------------
97,311,532 84,620,435
Less accumulated depreciation 41,085,007 33,210,402
-------------- -------------
$ 56,226,525 $ 51,410,033
============== =============
NOTE 6 - NOTES PAYABLE AND LONG-TERM DEBT
December 31
---------------------------------
2000 1999
------------ ------------
Notes payable to CoBank, payable by Alliance
Telecommunications Corporation in monthly installments,
average interest rate of 7.5%, due 2001 to 2011 $ 44,902,300 $ 47,580,800
Rural Utilities Service ("RUS") and Rural Telephone Bank ("RTB") mortgage notes,
payable by telephone company subsidiaries in monthly and quarterly
installments, average rate of 5.5%, due 2001 to 2028 40,129,684 38,041,254
Notes payable to Rural Telephone Finance Cooperative
in quarterly installments, interest rate of 8.4%, due 2013 3,560,905 3,743,712
Notes payable to former owners of Felton Telephone
Company, payable by a subsidiary of Alliance Tele-
communications Corporation in monthly installments,
interest rate of 8.25%, due 2005 2,122,460 2,522,990
------------ ------------
90,715,349 91,888,756
Less current portion 6,337,200 5,607,100
------------ ------------
$ 84,378,149 $ 86,281,656
============ ============
34
In 1996, the Company's 68% owned subsidiary, Alliance Telecommunications
Corporation negotiated a term loan agreement with the St. Paul Bank for
Cooperatives ("St. Paul Bank") to provide financing for the acquisition of Ollig
Utilities Company. As a condition to receiving the loans, Alliance purchased
stock in the bank. In 1999, St. Paul Bank merged with CoBank. As part of the
merger, Alliance's St. Paul Bank stock was revalued. Alliance recorded a loss of
$199,995 in 1999 due to this revaluation. At December 31, 2000, Alliance's
investment in CoBank stock was $3,254,000.
CoBank is a cooperative, owned and controlled by its customers. Each
customer borrowing from the bank on a patronage basis shares in the bank's net
income through payment of patronage refunds. Patronage refund accrued was
$231,000 in 2000; approximately 30% will be received in cash, with the balance
in stock in the bank. The accrued patronage refund was shown in the Company's
operating statement as a reduction of interest expense. No patronage refund was
accrued for 1999 or 1998. The Company cannot predict what patronage refunds
might be in future years.
Alliance's loan from CoBank is secured by a pledge of substantially all
the assets of Alliance and its subsidiaries. The loan covenants also restrict
Alliance's ability to pay dividends to its shareholders. Interest rates on the
loan are fixed for periods ranging from one to ten years at rates averaging
approximately 7.5%. Principal payments began in January 1997 and will continue
until March 2011.
The Rural Utilities Service (RUS) and the Rural Telephone Bank (RTB) are
the Company's primary sources of long-term financing for additions to telephone
plant and equipment. The RUS has made long-term, low-interest loans to telephone
companies since 1949 for the purpose of improving telephone service in rural
areas. The RUS is authorized to make hardship loans at a 5% interest rate and
cost-of-money loans at a rate reflecting the government's cost of money for a
like term. The RTB advances funds at the average U.S. government cost-of-money
for the year for like maturities. In some cases RTB loans are made concurrently
with RUS loans. At December 31, 2000, the Company's local exchange carrier
subsidiaries had unadvanced loan commitments under the RUS and RTB programs
aggregating approximately $11,498,000 to finance specific construction
activities in future years.
Substantially all of the telephone plant of the LEC subsidiaries is
pledged or is subject to mortgages to secure obligations to the RUS and RTB. In
addition, the amount of dividends on common stock that may be paid by the LEC
subsidiaries to the Company is limited by certain financial covenants set forth
in the mortgages. At December 31, 2000, $3,756,000 of retained earnings of these
subsidiaries was available for dividend payments to HCC.
The Company is continuing its construction program to upgrade its
telephone and cable television properties. Planned expenditures for HCC and
Alliance properties in 2001 are $4,530,000 and $7,109,000, respectively. The
Company intends to use RUS and RTB loan funds to help finance these projects.
Loan funds received are deposited in construction fund accounts and
disbursements are restricted, subject to RUS approval, to construction costs
authorized by the loan agreements.
The Company has a term loan and a $5,000,000 revolving line of credit
from Rural Telephone Financing Cooperative ("RTFC"). The interest rate on the
term loan varies according to the rate charged by the Lender for similar loans
(8.4% at December 31, 2000). Interest on borrowings against the credit line is
at the bank's prime rate plus 1.5%. Both the credit line and the term loan are
secured by a pledge of the stock of HCC's wholly owned subsidiaries.
In February 1995 the Company completed a public offering of 8.5%
convertible subordinated debentures. During 1999 and 1998, the Company issued
calls to retire the debentures, which resulted in $10,757,000 of debentures
being converted into stock and $1,893,000 of debentures being purchased and
retired.
The annual requirements for principal payments on notes payable and long-
term debt are as follows:
2001 $ 6,337,200
2002 6,548,100
2003 7,018,500
2004 7,513,000
2005 7,560,100
35
NOTE 7 - INCOME TAXES
Hector Communications Corporation and its wholly owned subsidiaries file
a consolidated tax return separate from the consolidated return for Alliance
Telecommunications Corporation and its subsidiaries. Income tax expenses
(benefits) consist of the following:
Year Ended December 31
-----------------------------------------
2000 1999 1998
------------- ------------ ------------
Currently payable taxes:
Federal $ 4,053,000 $ 8,120,000 $ 4,445,000
State 1,149,000 1,662,000 1,244,000
------------ ------------ ------------
5,202,000 9,782,000 5,689,000
Deferred income taxes (benefit) (934,000) (2,157,000) (604,000)
Deferred investment tax credits (61,000) (112,000) (136,000)
------------ ------------ ------------
$ 4,207,000 $ 7,513,000 $ 4,949,000
============ ============ ============
Deferred tax assets and (liabilities) as of December 31 related to the
following:
2000 1999
------------ ------------
Accelerated depreciation $(6,101,310) $(6,012,515)
Alternative minimum tax credits 56,000 28,000
Marketable securities (1,120,000) (4,073,000)
Partnership and LLC investments (393,000) (286,000)
Deferred compensation 366,000 363,000
Other 589,000 545,000
------------ ------------
$(6,603,310) $(9,435,515)
============ ============
The provision for income taxes varied from the federal statutory tax rate
as follows:
Year Ended December 31
---------------------------------
2000 1999 1998
------- ------- -------
Tax at U.S. statutory rate 35.0% 35.0% 35.0%
Surtax exemption (1.0) - (1.0)
State income taxes, net of federal benefit 8.0 3.8 7.8
Excess of cost over net assets acquired 7.0 3.0 5.1
Investment tax credits ( .7) ( .6) (1.3)
Other 1.1 ( .5) 1.1
------- ------- -------
Effective tax rate 49.4% 40.7% 46.7%
======= ======= =======
NOTE 8 - STOCKHOLDERS' EQUITY
Preferred stock is entitled to share ratably with common shareholders in
any dividends or distributions paid by the Company, but are not entitled to any
dividend distribution separate from common shareholders. Preferred shareholders
have no voting rights. Each share of preferred stock is convertible into one
share of common stock.
Common shares are reserved for issuance in connection with stock option
plans under which 800,000 shares may be issued pursuant to stock options, stock
appreciation rights, restricted stock or deferred stock granted to officers and
key employees. Exercise prices of stock options under the plan cannot be less
than fair market value of the stock on the date of grant. Rules and conditions
governing awards of stock options, stock appreciation rights and restricted or
deferred stock are determined by the Compensation Committee of the Board of
Directors, subject to certain limitations incorporated into the plan. Another
provision of the plans automatically grants 2,000 shares of nonqualified stock
options per year to each nonemployee director. Options issued under this
provision have a ten-year term and an exercise price not less than fair market
value at date of grant. At December 31, 2000, 300,675 shares remained available
to be issued under the plans.
36
Changes in outstanding employee and director stock options during the
three years ended December 31, 2000 is as follows:
Average
Number of exercise price
shares per share
---------------- -------------
Outstanding at December 31, 1997 239,750 $ 7.27
Granted 74,775 11.50
Exercised (48,200) 6.75
Canceled (300) 7.50
----------------- -------------
Outstanding at December 31, 1998 266,025 8.55
Granted 91,400 8.80
Exercised (43,675) 7.93
Canceled (6,100) 8.44
----------------- -------------
Outstanding at December 31, 1999 307,650 8.72
Granted 96,100 12.22
Exercised (46,575) 7.28
Canceled (8,100) 10.53
----------------- -------------
Outstanding at December 31, 2000 349,075 $ 9.83
================= =============
Options issued to officers and key employees are subject to vesting. Options are
vested and become exercisable one-third at the date of issue, one-third one year
from date of issue and one-third two years from date of issue. At December 31,
2000, 267,191 stock options are currently exercisable at an average price of
$9.45 per share. The following table summarizes the status of stock options
outstanding at December 31, 2000:
Weighted Average Weighted
Remaining Average
Range of Exercise Prices Shares Option Life Exercise Price
- ------------------------ -------- ----------- --------------
$ 6.50 to $ 8.50 168,150 2.1 years $ 7.82
$ 8.51 to $10.93 20,000 5.8 years 9.86
$10.94 to $13.20 160,925 3.9 years 11.92
Effective August 1, 1990, the 1990 Employee Stock Purchase Plan ("ESPP") was
adopted, for which 100,000 shares were reserved. Under terms of the plan,
eligible employees may acquire shares of common stock through payroll deductions
of not more than 10% of compensation. The price of shares purchased by the
employees is 85% of the lower of fair market value for such shares on one of two
specified dates in each plan year. A participant is limited to the acquisition
in any plan year to the number of shares which their payroll deductions for the
year would purchase based on the market price on the first day of the year or
$25,000, whichever is less. Shares issued to employees under the plan were
10,742, 14,890 and 10,753 for the plan years ended August 31, 2000, 1999 and
1998, respectively. At December 31, 2000 employees had subscribed to purchase an
additional 12,700 shares in the current plan cycle ending August 31, 2001.
The Company has adopted the disclosure provisions of SFAS No. 123, "Accounting
for Stock-Based Compensation", but applies APB Opinion No. 25, "Accounting for
Stock Issued to Employees" for measurement and recognition of stock-based
transactions with its employees. If the Company had elected to recognize
compensation cost for its stock based transactions using the method prescribed
by SFAS No. 123, net income and earnings per share would have been as follows:
Year Ended December 31
-----------------------------------------
2000 1999 1998
----------- ----------- -----------
Net income $ 2,958,163 $ 7,211,118 $ 3,709,988
Basic net income per share $ .83 $ 2.33 $ 1.54
Diluted net income per share $ .77 $ 1.90 $ 1.10
The fair value of the Company's stock options and Employee Stock Purchase
Plan transactions used to compute pro forma net income and net income per share
disclosures is the estimated present value at grant date using the Black-Scholes
option-pricing model. The following table displays the assumptions used in the
model:
37
Year Ended December 31
------------------------------------
2000 1999 1998
-------- -------- --------
Expected volatility 29.6% 28.2% 23.3%
Risk free interest rate .5% 5.3% 5.6%
Expected holding period - employees 4 years 4 years 4 years
Expected holding period - directors 7 years 7 years 7 years
Dividend yield 0% 0% 0%
Pro forma stock-based compensation cost was $351,260, $268,063 and
$200,255 and in 2000, 1999 and 1998, respectively. Fair value of all options
issued was $443,534, $286,529 and $271,770 in 2000, 1999 and 1998, respectively.
In 1995 the Company issued $12,650,000 (par value) of convertible
subordinated debentures. The debentures were convertible into common stock of
the Company at a rate of 112.5 common shares per $1,000 par value debenture.
During 1998 and 1999 the Company issued calls retiring the debentures;
$10,757,000 of debentures being converted into common stock and $1,893,000 of
debentures being retired for cash. The underwriters of the debenture offering
also received warrants to purchase shares of the Company's common stock at a
price of $8.70 per share. 88,311 shares, 8,742 shares and 7,876 shares were
issued upon exercise of warrants in 2000, 1999 and 1998, respectively. At
December 31, 2000, no warrants remain outstanding.
Effective August 1, 1990, the Board of Directors adopted a leveraged
employee stock ownership plan ("ESOP"). Contributions to the ESOP are determined
by the Board on an annual basis and can be made in cash or by issuing shares of
the Company's common stock. ESOP expense reflects the market value of company
stock contributed to the accounts of eligible employees at the time of the
contribution. ESOP expense was $100,000, $97,000, and $83,000 for 2000, 1999 and
1998, respectively. At December 31, 2000, the ESOP held 64,914 shares of the
Company's common stock, all of which had been allocated to the accounts of
participating employees. All eligible employees of Hector Communications
Corporation participate in the plan after completing one year of service.
Employees of Alliance Telecommunications Corporation do not participate in the
plan. Contributions are allocated to each participant based on compensation and
vest 30% after three years of service and incrementally thereafter, with full
vesting after seven years.
In 1999 the Board of Directors adopted a shareholders' rights plan. Under
the plan, the Board of Directors declared a distribution of one right per share
of common stock. Each right entitles the holder to purchase 1/100th of a share
of a new series of Junior Participating Preferred Stock of the Company at an
initial exercise price of $65. The rights expire on July 27, 2009. The rights
will become exercisable only following the acquisition by a person or group,
without the prior consent of the Board of Directors, of 15% or more of the
Company's voting stock, or following the announcement of a tender offer or
exchange offer to acquire an interest of 15% or more. If the rights become
exercisable, each rightholder will be entitled to purchase, at the exercise
price, common stock with a market value equal to twice the exercise price.
Should the Company be acquired, each right would entitle the holder to purchase,
at the exercise price, common stock of the acquiring company with a market value
equal to twice the exercise price. Any rights owned by the acquiring person or
group would become void.
38
NOTE 9 - EMPLOYEE BENEFIT PLANS
The Company has 401(k) savings plans for its employees. Employees who
meet certain age and service requirements may contribute up to 15% of their
salaries to the plan on a pretax basis. The Company matches a portion of
employee contributions. Contributions to the plan by the Company for 2000, 1999
and 1998 were approximately $172,000, $152,000 and $135,000, respectively.
Employees of Alliance Telecommunications Corporation who meet certain age
and service requirements are eligible to participate in a profit sharing plan.
Contributions are determined annually by Alliance's Board of Directors and are
allocated proportionately to the participants in each allocation group.
Contributions to the plan by the Company in 2000, 1999 and 1998 were $220,000,
$224,000 and $177,000, respectively.
Alliance has a deferred compensation agreement with two former officers of Ollig
Utilities, Inc. Under the agreement, the salaries of these officers were
continued after their retirement based on a formula stated in the agreement. The
Company's expense under the plan was $100,000 and $143,000 in 2000 and 1998,
respectively. The Company incurred no expense under this agreement in 1999.
Payments made under the agreement were $93,000 in each of the last three years.
NOTE 10 - TRANSACTIONS WITH COMMUNICATIONS SYSTEMS, INC.
Transactions between the Company and Communications Systems, Inc. (CSI), the
Company's former parent, are based on a distribution agreement, which provides
for the Company's use of certain of CSI's staff and facilities, with related
costs paid by the Company. Services provided by CSI aggregated approximately
$314,000, $270,000 and $300,000 in 2000, 1999 and 1998, respectively.
Employees of the Company also participated in a joint self-funded medical
insurance program with employees of CSI through August, 1999. Costs paid by the
Company into this program were $429,000 and $595,000 in 1999 and 1998,
respectively.
Costs of services from CSI may not be indicative of the costs of such services
had they been obtained from a different party. Intercompany accounts with CSI
are handled on an open account basis. Outstanding amounts payable to CSI were
$172,000 and $428,000 at December 31, 2000 and 1999, respectively.
39
NOTE 11 - SEGMENT INFORMATION
The Company is organized into two business segments: Hector Communications
Corporation and its wholly owned subsidiaries, and Alliance Telecommunications
Corporation and its subsidiaries. No single customer accounted for a material
portion of the Company's revenues in any of the last three years. Segment
information is as follows:
Hector Alliance Consolidated
--------------- -------------- ---------------
Year Ended December 31, 2000
Revenues $ 9,679,527 $ 28,110,575 $ 37,790,102
Costs and expenses 7,583,148 19,216,098 26,799,246
--------------- -------------- --------------
Operating income 2,096,379 8,894,477 10,990,856
Interest expense (952,574) (5,002,029) (5,954,603)
Income (loss) from unconsolidated
affiliates 611,321 (475) 610,846
Interest and dividend income 375,541 875,207 1,250,748
Gain on sale of marketable securities 1,622,226 1,622,226
--------------- -------------- --------------
Income before income taxes $ 2,130,667 $ 6,389,406 $ 8,520,073
=============== ============== ==============
Depreciation and amortization $ 2,821,781 $ 7,354,503 $ 10,176,284
=============== ============== ==============
Total assets $ 30,116,889 $ 128,561,092 $ 158,677,981
=============== ============== ==============
Capital expenditures $ 3,111,108 $ 6,335,082 $ 9,446,190
=============== ============== ==============
Year Ended December 31, 1999
Revenues $ 8,794,489 $ 25,322,827 $ 34,117,316
Costs and expenses 7,159,071 15,904,009 23,063,080
--------------- -------------- --------------
Operating income 1,635,418 9,418,818 11,054,236
Interest expense (1,279,386) (5,303,150) (6,582,536)
Loss from unconsolidated affiliates (259,588) (75,949) (335,537)
Interest and dividend income 198,559 917,539 1,116,098
Gain on sale of marketable securities 13,203,062 13,203,062
--------------- -------------- --------------
Income before income taxes $ 295,003 $ 18,160,320 $ 18,455,323
=============== ============== ==============
Depreciation and amortization $ 2,616,879 $ 5,930,740 $ 8,547,619
=============== ============== ==============
Total assets $ 29,141,485 $ 137,655,202 $ 166,796,687
=============== ============== ==============
Capital expenditures $ 2,901,944 $ 4,639,982 $ 7,541,926
=============== ============== ==============
Year Ended December 31, 1998
Revenues $ 7,886,758 $ 23,951,936 $ 31,838,694
Costs and expenses 5,886,884 15,304,923 21,191,807
--------------- -------------- --------------
Operating income 1,999,874 8,647,013 10,646,887
Interest expense (1,835,244) (5,479,909) (7,315,153)
Income from unconsolidated affiliates 60,665 822,431 883,096
Interest and dividend income 199,094 409,977 609,071
Gain on sale of marketable securities 965,069 965,069
Gain on sale of cellular partnership 4,817,498 4,817,498
--------------- -------------- --------------
Income before income taxes $ 424,389 $ 10,182,079 $ 10,606,468
=============== ============== ==============
Depreciation and amortization $ 2,068,701 $ 5,712,509 $ 7,781,210
=============== ============== ==============
Total assets $ 26,215,059 $ 124,464,728 $ 150,679,787
=============== ============== ==============
Capital expenditures $ 2,651,776 $ 7,064,359 $ 9,716,135
=============== ============== ==============
40
(b) SUPPLEMENTAL FINANCIAL INFORMATION
Unaudited Quarterly Operating Results
(in thousands except per share amounts)
Quarter Ended
-------------------------------------------
March 31 June 30 Sept.30 Dec.31
- ------------------------------------------ -------------------------------------
2000
Revenues $ 8,488 $ 9,343 $ 9,758 $10,201
Operating income 2,197 2,773 3,178 2,842
Net income 1,205 851 1,027 227
Basic net income per share $ .33 $ .24 $ .29 $ .06
Diluted net income per share $ .30 $ .22 $ .27 $ .06
1999
Revenues $ 8,319 $ 8,724 $ 8,935 $ 8,139
Operating income 2,826 3,347 3,130 1,752
Net income 755 719 2,232 3,773
Basic net income per share $ .28 $ .26 $ .65 $ 1.07
Diluted net income per share $ .22 $ .22 $ .57 $ .95
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE
Not applicable.
41
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information called for by paragraphs (a), (c), (d), (e), and (f) of Item 401
under Regulation S-K, to the extent applicable, will be set forth under the
caption "Election of Directors" in the Company's definitive proxy material for
its May 17, 2001 Annual Meeting of Shareholders to be filed within 120 days from
the end of the Registrant's fiscal year, which information is expressly
incorporated by reference herein. The information called for by paragraph (b) of
Item 401 is set forth under Item 1(c) herein. The information called for by Item
405 under Regulation S-K, to the extent applicable, will be set forth under the
caption "Certain Transactions" in the Company's above referenced definitive
proxy material.
ITEM 11. EXECUTIVE COMPENSATION
The information called for by Item 402 under Regulation S-K to the extent
applicable, will be set forth under the caption "Executive Compensation" in the
Company's definitive proxy materials for its May 17, 2001 Annual Meeting to be
filed within 120 days from the end of the Registrant's fiscal year, which
information is expressly incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information called for by Item 403 under Regulation S-K will be set forth
under the captions "Security Ownership of Certain Beneficial Owners and
Management" and "Election of Directors" in the Company's definitive proxy
materials for its May 17, 2001 Annual Meeting to be filed within 120 days from
the end of the Registrant's fiscal year, which information is expressly
incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information called for by Item 404 under Regulation S-K will be set forth
under the caption "Certain Transactions" in the Company's definitive proxy
materials for its May 17, 2001 Annual Meeting to be filed within 120 days from
the end of the Registrant's fiscal year, which information is expressly
incorporated herein by reference.
42
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE, AND REPORTS ON FORM 8-K
(a) (1) Consolidated Financial Statements
---------------------------------
The following Consolidated Financial Statements of Hector
Communications Corporation and subsidiaries appear at pages 26 to 42 herein:
Independent Auditors' Report for the years ended
December 31, 2000, 1999 and 1998
Consolidated Balance Sheets as of December 31, 2000 and 1999
Consolidated Statements of Income and Comprehensive Income for the
years ended December 31, 2000, 1999 and 1998
Consolidated Statements of Stockholders' Equity for the years ended
December 31, 2000, 1999 and 1998
Consolidated Statements of Cash Flows for the years ended
December 31, 2000, 1999 and 1998
Notes to Consolidated Financial Statements
(a) (2) Financial Statement Schedule Page Herein
---------------------------- -----------
The following financial statement schedule is being filed as part of
this Form 10-K Report:
Independent Auditors' Report on financial statement schedule
for the years ended December 31, 2000, 1999 and 1998 46
Schedule I - Condensed Financial Information of Registrant 47-50
All other schedules are omitted as the required information is inapplicable or
the information is presented in the financial statements or related notes.
Separate financial statements of Midwest Wireless Holdings LLC, a 50
percent or less owned equity method investment, included as this entity
constitutes a "significant subsidiary" pursuant to the provisions of
Regulation S-X, Article 3-09. 51-63
(a) (3) Exhibits
--------
The exhibits which accompany or are incorporated by reference in this
report, including all exhibits required to be filed with this report, are
described on the Exhibit Index which begins on page 64 of the sequential
numbering system used in this report.
(b) REPORTS ON FORM 8-K FILED DURING THE THREE MONTHS ENDED DECEMBER 31, 2000
Not Applicable.
43
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
HECTOR COMMUNICATIONS CORPORATION
Dated: March 29, 2001 /s/ Curtis A. Sampson
----------------------------------------
Curtis A. Sampson, Chairman of the Board
of Directors and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant in the capacities and on the dates indicated:
Each person whose signature appears below constitutes and appoints
CURTIS A. SAMPSON and PAUL N. HANSON as his true and lawful attorneys-in-fact
and agents, each acting alone, with full power of substitution and
resubstitution, for him and in his name, place and stead, in any and all
capacities, to sign any or all amendments to this Annual Report on Form 10-K and
to file the same, with all exhibits thereto, and other documents in connection
therewith, with the Securities and Exchange Commission, granting unto said
attorneys-in-fact and agents, each acting alone, full power and authority to do
and perform each and every act and thing requisite and necessary to be done in
and about the premises, as fully to all intents and purposes as he might or
could do in person, hereby ratifying and confirming all said attorneys-in-fact
and agents, each acting alone, or his substitute or substitutes, may lawfully do
or cause to be done by virtue thereof.
Signature Title Date
/s/Curtis A. Sampson Chairman of the Board of Directors, March 29, 2001
- -------------------- Chief Executive Officer and Director
Curtis A. Sampson
/s/Steven H. Sjogren President, Chief Operating Officer, March 29, 2001
- -------------------- and Director
Steven H. Sjogren
/s/Paul N. Hanson Vice President, Treasurer and March 29, 2001
- -------------------- Director
Paul N. Hanson
/s/Charles A. Braun Chief Financial Officer and March 29, 2001
- -------------------- Principal Accounting Officer
Charles A. Braun
Director March 29, 2001
- --------------------
Robert L. Hammond, Jr.
/s/James O. Ericson Director March 29, 2001
- --------------------
James O. Ericson
/s/Paul A. Hoff Director March 29, 2001
- --------------------
Paul A. Hoff
/s/Wayne E. Sampson Director March 29, 2001
- --------------------
Wayne E. Sampson
44
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
OF
HECTOR COMMUNICATIONS CORPORATION
FOR
YEAR ENDED DECEMBER 31, 2000
------------------------------
FINANCIAL STATEMENT SCHEDULE
- --------------------------------------------------------------------------------
45
INDEPENDENT AUDITORS' REPORT ON FINANCIAL STATEMENT SCHEDULE
Shareholders and Board of Directors
Hector Communications Corporation
The audit of the consolidated financial statements of Hector Communications
Corporation and subsidiaries referred to in our opinion dated February 14, 2001,
included the related financial statement schedule as listed in item 14(a)2. In
our opinion, this financial statement schedule, when considered in relation to
the basic consolidated financial statements, presents fairly in all material
respects the information set forth therein.
/s/ Olsen Thielen and Co., Ltd.
- -------------------------------
Olsen Thielen and Co., Ltd.
St. Paul, Minnesota
February 14, 2001
46
HECTOR COMMUNICATIONS CORPORATION
---------------------------------
SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
HECTOR COMMUNICATIONS CORPORATION (PARENT COMPANY)
BALANCE SHEETS
December 31
-------------------------------
2000 1999
------------- -------------
Assets:
Cash $ 12,083
Investment in subsidiaries 40,060,671 $ 41,255,044
Other current assets 551,992 464,374
Property, plant and equipment, net 658,366 92,548
Accounts with subsidiaries 1,474,677 2,157,388
Other investments 846,153 449,582
Other assets 25,000
------------- -------------
Total Assets $ 43,603,942 $ 44,443,936
============= =============
Liabilities and Stockholders' Equity:
Cash overdraft $ 29,931
Accounts payable $ 188,880 257,787
Other current liabilities 746,290 430,588
Current portion of long-term debt 195,000 183,000
Long-term debt 3,365,905 3,560,712
Stockholders' equity:
Preferred stock, par value $1.00 per share; 3,000,000 shares authorized:
Convertible Series A, 221,300 and 229,300
shares issued and outstanding 221,300 229,300
Common stock, par value $.01 per share;
10,000,000 shares authorized; 3,504,363 and
3,574,712 shares issued and outstanding 35,044 35,747
Additional paid-in capital 12,844,776 13,274,444
Retained earnings 24,945,512 23,115,945
Accumulated other comprehensive income 1,061,235 3,326,482
------------- -------------
Total Liabilities and Stockholders' Equity $ 43,603,942 $ 44,443,936
============= =============
47
HECTOR COMMUNICATIONS CORPORATION
----------------------------------
SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
HECTOR COMMUNICATIONS CORPORATION (PARENT COMPANY)
STATEMENT OF INCOME AND COMPREHENSIVE INCOME
Year Ended December 31
--------------------------------------------------
2000 1999 1998
------------- ------------- -------------
Revenues:
Sales $ 109,326 $ 303,779 $ 286,569
Expenses:
Operating expenses 215,104 116,466 103,164
Amortization of goodwill 34,721 34,721 41,245
Interest expense, net 284,942 719,739 1,329,491
Income tax benefit (122,816) (170,504) (412,835)
------------- ------------- -------------
Total expenses 411,951 700,422 1,061,065
Income (loss) before equity in earnings of
subsidiaries (302,625) (396,643) (774,496)
Equity in earnings of subsidiaries 3,612,048 7,875,824 4,684,739
------------- ------------- -------------
Net income 3,309,423 7,479,181 3,910,243
Other comprehensive income (loss):
Unrealized holding gains (losses) of subsidiaries on
marketable securities (3,903,896) 20,784,075 492,287
Reclassification adjustment for gains of subsidiaries
included in net income (1,622,226) (13,203,062) (965,069)
------------- ------------- -------------
Other comprehensive income (loss) before
income taxes (5,526,122) 7,581,013 (472,782)
------------- ------------- -------------
Income tax expense related to unrealized holding gains
(losses) of subsidiaries on marketable securities (1,539,833) 8,450,555 189,519
Income tax benefit related to reclassification adjustment for
gains of subsidiaries included in net income (639,862) (5,368,207) (371,529)
------------- ------------- -------------
Income tax expense (benefit) related to items of other
comprehensive income (2,179,695) 3,082,348 (182,010)
Minority interest in other comprehensive income (loss)
of subsidiaries (1,081,180) 1,559,887
------------- ------------- -------------
Other comprehensive income (loss) (2,265,247) 2,938,778 (290,772)
------------- ------------- -------------
Comprehensive income $ 1,044,176 $ 10,417,959 $ 3,619,471
============= ============= =============
48
HECTOR COMMUNICATIONS CORPORATION
---------------------------------
SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
HECTOR COMMUNICATIONS CORPORATION (PARENT COMPANY)
STATEMENTS OF CASH FLOWS
Year Ended December 31
--------------------------------------------------
2000 1999 1998
------------- ------------- -------------
Cash flows from operating activities:
Net income $ 3,309,423 $ 7,479,181 $ 3,910,243
Adjustments to reconcile net income to net cash provided by operating
activities:
Income from other investments (3,141)
Noncash patronage refund (8,780) (12,569)
Equity in earnings of subsidiaries (3,612,048) (7,875,824) (4,684,739)
Dividends from subsidiaries 1,671,639
Depreciation and amortization 90,661 190,151 272,326
Changes in assets and liabilities:
Decrease (increase) in other current assets (101,478) (310,195) (90,163)
Decrease (increase) in accounts with subsidiaries 682,711 3,651,869 (2,935,762)
Increase (decrease) in cash overdraft (29,931) 29,931
Increase (decrease) in accounts payable (68,907) (129,455) 240,890
Increase (decrease) in other current liabilities 412,694 213,616 (103,691)
------------- ------------- -------------
Net cash provided by (used in) operating activities 671,204 3,236,705 (1,719,257)
Cash flows from investing activities:
Purchases of property, plant and equipment (621,758) (44,214) (10,167)
Cash investments in affiliates (18,600)
Purchases of other investments (350,000) (342,171)
Cash proceeds from other investments 2,897
Decrease (increase) in other assets 25,000 (25,000)
------------- ------------- -------------
Net cash used in investing activities (946,758) (84,917) (352,338)
Cash flows from financing activities:
Issuance of debt 5,996,281
Repayment of long-term debt (182,807) (3,626,140) (4,519,429)
Issuance of common stock 1,139,764 466,328 489,703
Purchase of stock (3,154,983)
Investment by affiliate in parent company stock 2,485,663
ESOP shares allocated 63,095
------------- ------------- -------------
Net cash provided by (used in) financing activities 287,637 (3,159,812) 2,029,650
------------- ------------- -------------
Net decrease in cash and cash equivalents 12,083 (8,024) (41,945)
Beginning cash and cash equivalents - 8,024 49,969
------------- ------------- -------------
Ending cash and cash equivalents $ 12,083 $ - $ 8,024
============= ============= =============
Supplemental disclosures of cash flow information:
Interest paid $ 307,899 $ 890,545 $ 1,231,676
Income taxes paid 505,166 168,500 45,000
49
NOTES TO CONDENSED FINANCIAL STATEMENT OF REGISTRANT
Note 1 - Basis of Presentation
Pursuant to the rules and regulations of the Securities and Exchange Commission,
the Condensed Financial Statements of the Registrant do not include all of the
information and notes normally included in financial statements prepared in
accordance with generally accepted accounting principles. It is suggested that
these Condensed Financial Statements be read in conjunction with the
Consolidated Financial Statements and Notes thereto included in the Registrant's
Annual Report as referenced in Form 10-K, Part II, Item 8.
Note 2 - Transactions with Subsidiaries
The Registrant received cash dividends from its subsidiaries of $1,671,639 in
1998. No dividends were received in 2000 or 1999.
In 2000, a subsidiary of the Company purchased 171,425 shares of the Company's
common stock for $2,485,663. For financial presentation purposes, this stock has
been retired.
Note 3 - Long Term Debt
December 31
--------------------------------
2000 1999
----------- ------------
Notes payable to Rural Telephone Finance
Cooperative in quarterly installments,
interest rate of 8.4%, due 2013 $ 3,560,905 $ 3,743,712
Less current portion 195,000 183,000
----------- ------------
$ 3,365,905 $ 3,560,712
=========== ============
The annual requirements for principal payments on notes payable and long-term
debt are as follows:
2001 195,000
2002 209,000
2003 223,000
2004 238,000
2005 254,000
50
Midwest Wireless
Holdings L.L.C.
Report on Audits of Consolidated Financial Statements
For the Years Ended December 31, 2000 and 1999
51
Report of Independent Accountants
To the Board of Managers
Midwest Wireless Holdings L.L.C.:
In our opinion, the accompanying consolidated statements of financial position
and the related consolidated statements of operations, changes in members'
equity and cash flows present fairly, in all material respects, the financial
position of Midwest Wireless Holdings L.L.C. (the Company) and its subsidiaries
at December 31, 2000 and 1999, and the consolidated results of their operations
and their cash flows for the years then ended in conformity with accounting
principles generally accepted in the United States of America. These financial
statements are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements based on
our audits. We conducted our audits of these statements in accordance with
auditing standards generally accepted in the United States of America, which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
PRICEWATERHOUSECOOPERS LLP
February 2, 2001
52
Midwest Wireless Holdings L.L.C.
Consolidated Statements of Financial Position
At December 31, 2000 and 1999
- --------------------------------------------------------------------------------
ASSETS 2000 1999
Current assets:
Cash and cash equivalents $ 2,043,704 $ 1,378,350
Restricted cash 1,000,000
Accounts receivable, less allowance for
doubtful accounts of $477,152 and
$258,120 in 2000 and 1999, respectively 8,751,005 4,726,962
Inventories 2,718,772 2,519,796
Other 850,215 527,482
------------- -------------
Total current assets 14,363,696 10,152,590
Property, cellular plant and equipment, net 73,523,318 43,997,663
FCC licenses, net 169,125,264 16,514,927
Investments in cooperatives 7,530,617 2,201,408
Deferred acquisition costs 1,046,824
------------- -------------
Total assets $ 264,542,895 $ 73,913,412
============= ==============
LIABILITIES AND MEMBERS' EQUITY
Current liabilities:
Current portion of long-term debt $ 10,415,285 $ 2,426,350
Accounts payable 6,125,308 3,029,225
Accrued commissions 1,554,219 818,592
Other accrued expenses 7,303,171 3,862,594
------------- -------------
Total current liabilities 25,397,983 10,136,761
Other liabilities 2,103,289 1,156,949
Revolving loan 2,500,000 2,000,000
Long-term debt 119,922,125 26,334,775
------------- -------------
Total liabilities 149,923,397 39,628,485
Minority interest 5,844,777 4,847,057
Commitments
Members' equity 108,774,721 29,437,870
------------- -------------
Total liabilities and members' equity $ 264,542,895 $ 73,913,412
============= =============
The accompanying notes are an integral part of the consolidated financial
statements.
53
Midwest Wireless Holdings L.L.C.
Consolidated Statements of Operations
For the years ended December 31, 2000 and 1999
- --------------------------------------------------------------------------------
2000 1999
Operating revenues:
Subscriber service $ 63,993,328 $ 40,279,007
Roamer service 29,721,562 11,671,572
Equipment sales 9,015,304 5,651,878
Service fees 1,461,887 400,000
------------ -------------
104,192,081 58,002,457
------------ -------------
Operating expenses:
Operations and maintenance 19,785,719 10,502,756
Cost of equipment sold 10,458,625 5,570,633
Depreciation 12,278,169 7,528,105
Amortization of FCC licenses 3,780,643 494,381
Selling, general and administrative 24,520,349 14,711,883
Home roamer costs 8,823,278 1,699,261
------------ -------------
79,646,783 40,507,019
------------ -------------
Operating income 24,545,298 17,495,438
------------ -------------
Other income (expense):
Interest expense (8,651,813) (1,291,817)
Interest and dividend income 312,229 230,760
Other (6,186) (393,575)
------------ -------------
(8,345,770) (1,454,632)
------------ -------------
Net income before minority interest 16,199,528 16,040,806
Minority interest (1,902,457) (2,219,563)
------------- -------------
Net income $ 14,297,071 $ 13,821,243
============= =============
The accompanying notes are an integral part of the consolidated financial
statements.
54
Midwest Wireless Holdings L.L.C.
Consolidated Statements of Changes in Members' Equity For the years ended
December 31, 2000 and 1999
- ------------------------------------------------------------------------------------------------------------------
Total
Capital Accumulated Members'
Contributions Income Equity
Balance, December 31, 1998 $ 13,659,443 $ 19,162,709 $ 32,822,152
Redemption of units (1,012,261) (11,751,826) (12,764,087)
Equity adjustment for minority interests
related to redemption 670,371 777,852 1,448,223
Distributions to members (5,889,661) (5,889,661)
Net income 13,821,243 13,821,243
--------------- --------------- -----------------
Balance, December 31, 1999 13,317,553 16,120,317 29,437,870
Issuance of units related to the acquisition
of Iowa properties 51,418,250 51,418,250
Issuance of units related to the acquisition
of Wisconsin properties 20,061,217 20,061,217
Distributions to members (6,439,687) (6,439,687)
Net income 14,297,071 14,297,071
--------------- --------------- -----------------
Balance, December 31, 2000 $ 84,797,020 $ 23,977,701 $ 108,774,721
=============== =============== =================
The accompanying notes are an integral part of the consolidated financial
statements.
55
Midwest Wireless Holdings L.L.C.
Consolidated Statements of Cash Flows
For the years ended December 31, 2000 and 1999
- ------------------------------------------------------------------------------------------------------------------
2000 1999
Cash flows from operating activities:
Net income $ 14,297,071 $ 13,821,243
Adjustments to reconcile net income to net cash provided by
operating activities:
Net income allocated to minority interest 1,902,457 2,219,563
Provision for bad debts 623,261 (211,225)
Capitalized interest (608,199) (243,973)
Depreciation 12,278,169 7,582,105
Amortization of FCC licenses 3,780,643 494,381
Loss on disposal of equipment 27,278 390,567
Accretion of discount on marketable securities (124,204)
Changes in assets and liabilities:
Accounts receivable (2,665,409) (287,379)
Inventories (122,081) (895,770)
Accounts payable 1,471,296 (674,665)
Other accrued expenses 3,253,070 388,877
Other liabilities 946,340 639,458
Other (322,733) (174,858)
-------------- -------------
Net cash provided by operating activities 34,861,163 22,924,120
-------------- -------------
Cash flows from investing activities:
Acquisition of cellular properties (96,215,489)
Payments for property, cellular plant and equipment (28,028,072) (20,141,712)
Purchase of FCC licenses (354,900) (287,300)
Purchases of cooperative stock (5,329,209) (653,121)
Purchases of marketable securities (6,679,526)
Proceeds received upon maturity of marketable securities 10,750,000
Payments for deferred acquisition costs (921,824)
Release (restriction) of cash 1,000,000 (1,000,000)
-------------- -------------
Net cash used in investing activities (128,927,670) (18,933,483)
-------------- -------------
Cash flows from financing activities:
Proceeds on revolving loan 500,000 2,000,000
Proceeds on long-term debt borrowings 107,706,887 13,368,420
Payments on long-term debt (6,130,602) (1,534,435)
Distributions to members (6,439,687) (5,889,661)
Distribution from subsidiary to minority interest (904,737) (940,503)
Redemption of units (12,764,087)
-------------- -------------
Net cash provided by (used in) financing activities 94,731,861 (5,760,266)
-------------- -------------
Net change in cash and cash equivalents 665,354 (1,769,629)
Cash and cash equivalents, beginning of year 1,378,350 3,147,979
-------------- -------------
Cash and cash equivalents, end of year $ 2,043,704 $ 1,378,350
============== =============
Supplemental disclosure:
Cash paid during the year for interest $ 7,587,435 $ 1,156,323
Equity units issued for acquisitions 71,479,467
The accompanying notes are an integral part of the consolidated financial
statements.
56
Midwest Wireless Holdings L.L.C.
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
1. Organization and Significant Accounting Policies
Organization and Basis of Consolidation
Midwest Wireless Holdings L.L.C. (the Company) was formed in November
1999 as a Delaware limited liability company to acquire and operate
cellular communications properties in the Midwest portion of the United
States of America. Upon its formation, the Company exchanged its equity
units for approximately 86% of the equity units of Midwest Wireless
Communications, L.L.C. The transaction was accounted for on the
historical cost basis as a combination of entities under common control,
and the consolidated financial statements reflect the results of
operations as if the combination had occurred on January 1, 1999.
The consolidated financial statements include the Company's wholly-owned
subsidiaries, Midwest Wireless Iowa, L.L.C. and Midwest Wireless
Wisconsin, L.L.C., as well as its majority-owned subsidiary, Midwest
Wireless Communications, L.L.C. All significant intercompany balances
and transactions have been eliminated in consolidation.
Revenue Recognition
Service revenue consists of the base monthly service fee and airtime
revenue. Base monthly service fees are billed one month in advance and
are recognized in the month earned. Airtime and roamer revenue is
recognized when the service is provided. The Company recognizes other
service revenues from equipment installations, equipment sales and
connection fees when earned.
Use of Estimates
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported
amounts of assets and liabilities at the date of the financial statements
and disclosure of contingent assets and liabilities at the date of the
financial statements. Estimates also affect the reported amounts of
revenues and expenses during the periods reported. Actual results could
differ from those estimates.
Concentration of Credit Risk
The Company provides cellular service and cellular telephones to a
diversified group of consumers within a concentrated geographical area.
The Company performs credit evaluations of its customers and requires a
deposit when deemed necessary. Receivables are generally due within 30
days.
Cash and Cash Equivalents
For the purpose of the statements of cash flows, the Company considers
all investments purchased with original maturities of three months or
less to be cash equivalents.
Cellular Telephone Inventories
Inventories consist primarily of cellular phones and accessories held for
resale with cost determined using the specific identification method.
Losses on sales of cellular phones are recognized in the period in which
sales are made as a cost of acquiring subscribers.
57
Midwest Wireless Holdings L.L.C.
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
Property, Cellular Plant and Equipment
Property, cellular plant and equipment is stated at its original cost.
Depreciation is provided on a straight-line basis over the estimated
useful lives of the cellular plant and equipment, which range from 1 to
30 years.
Major renewals or betterments are capitalized, while repair and
maintenance expenditures are charged to operations as incurred. Interest
incurred on external borrowings during construction is capitalized. The
cost and accumulated depreciation of property, cellular plant and
equipment disposed of or sold are eliminated from their respective
accounts, and the resulting gain or loss is recorded in operations.
Long-Lived Assets
The Company periodically reviews long-lived assets, FCC licenses and
fixed assets, for impairment whenever events or changes in circumstances
indicate that the carrying value of the assets may not be recoverable.
Recoverability is based on projected cash flows on an undiscounted basis.
Federal Communications Commission (FCC) Licenses
FCC licenses consist of the cost of acquiring cellular, personal
communication services (PCS), and local multi-point distribution (LMDS)
licenses. It also includes the value assigned to cellular licenses
acquired through the acquisitions of operating cellular systems.
Amortization is computed using the straight-line method over lives
ranging from 10 to 39.5 years.
Income Taxes
No provision for income taxes has been recorded since all income, losses
and tax credits are allocated to the members for inclusion in their
respective income tax returns.
Advertising
Advertising costs are expensed as incurred. Total advertising expenses
were $3,021,650 and $1,754,394 for the years ended December 31, 2000 and
1999, respectively.
Accounting for Stock-Based Compensation
The Company accounts for employee stock and options using the intrinsic
value method.
2. Select Account Information
Restricted Cash
At June 29, 1999, the Company signed a letter of intent to acquire
certain cellular properties. In connection with the pending acquisition,
the Company deposited $1,000,000 into an escrow account. Upon closing of
the acquisition in 2000, the restricted funds were released to the
Company.
Deferred Acquisition Costs
During 1999, the Company paid certain external deferred acquisition costs
of $1,046,824 in connection with the pending acquisition of certain
cellular properties. These costs were allocated as part of the purchase
price upon the closing of the acquisition in 2000. See Note 3.
58
Midwest Wireless Holdings L.L.C.
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
Property, Cellular Plant and Equipment
2000 1999
Land $ 2,093,598 $ 1,696,989
Plant in service 94,427,420 56,271,401
Plant under construction 9,004,718 8,453,176
------------------ ----------------
105,525,736 66,421,566
Less accumulated depreciation (32,002,418) (22,423,903)
------------------ ----------------
$ 73,523,318 $ 43,997,663
================== ================
At December 31, 2000 and 1999, accounts payable includes $2,891,666 and
$1,295,835, respectively, related to the purchase of property, cellular
plant and equipment. The Company capitalized interest in the amount of
$608,199 and $243,973 for the years ended December 31, 2000 and 1999,
respectively.
FCC Licenses
2000 1999
Cellular license $ 173,541,780 $ 17,505,700
LMDS licenses 357,696 357,696
PCS licenses 287,300 287,300
Other 354,900
------------------ ----------------
174,541,676 18,150,696
Less accumulated amortization (5,416,412) (1,635,769)
------------------ ----------------
$ 169,125,264 $ 16,514,927
================== ================
3. Acquisitions
On February 29, 2000, the Company, through its wholly-owned subsidiary,
Midwest Wireless Iowa, L.L.C., completed its acquisition of cellular
communications properties providing services to a 28-county area of Iowa
(the "Iowa properties").
On March 17, 2000, the Company through its wholly-owned subsidiary,
Midwest Wireless Wisconsin, L.L.C., completed its acquisition of cellular
communications properties providing services to a 4-county area of
Wisconsin and Minnesota (the "Wisconsin properties").
The Company allocated the excess purchase price over net tangible assets
to FCC licenses and is amortizing it over 39.5 years. The acquisitions
were accounted for as purchases. As a result, the financial statements
include the operations related to the Iowa and Wisconsin properties
beginning at their respective acquisition dates.
59
Midwest Wireless Holdings L.L.C.
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
The following table presents the computation of the purchase price, the
estimated fair value of tangible assets acquired, and the amount
allocated to FCC licenses.
Iowa Wisconsin
Cash $ 89,242,760 $ 5,078,783
Equity units issued 51,418,250 20,061,217
Acquisition expenses 2,760,681 180,089
Liabilities assumed:
Accounts payable and accrued liabilities 28,956
Customer deposits 4,700 35,600
Advance revenue 792,218 90,616
------------------ ----------------
Total purchase price 144,218,609 25,475,261
Estimated fair value of tangible assets acquired:
Accounts receivable 1,699,586 282,309
Inventories 76,895
Property, cellular plant and equipment 9,101,600 2,497,400
------------------ ----------------
10,878,081 2,779,709
------------------ ----------------
FCC licenses $ 133,340,528 $ 22,695,552
================== ================
4. Members' Capital
Members' capital includes capital contributions made by the members and
the accumulated income resulting from operations. Company income or loss
is allocated to the individual members based upon their ownership
percentage, as defined in the Limited Liability Company Agreement (the
Agreement). Pursuant to the Agreement, members are not obligated for the
debts and obligations of the Company, including accumulated losses in
excess of capital contributions.
Under the Agreement, no member may transfer or sell any units unless the
board of managers approves the terms of such transfer or sale. Upon
receipt of a bona fide offer in writing from a third party, the other
members and then the Company have the right to purchase all, but not less
than all, of the units at the bona fide offer price within a specified
time frame.
The Agreement also contains the right of co-sale under which no member
may transfer its units to an acquiring person, as defined in the
Agreement, who after such transfer would be an acquiring person without
assuring that each of the other members may participate in the transfer
of units under the same terms and conditions. The right of co-sale would
terminate in the event the Company completes a sale of securities
pursuant to a securities act or if the Company's market capitalization
would exceed $200,000,000.
Each member is entitled to one vote for each unit owned. Certain
restrictions on voting rights exist when units are sold to an acquiring
person.
60
Midwest Wireless Holdings L.L.C.
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
5. Debt
Long-term debt consists of the following:
Rate at Balance at
December 31 December 31
--------------- ----------------------------------------
Maturity 2000 1999 2000 1999
RTFC note, variable rate 5/12/09 8.40% 6.95% $ 12,052,934 $ 13,113,035
RTFC note, fixed rate 7/29/08 5.75% 5.75% 7,458,340 8,171,831
RTFC note, variable rate 7/28/08 8.40% 6.95% 6,823,500 7,476,259
RTFC revolving note 7/29/03 9.10% 7.60% 2,500,000 2,000,000
RTFC note, variable rate 3/02/10 8.40% 95,743,583
RTFC note, variable rate 2/03/15 8.40% 8,259,053
------------------- ------------------
$ 132,837,410 $ 30,761,125
=================== ==================
The Company has entered into various agreements (the Agreements) with the
Rural Telephone Finance Cooperative (RTFC). In 2000, the Company entered
into an agreement to fund the acquisitions of the Iowa and Wisconsin
cellular markets and the construction of a new headquarters building. The
Agreements provide for borrowings of up to $159,725,739. The principal
and interest on the variable and fixed rate notes are payable in
quarterly installments. The Agreements provide the Company the option to
fix the interest rate on borrowings (or portions thereof) through the
maturity date. The variable rate is based on RTFC's cost of capital and
is adjusted monthly. The Agreements also provide for a revolving loan of
up to $10,000,000. Borrowings under the revolving loan bear interest at
the prime rate of 7.6% and 6.1% at December 31, 2000 and 1999,
respectively, plus one and one-half percent. The outstanding principal
and interest are due upon maturity.
The Agreements require the Company to maintain an investment in RTFC in
the amount of at least 5% of the outstanding debt balance. The Agreements
also contain covenants that restrict distributions to members and require
the Company to maintain a debt coverage service ratio of not less than
1.25. Substantially all assets of the Company are pledged as collateral
under the Agreement.
Maturities of long-term debt are as follows:
2001 $ 10,415,285
2002 11,182,775
2003 14,507,117
2004 12,892,539
2005 13,845,587
Thereafter 69,994,107
-----------------
$ 132,837,410
=================
61
Midwest Wireless Holdings L.L.C.
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
6. Commitments
Future minimum rental payments required under operating leases,
principally for real estate related to tower sites, and other contractual
commitments that have initial or remaining noncancellable terms in excess
of one year as of December 31, 2000, are as follows:
2001 $ 477,776
2002 405,853
2003 309,140
2004 224,424
2005 144,621
Thereafter 360,010
-----------------
$ 1,921,824
=================
Rental expense was $773,324 and $666,765 for the years ended December 31,
2000 and 1999, respectively.
7. Employee Benefits
The Company established the Midwest Wireless Holdings L.L.C. 401(k)
Profit Sharing Plan and Trust (formerly the Midwest Wireless
Communications L.L.C. Profit Sharing Plan and Trust) (the 401(k) Plan)
for all employees who meet certain service and age requirements. The
401(k) Plan is comprised of an employer matching contribution component
and a profit sharing component. Employer matching contributions to this
component of the plan were $292,508 and $185,909 for the years ended
December 31, 2000 and 1999, respectively. Profit sharing contributions
are 100% vested after five years of employment. Profit sharing
contribution expenses were $309,312 and $210,606 for the years ended
December 31, 2000 and 1999, respectively.
Effective January 1, 1997, the Company established the Midwest Wireless
Holdings L.L.C. Appreciation Rights Plan (formerly the Midwest Wireless
Communications L.L.C. Appreciation Rights Plan) (the Plan) for certain
key employees. Effective January 1, 2000, the Plan was amended to clarify
certain language and definitions in the Plan. The Plan is designed to
create two classes of appreciation rights, Class A and Class B, which
become fully vested three years and five years after the first day of the
year the rights are granted, respectively. Participants in the Plan are
eligible to receive awards based on defined increases in members' equity
from the date of grant through the end of the vesting period. The Board
of Managers granted both Class A and Class B appreciation rights in 1997.
Under the terms of the Plan, no additional Class B appreciation rights
will be granted, and additional Class A appreciation rights will be
granted at the discretion of the Board of Managers. In 2000, the Board of
Managers issued additional Class A appreciation rights to certain key
employees and authorized an additional 9,000 rights for potential new
Plan participants. The Company recognized $1,137,500 and $639,458 in
compensation expense related to the Plan for the years ended December 31,
2000 and 1999, respectively.
62
Midwest Wireless Holdings L.L.C.
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
8. Option Plan
During 2000, the Company's Board of Managers adopted and approved the
Midwest Wireless Holdings L.L.C. Unit Option Plan under which options to
purchase 46,742 units of the Company's membership units may be granted to
employees with terms and vesting periods determined by the Company's
Board of Managers at the date of grant. The exercise price is equal to
the fair market value of the units at the time the option is granted, as
determined by the Board of Managers. Options granted under the plan
expire ten years from the date of grant. During 2000, the Company granted
options to purchase 4,092 membership units under this plan at an exercise
price of $299.06 per unit. The options granted vest 100% three years
after they were granted. At December 31, 2000, there were 42,650 units
available for issuance under this plan.
The following table summarizes information about stock options
outstanding and exercisable at December 31, 2000:
Options Outstanding Options Exercisable
-------------------------------------------------- ---------------------
Weighted
Average Weighted Weighted
Remaining Average Average
Contractual Exercise Exercise
Exercise Prices Number Life Price Number Price
$299.06 4,092 9.58 $299.06 - -
The Company accounts for stock-based compensation using the intrinsic
value method. Accordingly, compensation cost for stock options granted to
employees is measured as the excess, if any, of the fair value of the
stock at the date of the grant over the amount an employee must pay to
acquire the stock. Such compensation costs are amortized on a
straight-line basis over the underlying option's vesting term. No such
compensation expense was recognized for the period ended December 31,
2000.
If the Company had elected to recognize compensation expense for options
granted using the fair value method in 2000, net income would have been
as follows:
Net income:
As reported $ 14,297,071
Pro forma 14,251,198
The weighted average fair value of options at the date of grant was
$80.71 in 2000.
The fair value for each option grant was estimated at the date of grant
using the Black-Scholes option-pricing model with the following
assumptions:
Dividend yield 2.07%
Volatility factor 1.00%
Risk-free interest rate 6.19%
Expected lives 10 years
63
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
OF
HECTOR COMMUNICATIONS CORPORATION
FOR
YEAR ENDED DECEMBER 31, 2000
EXHIBITS
- --------------------------------------------------------------------------------
64
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
Exhibit Index To
Form 10-K for the Year Ended December 31, 2000
Regulation S-K Location in Consecutive Numbering
Exhibit Table System as Filed With the
Reference Title of Document Securities and Exchange Commission
3.1 Articles of Incorporation, Filed as Exhibit 3.1 to the Form 10
as amended of the Company, File No. 0-18587
(the "Form 10") and incorporated
hereby by reference
3.2 Bylaws, as amended Filed as Exhibit 3.2 to the Form 10
of the Company and incorporated
hereby by reference.
4.1 Indenture dated Filed as Exhibit 4.1 to the
February 24, 1995 between Company's Registration Statement on
Hector Communications Corp. Form S-2 File No. 33-87888 and
and National City Bank of incorporated herein by reference
Minneapolis, trustee
10.1 1990 Stock Plan Filed as Exhibit 10.1 to the Form 10
of the Company and incorporated
herein by reference.
10.2 Employee Stock Purchase Plan Filed as Exhibit 10.2 to the Form 10
of the Company and incorporated
herein by reference.
10.3 Employee Stock Ownership Plan Filed as Exhibit 10.3 to the Form 10
of the Company and incorporated
herein by reference.
10.4 Employee Savings Plan and Trust Filed as Exhibit 10.4 to the Form 10
of the Company and incorporated
herein by reference.
10.5 Distribution Agreement Filed as Exhibit 10.5 to the Form 10
of the Company and incorporated
herein by reference.
10.7 Flexible Benefit Plan Filed as Exhibit 10.7 to the 1993
Form 10-K and incorporated herein
by reference.
10.8 Form of Rights Agreement dated Filed as Exhibit 1 to the Company's
as of July 27, 1999 between the Form 8-A on August 9, 1999 and
Company and Norwest Bank, incorporated herein by reference.
Minnesota, National Association
10.9 1999 Stock Plan Filed by the Company on Form S-8 on
December 3, 1999 and incorporated
herein by reference.
11 Calculation of Earnings Filed herewith at page 66.
Per Share
21 Subsidiaries of the Registrant Filed herewith at page 67.
23 Independent Auditors' Consent Filed herewith at page 68.
24 Power of Attorney Included in signatures at page 44.
The exhibits referred to in this Exhibit Index will be supplied to a shareholder
at a charge of $.25 per page upon written request directed to HCC's Assistant
Secretary at the executive offices of the Company.
65
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
EXHIBIT 11
CALCULATION OF EARNINGS PER SHARE
Year Ended December 31
------------------------------------------
Basic: 2000 1999 1998
- ------- ----------- ----------- -----------
Net income $ 3,309,423 $ 7,479,181 $ 3,910,243
=========== =========== ===========
Common shares:
Weighted average number of common
shares outstanding 3,544,349 3,095,028 2,402,794
=========== =========== ===========
Net income per common share $ .93 $ 2.42 $ 1.63
=========== =========== ===========
Diluted:
- -------------
Net income $ 3,309,423 $ 7,479,181 $ 3,910,243
Interest on convertible debentures,
net of tax 265,783 620,594
----------- ----------- -----------
Adjusted net income $ 3,309,423 $ 7,744,964 $ 4,530,837
=========== =========== ===========
Common and common equivalent shares:
Weighted average number of common
shares outstanding 3,544,349 3,095,028 2,402,794
Assumed conversion of convertible
debentures into common stock 431,152 1,119,683
Dilutive effect of convertible
preferred shares outstanding 222,863 321,961 352,867
Dilutive effect of stock options
outstanding after application of
treasury stock method 82,512 73,965 45,441
Dilutive effect of Employee Stock
Purchase Plan shares subscribed 1,042 688 4,664
Dilutive effect of warrants
outstanding 21,734 11,623
----------- ----------- -----------
3,850,766 3,944,528 3,937,072
=========== =========== ===========
Diluted net income per share $ .86 $ 1.96 $ 1.15
=========== =========== ===========
66
SUBSIDIARIES OF HECTOR COMMUNICATIONS CORPORATION
EXHIBIT 21
Subsidiaries Jurisdiction of Incorporation
Arrowhead Communications Corporation Minnesota
Eagle Valley Telephone Company Minnesota
Granada Telephone Company Minnesota
Indianhead Telephone Company Wisconsin
North American Communications Corporation Minnesota
Pine Island Telephone Company Minnesota
Indianhead Communications Corporation Wisconsin
Alliance Telecommunications Corporation Minnesota
Ollig Utilities Company Minnesota
Felton Telephone Company Minnesota
Loretel Systems, Inc. Minnesota
Sleepy Eye Telephone Company Minnesota
Sioux Valley Telephone Company South Dakota
Hills Telephone Company Minnesota
OU Connection, Inc. Minnesota
Aurora Cable TV, Inc. South Dakota
Loretel Financial Systems, Inc. Minnesota
Hastad Engineering Co. Minnesota
Valley Cablevision of SD, Inc. South Dakota
Hager TeleCom, Inc. Wisconsin
Cannon Communications Corp. Minnesota
Arrowhead Communications Corporation, Eagle Valley Telephone Company, Granada
Telephone Company, Indianhead Telephone Company, North American Communications
Corporation and Indianhead Communications Corporation are 100% owned by Hector
Communications Corporation. Pine Island Telephone Company is 69% owned by Hector
Communications Corporation and 31% owned by Indianhead Telephone Company.
Alliance Telecommunications Corporation is 68% owned by Hector Communications
Corporation, 20% owned by Golden West Telecommunications Cooperative, Inc. of
Wall, South Dakota and 12% owned by Split Rock Telecom Cooperative of Garretson,
South Dakota.
Loretel Systems, Inc., Sleepy Eye Telephone Company, Sioux Valley Telephone
Company, Hills Telephone Company, Felton Telephone Company, Hager TeleCom, Inc.,
Cannon Communications Corporation, Ollig Utilities Company, OU Connection, Inc.,
Aurora Cable TV, Inc., Loretel Financial Systems, Inc., Hastad Engineering Co.
and Valley Cablevision of SD, Inc. are 100% owned by Alliance Telecommunications
Corporation.
The financial statements of these subsidiaries are included in the Consolidated
Financial Statements of Hector Communications Corporation.
67
EXHIBIT 23
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in Registration Statements No.
33-39865, 33-39866, 33-65176, 33-87888, 333-45971, 333-45975 and 333-91967 of
Hector Communications Corporation of our report dated February 14, 2001,
appearing in this Annual Report on Form 10-K of Hector Communications
Corporation and its subsidiaries for the year ended December 31, 2000.
/s/ Olsen Thielen and Co., Ltd.
- -------------------------------
Olsen Thielen and Co., Ltd.
March 29, 2001
St. Paul, Minnesota
68