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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, 2001
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 $38,403,000 based upon the closing sale price of
the Company's common stock on the American Stock Exchange on March 22, 2002.
As of March 22, 2002 there were outstanding 3,508,879 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 16, 2002 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 15
4. Submission of Matters to a Vote of Security Holders 15
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 16
7a. Disclosures About Market Risk 23
8. Financial Statements and Supplementary Data 24
9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure 40
PART III
10. Directors and Executive Officers of the Registrant 40
11. Executive Compensation 40
12. Security Ownership of Certain Beneficial Owners and Management 40
13. Certain Relationships and Related Transactions 41
PART IV
14. Exhibits, Financial Statement Schedule and Reports on Form 8-K 41
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
7,529 access lines in 9 rural communities in Minnesota and Wisconsin at December
31, 2001. HCC, through its subsidiaries, also provides cable television service
to 4,786 subscribers in Minnesota and Wisconsin.
HCC's 68% owned subsidiary, Alliance Telecommunications Corporation, owns
and operates six additional LEC subsidiaries which served 31,350 access lines in
28 rural communities in Minnesota, Wisconsin, Iowa and South Dakota at December
31, 2001. Alliance, through its subsidiaries, also served 9,042 cable television
subscribers in Minnesota, North Dakota, South Dakota and Iowa. 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 City, WI and Red Wing, MN and has
an ownership interest in Midwest Wireless Holdings, LLC.
[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
The Company derives the majority of its revenues from providing basic
telephone services (often referred to as "plain old telephone service" or
"POTS") to residential and business customers within its service territories.
POTS revenues consist mainly of fees for local service which are billed directly
to customers and access revenues which are received for intrastate and
interstate exchange services provided to long distance carriers. POTS revenues
are subject to regulation by a number of state and federal government agencies.
The Company also earns revenues by providing a number of nonregulated
telecommunications services to customers. The most significant of these
nonregulated services is cable television. Other services include internet
services, lease of fiber optic transport facilities, billing and collection
services to long distance carriers, telephone directory services, engineering
services and equipment rental. The Company also makes retail sales of consumer
telecommunications equipment and sells wireless telephone services on a
commission basis.
The following table presents the percentage of revenues derived from
local service revenues, access revenues, nonregulated telecommunications
activities and cable television operations for the last three years:
3
Year Ended December 31
--------------------------------------------------
2001 2000 1999
----------- ---------- -----------
Local network 17.6% 17.6% 17.3%
Network access 55.0 55.1 56.9
Nonregulated activities 17.2 16.8 14.7
Cable television 10.2 10.5 11.1
----------- ----------- -----------
100.0% 100.0% 100.0%
=========== =========== ===========
The Company also owns minority interests in partnerships and limited
liability corporations ("LLCs") that provide a wide variety of
telecommunications services, including wireless telephone services, fiber-optic
transport services and telephone switching services. The most significant of
these investments is Midwest Wireless Holdings, LLC.
(1) Plain Old Telephone Service ("POTS")
Local Network
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, 2001, 2000 and 1999:
Access Lines*
---------------------------------------------------------
December 31
--------------------------------------------------
2001 2000 1999
----------- ----------- -----------
Hector Communications Corporation:
Arrowhead Communications Corporation 808 806 817
Eagle Valley Telephone Company 727 731 734
Granada Telephone Company 289 288 289
Pine Island Telephone Company 3,313 3,263 3,154
Indianhead Telephone Company 2,392 2,334 2,234
---------- ---------- ----------
Total Hector Access Lines 7,529 7,422 7,228
---------- ---------- ----------
Alliance Telecommunications Corporation:
Loretel Systems, Inc. 13,300 13,234 12,967
Sleepy Eye Telephone Company 6,556 6,511 6,467
Sioux Valley Telephone Company 5,893 5,939 5,756
Hills Telephone Company 2,812 2,788 2,706
Felton Telephone Company 752 764 743
Hager TeleCom, Inc. 2,037 2,087
---------- ---------- ----------
Total Alliance Access Lines 31,350 31,323 28,639
---------- ---------- ----------
Total Access Lines 38,879 38,745 35,867
========== ========== ==========
* 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.
4
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
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. In 2001, approximately 64% of the Company's access revenues were from
interstate sources and 36% were from intrastate sources.
A portion of the Company's interstate access revenue is derived from
subscriber line charges ("SLCs") determined by the FCC and billed directly to
end users for access to long distance carriers. Another portion consists of
universal service funds received based upon the high cost of providing service
to rural areas. The balance of the interstate access revenue 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.
Intrastate access revenues are received from long distance carriers based
on recorded customer usage multiplied by the appropriate tariff rate. Where
applicable, HCC's LECs 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.
(2) Nonregulated Telecommunications Activities
Revenues from internet services were $1,977,000 and $1,304,000 in 2001
and 2000, respectively. Internet access is available, through local dial-up
telephone numbers, to all of the Company's local service customers. Digital
subscriber lines ("DSL") permit high-speed Internet access and are available in
many of the Company's service areas. The Company provided dial-up internet
services to 8,859 and 7,876 customers at December 31, 2001 and 2000,
respectively. At December 31, 2001 an additional 1,162 customers subscribed to
DSL service.
Revenues from leases of fiber-optic transport facilities were $1,301,000
and $1,282,000 in 2001 and 2000, respectively. However, due to changes in market
conditions, the Company has renegotiated several of its leases, resulting in a
significant decline in anticipated future lease revenue. All of the fiber-optic
facilities leased are owned by HCC's LEC subsidiaries and are located within the
LEC's local exchange boundaries.
HCC's LECs sell and lease customer premise telephone equipment, provide
inside wiring services 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.
5
(3) Cable Television
The Company, through its cable television and LEC subsidiaries, owns and
operates 49 cable television systems serving 13,828 subscribers in Minnesota and
the surrounding states. 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.
In 2001 the Company deployed broadband equipment manufactured by Next
Level Communications, Inc. in its exchanges serving Pine Island, MN and Goodhue,
MN. This equipment makes it possible to deliver POTS, video and high speed
Internet services to the customer over the same circuit. Video programming is
delivered utilizing a digital "super headend" owned by Broadband Visions, Inc.,
in which the Company is an investor. The Company is planning to install
broadband equipment in its Sleepy Eye, MN exchange in 2002 and in additional
exchanges in future years. The Company's broadband product offerings are
dependent on the availability of equipment from Next Level Communications, Inc.
If the Company cannot obtain necessary equipment it could have a material
adverse affect on its operations.
(4) 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 227,000 customers. The Company accounts for its
investment in Midwest Wireless using the equity method. Income recognized was
$1,475,000, $1,248,000, and $1,481,000 in 2001, 2000 and 1999, 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 was unsuccessful and is
being liquidated. Its licenses and systems are being sold to other operators. In
2001, the Company made payments to Wireless North's primary lender of $1,129,000
to satisfy loan guarantees it gave with respect to Wireless North's debt. Cash
investments in Wireless North by the Company totaled $3,202,000. The Company has
written off its entire investment in Wireless North, has no obligation to
provide additional funding and does not expect to realize any additional value
from this investment.
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. The Company sold 326,707 shares of RCC stock in 1999 and recorded gains
on sales of securities of $11,600,000. At December 31, 2001, the Company owned
approximately 10,700 shares of RCC's common stock.
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,
6
Inc. is a leading provider of Internet, long distance, video-conferencing and
high-speed data networking services. Onvoy's customers include Minnesota based
Fortune 500 companies and many small-to-medium sized businesses. Onvoy also
serves the state's higher education institutions, the state's K-12 schools,
public libraries, state and county governments, more than 70 regional Internet
service providers and the state's independent local telephone companies.
During 2001 and 2000 the Company purchased $190,000 and $446,000
respectively, of debt issued by Onvoy to provide additional working capital to
Onvoy's operations. The Company is presently the second largest common
shareholder of Onvoy. 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 substantially all of its investment in
Onvoy common stock during the fourth quarter of 2000.
Fiber-Optic Transport Investments
- ---------------------------------
The Company has invested approximately $1,707,000 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 $4,991,000, $4,694,000 and $4,644,000 at December 31, 2001, 2000 and
1999, 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 an investor
in Fibercom LC, a compteting local exchange carrier ("CLEC") that has been
established to provide local communications services to business customers in
the Sioux City, Iowa area. The Company is also an investor in Desktop Media,
Inc., a CLEC using a network employing Ethernet architecture to provide
telecommunications services in southeastern Minnesota.
(5) Competition
Telephone
- ---------
LECs are subject to many forms of competition. Its principal competitors
are:
- - Facilities-based competition from providers, including cable television
service providers, with their own local service network;
- - Resale competition from resale interconnection (providers who purchase
local services from the LEC at wholesale rates and resell the services to
their customers);
- - Competition from unbundled network element interconnection (providers who
lease some of the network elements from the LEC)
- - Wireless providers who may charge a competitive fee for services that
could compete with wireline based local service.
Rural areas like those served by the Company are less likely to
experience competition from facilities-based competitors due to the significant
investment in plant and equipment required in relation to the lower customer
density in rural markets. Competition from resale interconnection or unbundled
network element interconnection is more likely. Under the Telecommunications Act
of 1996, the Company's LECs are not currently required to lease facilities to
competitors seeking to interconnect with our networks. 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.
7
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.
(6) Regulation
The Company's LECs and cable television systems are subject to federal,
state and local regulation. The Communications Act of 1934 and the
Telecommunications Act of 1996 govern Federal regulations. Under these federal
statutes, the FCC exercises jurisdiction over all interstate telecommunications
activities. Intrastate activities are governed by rules and regulations set by
the respective state public utility commissions.
Federal Regulations
- -------------------
Under federal regulations, incumbent local exchange carriers ("ILECs")
are required to comply with the Communications Act of 1934 and rules issued by
the FCC. While the Telecommunications Act of 1996 amended the earlier law to
reduce regulatory burdens and promote competition, ILECs remain subject to
extensive regulatory requirements. ILECs are required to maintain accounting
records according to Uniform System of Accounts, to structure access charges
according to FCC rules and to reflect their charges for interstate services at a
rate of return prescribed by the FCC. The FCC also regulates transfer of control
and assignments of operating authorizations and construction licenses. The FCC
requires carriers providing access services to file tariffs with the FCC
reflecting rates, terms and conditions of the services. Tariffs filed are
subject to review and potential objection by third parties.
Regulation of Cost Recovery and Nonregulated Revenue Allocation As a regulated
common carrier, the Company's LEC subsidiaries can set
maximum rates at a level that allows recovery of reasonable costs incurred to
provide regulated service and earns a reasonable return on the investment
required to provide these services.
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
8
- - 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. However, at this time it is not possible to predict what
changes, if any, may be made.
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. In 1984 the FCC 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 SLC was increased in 1989 to a $3.50 cap on residence and single
line business lines and a $6.00 cap on multi-line business lines. The remaining
portions of the interstate local loop costs were recovered from interstate
access charges to interexchange carriers.
In November 2001 the FCC adopted access charge reforms based in part on a
proposal by the Multi-Association Group (the "MAG Plan"). The MAG Plan increases
the maximum rate caps for SLCs as follows:
Residential and Single Line Business
January 1, 2002 Increase from $3.50 to $5.00
July 1, 2002 Increase from $5.00 to $6.00
July 1, 2003 Increase from $6.00 to $6.50
Multi-line Business
January 1, 2002 Increase from $6.00 to $9.20
The increased SLC revenues will be offset by reductions in recovery of
local loop costs from interexchange carriers. The plan is intended to be revenue
neutral for affected LECs.
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 universal
service fund support accounted for $1,744,000, $1,490,000 and $1,035,000 of the
Company's network access revenues in 2001, 2000 and 1999, respectively.
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
9
administer interstate access service rates, terms and conditions. NECA develops
interstate access rates on the basis of data provided by participating local
exchange carriers and blended to yield average rates. These rates are intended
to generate revenue equal to the aggregate costs plus a return on the investment
of all of the participants.
Individual LECs are likely to have service costs that differ from the
revenues generated by applying the overall NECA tariff rates. To allow for this,
revenues generated by participating LECs are pooled and redistributed on the
basis of each individual company's costs. This process eliminates the burden of
individual tariff filing and produces a system in which small companies can
share and spread risk. For example, if a small local exchange carrier filed its
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, however, 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 in 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:
10
- - Negotiate in good faith the terms and conditions of interconnection with
any competitive carrier making a bona fide request for same,
- - Interconnect their facilities and equipment with any requesting
telecommunications carrier at any technically feasible point,
- - Unbundle and provide nondiscriminatory access to unbundled network
elements, such as local loops, switches and transport facilities, at
nondiscriminatory rates and on nondiscriminatory terms and conditions,
- - Offer resale interconnection at wholesale rates,
- - 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.
11
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.
State Regulation of Rural LECs
- ------------------------------
HCC's LEC subsidiaries are subject to regulation by Minnesota, South
Dakota, Iowa and Wisconsin regulatory agencies with respect to:
o Intrastate toll rates,
o Intrastate access charges billed to intrastate IXCs, o Service areas, o
Service standards, o Accounting and related matters, and o The use of
radio frequencies in telephone operations
In some cases state regulations also apply to local service rates, rate
of return, depreciation rates, construction plans and borrowings, and certain
other financial transactions.
Local service rates are not directly determined by regulatory
authorities, but are limited by regulation of these other areas. The Company has
sought appropriate increases in local and other service rates and approval for
changes in rate structures necessary to achieve reasonable rates and earnings.
The bulk of the Company's access lines are located in Minnesota. A bill
passed by the 1995 Minnesota legislature allows telephone companies serving
fewer than 50,000 access lines to elect to provide service under an alternate
form of regulation. Companies choosing alternative regulation agreed 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
(except Felton Telephone Company) 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. In
2001, the Company increased its local service rate for Sleepy Eye Telephone
Company. The commission did not review the rate increase.
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.
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:
12
- - "Must carry" rules regarding the broadcast television and translator
signals that must be included in channel offerings to subscribers,
- - Exclusivity provisions which require the deletion of certain programming
carried by out-of-area stations where it would duplicate programming
carried by local stations,
- - Technical standards and performance testing requirements, and
- - Franchise fees applicable to state and local cable television franchises.
Thus far, HCC's cable systems have not experienced any difficulty in complying
with the FCC rules.
In Minnesota, the award of cable franchises and certain aspects of cable
operations are subject to rules of the Minnesota Cable Communications Board.
Cable television systems are operated under 15 year, non-exclusive franchises
granted by local government authorities. Franchises contain many conditions,
including time limitations on commencement or completion of construction,
approval of initial fees charged to subscribers for basic service, the number of
channels offered and the types of programming. HCC does not anticipate
difficulty in obtaining renewal of its franchises at the expiration of their
current terms.
The regulation of cable television at the federal, state and local levels
is subject to the political process and has been in constant flux over the past
decade. This process continues in the context of legislative proposals for new
laws and the adoption or deletion of administrative regulations and policies.
The Company anticipates further material developments in these areas, but cannot
anticipate their direction and impact on its cable television operations.
(7) Business Strategy
The Company is focused on business opportunities in rural
telecommunications. Its three-part strategy is to:
- - Expand its existing operations through internal growth
- - Pursue acquisitions of attractive properties, particularly the acquisition
of additional rural telephone exchanges and cable television properties
- - Participate in opportunities afforded by new telecommunications
technologies
Future growth in existing telephone and cable operations is expected to
come from providing service to new or presently unserved homes and businesses,
from sales of enhanced services to existing customers and from providing new
services made possible by improvements in technology.
The Company continually assesses acquisition opportunities. Competition
to acquire attractive telephone or cable television properties is intense.
Acquisitions of rural telephone exchanges are subject to the approval of
regulatory agencies in some states and, in some cases, to federal waivers that
may affect the form of regulation or amount of interstate cost recovery of
acquired telephone exchanges. The Company will aggressively pursue acquisitions
of telephone exchanges, but there is no assurance that acquisitions can be made
on acceptable terms or that regulatory approval, where required, will be
received.
The Company has aggressively invested in new telecommunications
technologies, primarily through investments in partnerships and limited
liability companies. The Company has substantial investments in wireless
communications companies, fiber optic transport groups, CLECs and Internet
service providers. The Company intends to pursue additional investment
opportunities in the future.
(8) Employees
At March 1, 2002, the Company had 169 full-time and part-time employees,
of which 112 employees work in the Alliance operations and 57 work in Hector
operations. None of the Company's employees are represented under collective
bargaining agreements. HCC believes its employee relations to be good.
13
(9) Executive Officers of Registrant
The executive officers of the Company and their ages at March 1, 2002
were as follows:
Name Age Position
---- --- --------
Curtis A. Sampson 68 Chairman of the Board and Chief
Executive Officer
Steven H. Sjogren 59 President and Chief Operating
Officer
Paul N. Hanson 55 Vice President and Treasurer
Charles A. Braun 44 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 50% 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.
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.
14
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.
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:
2001 2000
------------------------ -------------------------
Quarter High Low High Low
------- ------ ------- -------
First $ 11.50 $ 9.65 $ 15.75 $ 11.63
Second 13.30 9.60 14.88 11.38
Third 15.25 12.20 14.25 12.38
Fourth 16.65 13.60 13.25 10.00
[b] HOLDERS
At March 1, 2002 there were 555 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
------------------------------------------------------------
2001 2000 1999 1998 1997
- --------------------------------------------------------------------------------------------------------------------------------
Selected Income Statement Information
Revenues $ 40,633 $ 37,790 $ 34,117 $ 31,839 $ 28,866
Costs and Expenses 30,112 26,799 23,063 21,192 19,113
- --------------------------------------------------------------------------------------------------------------------------------
Operating Income 10,521 10,991 11,054 10,647 9,753
Other Income (Expenses), net 1,170 (2,471) 7,401 (40) (3,367)
- --------------------------------------------------------------------------------------------------------------------------------
Income Before Income Taxes 11,691 8,520 18,455 10,606 6,386
Income Tax Expense 5,321 4,207 7,513 4,949 2,867
- --------------------------------------------------------------------------------------------------------------------------------
Income Before Minority Interest 6,370 4,313 10,942 5,657 3,519
Minority Interest in Earnings of Alliance
Telecommunications Corporation 1,754 1,004 3,463 1,747 798
- --------------------------------------------------------------------------------------------------------------------------------
Net Income $ 4,616 $ 3,309 $ 7,479 $ 3,910 $ 2,721
================================================================================================================================
Basic Net Income Per Common Share $ 1.33 $ .93 $ 2.42 $ 1.63 $ 1.44
Diluted Net Income Per Common Share $ 1.23 $ .86 $ 1.96 $ 1.15 $ .93
Average Shares Outstanding:
Common shares only 3,465 3,544 3,095 2,403 1,893
Common and potential common shares 3,762 3,851 3,945 3,937 3,732
===============================================================================================================================
Selected Balance Sheet Information
Working Capital $ 7,633 $ 8,960 $ 18,736 $ 6,554 $ 8,504
Property, Plant and Equipment, net 57,362 56,227 51,410 50,810 45,927
Excess of Cost Over Net Assets Acquired, net 53,663 55,475 51,405 53,004 51,170
Total Assets 158,251 158,678 166,797 150,680 139,291
Long-Term Debt 79,642 84,378 86,282 94,232 97,793
Stockholders' Equity 42,241 39,108 39,982 22,720 14,447
- --------------------------------------------------------------------------------------------------------------------------------
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, 2001,
these subsidiaries provided telephone service to 7,529 customers in 9 rural
communities in Minnesota and Wisconsin. They also owned cable television systems
serving 4,786 customers in Minnesota and Wisconsin. HCC's 100%-owned
subsidiaries also have substantial investments in other telecommunications
ventures, including, Midwest Wireless Holdings, LLC.
HCC also owns a 68% interest in Alliance Telecommunications Corporation
("Alliance"). At December 31, 2001, Alliance, through its six LEC subsidiaries,
provided telephone service to 31,350 customers in 28 rural communities in
Minnesota, Wisconsin, South Dakota and Iowa. Alliance's subsidiaries also
provided cable television services to 9,042 subscribers in Minnesota, South
Dakota and North Dakota. Alliance's subsidiaries also own substantial
investments in Midwest Wireless Holdings, LLC and have other investments. The
minority interest in Alliance is owned by Golden West Telecommunications
Cooperative and Split Rock Telecom Cooperative.
16
Results of Operations
2001 Compared to 2000
Consolidated revenues increased 8% to $40,633,000 in 2001 from
$37,790,000 in 2000. The following table shows revenues by operating group for
2001 compared to 2000:
Alliance Hector
Year Ended December 31 Year Ended December 31
2001 2000 2001 2000
--------------- ---------------- ---------------- -----------------
Local network $ 5,586,670 $ 4,934,548 $ 1,562,398 $ 1,715,694
Network access 16,689,138 15,299,095 5,652,977 5,513,268
Nonregulated activities 5,859,932 5,407,525 1,126,656 966,561
Cable television 2,690,063 2,469,407 1,465,078 1,484,004
--------------- ---------------- ---------------- -----------------
$ 30,825,803 $ 28,110,575 $ 9,807,109 $ 9,679,527
--------------- ---------------- ---------------- -----------------
Consolidated local service revenues grew to $7,149,000 in 2001 from
$6,650,000 in 2000, an increase of $499,000 or 8%. Revenue growth in Alliance
was due to the acquisition of Hager TeleCom, Inc. in June 2000 and a local
service rate increase at Sleepy Eye Telephone Company. Hector's local network
revenues declined due to rate reductions in Wisconsin exchanges mandated by the
public service commission.
Network access revenues increased to $22,342,000 in 2001 compared to
$20,812,000 in 2000, an increase of $1,530,000 or 7%. The increase was due to
the acquisition of Hager TeleCom, Inc., which accounted for $402,000 of the
increase, increased universal service support payments and increased settlements
payments from NECA.
Nonregulated revenues grew to $6,987,000 in 2001 from $6,374,000 in 2000,
an increase of $613,000 or 10%. The acquisition of Hager TeleCom, Inc. accounted
for $371,000 of the increase. Revenues from internet services, excluding Hager,
increased $437,000, which offset decreases in billing and collection revenues.
Cable television revenues rose to $4,155,000 in 2001 from $3,953,000 in 2000, an
increase of $202,000 or 5% due to the acquisition of additional cable systems in
South Dakota.
Consolidated operating costs and expenses grew to $30,112,000 in 2001
from $26,799,000 in 2000, an increase of $3,313,000 or 12%. The acquisition of
Hager TeleCom, Inc. accounted for $1,113,000 of the increase. The following
table shows costs and expenses by operating group for 2001 compared to 2000:
Alliance Hector
Year Ended December 31 Year Ended December 31
2001 2000 2001 2000
--------------- ---------------- ---------------- -----------------
Plant operations $ 3,974,169 $ 3,586,255 $ 1,381,781 $ 1,224,546
Depreciation and amortization 8,138,515 7,354,503 3,178,259 2,821,781
Customer operations 2,051,760 1,805,330 384,286 310,304
General and administrative 3,307,150 2,803,504 1,565,399 1,772,180
Other operating expenses 4,472,835 3,666,506 1,657,742 1,454,337
--------------- ---------------- ---------------- -----------------
$ 21,944,429 $ 19,216,098 $ 8,167,467 $ 7,583,148
--------------- ---------------- ---------------- -----------------
Consolidated plant operations expenses increased to $5,356,000 in 2001
from $4,811,000 in 2000, an increase of $545,000 or 11% due to the acquisition
of Hager ($187,000 of the increase), and increased labor costs. Depreciation and
amortization increased to $11,317,000 in 2001 from $10,176,000 in 2000, an
increase of $1,141,000 or 11% due to increased depreciation on new telephone
equipment and the acquisition of Hager. Customer operations expenses increased
15% to $2,436,000 in 2001 from $2,116,000 in 2000 due to increased marketing and
sales costs. General and administrative expenses increased to $4,873,000 in 2001
from $4,576,000 in 2000, an increase of $297,000 or 6% due to the acquisition of
Hager. Other operating expenses increased $1,010,000 or 20% due to increased
cable television and internet service fees.
17
Consolidated operating income decreased $470,000 or 4% to $10,521,000 in
2001 from $10,991,000 in 2000.
Consolidated interest expenses decreased $653,000 to $5,302,000 in 2001
from $5,955,000 in 2000. The decrease was due to lower interest rates on
variable rate debt and increased patronage refunds from CoBank.
Income from investments in unconsolidated affiliates increased to
$2,140,000 in 2001 from $611,000 in 2000. 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 increased to $1,475,000
in 2001 from $1,248,000 in 2000.
Alliance had gains on sales of marketable securities totaling $3,659,000
in 2001 compared to gains on sales of $1,622,000 in 2000. Most of the gains were
on sales of Illuminet, Inc. (which was acquired by VeriSign) stock sold in 2001
and Qwest stock sold in 2000. Interest and dividend income decreased to $673,000
in 2001 from $1,251,000 in 2000 due to lower interest rates on invested funds
and lower dividend yields from marketable security investments.
Consolidated income before income taxes increased to $11,691,000 in 2001
from $8,520,000 in 2000. The Company's effective income tax rate of 45.5% 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 increased
to $6,370,000 in 2001 from $4,313,000 in 2000. Minority interest on earnings of
Alliance was $1,754,000 in 2001 compared to $1,004,000 in 2000. Net income
increased to $4,616,000 in 2001 compared to $3,309,000 in 2000.
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
Nonregulated activities 5,407,525 4,178,484 966,561 821,115
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 $6,374,000 in 2000 from $5,000,000 in 1999,
an increase of $1,374,000 or 27%. The acquisition of Hager TeleCom, Inc.
accounted for $790,000 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 and billing and collection revenues. 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.
18
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 1,805,330 1,784,422 310,304 329,191
General and administrative 2,803,504 2,223,743 1,772,180 1,544,670
Other operating expenses 3,666,506 3,020,202 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 were $2,116,000 in 2000 compared to $2,114,000 in 1999. General and
administrative expenses increased to $4,576,000 in 2000 from $3,768,000 in 1999,
an increase of $808,000 or 21% due to the acquisition of Hager. Other operating
expenses increased $574,000 or 13% due to the acquisition of Hager and increased
cable television and internet service fees.
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 Qwest stock sold in 2000 and sales of Rural Cellular
Corporation in 1999. At December 31, 2000, Alliance continued 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.
19
Liquidity and Capital Resources
Operations
----------
Cash flows from consolidated operating activities were $13,679,000,
$7,981,000 and $6,693,000 in 2001, 2000 and 1999, respectively. The increase in
cash flows from operations in 2001 was due to increased net income, increased
noncash expenses, lower accounts receivable levels and lower income tax
payments. At December 31, 2001, the Company's cash, cash equivalents and
marketable securities totaled $13,502,000 compared to $16,729,000 at December
31, 2000. Alliance's cash and securities were $7,536,000 of this total at
December 31, 2001. Working capital at December 31, 2001 was $7,633,000 compared
to $8,960,000 at December 31, 2000. The current ratio was 1.6 to 1 at December
31, 2001 compared to 1.8 to 1 at December 31, 2000.
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 2001, 2000 and 1999 were $3,985,000, $3,111,000 and
$2,902,000, respectively. Alliance's plant additions in 2001, 2000 (excluding
the acquisition of Hager TeleCom, Inc.) and 1999 were $6,634,000, $6,335,000 and
$4,640,000, respectively. Plant additions for 2002 for Hector and Alliance are
expected to total $2,993,000 and $9,300,000, respectively. These plant additions
will provide customers with additional advanced telecommunications services and
expand usage of high capacity fiber optics in the telephone network.
Investments
-----------
Investment income has been derived almost exclusively from interest
earned on the Company's cash and cash equivalents. Interest income has
fluctuated in relation to changes in interest rates and availability of cash for
investment. In 2001 Alliance received $3,675,000 from sales of marketable
securities, principally Illuminet, Inc. common stock. In 2000 Alliance received
$5,421,000 from sales of marketable securities, principally Qwest common stock.
In 1999 Alliance received $18,920,000 from sales of marketable securities,
principally Rural Cellular Corporation common stock. The Company does not expect
proceeds from marketable securities sales in future years to approach these
levels.
The Company owns 10.4% of 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. Wireless North was unsuccessful and is
being liquidated. Its licenses and systems are being sold to other operators. In
2001, the Company made payments to Wireless North's primary lender of $1,129,000
to satisfy loan guarantees made on Wireless North's debt. The Company had
accrued these payments in prior periods and they did not affect 2001 net income.
Total cash invested by the Company over the life of its investment in Wireless
North was $3,202,000. The Company has no additional obligations to provide
funding for Wireless North. The Company does not expect to realize any
additional value or incur additional costs from this investment.
The Company regularly invests cash in new telecommunications technologies
and ventures and in support of its existing affiliated interests. In 2001 the
Company invested $500,000 in Desktop Media, Inc., a start-up company providing
voice, data and internet telecommunications services in southeastern Minnesota.
The Company also invested $360,000 to support its investment in a fiber optic
transport company in northwestern Minnesota. In 2000, the Company invested
$700,000 in Broadband Visions, Inc., which constructed a digital "super headend"
in Hutchinson, MN. The Company expects to make additional investments of this
type as opportunities arise.
20
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"). At December 31, 2001 the
outstanding balance on this loan was $3,366,000. The interest rate on the loan
varies according to the rate RTFC charges for similar loans. The interest rate
was 5.25% at December 31, 2001.
The Company carries a significant amount of debt due to Alliance`s
borrowing to finance the acquisition of Ollig Utilities Company. Interest rates
on a portion of Alliance's acquisition loan from CoBank have been locked for
periods of one to ten years. At December 31, 2001 interest rates on the loan
averaged 6.6%. The outstanding balance on this loan at December 31, 2001 was
$41,532,000. 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. As a condition of maintaining
the loan, Alliance invested $344,000 of cash in the bank in 1999. 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. The 1999
calls resulted in $6,493,000 of debentures being converted into stock and
$1,455,000 of debentures being purchased and retired.
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 $2,201,000, $700,000
and $6,156,000 in 2001, 2000 and 1999, respectively. The average interest rate
on outstanding RUS and RTB loans is 5.5%. At December 31, 2001 unadvanced loan
commitments from the RUS and RTB to Hector's and Alliance's LEC subsidiaries
totaled $23,202,000.
The Company's loan agreements place significant restrictions on cash
distributions from the subsidiaries to the parent company. Substantially all of
the LEC's assets are pledged or are subject to mortgages to secure obligations
to the RUS and RTB. Alliance's loan covenants with CoBank also restrict dividend
payments at the Alliance level. A portion of any dividend payment from Alliance
to Hector would also be subject to federal and state income taxes. It is the
Company's plan, in so far as possible, to maintain its cash balances at the
subsidiary level to support their operations.
Common Stock
------------
The Company's Board of Directors has authorized the purchase and
retirement, from time to time, of shares of the Company's stock on the open
market, or in private transactions consistent with overall market and financial
conditions. In 2001 the Company purchased and retired 109,704 shares at a cost
of $1,268,000. In 2000, the Company purchased and retired 221,950 shares at a
cost of $3,155,000. At December 31, 2001 286,000 shares could be repurchased
under outstanding Board authorizations.
In 1995 the underwriters of the convertible debenture offering also
received warrants to purchase shares of the Company's common stock at a price of
$8.70 per share. Proceeds to the Company from exercises of outstanding warrants
were $757,000 in 2000. Proceeds to the Company from exercises of employee stock
options and employee stock purchase plan shares totaled $550,000, $382,000 and
$466,000 in 2001, 2000 and 1999, respectively.
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.
21
Potential Breakup of Alliance Telecommunications Corp.
------------------------------------------------------
Golden West Telecommunications Cooperative, Inc. and Split Rock Telecom
Cooperative, Inc., the 20% and 12% minority shareholders of Alliance, have
advised the Company that they are interested in exchanging their minority
investment for a share of the assets and liabilities of Alliance. Preliminary
discussions have been held regarding possible terms and effects of a breakup but
to date no conclusions or agreements have been reached. The Company has not
completed its analysis of the effect a breakup of Alliance would have on its
financial position or results of operations.
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. The purchase price was
$9,124,500 of cash plus acquisition costs.
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 major
telephone companies. 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.
New Accounting Standards
- ------------------------
In October, 2001 the Financial Accounting Standards Board ("FASB") issued
SFAS No. 144, "Accounting for Impairment or Disposal of Long-Lived Assets". SFAS
No. 144 is effective January 1, 2002. SFAS No. 144 sets forth requirements for
measuring and recognizing impairment losses on long-lived assets. The statement
also establishes financial reporting requirements when impairment losses are
recognized. The Company does not expect adoption of SFAS No. 144 to have a
material effect on its financial statements.
In July 2001 the FASB issued Statement of Financial Accounting Standards
("SFAS") No. 141, "Business Combinations". SFAS No. 141 requires that the
purchase method of accounting be used for all business combinations initiated
after June 30, 2001. SFAS No. 141 also requires that intangible assets acquired
in a business combination be recognized and reported apart from goodwill.
Adoption of this statement had no impact on the Company's financial position or
operating results in 2001.
In July 2001 the FASB also issued SFAS No. 142, "Goodwill and Other
Intangible Assets". SFAS No. 142 is effective January 1, 2002. It requires that
goodwill and intangible assets with indefinite useful lives no longer be
amortized, but instead tested on a regular (at least annual) basis for
impairment. Intangible assets with determinable useful lives will remain subject
to amortization. At December 31, 2001 the Company had unamortized goodwill of
$53,663,000. Amortization expense in 2001 was $1,813,000. Some of the
unconsolidated affiliates in which the Company is invested have material amounts
of intangible assets. The Company believes adoption of SFAS No. 142 could have a
material positive effect on net income. However, the Company has not completed
the complex valuation processes required to definitively determine its impact.
22
In June 2001 the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations". SFAS No. 143 is effective for fiscal years beginning
after June 15, 2002. The statement establishes accounting standards for
recognition and measurement of a liability for an asset retirement obligation
and an associated asset retirement cost. The statement applies to tangible
long-lived assets, including individual assets, functional groups of related
assets and significant parts of assets. It covers a company's legal obligations
resulting from the acquisition, construction, development or normal operation of
a capital asset. The Company is currently evaluating the provisions of SFAS No.
143, but does not expect its adoption to have a material impact on its financial
position or operating results.
In June 1998, the FASB issued 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.
Adoption of SFAS No. 133 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, changes in laws and
regulations determining access revenues and universal service fund allocations
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.
ITEM 7A. DISCLOSURES ABOUT MARKET RISK
The Company does not use derivative financial instruments in its
operations or investment portfolio. Its operations are not subject to risks
associated with changes in the value of foreign currencies. Portions of the
Company's long-term debt have variable interest rates based on the lenders' cost
of money. The Company has investments in money market funds that earn interest
at prevailing market rates. In the opinion of management, the Company does not
have a material exposure to loss caused by market risk.
23
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
(a) FINANCIAL STATEMENTS
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 accounting
principles generally accepted in the United States of America 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 /s/ Charles A. Braun
---------------------------- --------------------------
Curtis A. Sampson Charles A. Braun
Chairman and Chief Executive Officer Chief Financial Officer
INDEPENDENT AUDITORS' REPORT
To the Shareholders and Board of Directors of
Hector Communications Corporation
We have audited the accompanying consolidated balance sheets of Hector
Communications Corporation and subsidiaries as of December 31, 2001 and 2000 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, 2001. 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 of America. 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, 2001 and 2000 and
the results of their operations and their cash flows for each of the three years
in the period ended December 31, 2001 in conformity with accounting principles
generally accepted in the United States of America.
/s/ Olsen Thielen & Co., Ltd.
- -------------------------------
Olsen Thielen & Co., Ltd.
February 13, 2002
St. Paul, Minnesota
24
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
ASSETS
December 31
-----------------------------------
2001 2000
-------------- --------------
CURRENT ASSETS:
Cash and cash equivalents $ 13,083,481 $ 13,834,110
Construction fund (Note 6) 759,934 317,837
Accounts receivable (net of allowance for doubtful accounts of
$396,000 and $360,000, respectively) 4,736,131 5,548,622
Materials, supplies and inventories, at average cost 1,249,109 825,673
Other current assets 186,451 302,704
-------------- --------------
TOTAL CURRENT ASSETS 20,015,106 20,828,946
PROPERTY, PLANT AND EQUIPMENT,net (Notes 1 and 5) 57,362,325 56,226,525
OTHER ASSETS:
Excess of cost over net assets acquired, less amortization
of $10,025,000 and $8,212,000 (Note 1) 53,662,750 55,475,430
Marketable securities (Note 3) 419,004 2,895,272
Wireless telephone investments (Note 4) 14,174,179 12,509,975
Other investments (Notes 1 and 6) 12,290,004 10,527,727
Other assets (Note 1) 327,685 214,106
-------------- --------------
TOTAL OTHER ASSETS 80,873,622 81,622,510
-------------- --------------
TOTAL ASSETS $ 158,251,053 $ 158,677,981
============== ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Notes payable and current portion of long-term debt (Note 6) $ 6,752,100 $ 6,337,200
Accounts payable (Note 10) 2,497,804 2,664,520
Accrued expenses 2,409,669 2,479,779
Income taxes payable 722,797 387,100
-------------- --------------
TOTAL CURRENT LIABILITES 12,382,370 11,868,599
LONG-TERM DEBT, less current portion (Note 6) 79,641,269 84,378,149
DEFERRED INVESTMENT TAX CREDITS (Note 7) 48,269 79,668
DEFERRED INCOME TAXES (Note 7) 5,975,119 6,603,310
DEFERRED COMPENSATION (Note 9) 931,529 904,071
COMMITMENTS AND CONTINGENCIES (Note 4)
MINORITY INTEREST IN ALLIANCE TELECOMMUNICATIONS, CORP. 17,031,204 15,736,317
STOCKHOLDERS' EQUITY: (Notes 1, 6 and 8)
Preferred stock, par value $1.00 per share; 3,000,000 shares authorized:
Convertible Series A, 220,100 and 221,300 shares issued and outstanding 220,100 221,300
Common stock, par value $.01 per share; 10,000,000 shares authorized;
3,476,569 and 3,504,363 shares issued and outstanding 34,766 35,044
Additional paid-in capital 13,212,970 12,844,776
Retained earnings 28,702,145 24,945,512
-------------- --------------
42,169,981 38,046,632
Accumulated other comprehensive income (Note 3) 71,312 1,061,235
-------------- --------------
TOTAL STOCKHOLDERS' EQUITY 42,241,293 39,107,867
-------------- --------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 158,251,053 $ 158,677,981
============== ==============
See notes to consolidated financial
statements.
25
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
Year Ended December 31
--------------------------------------------------
2001 2000 1999
------------- ------------- -------------
REVENUES:
Local network $ 7,149,068 $ 6,650,242 $ 5,914,678
Network access 22,342,115 20,812,363 19,418,961
Nonregulated activities 6,986,588 6,374,086 4,999,599
Cable television revenues 4,155,141 3,953,411 3,784,078
------------- ------------- -------------
TOTAL REVENUES 40,632,912 37,790,102 34,117,316
COSTS AND EXPENSES:
Plant operations 5,355,950 4,810,801 4,086,923
Depreciation and amortization 11,316,774 10,176,284 8,547,619
Customer operations 2,436,046 2,115,634 2,113,613
General and administrative 4,872,549 4,575,684 3,768,413
Other operating expenses 6,130,577 5,120,843 4,546,512
------------- ------------- -------------
TOTAL COSTS AND EXPENSES 30,111,896 26,799,246 23,063,080
------------- ------------- -------------
OPERATING INCOME 10,521,016 10,990,856 11,054,236
OTHER INCOME (EXPENSES):
Interest expense (5,302,058) (5,954,603) (6,582,536)
Income (loss) from investments in unconsolidated
affiliates (Note 4) 2,140,230 610,846 (335,537)
Interest and dividend income 672,584 1,250,748 1,116,098
Gain on sale of marketable securities (Note 3) 3,659,055 1,622,226 13,203,062
------------- ------------- -------------
OTHER INCOME (EXPENSES), net 1,169,811 (2,470,783) 7,401,087
------------- ------------- -------------
INCOME BEFORE INCOME TAXES 11,690,827 8,520,073 18,455,323
INCOME TAX EXPENSE (Note 7) 5,321,000 4,207,000 7,513,000
------------- ------------- -------------
INCOME BEFORE MINORITY INTEREST 6,369,827 4,313,073 10,942,323
MINORITY INTEREST IN EARNINGS OF
ALLIANCE TELECOMMUNICATIONS CORPORATION 1,753,673 1,003,650 3,463,142
------------- ------------- -------------
NET INCOME 4,616,154 3,309,423 7,479,181
------------- ------------- -------------
OTHER COMPREHENSIVE INCOME (LOSS):
Unrealized holding gains (losses) on marketable securities 1,199,251 (3,903,896) 20,784,075
Reclassification adjustment for gains included in net income (3,659,055) (1,622,226) (13,203,062)
------------- ------------- -------------
OTHER COMPREHENSIVE INCOME (LOSS) BEFORE
INCOME TAXES (2,459,804) (5,526,122) 7,581,013
------------- ------------- -------------
Income tax expense (benefit) related to unrealized
holding gains and losses on marketable securities 492,948 (1,539,833) 8,450,555
Income tax benefit related to reclassification adjustment for
gains included in net income (1,504,043) (639,862) (5,368,207)
------------- ------------- -------------
Income tax expense (benefit) related to items of other
comprehensive income (loss) (1,011,095) (2,179,695) 3,082,348
Minority interest in other comprehensive income (loss) of
Alliance Telecommunications Corporation (458,786) (1,081,180) 1,559,887
------------- ------------- -------------
Other Comprehensive Income (Loss) (989,923) (2,265,247) 2,938,778
------------- ------------- -------------
COMPREHENSIVE INCOME $ 3,626,231 $ 1,044,176 $ 10,417,959
============= ============= =============
BASIC NET INCOME PER COMMON SHARE (Note 1) $ 1.33 $ .93 $ 2.42
============= ============= =============
DILUTED NET INCOME PER COMMON SHARE (Note 1) $ 1.23 $ .86 $ 1.96
============= ============= =============
AVERAGE SHARES OUTSTANDING (Notes 1 and 8):
Common shares only 3,465,000 3,544,000 3,095,000
Common and potential common shares 3,762,000 3,851,000 3,945,000
See notes to consolidated financial statements.
26
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Accumulated
Additional Other
Preferred Stock Common Stock Paid-in Retained Comprehensive
Shares Amount Shares Amount Capital Earnings Income Total
------- -------- --------- ------- ----------- ----------- ---------- -----------
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
Net income 4,616,154 4,616,154
Issuance of common stock under
Employee Stock Purchase Plan 11,626 116 136,998 137,114
Issuance of common stock under
Employee Stock Option Plan 52,375 524 412,351 412,875
Issuance of common stock in
exchange for preferred stock (1,200) (1,200) 1,200 12 1,188 0
Issuance of common stock to ESOP 16,709 167 225,026 225,193
Purchase and retirement of
common stock (109,704) (1,097) (407,369) (859,521) (1,267,987)
Change in unrealized gains on
marketable securities, net of
deferred taxes (989,923) (989,923)
------- -------- --------- ------- ----------- ----------- ---------- -----------
BALANCE AT DECEMBER 31, 2001 220,100 $220,100 3,476,569 $34,766 $13,212,970 $28,702,145 $ 71,312 $42,241,293
======= ======== ========= ======= =========== =========== ========== ===========
See notes to consolidated financial
statements.
27
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31
---------------------------------------------------
2001 2000 1999
------------- ------------- -------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income $ 4,616,154 $ 3,309,423 $ 7,479,181
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 11,318,010 10,177,520 8,663,181
Minority stockholders' interest in earnings
of Alliance Telecommunications Corporation 1,753,673 1,003,650 3,463,142
Gain on sales of marketable securities (3,659,055) (1,622,226) (13,203,062)
(Income) loss from unconsolidated affiliates (2,140,230) (610,846) 335,537
Proceeds from wireless cellular investments 901,295 716,653 709,668
Noncash patronage refunds (270,793) (8,780) (12,569)
Noncash investment income (48,325)
Changes in assets and liabilities net of effects from
the purchase of Hager Telecom, Inc.:
Decrease (increase) in accounts receivable 812,491 (566,951) (727,508)
Increase in materials, supplies and inventories (423,436) (172,847) (88,146)
Decrease in other current assets 116,253 111,795 8,702
Increase (decrease) in accounts payable (166,716) (62,254) 7,981
Increase in accrued expenses 155,083 121,137 477,147
Increase (decrease) in income taxes payable 335,697 (3,426,965) 1,942,370
Decrease in deferred investment tax credits (31,399) (60,718) (112,215)
Increase (decrease) in deferred income taxes 382,904 (934,383) (2,157,467)
Increase (decrease) in deferred compensation 27,458 6,958 (93,042)
------------- ------------- -------------
Net cash provided by operating activities 13,679,064 7,981,166 6,692,900
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property, plant and equipment (10,618,722) (9,446,190) (7,541,926)
Sales of marketable securities 3,675,519 5,420,957 18,920,352
Purchases of marketable securities (1,768,648)
Investments in wireless telephone (1,128,606) (183,276) (1,031,587)
Proceeds from wireless PCS investments 408,846
Decrease (increase) in construction fund (442,097) 8,169 (83,113)
Purchases of other investments (1,226,643) (2,393,458) (1,052,230)
Proceeds from other investments 486,821 205,584 463,734
Decrease in excess of cost over net assets acquired 15,170
Decrease (increase) in other assets (135,987) 109,954 (52,109)
Payments for purchase of Hager Telecom, Inc., net of cash acquired (8,532,392)
------------- ------------- -------------
Net cash (used in) provided by investing activities (9,389,715) (14,401,806) 7,869,643
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of notes payable and long-term debt (6,523,180) (5,485,803) (8,815,220)
Proceeds from issuance of notes payable and long-term debt 2,201,200 700,000 6,156,087
Issuance of common stock 549,989 1,139,764 466,328
Purchase of stock (1,267,987) (3,154,983)
------------- ------------- -------------
Net cash used in financing activities (5,039,978) (6,801,022) (2,192,805)
------------- ------------- -------------
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (750,629) (13,221,662) 12,369,738
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 13,834,110 27,055,772 14,686,034
------------- ------------- -------------
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 13,083,481 $ 13,834,110 $ 27,055,772
============= ============= =============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Interest paid $ 5,710,494 $ 6,189,304 $ 6,700,250
Income taxes paid 4,650,094 8,639,597 7,840,312
See notes to consolidated financial
statements.
28
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, 2001, the Company's wholly and majority
owned subsidiaries provided telephone service to 38,879 access lines in 37 rural
communities in Minnesota, Wisconsin, South Dakota and Iowa. Its cable television
operations provided cable television services to 13,828 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 $9,482,923, $8,415,178 and
$6,942,357 for 2001, 2000 and 1999, 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 $1,812,679, $1,739,225 and $1,583,380 in 2001, 2000 and 1999,
respectively.
In 1999 the Company amortized debenture issue costs 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 in 1999.
When the debentures were converted into common stock in 1999, the remaining
issue costs of $256,151 were charged to capital. None of the convertible
debentures remain outstanding.
29
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 $21,172, $21,881 and
$21,882 for 2001, 2000 and 1999, 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. 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 (including the current portion)
was $84,392,000 and $88,867,000 at December 31, 2001 and 2000, 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
the Company issued calls to retire outstanding convertible debentures. As a
result of these calls, $6,493,000 of debentures were converted into common stock
in noncash transactions.
New accounting principles: In October 2001 the Financial Accounting Standards
Board ("FASB") issued SFAS No. 144, "Accounting for Impairment or Disposal of
Long-Lived Assets". SFAS No. 144 is effective January 1, 2002. SFAS No. 144 sets
forth requirements for measuring and recognizing impairment losses on long-lived
assets. The statement also establishes financial reporting requirements when
impairment losses are recognized. The Company does not expect adoption of SFAS
No. 144 to have a material effect on its financial statements.
In July 2001 the FASB issued Statement of Financial Accounting Standards
("SFAS") No. 141, "Business Combinations". SFAS No. 141 requires that the
purchase method of accounting be used for all business combinations initiated
after June 30, 2001. SFAS No. 141 also requires that intangible assets acquired
in a business combination be recognized and reported apart from goodwill.
Adoption of this statement had no impact on the Company's financial position or
operating results in 2001.
30
In July 2001 the FASB issued SFAS No. 142, "Goodwill and Other Intangible
Assets". SFAS No. 142 is effective January 1, 2002. It requires that goodwill
and intangible assets with indefinite useful lives no longer be amortized, but
instead tested on a regular (at least annual) basis for impairment. Intangible
assets with determinable useful lives will remain subject to amortization. At
December 31, 2001 the Company had unamortized goodwill of $53,663,000.
Amortization expense in 2001 was $1,813,000. Some of the unconsolidated
affiliates in which the Company is invested have material amounts of intangible
assets. The Company believes adoption of SFAS No. 142 could have a material
positive effect on net income. However, the Company has not completed the
complex valuation processes required to definitively determine its impact.
In June 2001 the FASB issued SFAS No. 143, "Accounting for Asset Retirement
Obligations". SFAS No. 143 is effective for fiscal years beginning after June
15, 2002. The statement establishes accounting standards for recognition and
measurement of a liability for an asset retirement obligation and an associated
asset retirement cost. The statement applies to tangible long-lived assets,
including individual assets, functional groups of related assets and significant
parts of assets. It covers a company's legal obligations resulting from the
acquisition, construction, development or normal operation of a capital asset.
The Company is currently evaluating the provisions of SFAS No. 143, but does not
expect its adoption to have a material impact on its financial position or
operating results.
In June 1998, the FASB issued 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.
Adoption of SFAS No. 133 did not have a material effect on the Company's
financial statements.
Basis of presentation: Certain amounts in the 1999 and 2000 financial statements
have been reclassified to conform to the 2001 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. The
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
==============
31
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 Company's marketable
securities portfolio was classified as available-for-sale at December 31, 2001
and December 31, 2000. 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, 2001 $ 260,980 $ 172,159 $ (14,135) $ 419,004
December 31, 2000 $ 277,444 $ 2,630,212 $ (12,384) $ 2,895,272
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, 2001 and 2000 as follows:
Net Deferred Accumulated
Unrealized Income Minority Comprehensive
Gains Taxes Interest Income
-------------- ------------- ------------- -------------
December 31, 2001 $ 158,024 $ (66,791) $ (19,921) $ 71,312
December 31, 2000 $ 2,617,828 $ (1,077,886) $ (478,707) $ 1,061,235
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 $3,676,000,
$5,421,000 and $18,920,000 in 2001, 2000 and 1999 respectively. Gross realized
gains on sales of these securities were $3,659,000, $1,622,000 and $13,203,000
in 2001, 2000 and 1999, 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, 2001
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 $1,475,000, $1,248,000 and $1,481,000 in 2001, 2000
and 1999, respectively. Cash distributions received from Midwest Wireless were
$901,000, $717,000 and $710,000 in 2001, 2000 and 1999, 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 $8,046,000 and $8,299,000 at
December 31, 2001 and 2000, respectively. Excess cost is being amortized on the
straight-line method over periods ranging from twenty-five to forty years.
Amortization expense was $253,000, $249,000 and $183,000 in 2001, 2000 and 1999,
respectively. At December 31, 2001, the Company's cumulative share of income
from Midwest Wireless was $8,279,000, of which $4,700,000 was undistributed.
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 was unsuccessful and is being
liquidated. Its licenses and systems are being sold to other operators. In 2001,
the Company made payments to Wireless North's primary lender of $1,129,000 to
satisfy loan guarantees made on Wireless North's debt. Cash investments in
Wireless North by the Company totaled $3,202,000. The Company has no obligation
to provide additional funding for Wireless North. The Company suspended use of
the equity method of accounting when its recorded losses equaled the total of
its cash investments. As a result the Company has unrecorded losses of
$2,500,000 on its investment. The Company does not expect to realize any
additional value from this investment.
32
Summarized audited financial information for Midwest Wireless for 2001, 2000 and
1999 is as follows:
Year Ended December 31
2001 2000 1999
------------- ------------- -------------
Current assets $ 17,572,431 $ 14,363,696 $ 10,152,590
Noncurrent assets 285,452,749 250,179,199 63,760,822
Current liabilities 48,394,693 25,397,983 10,136,761
Noncurrent liabilities 130,528,309 124,525,414 29,491,724
Minority interest 6,913,996 5,844,777 4,847,057
Members' equity 117,188,182 108,774,721 29,437,870
Revenues 132,989,226 104,192,081 58,002,457
Expenses 116,400,866 89,895,010 44,181,214
Net income 16,588,360 14,297,071 13,821,243
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 2001 2000
----------- --------------- ---------------
Land $ 632,585 $ 630,750
Buildings 5-40 years 6,449,591 6,314,045
Machinery and equipment 3-15 years 3,619,690 2,754,648
Furniture and fixtures 5-10 years 2,310,545 2,208,319
Telephone plant 5-33 years 82,436,569 74,408,575
Cable television plant 10-15 years 10,343,032 9,436,721
Construction in progress 1,433,388 1,558,474
--------------- ---------------
107,225,400 97,311,532
Less accumulated depreciation 49,863,075 41,085,007
--------------- ---------------
$ 57,362,325 $ 56,226,525
=============== ===============
NOTE 6 - NOTES PAYABLE AND LONG-TERM DEBT
- -----------------------------------------
December 31
--------------------------------
2001 2000
-------------- --------------
Notes payable to CoBank, payable by Alliance
Telecommunications Corporation in monthly installments,
average interest rate of 6.6%, due 2002 to 2011 $ 41,531,600 $ 44,902,300
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 2002 to 2028 39,808,528 40,129,684
Notes payable to Rural Telephone Finance Cooperative
in quarterly installments, interest rate of 5.25%, due 2013 3,365,634 3,560,905
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 1,687,607 2,122,460
-------------- --------------
86,393,369 90,715,349
Less current portion 6,752,100 6,337,200
-------------- --------------
$ 79,641,269 $ 84,378,149
============== ==============
33
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, 2001, Alliance's
investment in CoBank stock was $3,516,000.
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 refunds accrued were
$325,000 and $231,000 in 2001 and 2000, respectively. Approximately 30% of
patronage refunds are 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. 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 6.6%. 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, 2001, the Company's local exchange carrier
subsidiaries had unadvanced loan commitments under the RUS and RTB programs
aggregating approximately $23,202,000 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, 2001, $4,838,000 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 2002 are $2,993,000 and $9,300,000, 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
(5.25% at December 31, 2001). 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 the Company issued calls to
retire the debentures, which resulted in $6,493,000 of debentures being
converted into stock and $1,455,000 of debentures being purchased and retired.
The annual requirements for principal payments on notes payable and long-
term debt are as follows:
2002 $ 6,752,100
2003 7,178,500
2004 7,633,000
2005 7,648,200
2006 7,969,100
34
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
-----------------------------------------
2001 2000 1999
------------ ------------ ------------
Currently payable taxes:
Federal $ 4,002,000 $ 4,053,000 $ 8,120,000
State 967,000 1,149,000 1,662,000
------------ ------------ ------------
4,969,000 5,202,000 9,782,000
Deferred income taxes (benefit) 383,000 (934,000) (2,157,000)
Deferred investment tax credits (31,000) (61,000) (112,000)
------------ ------------ ------------
$ 5,321,000 $ 4,207,000 $ 7,513,000
============ ============ ============
Deferred tax assets and (liabilities) as of December 31 related to the
following:
2001 2000
------------ ------------
Accelerated depreciation $ (5,256,119) $ (6,101,310)
Alternative minimum tax credits 56,000
Marketable securities (109,000) (1,120,000)
Partnership and LLC investments (1,623,000) (393,000)
Deferred compensation 377,000 365,000
Other 636,000 589,000
------------ ------------
$ (5,975,119) $ (6,603,310)
============ ============
The provision for income taxes varied from the federal statutory tax rate
as follows:
Year Ended December 31
----------------------------
2001 2000 1999
-------- -------- --------
Tax at U.S. statutory rate 35.0% 35.0% 35.0%
Surtax exemption (.9) (1.0) -
State income taxes, net of federal benefit 5.5 8.0 3.8
Excess of cost over net assets acquired 5.3 7.0 3.0
Investment tax credits (.3) (.7) (.6)
Other .9 1.1 (.5)
-------- -------- --------
Effective tax rate 45.5% 49.4% 40.7%
======== ======== ========
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, 2001 195,875 shares remained available
to be issued under the plans.
Changes in outstanding employee and director stock options during the
three years ended December 31, 2001 are as follows:
35
Average
Number of exercise price
shares per share
------------ -------------
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
Granted 105,550 10.28
Exercised (64,800) 7.79
Canceled (750) 10.84
------------ -------------
Outstanding at December 31, 2001 389,075 $ 10.29
============ =============
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,
2001, 297,892 stock options are currently exercisable at an average price of
$10.14 per share. The following table summarizes the status of stock options
outstanding at December 31, 2001:
Weighted Average Weighted
Remaining Average
Range of Exercise Prices Shares Option Life Exercise Price
- ------------------------ --------- ------------- --------------
$ 6.50 to $ 8.50 111,700 1.6 years $ 8.11
$ 8.51 to $ 10.93 104,000 4.3 years 10.02
$ 10.94 to $ 13.20 173,375 3.3 years 11.85
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
11,626, 10,742 and 14,890 for the plan years ended August 31, 2001, 2000 and
1999, respectively. At December 31, 2001 employees had subscribed to purchase an
additional 6,700 shares in the current plan cycle ending August 31, 2002.
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
-------------------------------------------
2001 2000 1999
------------ ------------ ------------
Net income $ 4,267,766 $ 2,958,163 $ 7,211,118
Basic net income per share $ 1.23 $ .83 $ 2.33
Diluted net income per share $ 1.13 $ .77 $ 1.90
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:
36
Year Ended December 31
-------------------------------------------
2001 2000 1999
------------ ------------ ------------
Expected volatility 29.3% 29.6% 28.2%
Risk free interest rate 4.7% 6.5% 5.3%
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 $348,388, $351,260 and
$268,063 in 2001, 2000 and 1999, respectively. Fair value of all options issued
was $358,950, $443,534 and $286,529 in 2001, 2000 and 1999, respectively.
The Company's Board of Directors has authorized the purchase and
retirement, from time to time, of shares of the Company's stock on the open
market, or in private transactions consistent with overall market and financial
conditions. In 2001, the Company purchased and retired 109,704 shares at a cost
of $1,268,000. In 2000, the Company purchased and retired 221,950 shares at a
cost of $3,155,000. At December 31, 2001 286,000 shares could be repurchased
under outstanding Board authorizations.
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 1999 the Company issued calls retiring the debentures; $6,493,000 of
debentures being converted into common stock and $1,455,000 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 and 8,742 shares were issued upon exercise of warrants
in 2000 and 1999, respectively. At December 31, 2001, 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 $133,200, $100,000 and $97,000 for 2001, 2000 and
1999, respectively. At December 31, 2001, the ESOP held 77,693 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.
37
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 2001, 2000
and 1999 were approximately $203,000, $172,000 and $152,000, 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 2001, 2000 and 1999 were $247,000,
$220,000 and $224,000, 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 $121,000 and $100,000 in 2001 and 2000,
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
$286,000, $314,000 and $270,000 in 2001, 2000 and 1999, 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 in 1999.
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
$152,000 and $172,000 at December 31, 2001 and 2000, respectively.
38
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, 2001
Revenues $ 9,807,109 $ 30,825,803 $ 40,632,912
Costs and expenses 8,167,467 21,944,429 30,111,896
--------------- -------------- --------------
Operating income 1,639,642 8,881,374 10,521,016
Interest expense (903,875) (4,398,183) (5,302,058)
Income from unconsolidated affiliates 561,289 1,578,941 2,140,230
Interest and dividend income 263,542 409,042 672,584
Gain on sale of marketable securities 3,659,055 3,659,055
--------------- -------------- --------------
Income before income taxes $ 1,560,598 $ 10,130,229 $ 11,690,827
=============== ============== ==============
Depreciation and amortization $ 3,178,259 $ 8,138,515 $ 11,316,774
=============== ============== ==============
Total assets $ 31,030,867 $ 127,220,186 $ 158,251,053
=============== ============== ==============
Capital expenditures $ 3,984,562 $ 6,634,160 $ 10,618,722
=============== ============== ==============
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
=============== ============== ==============
39
(b) SUPPLEMENTAL FINANCIAL INFORMATION
Unaudited Quarterly Operating Results
(in thousands except per share amounts)
Quarter Ended
-----------------------------------------------
March 31 June 30 Sept 30 Dec 31
- --------------------------------------------------------------------------------
2001
Revenues $ 9,885 $ 10,246 $ 10,386 $ 10,116
Operating income 2,640 2,389 3,029 2,463
Net income 694 1,137 1,969 816
Basic net income per share $ .20 $ .33 $ .57 $ .24
Diluted net income per share $ .19 $ .30 $ .52 $ .21
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
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE
Not applicable.
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 16, 2002 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 16, 2002 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 16, 2002 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.
40
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 16, 2002 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.
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, 2001, 2000
and 1999
Consolidated Balance Sheets as of December 31, 2001 and 2000
Consolidated Statements of Income and Comprehensive Income for the years
ended December 31, 2001, 2000 and 1999
Consolidated Statements of Stockholders' Equity for the years ended
December 31, 2001, 2000 and 1999
Consolidated Statements of Cash Flows for the years ended
December 31, 2001, 2000 and 1999
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, 2001, 2000 and 1999 44
Schedule I - Condensed Financial Information of Registrant 44-47
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. 48-62
(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 appears 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, 2001
Not Applicable.
41
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, 2002 /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, 2002
- -------------------- Chief Executive Officer and Director
Curtis A. Sampson
/s/Steven H. Sjogren President, Chief Operating Officer, March 29, 2002
- -------------------- and Director
Steven H. Sjogren
/s/Paul N. Hanson Vice President, Treasurer and March 29, 2002
- -------------------- Directo
Paul N. Hanson
/s/Charles A. Braun Chief Financial Officer and March 29, 2002
- -------------------- Principal Accounting Officer
Charles A. Braun
/s/Robert L. Hammond, Jr. Director March 29, 2002
- --------------------
Robert L. Hammond, Jr.
/s/James O. Ericson Director March 29, 2002
- --------------------
James O. Ericson
/s/Paul A. Hoff Director March 29, 2002
- --------------------
Paul A. Hoff
/s/Wayne E. Sampson Director March 29, 2002
- --------------------
Wayne E. Sampson
42
- --------------------------------------------------------------------------------
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, 2001
FINANCIAL STATEMENT SCHEDULE
- --------------------------------------------------------------------------------
43
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 13, 2002,
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 13, 2002
HECTOR COMMUNICATIONS CORPORATION
SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
HECTOR COMMUNICATIONS CORPORATION (PARENT COMPANY)
BALANCE SHEETS
December 31
------------------------------
2001 2000
------------ ------------
Assets:
Cash $ 154,401 $ 12,083
Investment in subsidiaries 43,829,268 40,060,671
Other current assets 544,217 551,992
Property, plant and equipment, net 667,195 658,366
Accounts with subsidiaries 398,828 1,474,677
Other investments 830,742 846,153
------------ ------------
Total Assets $ 46,424,651 $ 43,603,942
============ ============
Liabilities and Stockholders' Equity:
Accounts payable $ 106,187 $ 188,880
Other current liabilities 711,537 746,290
Current portion of long-term debt 209,000 195,000
Long-term debt 3,156,634 3,365,905
Stockholders' equity:
Preferred stock, par value $1.00 per share;
3,000,000 shares authorized:
Convertible Series A, 220,100 and 229,300
shares issued and outstanding 220,100 221,300
Common stock, par value $.01 per share;
10,000,000 shares authorized; 3,476,569 and
3,504,363 shares issued and outstanding 34,766 35,044
Additional paid-in capital 13,212,970 12,844,776
Retained earnings 28,702,145 24,945,512
Accumulated other comprehensive income 71,312 1,061,235
------------ ------------
Total Liabilities and Stockholders' Equity $ 46,424,651 $ 43,603,942
============ ============
44
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
------------------------------------------------
2001 2000 1999
----------- ----------- ------------
Revenues:
Sales $ 181,623 $ 109,326 $ 303,779
Expenses:
Operating expenses 140,331 215,104 116,466
Amortization of goodwill 34,721 34,721 34,721
Interest expense, net 204,236 284,942 719,739
Income tax benefit (33,999) (122,816) (170,504)
----------- ----------- ------------
Total expenses 345,289 411,951 700,422
Income (loss) before equity in earnings of
subsidiaries (163,666) (302,625) (396,643)
Equity in earnings of subsidiaries 4,779,820 3,612,048 7,875,824
----------- ----------- ------------
Net income 4,616,154 3,309,423 7,479,181
Other comprehensive income (loss):
Unrealized holding gains (losses) of
subsidiaries on marketable securities 1,199,251 (3,903,896) 20,784,075
Reclassification adjustment for gains of
subsidiaries included in net income (3,659,055) (1,622,226) (13,203,062)
----------- ----------- ------------
Other comprehensive income (loss) before
income taxes (2,459,804) (5,526,122) 7,581,013
----------- ----------- ------------
Income tax expense related to unrealized
holding gains (losses) of subsidiaries
on marketable securities 492,948 (1,539,833) 8,450,555
Income tax benefit related to
reclassification adjustment for gains of
subsidiaries included in net income (1,504,043) (639,862) (5,368,207)
----------- ----------- ------------
Income tax expense (benefit) related to
items of other comprehensive incom (1,011,095) (2,179,695) 3,082,348
Minority interest in other comprehensive
income (loss) of subsidiaries (458,786) (1,081,180) 1,559,887
----------- ----------- ------------
Other comprehensive income (loss) (989,923) (2,265,247) 2,938,778
----------- ----------- ------------
Comprehensive income $ 3,626,231 $ 1,044,176 $ 10,417,959
=========== =========== ============
45
HECTOR COMMUNICATIONS CORPORATION
SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
HECTOR COMMUNICATIONS CORPORATION (PARENT COMPANY)
--------------------------------------------------
STATEMENTS OF CASH FLOWS
Year Ended December 31
------------------------------------------------
2001 2000 1999
----------- ----------- -----------
Cash flows from operating activities:
Net income $ 4,616,154 $ 3,309,423 $ 7,479,181
Adjustments to reconcile net income to net cash provided by operating
activities:
Loss (income) from other investments 448 (3,141)
Noncash patronage refund (8,326) (8,780) (12,569)
Equity in earnings of subsidiaries (4,779,820) (3,612,048) (7,875,824)
Dividends from subsidiaries
Depreciation and amortization 108,135 90,661 190,151
Changes in assets and liabilities:
Decrease (increase) in other current assets 16,721 (101,478) (310,195)
Decrease in accounts with subsidiaries 1,075,849 682,711 3,651,869
Increase (decrease) in cash overdraft (29,931) 29,931
Decrease in accounts payable (82,693) (68,907) (129,455)
Increase in other current liabilities 190,440 412,694 213,616
----------- ----------- -----------
Net cash provided by operating activities 1,136,908 671,204 3,236,705
Cash flows from investing activities:
Purchases of property, plant and equipment (82,243) (621,758) (44,214)
Cash investments in affiliates (18,600)
Purchases of other investments (350,000)
Cash proceeds from other investments 922 2,897
Decrease (increase) in other assets 25,000 (25,000)
----------- ----------- -----------
Net cash used in investing activities (81,321) (946,758) (84,917)
Cash flows from financing activities:
Repayment of long-term debt (195,271) (182,807) (3,626,140)
Issuance of common stock 549,989 1,139,764 466,328
Purchase of stock (1,267,987) (3,154,983)
Investment by affiliate in parent company stock 2,485,663
----------- ----------- -----------
Net cash provided by (used in) financing activities (913,269) 287,637 (3,159,812)
----------- ----------- -----------
Net increase (decrease) in cash and cash equivalents 142,318 12,083 (8,024)
Beginning cash and cash equivalents 12,083 - 8,024
----------- ----------- -----------
Ending cash and cash equivalents $ 154,401 $ 12,083 $ -
=========== =========== ===========
Supplemental disclosures of cash flow information:
Interest paid $ 342,242 $ 307,899 $ 890,545
Income taxes paid 285,000 505,166 168,500
46
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
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
------------------------------------
2001 2000
-------------- -------------
Notes payable to Rural Telephone
Finance Cooperative in quarterly
installments, interest rate of
5.25%, due 2013 $ 3,365,634 $ 3,560,905
Less current portion 209,000 195,000
-------------- ------------
$ 3,156,634 $ 3,365,905
============== ============
The annual requirements for principal payments on notes payable and long-term
debt are as follows:
2002 209,000
2003 223,000
2004 238,000
2005 254,000
2006 272,000
47
Midwest Wireless
Holdings L.L.C.
Report on Audits of Consolidated Financial Statements
For the Years Ended December 31, 2001, 2000 and 1999
48
Report of Independent Accountants
To the Board of Managers and Members of
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
consolidated financial position of Midwest Wireless Holdings L.L.C. and
Subsidiaries at December 31, 2001 and 2000, and the consolidated results of
their operations, changes in members' equity and their cash flows for each of
the three years in the period ended December 31, 2001, 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
Minneapolis, Minnesota
February 8, 2002
49
Midwest Wireless Holdings L.L.C.
Consolidated Statements of Financial Position
At December 31, 2001 and 2000
- --------------------------------------------------------------------------------
ASSETS 2001 2000
Current assets:
Cash and cash equivalents $ 3,032,464 $ 2,043,704
Accounts receivable, less allowance for
doubtful accounts of $572,120 and
$477,152 in 2001 and 2000, respectively 10,935,228 8,751,005
Inventories 2,207,887 2,718,772
Other assets 1,396,852 850,215
------------- -------------
Total current assets 17,572,431 14,363,696
Property, cellular plant and equipment, net 89,469,296 73,523,318
FCC licenses, net 187,211,924 169,125,264
Investments in cooperatives 8,771,529 7,530,617
------------- -------------
Total assets $ 303,025,180 $ 264,542,895
============= =============
LIABILITIES AND MEMBERS' EQUITY
Current liabilities:
Current portion of long-term debt $ 13,679,657 $ 10,415,285
Revolving loan 20,000,000 -
Accounts payable 3,969,202 6,125,308
Accrued commissions 1,855,554 1,554,219
Other accrued expenses 8,890,280 7,303,171
------------- -------------
Total current liabilities 48,394,693 25,397,983
Other liabilities 1,413,672 2,103,289
Revolving loan - 2,500,000
Long-term debt 129,114,637 119,922,125
------------- -------------
Total liabilities 178,923,002 149,923,397
Minority interest 6,913,996 5,844,777
Commitments
Members' equity 117,188,182 108,774,721
------------- -------------
Total liabilities and members' equity $ 303,025,180 $ 264,542,895
============= =============
The accompanying notes are an integral part of the financial statements.
50
Midwest Wireless Holdings L.L.C.
Consolidated Statements of Operations
For the years ended December 31, 2001, 2000 and 1999
- -------------------------------------------------------------------------------------------------------------------------
2001 2000 1999
----------------- ----------------- -----------------
Operating revenues:
Subscriber service $ 85,927,934 $ 63,993,328 $ 40,279,007
Roamer service 36,953,474 29,721,562 11,671,572
Equipment sales 10,058,368 9,015,304 5,651,878
Service fees 49,450 1,461,887 400,000
------------------ ------------------ -----------------
132,989,226 104,192,081 58,002,457
------------------ ------------------ -----------------
Operating expenses:
Operations and maintenance 24,776,324 19,785,719 10,502,756
Cost of equipment sold 13,654,007 10,458,625 5,570,633
Home roamer costs 12,919,143 8,823,278 1,699,261
Depreciation 17,822,738 12,278,169 7,528,105
Amortization of FCC licenses 4,505,851 3,780,643 494,381
Selling, general and administrative 31,292,529 24,520,349 14,711,883
------------------ ------------------ -----------------
104,970,592 79,646,783 40,507,019
------------------ ------------------ -----------------
Operating income 28,018,634 24,545,298 17,495,438
------------------ ------------------ -----------------
Other income (expense):
Interest expense (9,416,290) (8,651,813) (1,291,817)
Interest and dividend income 136,870 312,229 230,760
Other (41,784) (6,186) (393,575)
------------------ ------------------ -----------------
(9,321,204) (8,345,770) (1,454,632)
------------------ ------------------ -----------------
Net income before minority interest 18,697,430 16,199,528 16,040,806
Minority interest (2,109,070) (1,902,457) (2,219,563)
------------------ ------------------ -----------------
Net income $ 16,588,360 $ 14,297,071 $ 13,821,243
================== ================== =================
The accompanying notes are an integral part of
the financial statements.
51
Midwest Wireless Holdings L.L.C.
Consolidated Statements of Changes in Members' Equity For the years ended
December 31, 2001, 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) (6,439687)
Net income - 14,297,071 14,297,071
---------------- ----------------- ------------------
Balance, December 31, 2000 84,797,020 23,977,701 108,774,721
Distributions to members - (8,174,899) (8,174,899)
Net income - 16,588,360 16,588,360
---------------- ----------------- ------------------
Balance, December 31, 2001 $ 84,797,020 $ 32,391,162 $ 117,188,182
================ ================= ==================
The accompanying notes are an integral part of the
financial statements.
52
Midwest Wireless Holdings L.L.C.
Consolidated Statements of Cash Flows
For the years ended December 31, 2001, 2000 and 1999
- --------------------------------------------------------------------------------------------------------------------------
2001 2000 1999
Cash flows from operating activities:
Net income $ 16,588,360 $ 14,297,071 $ 13,821,243
Adjustments to reconcile net income to net cash
provided by operating activities:
Net income allocated to minority interest 2,109,070 1,902,457 2,219,563
Provision for bad debts 1,115,719 623,261 (211,225)
Depreciation 17,822,738 12,278,169 7,582,105
Amortization of FCC licenses 4,505,851 3,780,643 494,381
Loss (gain) on disposal of fixed assets (2,124) 27,278 390,567
Patronage received in form of cooperative stock (132,785) - -
Accretion of discount on marketable securities - - (124,204)
Changes in assets and liabilities:
Accounts receivable (3,299,942) (2,665,409) (287,379)
Inventories 510,885 (122,081) (895,770)
Other assets (546,637) (322,733) (174,858)
Accounts payable (2,156,106) 1,471,296 (674,665)
Other accrued expenses 1,888,444 3,253,070 388,877
Other liabilities (689,617) 946,340 639,458
--------------- ----------------- ----------------
Net cash provided by operating activities 37,713,856 35,469,362 23,168,093
--------------- ----------------- ----------------
Cash flows from investing activities:
Acquisition of cellular properties - (96,215,489) -
Payments for property, cellular plant and equipment (33,804,163) (28,636,271) (20,385,685)
Purchases of marketable securities - - (6,679,526)
Proceeds received upon maturity of marketable securities - - 10,750,000
Proceeds from the disposal of fixed assets 37,571 - -
Purchase of FCC licenses (22,400,000) (354,900) (287,300)
Purchases of cooperative stock (1,176,440) (5,329,209) (653,121)
Redemption of cooperative stock 68,313 - -
Payments for deferred acquisition costs (192,511) - (921,824)
Release (restriction) of cash - 1,000,000 (1,000,000)
--------------- ----------------- ----------------
Net cash used in investing activities (57,467,230) (129,535,869) (19,177,456)
--------------- ----------------- ----------------
Cash flows from financing activities:
Proceeds on revolving loan 17,500,000 500,000 2,000,000
Proceeds from long-term debt borrowings 23,473,686 107,706,887 13,368,420
Payments on long-term debt (11,016,802) (6,130,602) (1,534,435
Distributions to members (8,174,899) (6,439,687) (5,889,661)
Distribution from subsidiary to minority interest (1,039,851) (904,737) (940,503)
Redemption of units - - (12,764,087)
--------------- ----------------- ----------------
Net cash provided by (used in) financing activities 20,742,134 94,731,861 (5,760,266)
--------------- ----------------- ----------------
Net change in cash and cash equivalents 988,760 665,354 (1,769,629)
Cash and cash equivalents, beginning of year 2,043,704 1,378,350 3,147,979
--------------- ----------------- ----------------
Cash and cash equivalents, end of year $ 3,032,464 $ 2,043,704 $ 1,378,350
=============== ================= ================
Supplemental disclosure:
Cash paid during the year for interest $ 10,461,525 $ 7,587,435 $ 1,156,323
Equity units issued for acquisitions - 71,479,467 -
The accompanying notes are an integral part of the financial statements.
53
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 revenue
for equipment installation when the installation is completed.
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
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.
54
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. The estimated useful lives of the
cellular plant and equipment are as follows:
Building and improvements 3 - 30 years
Other equipment 2 - 20 years
Communication and network equipment 7 - 15 years
Vehicles 3 years
Computer equipment 3 years
Leased phones 1 year
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
$4,448,949, $3,021,650 and $1,754,394 for the years ended December 31, 2001,
2000 and 1999, respectively.
Accounting for Stock-Based Compensation
The Company accounts for employee stock and options using the intrinsic value
method.
55
Midwest Wireless Holdings L.L.C.
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
2. Select Account Information
Property, Cellular Plant and Equipment
2001 2000
Land $ 2,502,910 $ 2,093,598
Plant in service 128,305,172 94,427,420
Plant under construction 5,777,756 9,004,718
--------------- ---------------
136,585,838 105,525,736
Less accumulated deprecation (47,116,542) (32,002,418)
--------------- ---------------
$ 89,469,296 $ 73,523,318
=============== ===============
The Company capitalized interest in the amount of $581,879, $608,199 and
$243,973 for the years ended December 31, 2001, 2000 and 1999,
respectively. At December 31, 2001, 2000 and 1999, accounts payable
included $1,269,501, $2,891,666 and $1,295,835, respectively, related to
the purchase of property, cellular, plant and equipment.
FCC Licenses
2001 2000
Cellular license $ 173,541,780 $ 173,541,780
LMDS licenses 357,696 357,696
PCS licenses 22,879,812 287,300
Other 354,900 354,900
--------------- ---------------
197,134,188 174,541,676
Less accumulated amortization (9,922,264) (5,416,412)
--------------- ---------------
$ 187,211,924 $ 169,125,264
=============== ===============
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).
56
Midwest Wireless Holdings L.L.C.
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
The Company allocated the excess purchase price over the fair value of
the net tangible assets acquired 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.
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
============ ============
On June 25, 2001, the Company acquired eight digital PCS licenses from
McLeod USA, Inc. for a total purchase price of $22,400,000. The purchase
is for spectrum licenses only and does not include any other assets. The
licenses cover a total population of approximately 1.4 million in 63
counties in northern Iowa, southern Minnesota, eastern South Dakota,
eastern Nebraska and western Illinois. The purchase price together with
costs incurred of approximately $100,000 to complete the transaction is
allocated to FCC licenses.
4. Purchase Agreement
On August 10, 2001, the Company entered into a purchase agreement for the
acquisition of three digital PCS licenses for a total purchase price of
$8,635,058. The agreement is for the purchase of spectrum licenses only
and does not include any other assets. The licenses cover 26 counties
primarily in southern Minnesota. At December 31, 2001, the FCC has not
approved this transaction. However, the Company expects approval and
expects the acquisition will be completed in 2002.
57
Midwest Wireless Holdings L.L.C.
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
5. 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.
6. Debt
Long-term debt consists of the following:
Rate at Balance at
December 31 December 31
------------------ ------------------------------------
Maturity 2001 2000 2001 2000
RTFC note, variable rate 5/12/09 5.25 % 8.40 % $ 10,928,336 $ 12,052,934
RTFC, variable rate 4/30/09 5.25 % 22,872,168 -
RTFC note, fixed rate 7/29/08 5.75 % 5.75 % 6,696,207 7,458,340
RTFC note, variable rate 7/28/08 5.25 % 8.40 % 6,126,238 6,823,500
RTFC revolving note 7/29/03 5.95 % 9.10 % - 2,500,000
RTFC note, variable rate 3/2/10 5.25 % 8.40 % 88,254,536 95,743,583
RTFC note, variable rate 2/3/15 5.25 % 8.40 % 7,916,809 8,259,053
CoBank note, variable rate 10/21/02 4.85 % 20,000,000 -
-------------- --------------
$ 162,794,294 $ 132,837,410
============== ==============
58
Midwest Wireless Holdings L.L.C.
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
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 4.45% and 7.6% at December 31, 2001 and 2000, 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. At December 31,
2001, the Company was not in compliance with this covenant, but a waiver was
provided by RTFC. Substantially all assets of the Company are pledged as
collateral under the Agreement.
On October 22, 2001 the Company entered into an agreement with CoBank, ACB
("CoBank") to fund the acquisition of various PCS licenses, capital expenditures
and operating funds. The agreement provides for borrowings of up to $40,000,000
(the "revolving loan"). At December 31, 2001, the Company had drawn $20,000,000
on the revolving loan. At December 31, 2001, borrowings under the agreement bear
interest at LIBOR plus 2.5% or 4.85%. The outstanding principal and interest are
due upon maturity (October 21, 2002). The agreement with CoBank expires on
October 21, 2002. Management plans to pursue a refinancing of this debt prior to
its maturity.
The revolving loan is subject to various covenants including a limit on the
ratio of indebtedness to annualized operating cash flow, a minimum ratio of
operating cash flow to interest paid, and a minimum debt coverage service ratio.
Substantially all the assets of the Company are pledged as collateral under the
agreement with CoBank.
RTFC and CoBank have agreed to share a security interest in the Company's assets
on a pro rata basis.
Maturities of long-term debt are as follows:
2002 $ 33,679,657
2003 14,655,912
2004 15,702,490
2005 16,826,497
2006 18,027,422
Thereafter 63,902,316
-------------
$ 162,794,294
=============
59
Midwest Wireless Holdings L.L.C.
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
7. 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 at December 31, 2001, are as follows:
2002 $ 671,973
2003 498,840
2004 413,579
2005 294,546
2006 154,359
Thereafter 509,835
-------------
$ 2,543,132
=============
Rental expense was $955,514, $773,324 and $666,765 for the years ended
December 31, 2001, 2000 and 1999, respectively.
8. 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 $376,783, $292,508 and $185,909 for the years
ended December 31, 2001, 2000 and 1999, respectively. Profit sharing
contribution expenses were $455,778, $309,312 and $210,606 for the years
ended December 31, 2001, 2000 and 1999, respectively. Profit sharing
contributions are 100% vested after five years of employment.
Effective January 1, 1997, the Company established the Midwest Wireless
Holdings L.L.C. Appreciation Rights Plan, as amended (formerly the
Midwest Wireless Communications L.L.C. Appreciation Rights Plan) (the
Plan) for certain key employees. The Plan is designed to create two
classes of appreciation rights, Class A and Class B, which become fully
vested three years and five years, respectively, after the first day of
the year the rights are granted. 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. However, effective
January 1, 2002, the Plan was amended to enable additional Class B
appreciation rights to be granted in 2002. In 2000 and 2001, the Board of
Managers issued additional Class A appreciation rights to certain key
employees and in 2000 authorized an additional 9,000 rights for new Plan
participants. The Company recognized $1,053,863, $1,137,500 and $639,458
in compensation expense related to the Plan for the years ended December
31, 2001, 2000 and 1999, respectively.
60
Midwest Wireless Holdings L.L.C.
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
9. Option Plan
During 2000, the Company's Board of Managers adopted and approved the
Midwest Wireless Holdings L.L.C. Unit Option Plan, as amended. Effective
July 2001, the Plan was amended to clarify certain language and
definitions in the Plan. Under the Plan, 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. The options granted vest 100% three years after they were
granted. At December 31, 2001, there were 37,940 units available for
issuance under this plan.
Options Outstanding
Weighted
Available Number Average
for Of Price per
Grant Units Unit
Balance, December 31, 1999 - - -
Authorized 46,742 - -
Granted (4,092) 4,092 $ 299.06
---------- ---------
Balance, December 31, 2000 42,650 4,092 $ 299.06
Granted (4,710) 4,710 $ 318.32
---------- ---------
Balance, December 31, 2001 37,940 8,802 $ 309.37
========== =========
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,
2001 or 2000.
If the Company had elected to recognize compensation expense for options
granted using the fair value method, net income would have been as
follows:
2001 2000
Net income:
As reported $ 16,588,360 $ 14,297,071
Pro forma 16,373,577 14,251,198
61
Midwest Wireless Holdings L.L.C.
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
The weighted average fair value of options at the date of grant was
$52.73 and $80.71 in 2001 and 2000, respectively.
The following table summarizes information about stock options
outstanding and exercisable at December 31, 2001:
Options Outstanding Options Exercisable
---------------------------- --------------------
Weighted
Average Weighted Weighted
Remaining Average Average
Range of Contractual Exercise Exercise
Exercise Prices Number Life Price Number Price
$299.06 - $318.32 8,802 8.31 $309.37 - -
The fair value for each option grant was estimated at the date of grant
using the minimum value method with the following assumptions:
Fiscal Year
------------------------------------
2001 2000
Dividend yield 2.47% 2.07%
Risk-free interest rate 4.73% 6.19%
Expected lives 10 years 10 years
62
- --------------------------------------------------------------------------------
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, 2001
EXHIBITS
- --------------------------------------------------------------------------------
63
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
Exhibit Index To
Form 10-K for the Year Ended December 31, 2001
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 65.
Per Share
21 Subsidiaries of the Registrant Filed herewith at page 66.
23 Independent Auditors' Consent Filed herewith at page 67.
24 Power of Attorney Included in signatures at page 42.
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.
64
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
EXHIBIT 11
CALCULATION OF EARNINGS PER SHARE
Year Ended December 31
-------------------------------------------
Basic: 2001 2000 1999
- ------- ----------- ----------- -----------
Net income $ 4,616,154 $ 3,309,423 $ 7,479,181
=========== =========== ===========
Common shares:
Weighted average number of
common shares outstanding 3,465,086 3,544,349 3,095,028
=========== =========== ===========
Net income per common share $ 1.33 $ .93 $ 2.42
=========== =========== ===========
Diluted:
- -------------
Net income $ 4,616,154 $ 3,309,423 $ 7,479,181
Interest on convertible
debentures, net of tax 265,783
----------- ----------- -----------
Adjusted net income $ 4,616,154 $ 3,309,423 $ 7,744,964
=========== =========== ===========
Common and common equivalent shares:
Weighted average number of
common shares outstanding 3,465,086 3,544,349 3,095,028
Assumed conversion of convertible
debentures into common stock 431,152
Dilutive effect of convertible
preferred shares outstanding 221,195 222,863 321,961
Dilutive effect of stock options
outstanding after application of
treasury stock method 76,122 82,512 73,965
Dilutive effect of Employee Stock
Purchase Plan shares subscribed 1,042 688
Dilutive effect of
warrants outstanding 21,734
----------- ----------- -----------
3,762,403 3,850,766 3,944,528
=========== =========== ===========
Diluted net income per share $ 1.23 $ .86 $ 1.96
=========== =========== ===========
65
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
Mustang Communications Corporation Minnesota
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, Indianhead Communications Corporation and Mustang 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.
66
EXHIBIT 23
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in Registration Statements No.
33-39865, 33-39866, 33-65176, 333-40118, 333-45971, 333-45975 and 333-91967 of
Hector Communications Corporation of our report dated February 13, 2002,
appearing in this Annual Report on Form 10-K of Hector Communications
Corporation and its subsidiaries for the year ended December 31, 2001.
/s/ Olsen Thielen and Co., Ltd.
Olsen Thielen and Co., Ltd.
March 29, 2002
St. Paul, Minnesota
67