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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, 2002
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
- --------------------------------- -------------------
(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 ( )
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)
Indicate by a check mark whether the registrant is an accelerated filer (as
defined by Rule 12b-2 of the Act). Yes ( ) No (X)
The aggregate market value of the voting stock held by non-affiliates of the
Registrant was approximately $33,471,000 based upon the closing sale price of
the Company's common stock on the American Stock Exchange on March 21, 2003.
As of March 21, 2003 there were outstanding 3,473,629 shares of the Registrant's
common stock.
Documents Incorporated by Reference: Portions of the Company's definitive proxy
statement for its Annual Meeting of
Shareholders to be held on May 21, 2003 are
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 15
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 16
6. Selected Financial Data 17
7. Management's Discussion and Analysis of Financial Condition
and Results of Operations 18
7a. Disclosures About Market Risk 27
8. Financial Statements and Supplementary Data 28
9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure 48
PART III
10. Directors and Executive Officers of the Registrant 49
11. Executive Compensation 49
12. Security Ownership of Certain Beneficial Owners and Management 49
13. Certain Relationships and Related Transactions 49
14. Controls and Procedures 49
PART IV
15. Exhibits, Financial Statement Schedule and Reports on Form 8-K 50
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
7,620 access lines in 9 rural communities in Minnesota and Wisconsin at December
31, 2002. HCC, through its wholly-owned subsidiaries, also provides cable
television service or video service to 4,603 subscribers in Minnesota and
Wisconsin.
HCC's 68% owned subsidiary, Alliance Telecommunications Corporation
("Alliance"), owns and operates six additional LEC subsidiaries which served
31,157 access lines in 28 rural communities in Minnesota, Wisconsin, Iowa and
South Dakota at December 31, 2002. Alliance, through its subsidiaries, also
served 9,112 cable television and video subscribers in Minnesota, North Dakota,
South Dakota and Iowa. Golden West Telecommunications Cooperative, Inc. ("Golden
West") of Wall, South Dakota and Alliance Communications Cooperative, Inc.
("ACCI", formerly Splitrock Telecom) of Garretson, South Dakota own the
remaining interests in Alliance.
The directors of Alliance have approved a reorganization of Alliance
under Section 355 of the Internal Revenue Code. Pursuant to the reorganization,
Golden West will exchange its 20% ownership interest in Alliance for all of the
outstanding stock of Sioux Valley Telephone Company and certain other Alliance
assets and ACCI will exchange its12% ownership interest in Alliance for all of
the outstanding stock of Hills Telephone Company and certain other Alliance
assets. The reorganization is expected to be completed on or about April 30,
2003. Further information concerning the reorganization is set forth under Item
7, Management's Discussion and Analysis of Financial Condition and Results of
Operations under the heading "Liquidity and Capital Resources - Break up of
Alliance Telecommunications Corporation"
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.
The Company maintains a website at www.hectorcom.com. Our annual
reports on Form 10-K, our quarterly reports on Form 10-Q and our periodic
reports on Form 8-K (and any amendments to these reports) are available free of
charge by linking from our website to the Securities & Exchange Commission
website.
[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 13 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.
3
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 or video service. Other services
include internet access 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:
Year Ended December 31
---------------------------------------------
2002 2001 2000
------- ------- -------
Local network 18.7% 17.6% 17.6%
Network access 53.5 55.0 55.1
Video services 11.1 10.2 10.5
Internet services 6.1 4.9 3.4
Other nonregulated services 10.6 12.3 13.4
------- ------- -------
100.0% 100.0% 100.0%
======= ======= =======
The Company also owns minority interests in joint ventures, 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, 2002, 2001 and 2000:
Access Lines*
-----------------------------------
December 31
-----------------------------------
2002 2001 2000
------- ------- -------
Hector Communications Corporation:
Arrowhead Communications Corporation 806 808 806
Eagle Valley Telephone Company 747 727 731
Granada Telephone Company 296 289 288
Pine Island Telephone Company 3,368 3,313 3,263
Indianhead Telephone Company 2,403 2,392 2,334
------- ------- -------
Total Hector Access Lines 7,620 7,529 7,422
------- ------- -------
Alliance Telecommunications Corporation:
Loretel Systems, Inc. 13,286 13,300 13,234
Sleepy Eye Telephone Company 6,503 6,556 6,511
Sioux Valley Telephone Company 5,780 5,893 5,939
Hills Telephone Company 2,762 2,812 2,788
Felton Telephone Company 765 752 752
Hager TeleCom, Inc. 2,061 2,037 2,087
------- ------- -------
Total Alliance Access Lines 31,157 31,350 31,323
------- ------- -------
Total Access Lines 38,777 38,879 38,745
======= ======= =======
* An "access line" is a single or multi-party circuit between the customer's
establishment and the central switching office.
4
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.
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 2002, approximately 70% of the Company's access revenues were from
interstate sources and 30% 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. Through the 1980s and 1990s a variety of
factors, including increased subscriber counts, cultural and technological
changes, and rate reductions by IXCs, resulted in a consistent pattern of
increasing use of the nation's telephone network. This growth produced higher
revenues for NECA and increased settlements for its participating LECs.
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
Video services
--------------
The Company, through its cable television and LEC subsidiaries, provide
cable television services to 13,715 subscribers in Minnesota and the surrounding
states. Video service revenues are derived almost exclusively from monthly fees
for basic and premium programming. Fees for basic services range from $9.00 to
$44.85 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. 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 and 2002 the Company deployed broadband equipment manufactured by
Next Level Communications, Inc. in its exchanges serving Pine Island, MN,
Goodhue, MN and Sleepy Eye, MN. This equipment makes it possible to deliver
5
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, LLC, in which the Company is an investor. The
Company is planning to install broadband equipment 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.
Internet
Revenues from internet services were $2,405,000, $1,977,000 and
$1,304,000 in 2002, 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 9,358, 8,859 and 7,876 customers at December 31,
2002, 2001 and 2000 respectively. The Company provided DSL services to 2,023 and
1,162 customers at December 31, 2002 and 2001, respectively. Approximately half
of the Company's DSL subscribers are in the Pine Island, Sleepy Eye and Goodhue
exchanges where service is available utilizing Next Level equipment.
Other services
HCC's LECs provide fiber optic transport facilities, 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.
Due to changes in market conditions the Company renegotiated several of
its fiber leases in 2001, resulting in a significant decline in 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 revenues from other nonregulated services were as follows:
2002 2001 2000
----------- ----------- -----------
Fiber leases $ 947,045 $ 1,300,601 $ 1,282,246
Engineering fees 438,534 464,807 536,302
Directory 408,551 429,545 378,072
Billing and collection 375,106 530,803 694,171
Retail sales 346,508 540,595 595,047
Cellular sales commissions 333,714 300,146 218,752
Resale of long distance service 250,937 214,385 273,582
Equipment rent 237,613 243,189 210,191
Other 885,347 985,594 881,237
----------- ----------- -----------
$ 4,223,355 $ 5,009,665 $ 5,069,600
=========== =========== ===========
(4) Investments in Unconsolidated Affiliates
Midwest Wireless Holdings LLC
-----------------------------
Midwest Wireless Holdings LLC ("Midwest Wireless") provides wireless
telecommunications services to 289,000 customers in 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 a
complete package of services, including custom calling features, facsimile and
data transmission.
Midwest Wireless is owned by telecommunications companies (principally
ILECs) located within Midwest Wireless' operating footprint in southern
Minnesota, northern Iowa and southeastern Wisconsin. HCC is presently the
largest member of Midwest Wireless Holdings LLC, with a 10.4% ownership stake.
HCC actively participates in Midwest Wireless' operations and has had a seat on
the Board of Directors since the inception of the Company. HCC influences
Midwest Wireless policies and procedures applying to administration, planning
and budgeting, cell siting, technology selection, roaming agreements,
affiliation agreements, marketing and customer service, financing, accounting
policies and financial reporting and disclosure policies and the timing of
financial reports. HCC accounts for its investment in Midwest Wireless using the
equity method. Income recognized was $2,928,000, $1,475,000 and $1,248,000 in
2002, 2001 and 2000, respectively.
6
Fiber-Optic Transport Investments
---------------------------------
The Company has invested approximately $1,700,000 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.
Other Investments
-----------------
The Company has an ownership interest in SDN Communications, which
provides integrated voice, data and network services in South Dakota. The
Company is an investor in Fibercom LC, a competing 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.
Wireless North, LLC
-------------------
The Company was a 10.4% owner of Wireless North, which provided personal
communications services ("PCS") to parts of Minnesota, Wisconsin, Iowa, North
Dakota and South Dakota. Wireless North was unsuccessful and has been
liquidated. Its licenses and systems were sold to other operators, or were shut
down. 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.
(5) Other Investments
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 $5,241,000 and $4,991,000 at December 31, 2002 and 2001 respectively.
Onvoy, Inc.
-----------
Onvoy, Inc. is a privately held company that provides integrated voice,
data, and network services through its fiber optic communications network
linking communities throughout Minnesota, including all major metropolitan
areas. Onvoy, Inc. is 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.
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 took a charge against earnings of $1,273,000,
representing substantially all of its investment in Onvoy common stock, during
the fourth quarter of 2000.
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. At December 31, 2002, the Company's investment in Onvoy debt
totaled $591,000.
Other long-term investments
---------------------------
The Company has long-term investments in Iowa Network Services, Inc.,
Independent Information Services Corp. and NECA, Inc., which it accounts for
using the cost method. The Company also has receivables from economic
development loans made through the Rural Utilities Service and has other small
investments.
7
(6) Competition
Telephone Service
-----------------
LECs are subject to many forms of competition. Its competitors
principally are:
o Facilities-based competition from providers, including cable television
service providers, with their own local service network;
o Resale competition from resale interconnection (providers who purchase
local services from the LEC at wholesale rates and resell the services to
their customers);
o Competition from unbundled network element interconnection (providers who
lease some of the network elements from the LEC)
o 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 its networks. However, there is no
assurance that interconnection may not be required in the future.
Wireless service has always competed directly with wireline local service
among certain classes of customers, principally customers with seasonal or lake
homes. Newer wireless service offerings that bundle local and long distance
minutes for a flat fee are competing with wireline services over a broader class
of customers. These wireless service offerings can be particularly attractive in
rural areas, where the toll free dialing areas offered by wireline carriers are
usually quite small. The Company believes that significant numbers of long
distance minutes are migrating from the wireline to the wireless network due to
these rate plans. This drives down the revenues of IXCs and negatively impacts
the Company's access revenues. Developments in technology related to cellular,
PCS, digital microwave, coaxial cable, fiber optics and other wireline or
wireless services could also lead to greater competition for traditional local
services.
LECs are increasingly subject to competition from competing access
providers ("CAPs") which construct, modify or lease facilities that enable high
volume long distance users to bypass the local telephone network. Cable
television companies may also be able to modify their networks to carry
telephone messages that bypass the local telephone network. The Company believes
its LEC subsidiaries have experienced only a small loss of traffic due to
bypass.
Video Services
--------------
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. It also
competes with a much larger multi-system operator in Sleepy Eye, where the
Company is using broadband equipment to deliver video services. 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. The Company expects to compete based
upon product, service quality, breadth of services offered and, to a lesser
extent, on price.
8
Maintaining and expanding the Company's 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 service area. Promotional efforts
for video services 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:
o Monthly charges to end users for basic local telephone services and
enhanced services;
o Access charges to interexchange carriers for originating and terminating
interstate and intrastate interexchange calls; and
o 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.
9
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 $1,832,000, $1,744,000 and $1,490,000 of the
Company's network access revenues in 2002, 2001 and 2000, 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
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.
10
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:
o Offer reasonable and nondiscriminatory resale of their
telecommunications services,
o Ensure that customers can keep their telephone numbers when changing
carriers,
o 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,
o Ensure access to telephone poles, ducts, conduits and rights of way and
o Compensate competitors for the costs of terminating traffic.
The Telecommunications Act also requires incumbent local exchange
carriers to:
o Negotiate in good faith the terms and conditions of interconnection
with any competitive carrier making a bona fide request for same,
o Interconnect their facilities and equipment with any requesting
telecommunications carrier at any technically feasible point,
o 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,
o Offer resale interconnection at wholesale rates,
o 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
o 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.
11
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:
o Providing for the identification of those services eligible for
universal service support,
o Requiring the FCC to make implicit subsidies explicit,
o Expanding the types of communications carriers required to pay
universal service support and
o 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.
Pursuant to the Telecommunications Act, federal Universal Service Fund
payments are only available to carriers that are designated as eligible
telecommunications carriers ("ETC") 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. Wireless providers
have received ETC designation in Company served areas in North Dakota and Iowa,
and have applied for ETC designation in Minnesota. 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
12
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:
o "Must carry" rules regarding the broadcast television and translator
signals that must be included in channel offerings to subscribers,
o Exclusivity provisions which require the deletion of certain
programming carried by out-of-area stations where it would duplicate
programming carried by local stations,
o Technical standards and performance testing requirements, and
o Franchise fees applicable to state and local cable television
franchises.
Thus far, HCC's cable systems have not experienced any difficulty in complying
with the FCC rules.
In Minnesota, the award of cable franchises and certain aspects of cable
operations are subject to rules of the Minnesota Cable Communications Board.
Cable television systems are operated under 15 year, non-exclusive franchises
granted by local government authorities. Franchises contain many conditions,
including time limitations on commencement or completion of construction,
approval of initial fees charged to subscribers for basic service, the number of
channels offered and the types of programming. HCC does not anticipate
difficulty in obtaining renewal of its franchises at the expiration of their
current terms.
The regulation of cable television at the federal, state and local levels
is subject to the political process and has been in constant flux over the past
decade. This process continues in the context of legislative proposals for new
laws and the adoption or deletion of administrative regulations and policies.
The Company anticipates further material developments in these areas, but cannot
anticipate their direction and impact on its cable television operations.
(7) Business Strategy
The Company is focused on business opportunities in rural
telecommunications. Its three-part strategy is to:
13
o Expand its existing operations through internal growth
o Pursue acquisitions of attractive properties, particularly the
acquisition of additional rural telephone exchanges and cable
television properties
o Participate in opportunities afforded by new telecommunication
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 possible 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, 2003, the Company had 181 full-time and part-time employees,
of which 124 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.
(9) Executive Officers of Registrant
The executive officers of the Company and their ages at March 1, 2003
were as follows:
Name Age Position
----------------- --- -------------------------------
Curtis A. Sampson 69 Chairman of the Board and Chief
Executive Officer
Steven H. Sjogren 60 President and Chief Operating Officer
Paul N. Hanson 56 Vice President and Treasurer
Charles A. Braun 45 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.
14
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 are rented by 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 rented from utilities serving the community.
See Note 8 of "Notes to Consolidated Financial Statements" for additional
information regarding pledged assets.
ITEM 3. LEGAL PROCEEDINGS
No material litigation or other claims are presently pending against the
Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
15
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:
2002 2001
------------------------ -------------------------
Quarter High Low High Low
First $ 16.95 $ 12.50 $ 11.50 $ 9.65
Second 14.85 11.62 13.30 9.60
Third 11.90 9.00 15.25 12.20
Fourth 12.65 8.90 16.65 13.60
[b] HOLDERS
At March 1, 2003 there were 550 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 8 to the Consolidated Financial Statements under Item 8 herein for a
description of restrictions on dividends.
[d] OTHER INFORMATION REGARDING EQUITY COMPENSATION PLANS
The following table presents information about our equity compensation
plans as of December 31, 2002:
Securities Authorized For Issuance Under Equity Compansations Plans
(a) (b) (c)
Number of shares of
Number of shares of common stock remaining
common stock to be available for future
issued upon exercise Weighted-average issuance under equity
of outstanding exercise price of compensation plans
options, warrants and outstanding options, (excluding shares in
Plan Category (1) rights warrants and rights column (a))
--------------- --------------------- -------------------- ----------------------
Equity compensation plans approved by security holders:
1990 Stock Plan 231,725 $ 10.77 -
1999 Stock Plan 214,450 11.83 83,850
1990 Employee Stock Purchase Plan 15,685 8.37 15,685
Equity compensation plans not approved by security holders:
None
-----------------------------------------------------
(1) The Company does not have individual compensation arrangements involving
the granting of options, warrants and rights.
16
ITEM 6. SELECTED FINANCIAL DATA
SELECTED CONSOLIDATED FINANCIAL INFORMATION
(in thousands except per share amounts)
Year Ended December 31
-------------------------------------------------------------
2002 2001 2000 1999 1998
- ---------------------------------------------------------------------------------------------------------------------------------
Selected Income Statement Information
Revenues $ 39,722 $ 40,633 $ 37,790 $ 34,117 $ 31,839
Costs and Expenses 29,680 30,112 26,799 23,063 21,192
- ---------------------------------------------------------------------------------------------------------------------------------
Operating Income 10,042 10,521 10,991 11,054 10,647
Other Income (Expenses), net (1,309) 1,170 (2,471) 7,401 (40)
- ---------------------------------------------------------------------------------------------------------------------------------
Income Before Income Taxes and Minority Interest 8,733 11,691 8,520 18,455 10,606
Income Tax Expense 3,670 5,321 4,207 7,513 4,949
- ---------------------------------------------------------------------------------------------------------------------------------
Income Before Minority Interest 5,063 6,370 4,313 10,942 5,657
Minority Interest in Earnings of Alliance
Telecommunications Corporation 1,408 1,754 1,004 3,463 1,747
- ---------------------------------------------------------------------------------------------------------------------------------
Income Before Change in Accounting Principle 3,655 4,616 3,309 7,479 3,910
Cumulative Effect of Change in Accounting Principle,
net of Income Taxes and Minority Interest 3,147
- ---------------------------------------------------------------------------------------------------------------------------------
Net Income $ 508 $ 4,616 $ 3,309 $ 7,479 $ 3,910
=================================================================================================================================
Basic Net Income Per Common Share $ .15 $ 1.33 $ .93 $ 2.42 $ 1.63
Diluted Net Income Per Common Share $ .13 $ 1.23 $ .86 $ 1.96 $ 1.15
Average Shares Outstanding:
Common shares only 3,498 3,465 3,544 3,095 2,403
Common and potential common shares 3,770 3,763 3,851 3,945 3,937
=================================================================================================================================
Selected Balance Sheet Information
Working Capital $ 5,718 $ 7,633 $ 8,960 $ 18,736 $ 6,554
Property, Plant and Equipment, net 56,666 57,362 56,227 51,410 50,810
Excess of Cost Over Net Assets Acquired, net 49,075 53,663 55,475 51,405 53,004
Total Assets 154,486 158,251 158,678 166,797 150,680
Long-Term Debt 75,148 79,642 84,378 86,282 94,232
Stockholders' Equity 42,249 42,241 39,108 39,982 22,720
- ---------------------------------------------------------------------------------------------------------------------------------
Effective January 1, 2002, the Company adopted the provisions of Statement of Financial Accouting Standards No. 142, "Goodwill and
Other Intangible Assets".
17
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, 2002,
these subsidiaries provided telephone service to 7,620 customers in 9 rural
communities in Minnesota and Wisconsin. They also owned cable television systems
serving 4,603 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, 2002, Alliance, through its six LEC subsidiaries,
provided telephone service to 31,157 customers in 28 rural communities in
Minnesota, Wisconsin, South Dakota and Iowa. Alliance's subsidiaries also
provided cable television services to 9,112 subscribers in Minnesota, South
Dakota and North Dakota. Alliance's subsidiaries also own substantial
investments in Midwest Wireless Holdings LLC and have other investments. Golden
West Telecommunications Cooperative, Inc. ("Golden West") of Wall, South Dakota
and Alliance Communications Cooperative, Inc. ("ACCI", formerly Splitrock
Telecom) of Garretson, South Dakota own the remaining interests in Alliance.
Results of Operations
- ---------------------
2002 Compared to 2001
---------------------
Consolidated revenues decreased 2% to $39,722,000 in 2002 from
$40,633,000 in 2001. The following table shows revenues by operating group for
2002 compared to 2001:
Alliance Hector
Year Ended December 31 Year Ended December 31
2002 2001 2002 2001
--------------- ---------------- ---------------- -----------------
Local network $ 5,836,767 $ 5,586,670 $ 1,611,184 $ 1,562,398
Network access 16,125,314 16,689,138 5,107,970 5,652,977
Video services 2,811,913 2,690,063 1,600,459 1,465,078
Internet services 1,927,473 1,667,999 477,211 308,924
Other nonregulated services 3,554,166 4,191,933 669,189 817,732
--------------- ---------------- ---------------- -----------------
$ 30,255,633 $ 30,825,803 $ 9,466,013 $ 9,807,109
--------------- ---------------- ---------------- -----------------
Consolidated local service revenues increased 4% to $7,448,000 in 2002
from $7,149,000 in 2001. Revenue growth in Alliance was due to the full year
effect of a 2001 local service rate increase at Sleepy Eye Telephone Company.
Hector's local network revenues increased due to increases in the number of
access lines served.
Network access revenues declined $1,109,000 or 5% to $21,233,000 in 2002
compared to $22,342,000 in 2001. The Company's access revenues were reduced
$708,000 in 2002 due to write-offs associated with the bankruptcy filings of
World Com and Global Crossings. Interstate access revenues were negatively
affected by FCC mandated reductions in NECA's tariff rates. Universal service
support increased due to Alliance's increased investment in plant and equipment
in Sleepy Eye. Alliance's intrastate access revenues in South Dakota were
negatively affected by changes in settlement calculation methods.
Video service revenues increased 6% to $4,412,000 due to rate increases,
the 2001 acquisition of additional cable systems and introduction of broadband
video services in Sleepy Eye. Revenues from internet services increased 22% to
$2,405,000 due to increased customer acceptance of the technology and increased
availability of broadband DSL services to customers. Revenues from other
nonregulated services decreased $786,000 to $4,223,000 due to lower revenues
from leases of fiber optic transport facilities, lower billing and collections
revenues and lower retail sales.
18
Consolidated operating costs and expenses were $29,680,000 in 2002
compared to $30,112,000 in 2001. If the provisions of SFAS 142 had been in
effect at January 1, 2001, 2001 operating costs would have been $28,278,000.
Costs and expenses by operating group were as follows:
Alliance Hector
Year Ended December 31 Year Ended December 31
2002 2001 2002 2001
--------------- ---------------- ---------------- -----------------
Plant operations $ 3,803,872 $ 3,974,169 $ 1,581,666 $ 1,381,781
Depreciation and amortization 6,822,974 8,138,515 3,139,678 3,178,259
Customer operations 2,032,467 2,051,760 397,986 384,286
General and administrative 3,866,226 3,307,150 1,607,773 1,565,399
Other operating expenses 4,613,145 4,472,835 1,814,106 1,657,742
--------------- ---------------- ---------------- -----------------
$ 21,138,684 $ 21,944,429 $ 8,541,209 $ 8,167,467
--------------- ---------------- ---------------- -----------------
Consolidated plant operations expenses increased 1% to $5,386,000 in 2002
compared to $5,356,000 in 2001. Depreciation expense increased $480,000 due to
depreciation on new plant additions. Amortization expense decreased $1,834,000
due to the adoption of SFAS #142. Customer operations expenses decreased
$2,430,000 in 2002 from $2,436,000 in 2001. General and administrative expenses
increased 12% to $5,474,000 in 2002 from $4,873,000 in 2001 due to accounting
and legal expenses incurred in the breakup of Alliance. Other operating expenses
increased $297,000 or 5% due to increased video signal fees and increased
internet service fees.
Consolidated operating income decreased $479,000 or 5% to $10,042,000 in
2002 from $10,521,000 in 2001.
Consolidated interest expenses decreased $575,000 to $4,727,000 in 2001
from $5,302,000 in 2001. The decrease was due to lower interest rates on
variable rate debt from CoBank and lower debt levels due to principal payments.
Income from the Company's investment in Midwest Wireless Holdings LLC
increased to $2,928,000 in 2002 from $1,475,000 in 2001. Midwest Wireless' 2001
results included amortization of intangible assets totaling $721,000, which
ceased with the adoption of SFAS 142. Income from investments in other
unconsolidated affiliates decreased to $143,000 in 2002 from $665,000 in 2001
due to lower profits from fiber optic transport company investments and losses
from the Company's investment in Desktop Media.
Alliance recorded an impairment loss on its marketable securities
portfolio of $134,000 in 2002. Alliance had gains on sales of marketable
securities of Illuminet, Inc. totaling $3,659,000 in 2001. Interest and dividend
income decreased to $481,000 in 2002 from $673,000 in 2001 due to lower interest
rates on invested funds and lower dividend yields from marketable security
investments.
Consolidated income before income taxes and minority interest decreased
to $8,733,000 in 2002 from $11,691,000. The Company's effective income tax rates
was 42% compared to 45.5% in 2001. The Company's tax rate declined due to the
adoption of SFAS #142, which eliminated amortization of nondeductible goodwill.
Income before the minority interest in Alliance's earnings decreased to
$5,063,000 in 2002 from $6,370,000 in 2001. Minority interest on earnings of
Alliance was $1,408,000 compared to $1,754,000 in 2001. Income before change in
accounting principle decreased to $3,655,000 in 2002 compared to $4,616,000 in
2001.
In 2002, the Company took a charge against earnings related to the
cumulative effect of impairment of the value of its goodwill and intangible
assets, before income tax benefits and minority interest, of $4,663,000. After
income tax benefits of $121,000 and minority interest of $1,395,000, the net
charge against earnings was $3,147,000 (see Note 3 to the consolidated financial
statements). Net income for 2002 was $508,000 compared to $4,616,000 in 2001.
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:
19
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
Video services 2,690,063 2,469,407 1,465,078 1,484,004
Internet services 1,667,999 1,099,460 308,924 205,026
Other nonregulated services 4,191,933 4,308,065 817,732 761,535
--------------- ---------------- ---------------- -----------------
$ 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.
Video services revenue 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. Revenues from internet services increased by $672,000
due to the acquisition of Hager and increased customer counts for both dial-up
and DSL service. Revenues from other nonregulated services declined to
$5,010,000 in 2001 from $5,070,000 in 2000 due to lower billing and collection
revenues.
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.
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.
20
Income from investments in Midwest Wireless Holdings LLC increased to
$1,475,000 in 2001 from $1,248,000 in 2000. Income from other unconsolidated
affiliates was $665,000 in 2001 compared to $647,000 in 2000. The Company
recorded losses on other investments in 2000 of $1,284,000. $1,273,000 of those
losses was due to impairment of the Company's investment in Onvoy, Inc.
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.
Liquidity and Capital Resources
- -------------------------------
Operations
----------
Cash flows from consolidated operating activities were $13,116,000,
$14,103,000 and $8,421,000 in 2002, 2001 and 2000, respectively. The decrease in
cash flows from operations in 2002 was due to smaller profits from internal
operations. At December 31, 2002, the Company's cash, cash equivalents and
marketable securities totaled $12,134,000 compared to $13,502,000 at December
31, 2001. Alliance's cash and securities were $5,653,000 of this total at
December 31, 2002. Working capital at December 31, 2002 was $5,718,000 compared
to $7,633,000 at December 31, 2001. The current ratio was 1.4 to 1 at December
31, 2002 compared to 1.6 to 1 at December 31, 2001.
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 2002, 2001 and 2000 were $2,609,000, $3,985,000 and
$3,111,000 respectively. Alliance's plant additions in 2002, 2001 and 2000
(excluding the acquisition of Hager TeleCom, Inc.) were $6,657,000, $6,634,000
and $6,335,000 respectively. Plant additions for 2003 for Hector and Alliance
are expected to total $6,276,000. These plant additions will provide customers
with additional advanced telecommunications services and expand usage of Next
Level broadband equipment and 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.
The Company does not expect proceeds from marketable securities sales in future
years to approach these levels.
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, LLC, which constructed a digital "super headend"
in Hutchinson, MN. The Company expects to make additional investments of this
type as opportunities arise.
21
The Company was a 10.4% owner of Wireless North, which provided personal
communications services ("PCS") to parts of Minnesota, Wisconsin, Iowa, North
Dakota and South Dakota. Wireless North was unsuccessful and has been
liquidated. Its licenses and systems were sold to other operators, or were shut
down. 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's other investments consist primarily of loan related bank
stocks, long-term investments in non-marketable corporations, and notes
receivable. In 2002, the Company made investments in mutual funds and rural
development note receivables that were funded by no-interest loans from the
Rural Utilities Service.
Credit Risk
-----------
Financial instruments that potentially subject the Company to
concentrations of credit risk consist principally of cash and temporary cash
investments. The Company places its cash investments with high credit quality
financial institutions. The Company maintains its cash in bank deposit accounts.
The account balances at times exceed the federally insured limits. The Company
has not experienced losses in these accounts and does not believe they are
exposed to any significant credit risk.
A significant portion of the Company's revenues are received from long
distance carriers in the telephone industry. Consequently, the Company is
directly affected by the financial well-being of that industry. The credit risk
associated with these accounts is minimized due to the large number of long
distance carriers.
Debt and Loan Commitments
-------------------------
As part of financing its 68% ownership interest in Alliance, the Company
borrowed $6,000,000 from CoBank. In 1998, the Company replaced the loan with a
15-year term loan from Rural Telephone Finance Cooperative ("RTFC"). At December
31, 2002 the outstanding balance on this loan was $3,157,000. The interest rate
on the loan varies according to the rate RTFC charges for similar loans. The
interest rate was 5.5% at December 31, 2002.
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, 2002 interest rates on the loan
averaged 6.8%. The outstanding balance on this loan at December 31, 2002 was
$38,186,000. 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 owns stock in the bank. Its investment in CoBank stock was
$3,772,000 at December 31, 2002.
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 $2,954,000, $2,201,000
and $700,000 in 2002, 2001 and 2000, respectively. The average interest rate on
outstanding RUS and RTB loans is 5.4%. At December 31, 2002 unadvanced loan
commitments from the RUS and RTB to Hector's and Alliance's LEC subsidiaries
totaled $19,937,000.
Substantially all of the assets of the Company's LEC subsidiaries are
pledged or are subject to mortgages to secure obligations to the RUS and RTB.
The Company's loan agreements place significant restrictions on cash
distributions from the subsidiaries to the parent company. 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. At December 31, 2002, $4,294,000 of
subsidiaries' retained earnings was available for dividend payments to HCC. At
December 31, 2002, $24,449,000 of HCC's retained earnings were not available to
pay dividends to shareholders due to restrictions in the debt agreements. It is
the Company's plan, in so far as possible, to maintain its cash balances at the
subsidiary level to support their operations.
22
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 2002, the Company purchased and retired 70,239 shares at a cost
of $737,000. 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, 2002 216,000 shares could be repurchased
under outstanding Board authorizations.
In 1995 the underwriters of the Company's convertible debenture offering
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 $320,000, $550,000 and
$382,000 in 2002, 2001 and 2000, 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.
Breakup of Alliance Telecommunications Corporation
--------------------------------------------------
In July 2001, Golden West and ACCI, respectively the 20% and 12% minority
shareholders of Alliance, advised the Company that they were interested in
exchanging their minority investment for a pro rata share of the assets and
liabilities of Alliance. Thereafter the parties engaged in negotiations that
continued through December 2002. The negotiation process included evaluations
and appraisals of Alliance's business components, negotiations with Alliance's
lenders (CoBank, Rural Utilities Service and Rural Telephone Bank) regarding
waivers, lien releases, interest penalties where applicable and future financing
terms. The process also included seeking necessary regulatory approvals from
local, state and national regulators.
The Company expects to complete the Alliance breakup transactions by
April 30, 2003. As agreed among the parties, in the breakup, Golden West will
exchange its 20% ownership interest in Alliance for all of the outstanding stock
of Sioux Valley Telephone Company and certain other Alliance assets. ACCI will
exchange its 12% ownership interest in Alliance for all of the outstanding stock
of Hills Telephone Company and certain other Alliance assets. Sioux Valley
Telephone Company and Hills Telephone Company collectively serve 8,700 telephone
access lines and 2,400 cable television customers. In addition, under the
breakup, 32% of Alliance's ownership interest in Midwest Wireless Holdings LLC
will be transferred to Golden West and ACCI, reducing Hector's total ownership
from 10.4% to 8%. Immediately prior to the breakup Sioux Valley and Hills will
pay a dividend to Alliance of approximately $13,400,000 to equalize post breakup
values in proportion to the current 68%-20%-12% stock ownership percentages. The
dividend proceeds will used to reduce Alliance's debt to its primary lender,
CoBank. A number of other stock and asset transfers will also occur among
Alliance and its subsidiaries prior to the breakup in order to satisfy various
tax, regulatory and lender requirements.
Alliance expects the breakup transactions to be tax-free under Section
355 of the Internal Revenue Code. Alliance also expects the related internal
stock and asset transfers to be tax-free under Section 355, related Code
provisions and the consolidated return regulations, although no private letter
ruling is being sought from the IRS in connection with the breakup. Prior to
conducting the breakup transaction, the parties will enter into one or more
agreements with regard to cooperation, exchange of information, interim use of
common services, employee benefits, tax allocations and indemnification
generally in proportion to ownership percentages with respect to unexpected
adverse tax consequences, and other matters arising after the breakup
transaction which relate to commitments, events or circumstances in effect as of
the date of the breakup transaction.
The following pro forma financial statements of income and explanatory
notes show the pro forma effect on the operating results of the Company as if
the breakup occurred January 1, 2002. The pro forma balance sheet and
explanatory notes show the effect on the Company's financial position as if the
breakup occurred December 31, 2002.
23
The pro forma financial information and explanatory notes are unaudited
and include adjustments which are based on management's assumptions. Management
believes these statements provide a reasonable basis for presenting the
significant effects of the breakup and the pro forma adjustments are properly
applied in the pro forma statements.
The pro forma financial statements are not necessarily indicative of the
results of operations had the acquisition occurred at the beginning of the
periods presented, nor are they necessarily indicative of the results of future
operations.
Pro forma income statement
- -------------------------- Twelve Months Ended December 31, 2002
Eliminate Eliminate
Hector Sioux Valley Hills Other
Communications Telephone Telephone Pro forma Pro forma
Corporation Company Company Adjustments Combined
------------- ------------- ------------- ------------- -------------
REVENUES:
Local network $ 7,447,951 $ (1,276,797) $ (296,426) $ 5,874,728
Network access 21,233,284 (3,491,201) (2,438,226) 15,303,857
Video services 4,412,372 (393,184) 4,019,188
Internet services 2,404,684 (291,252) (168,521) 1,944,911
Other nonregulated services 4,223,355 (236,228) (292,623) 3,694,504
------------- ------------- ------------- ------------- -------------
TOTAL REVENUES 39,721,646 (5,688,662) (3,195,796) - 30,837,188
COSTS AND EXPENSES:
Plant operations 5,385,538 (853,145) (451,977) 4,080,416
Depreciation and amortization 9,962,652 (1,460,648) (501,642) 8,000,362
Customer operations 2,430,453 (385,820) (188,278) 1,856,355
General and administrative 5,473,999 (489,379) (227,970) $ (44,160)(e) 4,712,490
Other operating expenses 6,427,251 (776,605) (230,980) 5,419,666
------------- ------------- ------------- ------------- -------------
TOTAL COSTS AND EXPENSES 29,679,893 (3,965,597) (1,600,847) (44,160) 24,069,289
------------- ------------- ------------- ------------- -------------
OPERATING INCOME 10,041,753 (1,723,065) (1,594,949) 44,160 6,767,899
OTHER INCOME (EXPENSES):
Interest expense (4,726,799) 319,831 133,465 698,906 (a)(b)(c) (3,574,597)
Income from investments in unconsolidated
affilates:
Midwest Wireless Holdings, LLC 2,928,251 (666,831)(d) 2,261,420
Other unconsolidated affiliates 142,535 (147,300) (51,546) (56,311)
Interest and dividend income 481,258 (117,003) (30,352) 333,903
Gain (loss) on sale of marketable securities (134,498) (134,498)
------------- ------------- ------------- ------------- -------------
OTHER INCOME (EXPENSES), net (1,309,253) 55,528 51,567 32,075 (1,170,083)
------------- ------------- ------------- ------------- -------------
INCOME BEFORE INCOME TAXES AND
MINORITY INTEREST 8,732,500 (1,667,537) (1,543,382) 76,235 5,597,816
Income tax expense 3,670,000 (575,000) (643,000) 30,494 (f) 2,482,494
------------- ------------- ------------- ------------- -------------
INCOME BEFORE MINORITY INTEREST 5,062,500 (1,092,537) (900,382) 45,741 3,115,322
Minority interest in earnings of
Alliance Telecommunications Corporation 1,407,611 (1,407,611)(g) 0
------------- ------------- ------------- ------------- -------------
INCOME BEFORE CHANGE IN ACCOUNTING PRINCIPLE 3,654,889 (1,092,537) (900,382) 1,453,352 3,115,322
Cumulative effect of change in accounting
principle, net of income taxes and
minority interest 3,146,569 1,395,000 (h) 4,541,569
------------- ------------- ------------- ------------- -------------
NET INCOME (LOSS) $ 508,320 $ (1,092,537) $ (900,382) $ 58,352 $ (1,426,247)
============= ============= ============= ============= =============
BASIC NET INCOME (LOSS) PER COMMON SHARE:
Before cumulative effect of change in
accounting principle $ 1.05 $ .89
Cumulative effect of accounting change (.90) (1.30)
------------- -------------
$ .15 $ (.41)
============= =============
DILUTED NET INCOME (LOSS) PER COMMON SHARE:
Before cumulative effect of change in
accounting principle $ .97 $ .83
Cumulative effect of accounting change (.84) (1.21)
------------- -------------
$ .13 $ (.38)
============= =============
AVERAGE SHARES OUTSTANDING
Common shares only 3,498,000 3,498,000
Common and potential common shares 3,770,000 3,770,000
24
The following is a summary of the income statement adjustments required
in accordance with generally accepted accounting principles:
(a) Interest adjustment on CoBank loan at average interest rate(6.8%) $ 914,841
(b) Interest adjustment on CoBank loan for accrued patronage 95,935
(c) Estimated loan fee - CoBank refinancing 120,000
(d) Adjustment to income on Midwest Wireless Holdings LLC investment
due to ownership transfer 666,831
(e) Adjust deferred compensation expense for transfer of obligation 44,160
(f) Record income tax effect of adjustments (a),(b),(c),(d)
and (e) - 40% tax rate 30,494
(g) Eliminate minority interest in earnings of Alliance 1,407,611
(h) Eliminate minority interest from cumulative effect
of accounting change 1,395,000
Pro forma balance sheet - December 31, 2002
- -------------------------------------------
Hector Eliminate Eliminate
Communications Sioux Valley Hills Other
Corporation Telephone Telephone Pro forma Pro forma
Assets December 31, 2002 Company Company Adjustments Combined
---------------- ------------- ------------ -------------- -------------
Current assets:
Cash and cash equivalents $ 12,020,186 $ (1,467,421) $ (921,075) $ 9,631,690
Construction fund 662,232 (3) (4,184) 658,045
Accounts receivable, net 4,819,174 (839,754) (454,081) 3,525,339
Materials, supplies and inventories 1,175,587 (140,069) 1,035,518
Other current assets 231,685 (17,799) (10,369) 203,517
Accounts with affiliates (347,990) 391,027 43,037
------------- ------------- ------------ -------------
Total Current Assets 18,908,864 (2,813,036) (998,682) 15,097,146
Property, plant and equipment, net 56,665,798 (7,241,401) (2,773,900) 46,650,497
Investments and other assets:
Excess of cost over net assets acquired, net 49,074,993 $ (13,192,878)(e) 35,882,115
Marketable securities 114,234 114,234
Investment in Midwest Wireless Holdings LLC 16,232,707 (4,211,292)(a) 12,021,415
Investments in other unconsolidated
affiliates 4,373,597 (500,438) (943,058) 2,930,101
Other investments 8,704,268 (947,836) (225,907) (1,206,961)(c) 6,323,564
Other assets 411,499 (195,374) (48,832) 167,293
------------- ------------- ------------ -------------- -------------
Total investments and other assets 78,911,298 (1,643,648) (1,217,797) (18,611,131) 57,438,722
------------- ------------- ------------ -------------- -------------
Total Assets $ 154,485,960 $(11,698,085) $ (4,990,379) $ (18,611,131) $ 119,186,365
============= ============= ============ ============== =============
Liabilities and Stockholders Equity
Current liabilities:
Notes payable and current portion
of long-term debt $ 7,364,600 $ 7,364,600
Accounts payable 2,523,878 $ (193,341) $ (82,553) 2,247,984
Accrued expenses 2,422,986 (362,473) (80,080) 1,980,433
Income taxes payable 879,417 2,399 9,950 891,766
------------- ------------- ------------- -------------
Total current liabilities 13,190,881 (553,415) (152,683) 12,484,783
Long-term debt, less current portion 75,147,560 (4,251,209) (1,539,972) $ (13,453,550)(d) 55,902,829
Deferred investment tax credits 27,554 27,554
Deferred income taxes 5,866,754 (869,378) (484,411) (42,301)(a) 4,470,664
Deferred compensation 976,179 (312,377)(b) 663,802
Minority interest in Alliance
Telecommunications Corporation 17,027,697 (17,027,697)(f) 0
Stockholders' equity 42,249,335 (6,024,083) (2,813,313) 12,224,794 (a,b,c,d,e,f) 45,636,733
------------- ------------- ------------- -------------- -------------
Total Liabilities and Stockholders' Equity $ 154,485,960 $(11,698,085) $ (4,990,379) $ (18,611,131) $ 119,186,365
============= ============= ============= ============== =============
The following is a summary of the balance sheet adjustments required in
accordance with generally accepted accounting principles: (a) Record transfer of
32% of Alliance's ownership interest in Midwest Wireless
Holdings LLC, and related deferred tax liabilities of $162,523 $ 4,211,292
(b) Record transfer of 32% of deferred compensation obligations
and related deferred tax assets of $120,222 312,377
(c) Transfer 32% of investment in CoBank stock 1,206,961
(d) Record repayment of CoBank debt through dividend from Sioux Valley and Hills 13,453,550
(e) Eliminate goodwill recorded on investment in Sioux Valley and Hills 13,192,878
(f) Eliminate minority interest in Alliance Telecommunications Corporation 17,027,697
25
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 continually evaluating possible acquisitions 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 was 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. Adoption of SFAS No. 144 did not have a material effect on the
Company's 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 July 2001 the FASB also issued SFAS No. 142, "Goodwill and Other
Intangible Assets". SFAS No. 142 was 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. The impact of SFAS No. 142 on the Company's financial
statements is disclosed in Note 3 to the Financial Statements included in Item 8
of this report.
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 FCC has notified the Company's ILECs that SFAS No. 143 will
not be adopted for regulatory accounting purposes. Current regulatory accounting
requires ILECs to accrue for asset retirement obligations through depreciation
rates. Considering the FCC order and the provisions of SFAS No. 71, the Company
does not expect adoption of SFAS No. 143 to have a material impact on its
financial position or operating results.
26
In June 2002, the Financial Accounting Standards Board issued SFAS
No.146, "Accounting for Costs Associated with Exit or Disposal Activities". SFAS
No. 146 nullifies Emerging Issues Task Force (EITF) Issue No. 94-3, "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity (including Certain Costs Incurred in a Restructuring)." This statement
requires that a liability for a cost associated with an exit or disposal
activity be recognized when the liability is incurred. Under EITF Issue No.
94-3, a liability for an exit cost was recognized at the date of the entity
committed to an exit plan. The provisions of this statement are effective for
exit or disposal activities that are initiated after December 31, 2002, with
early application encouraged. The Company does not believe that the adoption of
SFAS No. 146 will have a material impact on its financial position or results of
operations.
In December 2002, the FASB issued SFAS No. 148, "Accounting for
Stock-Based Compensation - Transition Disclosure - an amendment of FAS 123".
This statement amends SFAS No. 123 "Accounting for Stock-Based Compensation" to
provide alternative methods of transition for a voluntary change to the fair
value based method of accounting for stock-based employee compensation. In
addition, this Statement amends the disclosure requirements of Statement 123 to
require prominent disclosures in both annual and interim financial statements
about the method of accounting for stock-based employee compensation and the
effect of the method used on reported results. The provisions of FAS 148 are
effective for financial statements for fiscal years ending after December 15,
2002, and disclosure requirements shall be effective for interim periods
beginning after December 15, 2002. The Company intends to continue to account
for stock-based compensation to its employees and directors using the intrinsic
value method prescribed by APB Opinion No. 25, and related interpretations. The
Company has made certain disclosures required by SFAS No. 148 in the
consolidated financial statements for the year ended December 31, 2002 and will
begin making the additional disclosures required by SFAS No. 148 in the first
quarter of 2003. Accordingly, adoption of SFAS No. 148 will not impact the
Company's financial position or results of operations.
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others". This interpretation elaborates on the
disclosures required in financial statements concerning obligations under
certain guarantees. It also clarifies the requirements related to the
recognition of liabilities by a guarantor at the inception of certain
guarantees. The disclosure requirements of this interpretation were effective on
December 31, 2002, but did not require any additional disclosures on the part of
the Company. The recognition provisions of the interpretation effective for 2003
are applicable only to guarantees issued or modified after December 31, 2002.
The Company does not expect adoption of these provisions to have a material
impact on its financial position or results of operations.
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 and mutual 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.
27
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, 2002 and 2001 and
the related consolidated statements of income, comprehensive income,
stockholders' equity, and cash flows for each of the three years in the period
ended December 31, 2002. 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, 2002 and 2001 and
the results of their operations and their cash flows for each of the three years
in the period ended December 31, 2002 in conformity with accounting principles
generally accepted in the United States of America.
As described in Note 3 to the consolidated financial statements, effective
January 1, 2002 the Company adopted Statement of Financial Accounting Standards
No. 142, "Goodwill and Other Intangible Assets".
/s/ Olsen Thielen & Co., Ltd.
- ----------------------------------
Olsen Thielen & Co., Ltd.
February 12, 2003
St. Paul, Minnesota
28
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
ASSETS
December 31
----------------------------------
2002 2001
------------- -------------
CURRENT ASSETS:
Cash and cash equivalents $ 12,020,186 $ 13,083,481
Construction fund (Note 8) 662,232 759,934
Accounts receivable (net of allowance for doubtful accounts of
$716,000 and $396,000, respectively) 4,819,174 4,736,131
Materials, supplies and inventories, at average cost 1,175,587 1,249,109
Other current assets 231,685 186,451
------------- -------------
TOTAL CURRENT ASSETS 18,908,864 20,015,106
PROPERTY, PLANT AND EQUIPMENT,net (Notes 1 and 2) 56,665,798 57,362,325
INVESTMENTS AND OTHER ASSETS:
Excess of cost over net assets acquired, less amortization
of $10,025,000 (Notes 1 and 3) 49,074,993 53,662,750
Marketable securities (Note 4) 114,234 419,004
Investment in Midwest Wireless Holdings LLC (Note 5) 16,232,707 14,174,179
Investments in other unconsolidated affiliates (Note 6) 4,373,597 4,347,354
Other investments (Note 1) 8,704,268 7,942,650
Other assets (Notes 1 and 3) 411,499 327,685
------------- -------------
TOTAL OTHER ASSETS 78,911,298 80,873,622
------------- -------------
TOTAL ASSETS $ 154,485,960 $ 158,251,053
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Notes payable and current portion of long-term debt (Note 8) $ 7,364,600 $ 6,752,100
Accounts payable (Note 11) 2,523,878 2,497,804
Accrued expenses 2,422,986 2,409,669
Income taxes payable 879,417 722,797
------------- -------------
TOTAL CURRENT LIABILITIES 13,190,881 12,382,370
LONG-TERM DEBT, less current portion (Note 8) 75,147,560 79,641,269
DEFERRED INVESTMENT TAX CREDITS (Note 7) 27,554 48,269
DEFERRED INCOME TAXES (Note 7) 5,866,754 5,975,119
DEFERRED COMPENSATION (Note 10) 976,179 931,529
COMMITMENTS AND CONTINGENCIES (Note 8)
MINORITY INTEREST IN ALLIANCE TELECOMMUNICATIONS, CORP. 17,027,697 17,031,204
STOCKHOLDERS' EQUITY: (Notes 1, 8 and 9)
Preferred stock, par value $1.00 per share; 3,000,000 shares authorized:
Convertible Series A, 220,100 shares issued and outstanding 220,100 220,100
Common stock, par value $.01 per share; 10,000,000 shares authorized;
3,455,067 and 3,476,569 shares issued and outstanding 34,551 34,766
Additional paid-in capital 13,262,969 13,212,970
Retained earnings 28,742,832 28,702,145
------------- -------------
42,260,452 42,169,981
Accumulated other comprehensive income (loss) (Note 4) (11,117) 71,312
------------- -------------
TOTAL STOCKHOLDERS' EQUITY 42,249,335 42,241,293
------------- -------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 154,485,960 $ 158,251,053
============= =============
See notes to consolidated financial statements.
29
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
Year Ended December 31
--------------------------------------------------
2002 2001 2000
------------- ------------- -------------
REVENUES:
Local network $ 7,447,951 $ 7,149,068 $ 6,650,242
Network access 21,233,284 22,342,115 20,812,363
Video services 4,412,372 4,155,141 3,953,411
Internet services 2,404,684 1,976,923 1,304,486
Other nonregulated services 4,223,355 5,009,665 5,069,600
------------- ------------- -------------
TOTAL REVENUES 39,721,646 40,632,912 37,790,102
COSTS AND EXPENSES:
Plant operations 5,385,538 5,355,950 4,810,801
Depreciation and amortization 9,962,652 11,316,774 10,176,284
Customer operations 2,430,453 2,436,046 2,115,634
General and administrative 5,473,999 4,872,549 4,575,684
Other operating expenses 6,427,251 6,130,577 5,120,843
------------- ------------- -------------
TOTAL COSTS AND EXPENSES 29,679,893 30,111,896 26,799,246
------------- ------------- -------------
OPERATING INCOME 10,041,753 10,521,016 10,990,856
OTHER INCOME (EXPENSES):
Interest expense (4,726,799) (5,302,058) (5,954,603)
Income from investments in unconsolidated affilates:
Midwest Wireless Holdings, LLC (Note 5) 2,928,251 1,474,865 1,248,260
Other unconsolidated affiliates (Note 6) 142,535 665,365 646,594
Loss from other investments (1,284,008)
Interest and dividend income 481,258 672,584 1,250,748
Gain (loss) on marketable securities (Note 4) (134,498) 3,659,055 1,622,226
------------- ------------- -------------
OTHER INCOME (EXPENSES), net (1,309,253) 1,169,811 (2,470,783)
------------- ------------- -------------
INCOME BEFORE INCOME TAXES AND
MINORITY INTEREST 8,732,500 11,690,827 8,520,073
Income tax expense (Note 7) 3,670,000 5,321,000 4,207,000
------------- ------------- -------------
INCOME BEFORE MINORITY INTEREST 5,062,500 6,369,827 4,313,073
Minority interest in earnings of
Alliance Telecommunications Corporation 1,407,611 1,753,673 1,003,650
------------- ------------- -------------
INCOME BEFORE CHANGE IN ACCOUNTING PRINCIPLE 3,654,889 4,616,154 3,309,423
Cumulative effect of change in accounting principle,
net of income taxes and minority interest (Note 3) 3,146,569
------------- ------------- -------------
NET INCOME $ 508,320 $ 4,616,154 $ 3,309,423
============= ============= =============
BASIC NET INCOME PER COMMON SHARE (Note 1):
Before cumulative effect of change in accounting principle $ 1.05 $ 1.33 $ .93
Cumulative effect of accounting change (.90)
------------- ------------- -------------
$ .15 $ 1.33 $ .93
============= ============= =============
DILUTED NET INCOME PER COMMON SHARE (Note 1):
Before cumulative effect of change in accounting principle $ .97 $ 1.23 $ .86
Cumulative effect of accounting change (.84)
------------- ------------- -------------
$ .13 $ 1.23 $ .86
============= ============= =============
AVERAGE SHARES OUTSTANDING (Notes 1 and 9):
Common shares only 3,498,000 3,465,000 3,544,000
Common and potential common shares 3,770,000 3,763,000 3,851,000
See notes to consolidated financial statements.
30
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Year Ended December 31
--------------------------------------------------
2002 2001 2000
------------- ------------- -------------
Net income $ 508,320 $ 4,616,154 $ 3,309,423
Other comprehensive loss:
Unrealized holding gains (losses) on marketable securities (304,758) 1,199,251 (3,903,896)
Reclassification adjustment for losses (gains)
included in net income 134,498 (3,659,055) (1,622,226)
------------- ------------- -------------
Other comprehensive loss before income taxes (170,260) (2,459,804) (5,526,122)
------------- ------------- -------------
Income tax expense (benefit) related to unrealized
holding gains and losses on marketable securities (125,492) 492,948 (1,539,833)
Income tax expense (benefit) related to reclassification
adjustment for gains and losses included in net income 53,799 (1,504,043) (639,862)
------------- ------------- -------------
Income tax benefit related to items of other
comprehensive loss (71,693) (1,011,095) (2,179,695)
Minority interest in other comprehensive loss of
Alliance Telecommunications Corporation (16,138) (458,786) (1,081,180)
------------- ------------- -------------
Other comprehensive Ioss (82,429) (989,923) (2,265,247)
------------- ------------- -------------
Comprehensive income $ 425,891 $ 3,626,231 $ 1,044,176
============= ============= =============
See notes to consolidated financial statements
31
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 (Loss) Total
------- -------- --------- ------- ----------- ----------- ---------- -----------
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 and
losses 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 and
losses 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
Net income 508,320 508,320
Issuance of common stock under
Employee Stock Purchase Plan 11,578 116 96,827 96,943
Issuance of common stock under
Employee Stock Option Plan 37,159 371 222,292 222,663
Purchase and retirement of
common stock (70,239) (702) (269,120) (467,633) (737,455)
Change in unrealized gains and
losses on marketable securities,
net of deferred taxes (82,429) (82,429)
------- -------- --------- ------- ----------- ----------- ---------- -----------
BALANCE AT DECEMBER 31, 2002 220,100 $220,100 3,455,067 $34,551 $13,262,969 $28,742,832 $ (11,117) $42,249,335
======= ======== ========= ======= =========== =========== ========== ===========
See notes to consolidated financial statements.
32
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31
-----------------------------------------------
2002 2001 2000
------------- ------------- -------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income $ 508,320 $ 4,616,154 $ 3,309,423
Adjustments to reconcile net income to net cash
provided by operating activities:
Noncash cumulative effect of change in accounting principle 4,663,039
Depreciation and amortization 9,963,888 11,318,010 10,177,520
Minority stockholders' interest in earnings
of Alliance Telecommunications Corporation 12,632 1,753,673 1,003,650
Gain on sales of marketable securities (3,659,055) (1,622,226)
Noncash marketable securities impairment charge 134,498
Income from Midwest Wireless Holdings LLC (2,928,251) (1,474,865) (1,248,260)
Income from other unconsolidated affiliates (142,535) (665,365) (646,594)
Noncash loss on other investments 1,284,008
Cash distributions from Midwest Wireless Holdings LLC 869,723 901,295 716,653
Cash distributions from other unconsolidated affiliates 166,292 423,581 439,378
Noncash patronage refunds (260,233) (270,793) (8,780)
Noncash investment income (48,325)
Changes in assets and liabilities net of effects from
the purchase of Hager Telecom, Inc.:
Accounts receivable (83,043) 812,491 (566,951)
Materials, supplies and inventories 73,522 (423,436) (172,847)
Other current assets (45,234) 116,253 111,795
Accounts payable 26,074 (166,716) (62,254)
Accrued expenses 13,317 155,083 121,137
Income taxes payable 119,804 335,697 (3,426,965)
Deferred investment tax credits (20,715) (31,399) (60,718)
Deferred income taxes 155 382,904 (934,383)
Deferred compensation 44,650 27,458 6,958
------------- ------------- -------------
Net cash provided by operating activities 13,115,903 14,102,645 8,420,544
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property, plant and equipment (9,265,040) (10,618,722) (9,446,190)
Sales of marketable securities 3,675,519 5,420,957
Decrease (increase) in construction fund 97,702 (442,097) 8,169
Investments in other unconsolidated affiliates (50,000) (1,988,606) (883,276)
Purchases of other investments (1,301,265) (366,643) (1,693,458)
Proceeds from other investments 799,880 63,240 175,052
Decrease (increase) in other assets (161,417) (135,987) 109,954
Payments for purchase of Hager Telecom, Inc.,
net of cash acquired (8,532,392)
------------- ------------- -------------
Net cash used in investing activities (9,880,140) (9,813,296) (14,841,184)
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of notes payable and long-term debt (6,835,525) (6,523,180) (5,485,803)
Proceeds from issuance of notes payable and long-term debt 2,954,316 2,201,200 700,000
Issuance of common stock 319,606 549,989 1,139,764
Purchase of stock (737,455) (1,267,987) (3,154,983)
------------- ------------- -------------
Net cash used in financing activities (4,299,058) (5,039,978) (6,801,022)
------------- ------------- -------------
NET DECREASE IN CASH AND CASH EQUIVALENTS (1,063,295) (750,629) (13,221,662)
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 13,083,481 13,834,110 27,055,772
------------- ------------- -------------
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 12,020,186 $ 13,083,481 $ 13,834,110
============= ============= =============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Interest paid $ 5,039,440 $ 5,710,494 $ 6,189,304
Income taxes paid 3,596,254 4,650,094 8,639,597
See notes to consolidated financial statements.
33
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, 2002, the Company's wholly and majority
owned subsidiaries provided telephone service to 38,777 access lines in 37 rural
communities in Minnesota, Wisconsin, South Dakota and Iowa. Its provided cable
television services to 13,715 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).
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.
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 and warrants. The calculation of the Company's
net income per share is included in Exhibit 11 of this form 10-K.
34
Stock compensation: The Company has stock plans under which stock options, stock
appreciation rights, restricted stock or deferred stock may be granted to
officers, key employees and nonemployee directors. Employees may also
participate in an employee stock purchase plan which allows them to purchase
shares through payroll deductions on favorable terms. These plans are described
more fully in Note 9. The Company has elected to apply APB Opinion No. 25,
"Accounting for Stock Issued to Employees" for measurement and recognition of
stock-based transactions with its employees and directors. If the Company had
elected to recognize compensation cost for its stock-based transactions based on
the fair value of the options method prescribed by SFAS No. 123 (see Note 9),
net income and net income per share would have been as follows:
2002 2001 2000
---------- ----------- -----------
Net income as reported $ 508,320 $ 4,616,154 $ 3,309,423
Less: Total stock-based employee
compensation expense determined
under the fair value method for
all awards (460,794) (348,388) (351,260)
---------- ----------- -----------
Pro forma net income $ 47,526 $ 4,267,766 $ 2,958,163
========== =========== ===========
Basic net income per share:
As reported $ .15 $ 1.33 $ .93
Pro forma $ .01 $ 1.23 $ .83
Diluted net income per share:
As reported $ .13 $ 1.23 $ .86
Pro forma $ .01 $ 1.13 $ .77
Cash and cash equivalents: The Company considers temporary cash investments with
an original maturity of three months or less to be cash equivalents.
Accounts receivable: Receivables are stated at the amount the Company expects to
collect from outstanding balances. The Company provides for probable
uncollectible amounts through a charge to earnings and a credit to a valuation
allowance based on its assessment of the current status of individual accounts.
Balances that are still outstanding after the Company has used reasonable
collection efforts are written off through a charge to the valuation allowance
and a credit to the receivable accounts.
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 $9,961,567, $9,482,923 and
$8,415,178 for 2002, 2001 and 2000, 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.
Goodwill: In July, 2001 the Financial Accounting Standards Board issued SFAS No.
141, "Business Combinations" and SFAS No. 142, "Goodwill and Other Intangible
Assets". The Company adopted these standards effective January 1, 2002. Under
the new standards, goodwill is no longer amortized but is reviewed annually for
impairment (Note 3).
Prior to the adoption of SFAS No. 142, goodwill was amortized on the
straight-line method over periods ranging from fifteen to forty years.
Amortization included in costs and expenses was $1,812,679 and $1,739,225 in
2001 and 2000, respectively.
Investments in unconsolidated affiliates: The Company is a co-investor with
other rural ILECS in Midwest Wireless Holdings LLC (Note 5) and several other
partnerships and limited liability corporations (Note 6). The Company's
percentage of ownership in these joint ventures ranges from 4% to 25%. The
Company has board of director representation in each of these joint ventures and
has the ability to influence their operations. The Company uses the equity
method of accounting for these investments, which reflects original cost and
recognition of the Company's share of operating income or losses from the
respective operations.
35
Other investments: The Company owns Rural Telephone Bank stock, CoBank stock,
long-term certificates of deposit, and investments in the stock of other
telecommunications service providers. Long-term investments in corporations that
are not intended for resale or are not readily marketable and in which the
Company does not exercise significant influence are valued at cost, which does
not exceed net realizable value. During the fourth quarter of 2000, the Company
took a charge against earnings of $1,273,000 due to impairment of its investment
in Onvoy, Inc. common stock.
Other assets: Other assets owned by the Company include cable television
franchises, customer lists and other deferred charges. Other intangible assets
determined to have an indefinite useful life are not amortized in accordance
with SFAS 142. Intangible assets with a determinable life are amortized over the
useful life. Amortization included in expenses was $1,085, $21,172 and $21,881
for 2002, 2001 and 2000, respectively (Note 3).
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 $83,883,000 and $84,392,000 at December 31, 2002 and 2001, respectively.
Fair values were estimated based on current rates offered to the Company for
debt with similar terms and maturities.
New accounting principles: Effective January 1, 2002, the Company adopted SFAS
No. 144, "Accounting for Impairment or Disposal of Long-Lived Assets". 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. Adoption of SFAS No. 144 did
not have a material effect on the Company's financial statements.
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 FCC has notified the Company's ILEC subsidiaries that SFAS No. 143 will not
be adopted for regulatory purposes. Current regulatory accounting requires ILECs
to accrue for asset retirement obligations through prescribed depreciation
rates. Considering the FCC's order and the provisions of SFAS No. 71, the
Company does not expect the provisions of SFAS No. 143 to have a material impact
on its financial position or operating results.
In June 2002, the Financial Accounting Standards Board issued SFAS No.146,
"Accounting for Costs Associated with Exit or Disposal Activities". SFAS No. 146
nullifies Emerging Issues Task Force (EITF) Issue No. 94-3, "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity (including Certain Costs Incurred in a Restructuring)." This statement
requires that a liability for a cost associated with an exit or disposal
activity be recognized when the liability is incurred. Under EITF Issue No.
94-3, a liability for an exit cost was recognized at the date of the entity
committed to an exit plan. The provisions of this statement are effective for
exit or disposal activities that are initiated after December 31, 2002, with
early application encouraged. The Company does not believe that the adoption of
SFAS No. 146 will have a material impact on its financial position or results of
operations.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition Disclosure - an amendment of FAS 123". This statement
amends SFAS No. 123 "Accounting for Stock-Based Compensation" to provide
alternative methods of transition for a voluntary change to the fair value based
method of accounting for stock-based employee compensation. In addition, this
Statement amends the disclosure requirements of Statement 123 to require
prominent disclosures in both annual and interim financial statements about the
method of accounting for stock-based employee compensation and the effect of the
method used on reported results. The provisions of FAS 148 are effective for
financial statements for fiscal years ending after December 15, 2002, and
disclosure requirements shall be effective for interim periods beginning after
December 15, 2002. The Company intends to continue to account for stock-based
compensation to its employees and directors using the intrinsic value method
prescribed by APB Opinion No. 25, and related interpretations. The Company has
made certain disclosures required by SFAS No. 148 in the consolidated financial
statements for the year ended December 31, 2002 and will begin making the
additional disclosures required by SFAS No. 148 in the first quarter of 2003.
Accordingly, adoption of SFAS No. 148 will not impact the Company's financial
position or results of operations.
36
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's Accounting
and Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others". This interpretation elaborates on the disclosures
required in financial statements concerning obligations under certain
guarantees. It also clarifies the requirements related to the recognition of
liabilities by a guarantor at the inception of certain guarantees. The
disclosure requirements of this interpretation were effective on December 31,
2002, but did not require any additional disclosures on the part of the Company.
The recognition provisions of the interpretation effective for 2003 are
applicable only to guarantees issued or modified after December 31, 2002. The
Company does not expect adoption of these provisions to have a material impact
on its financial position or results of operations.
Basis of presentation: Certain amounts in the 2000 and 2001 financial statements
have been reclassified to conform to the 2002 financial statement presentation.
These reclassifications had no effect on net income or stockholders' equity as
previously reported.
NOTE 2 - PROPERTY, PLANT AND EQUIPMENT
The cost of property, plant and equipment and the estimated useful lives are as
follows:
December 31
Estimated -----------------------------
useful life 2002 2001
----------- ------------- -------------
Land $ 634,160 $ 632,585
Buildings 5-40 years 6,658,469 6,449,591
Machinery and equipment 3-15 years 4,032,923 3,619,690
Furniture and fixtures 5-10 years 2,221,407 2,310,545
Telephone plant 5-33 years 91,153,581 82,436,569
Cable television plant 10-15 years 10,445,523 10,343,032
Construction in progress 400,533 1,433,388
------------- -------------
115,546,596 107,225,400
Less accumulated depreciation 58,880,798 49,863,075
------------- -------------
$ 56,665,798 $ 57,362,325
============= =============
NOTE 3 - GOODWILL AND INTANGIBLE ASSETS
Effective January 1, 2002 the Company adopted SFAS No. 142, "Goodwill and Other
Intangible Assets". Under the provisions of this accounting standard, goodwill
and intangible assets with indefinite useful lives are no longer amortized but
are instead tested for impairment on at least an annual basis.
At December 31, 2001 the Company had excess of cost over net assets acquired or
"goodwill" of $53,663,000, which was net of an amortization reserve of
$10,025,000. The Company determined that these assets have indefinite useful
lives and ceased amortization effective January 1, 2002.
During the first half of 2002, the Company tested the beginning value of its
goodwill and intangible assets as required by SFAS No. 142. As a result of this
test, the Company concluded that the carrying value of the goodwill and
intangible assets in certain of its operating units exceeded the market value.
Accordingly, the Company recognized an impairment loss and reduced its goodwill
and intangible assets by $4,663,000. After income tax benefits of $121,000 and
minority interest of $1,395,000, the charge against earnings was $3,147,000
which was recognized as a cumulative effect of change in accounting principle
and carried back to the first quarter of 2002.
In calculating the impairment charge, the fair value of the impaired reporting
units underlying the segments were estimated using used the same valuation
methodology the Company is using to negotiate the breakup of Alliance. The
valuation is an average of access line and customer valuations and cash flow
multiple valuations considered appropriate in the current marketplace. The
Company believes the valuations placed on these units are consistent with values
placed on properties in recent comparable transactions and that valuation of the
reporting units using different methods would have yielded similar results.
37
The goodwill impairment is associated principally with goodwill resulting from
the Company's acquisition of Hager TeleCom, Inc, but also included charges from
cable television acquisitions and the acquisition of Ollig Utilities. The amount
of the impairment primarily reflects the decline in the market valuations for
telephone access lines and internet customers and valuations of competing local
exchange carrier ("CLEC") assets that have occurred since the acquisition.
Changes in the Company's goodwill by segment are as follows:
Hector Alliance Consolidated
Balance December 31, 2001 $ 623,721 $ 53,039,029 $ 53,662,750
Impairment loss (228,447) (4,359,310) (4,587,757)
-------------- ------------- -------------
Balance December 31, 2002 $ 395,274 $ 48,678,719 $ 49,074,993
============== ============= =============
The Company owns 10.4% of Midwest Wireless Holdings LLC. The Company accounts
for its investment in Midwest Wireless Holdings using the equity method, and
earnings from the investment are material to the Company's net income. At
December 31, 2001 Midwest Wireless Holdings LLC had investments in cellular,
LMDS and PCS licenses totaling $187,212,000, net of amortization of $9,922,000.
Midwest Wireless Holdings LLC has determined that these licenses have indefinite
useful lives and ceased amortization on January 1, 2002.
The Company's other intangible assets consist of cable television franchises and
internet customer lists. Amortization expense is estimated to be $21,000 per
year for 2003 through 2007.
At December 31, 2001, the Company had an investment in cable television
franchises of $77,000, net of an amortization reserve of $146,000. Under the
provisions of SFAS 142, the Company determined its cable television franchises
have an indefinite useful life and ceased amortization effective January 1,
2002. Cable television franchises are limited to 15 years, but are renewable as
long as the Company continues to comply with the applicable Federal
Communications Commission (FCC) rules and policies and the terms of the local
franchising authorities. Franchises may be renewed at minimal cost. The Company
intends to renew the franchises indefinitely, and has had no problems obtaining
necessary renewals. The Company will evaluate each reporting period whether
events and circumstances continue to support an indefinite useful life for the
franchises.
Changes in the Company's intangible assets and other assets by segment are as
follows:
Alliance
Hector -----------------------
Intangible Intangible
Assets Assets Other Assets Consolidated
---------- ---------- ----------- ------------
Balance at December 31, 2001 $ 77,060 $ - $ 250,625 $ 327,685
Additions 7,700 98,358 54,123 160,181
Amortization (1,085) - - (1,085)
Impairment loss (75,282) - - (75,282)
---------- ---------- ----------- -----------
Balance at December 31, 2002 $ 8,393 $ 98,358 $ 304,748 $ 411,499
========== ========== =========== ===========
The following table provides a reconciliation of reported net income to pro
forma net income, including net income per share information, for the periods
ended December 31, 2002, 2001 and 2000 as if the provisions of SFAS 142 had been
effective January 1, 2000:
2002 2001 2000
------------- ------------- -------------
Net income as reported $ 508,320 $ 4,616,154 $ 3,309,423
Amortization - 1,833,851 1,760,662
Midwest Wireless amortization - 468,609 393,187
Midwest Wireless goodwill - 252,780 248,664
Income tax expense - (289,000) (257,000)
Minority interest - (669,282) (633,791)
------------- ------------- -------------
Pro forma net income $ 508,320 $ 6,213,112 $ 4,821,145
============= ============= =============
Basic net income per share:
As reported $ .15 $ 1.33 $ .93
Pro forma $ .15 $ 1.79 $ 1.36
Diluted net income per share:
As reported $ .13 $ 1.23 $ .86
Pro forma $ .13 $ 1.65 $ 1.25
38
NOTE 4 - 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, 2002
and December 31, 2001. 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, 2002 $ 126,482 $ 21,292 $ (33,540) $ 114,234
December 31, 2001 260,980 $ 172,159 $ (14,135) $ 419,004
Net unrealized gains on marketable securities, net of related deferred taxes and
minority interest, are included in stockholders' equity as accumulated other
comprehensive income (loss) at December 31, 2002 and 2001 as follows:
Net Deferred Accumulated
Unrealized Income Minority Comprehensive
Gains (Losses) Taxes Interest Income (Loss)
------------- ----------- ----------- -------------
December 31, 2002 $ (12,248) $ 4,914 $ (3,783) $ (11,117)
December 31, 2001 $ 158,024 $ (66,791) $ (19,921) $ 71,312
These amounts have no cash effect and are not included in the statement of cash
flows.
During 2002 the Company determined that its investment in certain
available-for-sale securities was permanently impaired. Due to the impairment,
the Company reduced the cost basis of its marketable securities by $134,500 and
recorded a charge against net income for a similar amount.
Gross proceeds from sales of available-for-sale securities were $3,676,000 and
$5,421,000 in 2001 and 2000. Gross realized gains on sales of securities were
$3,659,000 and $1,622,000 in 2001 and 2000 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 5 - MIDWEST WIRELESS HOLDINGS LLC
At December 31, 2002 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. The investment is recorded on the
equity method of accounting, which reflects original cost and recognition of the
Company's share of income or losses. Income from this investment, net of
associated amortization expense, was $2,928,000, $1,475,000, and $1,248,000 in
2002, 2001 and 2000, respectively. Cash distributions received from Midwest
Wireless were $870,000, $901,000 and $717,000 in 2002, 2001 and 2000,
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 at December 31, 2002. Excess cost was amortized in 2001 and 2000 on
the straight-line method over periods ranging from twenty-five to forty years.
Amortization expense was $253,000 and $249,000 in 2001 and 2000, respectively.
At December 31, 2002, the Company's cumulative share of income from Midwest
Wireless was $11,207,000, of which $6,758,000 was undistributed.
Midwest Wireless has loan agreements with the Rural Telephone Finance
Cooperative ("RTFC") that restrict distributions to members. At December 31,
2002, under these covenants Midwest Wireless could not make distributions to
members except for amounts necessary to pay income taxes.
Summarized audited financial information for Midwest Wireless for 2002, 2001 and
2000 is as follows:
39
Year Ended December 31
2002 2001 2000
-------------- ------------- -------------
Current assets $ 12,445,979 $ 17,409,300 $ 14,363,696
Noncurrent assets 305,838,514 285,615,880 250,179,199
Current liabilities 56,909,149 48,394,693 25,397,983
Noncurrent liabilities 115,446,843 130,528,309 124,525,414
Minority interest 9,428,619 6,913,996 5,844,777
Members' equity 136,499,882 117,188,182 108,774,721
Revenues 162,697,183 140,538,515 112,345,743
Expenses 134,583,663 123,950,155 98,048,672
Net income 28,113,520 16,588,360 14,297,071
NOTE 6 - INVESTMENTS IN UNCONSOLIDATED AFFILIATES
The Company is a co-investor with other rural ILECS in several other
partnerships and limited liability corporations. These joint ventures make it
possible to offer certain services to customers, including centralized switching
or fiber optic transport of messaging, that the Company could not afford to
offer on its own. These joint ventures also make it possible to invest in new
technologies with a lower level of financial risk. The Company recognizes income
and losses from these investments on the equity method of accounting. The
following table summarizes the Company's ownership percentage, current
investment and income or loss from these investments in 2002, 2001 and 2000:
Book Value at
December 31 Income (Loss) on Investment
Ownership ---------------------- -----------------------------------------
Interest 2002 2001 2002 2001 2000
--------- ---------- ---------- ---------- ---------- ----------
Broadband Visions 17.9% $ 698,155 $ 700,345 $ (2,190) $ (949) $ 3,140
Communications Mgmt Grp 6.5% 176,242 183,414 (7,172) (56,134) (41,520)
Desktop Media 10.0% 375,000 500,000 (125,000) - -
Fibercom 12.5% 447,795 451,060 (53,265) 175,612 87,372
Fibernet 12.8% 495,263 428,912 104,811 85,408 24,056
Northern Transport Group 20.0% 353,439 394,060 (40,621) 121,204 350,705
NW Minnesota Spec Access 5.3% 88,612 72,580 16,032 53,232 -
South Central Switching 25.0% 101,399 152,042 13,039 41,906 22,881
SDN Communications 4.1% 500,438 387,288 147,300 78,854 184,246
Val-Ed Joint Venture 18.1% 923,561 894,723 28,838 150,671 (53,460)
West Central Transport 5.0% 213,693 182,930 60,763 53,533 54,216
Wireless North 10.4% - - - (37,972) 14,958
---------- ---------- ---------- ---------- ----------
$4,373,597 $4,347,354 $ 142,535 $ 665,365 $ 646,594
========== ========== ========== ========== ==========
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
---------------------------------------
2002 2001 2000
----------- ----------- -----------
Currently payable taxes:
Federal $ 2,728,000 $ 4,002,000 $ 4,053,000
State 963,000 967,000 1,149,000
----------- ----------- -----------
3,691,000 4,969,000 5,202,000
Deferred income taxes (benefit) - 383,000 (934,000)
Deferred investment tax credits (21,000) (31,000) (61,000)
----------- ----------- -----------
$ 3,670,000 $ 5,321,000 $ 4,207,000
=========== =========== ===========
Deferred tax assets and liabilities as of December 31 related to the following:
40
2002 2001
------------ ------------
Deferred tax liabilities:
Accelerated depreciation $ 6,158,754 $ 5,256,119
Partnership and LLC investments 903,000 1,623,000
Marketable securities 1,000 109,000
Other - 88,000
------------ ------------
7,062,754 7,076,119
Deferred tax assets:
Deferred compensation 376,000 377,000
Intangibles 238,000 200,000
Accrued expenses 272,000 256,000
Bad debts 255,000 159,000
Other 55,000 -
------------ ------------
1,196,000 992,000
Net deferred tax liability $ 5,866,754 $ 5,975,119
============ =============
The provision for income taxes varied from the federal statutory tax rate as
follows:
Year Ended December 31
---------------------------
2002 2001 2000
------- ------- -------
Tax at U.S. statutory rate 35.0% 35.0% 35.0%
Surtax exemption (1.0) (.9) (1.0)
State income taxes, net of federal benefit 8.5 5.5 8.0
Excess of cost over net assets acquired - 5.3 7.0
Investment tax credits (.2) (.3) (.7)
Other (.3) .9 1.1
------- ------- -------
Effective tax rate 42.0% 45.5% 49.4%
======= ======= =======
NOTE 8 - NOTES PAYABLE AND LONG-TERM DEBT
December 31
-----------------------------
2002 2001
------------ ------------
Notes payable to CoBank, payable by Alliance
Telecommunications Corporation in monthly
installments, average interest rate of 6.8%,
due 2003 to 2011 $ 38,186,000 $ 41,531,600
Rural Utilities Service ("RUS") and Rural
Telephone Bank ("RTB") mortgage notes,
payable by telephone company subsidiaries in
monthly and quarterly installments, average
rate of 5.4%, due 2003 to 2028 39,953,618 39,808,528
Notes payable to Rural Telephone Finance
Cooperative in quarterly installments,
interest rate of 5.5%, due 2013 3,157,051 3,365,634
Notes payable to former owners of Felton
Telephone Company, payable by a subsidiary
of Alliance Telecommunications Corporation
in monthly installments, interest rate of
8.25%, due 2005 1,215,491 1,687,607
------------ ------------
82,512,160 86,393,369
Less current portion 7,364,600 6,752,100
------------ ------------
$ 75,147,560 $ 79,641,269
============ ============
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. 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.
At December 31, 2002, the Company's local exchange carrier subsidiaries had
unadvanced loan commitments under the RUS and RTB programs aggregating
approximately $19,937,000 to finance specific construction activities in future
years.
41
Alliance Telecommunications Corporation has a term loan agreement with the
CoBank to fund the acquisition of Ollig Utilities Company. As a condition of
maintaining the loan, Alliance owns stock in the bank. At December 31, 2002,
Alliance's investment in CoBank stock was $3,772,000.
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 $300,000,
$325,000 and $231,000 in 2002, 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 is reflected in the Company's operating statement
as a reduction of interest expense. The Company cannot predict what patronage
refunds might be in future years.
CoBank's loan is secured by a pledge of the stock of Alliance and its
subsidiaries and a second position secured interest in the assets of Alliance's
LEC subsidiaries. Interest rates on long-term portions of the loan are fixed for
periods ranging from one to ten years, while the current portion floats at
short-term market rates. The average rate on the total loan was approximately
6.8% at December 31, 2002. Principal payments began in January 1997 and will
continue until March 2011.
The amount of dividends on common stock that may be paid by the subsidiaries to
the Company is limited by certain financial covenants set forth in the RUS, RTB
and CoBank mortgages. At December 31, 2002, $4,294,000 of subsidiaries' retained
earnings was available for dividend payments to HCC.
At December 31, 2002, $24,449,000 of HCC's retained earnings were not available
to pay dividends to shareholders due to restrictions in the debt agreements.
The Company is continuing its construction program to upgrade its telephone and
cable television properties. Planned expenditures for HCC and Alliance
properties in 2003 are $6,276,000. 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 Finance Cooperative ("RTFC"). The interest rate on the term loan
varies according to the rate charged by the Lender for similar loans (5.5% at
December 31, 2002). 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.
The annual requirements for principal payments on notes payable and long-term
debt are as follows:
2003 $ 7,364,600
2004 7,890,100
2005 7,951,700
2006 8,267,700
2007 8,791,700
NOTE 9 - 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.
42
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, 2002, 83,850 shares were available to be
issued under the plans. Changes in outstanding employee and director stock
options during the three years ended December 31, 2002 are as follows:
Average
Number of exercise price
shares per share
------------- -------------
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
Granted 111,800 13.27
Exercised (53,800) 8.24
Canceled (900) 11.91
------------- -------------
Outstanding at December 31, 2002 446,175 $ 11.28
============= =============
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,
2002, 348,242 stock options are currently exercisable at an average price of
$11.00 per share. The following table summarizes the status of stock options
outstanding at December 31, 2002:
Weighted Average Weighted
Remaining Average
Range of Exercise Prices Shares Option Life Exercise Price
- ------------------------ ------- ----------- --------------
$ 6.50 to $ 9.99 75,600 1.5 years $ 8.52
$10.00 to $12.00 231,225 2.8 years 11.03
$12.01 to $14.43 139,350 4.4 years 13.20
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
11,578, 11,626 and 10,742 for the plan years ended August 31, 2002, 2001 and
2000, respectively. At December 31, 2002 employees had subscribed to purchase an
additional 15,700 shares in the current plan cycle ending August 31, 2003.
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:
43
Year Ended December 31
--------------------------------------------------
2002 2001 2000
------------- -------------- ----------------
Net income $ 47,526 $ 4,267,766 $ 2,958,163
Basic net income per share $ .01 $ 1.23 $ .83
Diluted net income per share $ .01 $ 1.13 $ .77
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:
Year Ended December 31
--------------------------------------
2002 2001 2000
---------- ---------- ----------
Expected volatility 29.8% 29.3% 29.6%
Risk free interest rate 4.6% 4.7% 6.5%
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 $460,794, $348,388 and $351,260 in
2002, 2001 and 2000, respectively. Fair value of all options issued was
$515,360, $358,950 and $443,534 in 2002, 2001 and 2000, 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.
The Company purchased and retired 70,239, 109,704 and 221,950 shares in 2002,
2001 and 2000 respectively. Cost of the repurchased shares was $737,000,
$1,268,000. and $3,155,000 in 2002, 2001 and 2000 respectively. At December 31,
2002, 216,000 shares could be repurchased under outstanding Board
authorizations.
In 1995 the Company issued convertible subordinated debentures. 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 were issued
upon exercise of warrants in 2000. At December 31, 2002, 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 $139,200, $133,200 and $100,000 for 2002, 2001
and 2000, respectively. At December 31, 2002, the ESOP held 75,974 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.
44
NOTE 10 - 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 2002, 2001 and 2000
were approximately $226,000, $203,000 and $172,000 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 2002, 2001 and 2000 were $268,000,
$247,000 and $220,000 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 $138,000, $121,000 and $100,000 in 2002,
2001 and 2000 respectively. Payments made under the agreement were $93,000 in
each of the last three years.
NOTE 11 - 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
$186,000, $286,000 and $314,000 in 2002, 2001 and 2000 respectively.
Costs of services from CSI may not be indicative of the costs of such services
had they been obtained from a different party. Intercompany accounts with CSI
are handled on an open account basis. Outstanding amounts payable to CSI were
$74,000 and $152,000 at December 31, 2002 and 2001, respectively.
NOTE 12 - 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
was accounted for as a purchase. Excess of cost over net assets acquired in the
transaction was $5,810,000. 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
==================
NOTE 13 - 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:
45
Hector Alliance Consolidated
-------------- -------------- ----------------
Year Ended December 31, 2002
Revenues $ 9,466,013 $ 30,255,633 $ 39,721,646
Costs and expenses 8,541,209 21,138,684 29,679,893
--------------- --------------- ----------------
Operating income 924,804 9,116,949 10,041,753
Interest expense (891,553) (3,835,246) (4,726,799)
Income from unconsolidated affiliates:
Midwest Wireless Holdings LLC 844,403 2,083,848 2,928,251
Other unconsolidated affiliates 46,892 95,643 142,535
Interest and dividend income 135,169 346,089 481,258
Loss on marketable securities (134,498) (134,498)
--------------- ---------------- -----------------
Income before income taxes and minority interest $ 1,059,715 $ 7,672,785 $ 8,732,500
=============== =============== ================
Depreciation and amortization $ 3,139,678 $ 6,822,974 $ 9,962,652
=============== =============== ================
Total assets $ 30,564,628 $ 123,921,332 $ 154,485,960
=============== =============== ================
Capital expenditures $ 2,608,523 $ 6,656,517 $ 9,265,040
=============== =============== ================
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:
Midwest Wireless Holdings LLC 467,708 1,007,157 1,474,865
Other unconsolidated affiliates 93,581 571,784 665,365
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 and minority interest $ 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 from unconsolidated affiliates:
Midwest Wireless Holdings LLC 436,062 812,198 1,248,260
Other unconsolidated affiliates 299,279 347,315 646,594
Loss from other investments (124,020) (1,159,988) (1,284,008)
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 and minority interest $ 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
=============== =============== ================
46
NOTE 14 - BREAKUP OF ALLIANCE TELECOMMUNICATIONS CORPORATION
In 2001, Golden West and ACCI, the 20% and 12% minority shareholders of
Alliance, advised the Company that they were interested in exchanging their
minority investment for a share of the assets and liabilities of Alliance.
Negotiations were conducted throughout 2002. The negotiation process included
evaluations and appraisals of Alliance's business components, negotiations with
Alliance's lenders (CoBank, Rural Utilities Service and Rural Telephone Bank)
regarding waivers, lien releases, interest penalties where applicable and future
financing terms. The process also included seeking necessary regulatory
approvals from local, state and national regulators.
The Company expects to complete the Alliance breakup transactions on or
about April 30, 2003. In the transactions, Golden West and ACCI will exchange
their stock in Alliance in exchange for Alliance's stock in Hills Telephone
Company and Sioux Valley Telephone Company, which serve 8,700 telephone access
lines and 2,400 cable television customers. 32% of Alliance's ownership interest
in Midwest Wireless Holdings LLC would also be transferred, reducing Hector's
total ownership from 10.4% to 8%. Sioux Valley and Hills would pay a dividend to
Alliance prior to the breakup of $13,400,000, which would be used to reduce the
Alliance's debt to CoBank. Concurrent with the breakup, Alliance will enter into
a new loan agreement with CoBank.
47
(b) SUPPLEMENTAL FINANCIAL INFORMATION
Unaudited Quarterly Operating Results
(in thousands except per share amounts)
Quarter Ended
--------------------------------------------------------
March 31 June 30 Sept 30 Dec 31
- ------------------------------------------------------------------------------------------------------------------
2002
Revenues $ 9,859 $ 9,557 $ 10,436 $ 9,870
Operating income 2,557 2,106 3,351 2,028
Income before cumulative effect of
change in accounting principle 1,085 737 1,329 504
Cumulative effect of change in accounting principle (3,147)
Net income (loss) (2,062) 737 1,329 504
Basic net income (loss) per share:
Before cumulative effect of accounting change $ .31 $ .21 $ .38 $ .14
Cumulative effect of accounting change (.90)
--------- --------- --------- --------
$ (.59) $ .21 $ .38 $ .14
========= ========= ========= ========
Diluted net income (loss) per share:
Before cumulative effect of accounting change $ .29 $ .19 $ .35 $ .14
Cumulative effect of accounting change (.84)
--------- --------- --------- --------
$ (.55) $ .19 $ .35 $ .14
========= ========= ========= ========
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
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE
Not applicable.
48
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 21, 2003 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(a)(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 21, 2003 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 21, 2003 Annual Meeting to be filed within 120 days from
the end of the Registrant's fiscal year, which information is expressly
incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information called for by Item 404 under Regulation S-K will be set forth
under the caption "Certain Transactions" in the Company's definitive proxy
materials for its May 21, 2003 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 14. CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures
Within the 90-day period prior to the filing of this Annual Report on Form 10-K,
an evaluation was carried out under the supervision and with the participation
of our management, including our Chief Executive Officer ("CEO") and Chief
Financial Officer ("CFO"), of the effectiveness of our disclosure controls and
procedures. Disclosure controls and procedures are procedures that are designed
with the objective of ensuring that information required to be disclosed in our
reports filed under the Securities Exchange Act of 1934, such as this Form 10-K,
is recorded, processed, summarized and reported within the time periods
specified in the Securities and Exchange Commission's rules and forms. Based on
that evaluation, our CEO and CFO have concluded that our disclosure controls and
procedures are effective to satisfy the objectives for which they are intended.
(b) Changes in Internal Controls
Subsequent to the date of the evaluation referred to in paragraph (a) through
the date of this report, there were no significant changes in our internal
controls or in other factors that could significantly affect these controls,
including any corrective actions with regard to significant deficiencies and
material weaknesses.
49
PART IV
ITEM 15. 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, 2002, 2001 and 2000
Consolidated Balance Sheets as of December 31, 2002 and 2001
Consolidated Statements of Income for the years ended
December 31, 2002, 2001 and 2000
Consolidated Statements of Comprehensive Income for the years ended
December 31, 2002, 2001 and 2000
Consolidated Statements of Stockholders' Equity for the years ended
December 31, 2002, 2001 and 2000
Consolidated Statements of Cash Flows for the years ended
December 31, 2002, 2001 and 2000
Notes to Consolidated Financial Statements
(a) (2) Financial Statement Schedules Page Herein
----------------------------- -----------
The following financial statement schedules are being filed as part of this
Form 10-K Report:
Independent Auditors' Report on financial statement schedules
for the years ended December 31, 2002, 2001 and 2000 55
Schedule I - Condensed Financial Information of Registrant 55-58
Schedule II - Valuation and Qualifying Accounts and Reserves 58
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. 58-71
(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, 2002
Not Applicable.
50
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 28, 2003 /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 28, 2003
- ------------------------- Chief Executive Officer and Director
Curtis A. Sampson
/s/Steven H. Sjogren President, Chief Operating Officer, March 28, 2003
- ------------------------- and Director
Steven H. Sjogren
/s/Paul N. Hanson Vice President, Treasurer and March 28, 2003
- ------------------------- Director
Paul N. Hanson
/s/Charles A. Braun Chief Financial Officer and March 28, 2003
- ------------------------- Principal Accounting Officer
Charles A. Braun
/s/Ronald J. Bach Director March 28, 2003
- -------------------------
Ronald J. Bach
Director March 28, 2003
- -------------------------
James O. Ericson
/s/Luella Gross Goldberg Director March 28, 2003
- -------------------------
Luella Gross Goldberg
/s/Paul A. Hoff Director March 28, 2003
- -------------------------
Paul A. Hoff
/s/Gerald D. Pint Director March 28, 2003
- -------------------------
Gerald D. Pint
/s/Wayne E. Sampson Director March 28, 2003
- -------------------------
Wayne E. Sampson
51
Certification
-------------
I, Curtis A. Sampson, Chairman and Chief Executive Officer of Hector
Communications Corporation, certify that:
1. I have reviewed this annual report on Form 10-K of Hector Communications
Corporation;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this annual report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this annual
report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the effectiveness of
the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether or not there were significant changes in internal controls
or in other factors that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: March 28, 2003
/s/ Curtis A. Sampson
- ------------------------------------
Curtis A. Sampson
Chairman and Chief Executive Officer
52
Certification
-------------
I, Charles A. Braun, Chief Financial Officer of Hector Communications
Corporation, certify that:
1. I have reviewed this annual report on Form 10-K of Hector Communications
Corporation;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this annual report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this annual
report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the effectiveness of
the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether or not there were significant changes in internal controls
or in other factors that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: March 28, 2003
/s/ Charles A. Braun
- -----------------------------
Chief Financial Officer
53
- --------------------------------------------------------------------------------
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, 2002
-----------------------------
FINANCIAL STATEMENT SCHEDULES
54
INDEPENDENT AUDITORS' REPORT ON FINANCIAL STATEMENT SCHEDULES
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 12, 2003,
included the related financial statement schedules as listed in item 14(a)2. In
our opinion, these financial statement schedules, when considered in relation to
the basic consolidated financial statements, present 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 12, 2003
HECTOR COMMUNICATIONS CORPORATION
---------------------------------
SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
HECTOR COMMUNICATIONS CORPORATION (PARENT COMPANY)
BALANCE SHEETS
December 31
-------------------------------
2002 2001
------------- -------------
Assets:
Cash $ 168,749 $ 154,401
Investment in subsidiaries 44,381,330 43,829,268
Other current assets 217,996 544,217
Property, plant and equipment, net 613,875 667,195
Accounts with subsidiaries 167,731 398,828
Other investments 771,518 830,742
------------- -------------
Total Assets $46,321,199 $46,424,651
============= =============
Liabilities and Stockholders' Equity:
Accounts payable $ 40,276 $ 106,187
Other current liabilities 874,537 711,537
Current portion of long-term debt 223,000 209,000
Long-term debt 2,934,051 3,156,634
Stockholders' equity:
Preferred stock, par value $1.00 per share;
3,000,000 shares authorized:
Convertible Series A, 220,100 shares
issued and outstanding 220,100 220,100
Common stock, par value $.01 per share;
10,000,000 shares authorized; 3,455,067 and
3,476,569 shares issued and outstanding 34,551 34,766
Additional paid-in capital 13,262,969 13,212,970
Retained earnings 28,742,832 28,702,145
Accumulated other comprehensive income (loss) (11,117) 71,312
------------- -------------
Total Liabilities and Stockholders' Equity $46,321,199 $46,424,651
============= =============
See notes to condensed financial statements of registrant.
55
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
------------------------------------------------
2002 2001 2000
------------ ------------ ------------
Revenues:
Sales $ 175,232 $ 181,623 $ 109,326
Expenses:
Operating expenses 154,000 140,331 215,104
Amortization of goodwill 34,721 34,721
Interest expense, net 164,131 204,236 284,942
Income tax benefit (44,775) (33,999) (122,816)
------------ ------------ ------------
Total expenses 273,356 345,289 411,951
Income (loss) before equity in earnings of
subsidiaries (98,124) (163,666) (302,625)
Equity in earnings of subsidiaries 606,444 4,779,820 3,612,048
------------ ------------ ------------
Net income 508,320 4,616,154 3,309,423
Other comprehensive income (loss):
Unrealized holding gains (losses) of
subsidiaries on marketable securities (304,770) 1,199,251 (3,903,896)
Reclassification adjustment for losses
(gains) of subsidiaries included in net income 134,498 (3,659,055) (1,622,226)
------------ ------------ ------------
Other comprehensive loss before
income taxes (170,272) (2,459,804) (5,526,122)
------------ ------------ ------------
Income tax expense related to unrealized holding
gains (losses) of subsidiaries on marketable
securities (125,504) 492,948 (1,539,833)
Income tax expense (benefit) related to
reclassification adjustment for gains of
subsidiaries included in net income 53,799 (1,504,043) (639,862)
------------ ------------ ------------
Income tax benefit related to items of other
comprehensive income (71,705) (1,011,095) (2,179,695)
Minority interest in other comprehensive
income (loss) of subsidiaries (16,138) (458,786) (1,081,180)
------------ ------------ ------------
Other comprehensive loss (82,429) (989,923) (2,265,247)
------------ ------------ ------------
Comprehensive income $ 425,891 $ 3,626,231 $ 1,044,176
============ ============ ============
See notes to condensed financial statements of registrant.
56
HECTOR COMMUNICATIONS CORPORATION
SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
HECTOR COMMUNICATIONS CORPORATION (PARENT COMPANY)
--------------------------------------------------
STATEMENTS OF CASH FLOWS
Year Ended December 31
------------------------------------------------
2002 2001 2000
------------ ------------ ------------
Cash flows from operating activities:
Net income $ 508,320 $ 4,616,154 $ 3,309,423
Adjustments to reconcile net income to net
cash provided by operating activities:
Loss (income) from other investments 2,692 448 (3,141)
Noncash patronage refund (4,483) (8,326) (8,780)
Equity in earnings of subsidiaries (606,444) (4,779,820) (3,612,048)
Depreciation and amortization 74,027 108,135 90,661
Changes in assets and liabilities:
Other current assets 344,919 16,721 (101,478)
Accounts with subsidiaries 231,097 1,075,849 682,711
Cash overdraft (29,931)
Accounts payable (65,911) (82,693) (68,907)
Other current liabilities 163,000 190,440 412,694
------------ ------------ ------------
Net cash provided by operating activities 647,217 1,136,908 671,204
Cash flows from investing activities:
Purchases of property, plant and equipment (20,706) (82,243) (621,758)
Purchases of other investments (350,000)
Cash proceeds from other investments 14,269 922
Decrease in other assets 25,000
------------ ------------ ------------
Net cash used in investing activities (6,437) (81,321) (946,758)
Cash flows from financing activities:
Repayment of long-term debt (208,583) (195,271) (182,807)
Issuance of common stock 319,606 549,989 1,139,764
Purchase of stock (737,455) (1,267,987) (3,154,983)
Investment by affiliate in parent company stock 2,485,663
------------ ------------ ------------
Net cash provided by (used in)
financing activities (626,432) (913,269) 287,637
------------ ------------ ------------
Net increase in cash and cash equivalents 14,348 142,318 12,083
Beginning cash and cash equivalents 154,401 12,083 0
------------ ------------ ------------
Ending cash and cash equivalents $ 168,749 $ 154,401 $ 12,083
============ ============ ============
Supplemental disclosures of cash flow information:
Interest paid $ 177,004 $ 342,242 $ 307,899
Income taxes paid 371,000 285,000 505,166
See notes to condensed financial statements of registrant.
57
NOTES TO CONDENSED FINANCIAL STATEMENTS 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
------------------------------
2002 2001
------------ ------------
Notes payable to Rural Telephone
Finance Cooperative in quarterly installments,
interest rate of 5.5%, due 2013 $ 3,157,051 $ 3,365,634
Less current portion 223,000 209,000
------------ ------------
$ 2,934,051 $ 3,156,634
============ ============
The annual requirements for principal payments on notes payable and long-term
debt are as follows:
2003 $ 223,000
2004 238,000
2005 254,000
2006 272,000
2007 290,000
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES Schedule II -
Valuation and Qualifying Accounts and Reserves
Balance at Additions Deductions Balance
Beginning of Charged to from at End
Description Period Revenues Reserves of Period
- ----------- --------- ----------- --------- ---------
Allowance for doubtful accounts:
Year ended:
December 31, 2002 $ 396,000 $ 1,017,000 $ 697,000 (A) $ 716,000
December 31, 2001 $ 360,000 $ 311,000 $ 275,000 (A) $ 396,000
December 31, 2000 $ 447,000 $ 475,000 $ 562,000 (A) $ 360,000
(A) Accounts determined to be uncollectible and charged off against reserve.
58
Midwest Wireless
Holdings L.L.C.
Report on Audits of Consolidated Financial Statements
For the Years Ended December 31, 2002, 2001 and 2000
59
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, 2002 and 2001, 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, 2002, 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.
As discussed in Note 3 to the financial statements, the Company adopted
Statement of Financial Accounting Standards No. 142, "Goodwill and Other
Intangible Assets," on January 1, 2002.
PricewaterhouseCoopers LLP
Minneapolis, Minnesota
February 6, 2003
60
Midwest Wireless Holdings L.L.C.
Consolidated Statements of Financial Position
At December 31, 2002 and 2001
- --------------------------------------------------------------------------------
ASSETS 2002 2001
Current assets:
Cash and cash equivalents $ 1,367,210 $ 3,032,464
Accounts receivable, less allowance for
doubtful accounts of $550,403 and
$572,120 in 2002 and 2001, respectively 8,155,607 10,935,228
Inventories 1,411,573 2,207,887
Other assets 1,511,589 1,233,721
------------ ------------
Total current assets 12,445,979 17,409,300
Property, cellular plant and equipment, net 102,219,504 89,632,427
FCC licenses, net 194,612,163 187,211,924
Investments in cooperatives 9,006,847 8,771,529
------------ ------------
Total assets $318,284,493 $303,025,180
============ ============
LIABILITIES AND MEMBERS' EQUITY
Current liabilities:
Current portion of debt $ 14,655,912 $ 13,679,657
Revolving loan 25,000,000 20,000,000
Accounts payable 5,643,416 3,969,202
Accrued commissions 1,436,325 1,855,554
Other accrued expenses 10,173,496 8,890,280
------------ ------------
Total current liabilities 56,909,149 48,394,693
Other liabilities 988,120 1,413,672
Debt 114,458,723 129,114,637
------------ ------------
Total liabilities 172,355,992 178,923,002
Minority interest 9,428,619 6,913,996
Commitments
Members' equity 136,499,882 117,188,182
------------ ------------
Total liabilities and members' equity $318,284,493 $303,025,180
============ ============
The accompanying notes are an integral part of the consolidated financial
statements.
61
Midwest Wireless Holdings L.L.C.
Consolidated Statements of Operations
For the years ended December 31, 2002, 2001 and 2000
- -----------------------------------------------------------------------------------------------------
2002 2001 2000
Operating revenues:
Subscriber service $118,573,698 $ 93,477,223 $ 72,146,990
Roamer service 37,205,402 36,953,474 29,721,562
Equipment sales 6,352,249 10,058,368 9,015,304
Service fees 565,834 49,450 1,461,887
------------ ------------ ------------
162,697,183 140,538,515 112,345,743
------------ ------------ ------------
Operating expenses:
Operations and maintenance 30,506,792 24,776,324 19,785,719
Cost of equipment sold 10,448,214 13,654,007 10,458,625
Home roamer costs 27,668,831 20,468,432 16,976,940
Depreciation 19,318,449 17,822,738 12,278,169
Amortization of FCC licenses - 4,505,851 3,780,643
Selling, general and administrative 35,113,593 31,292,529 24,520,349
------------ ------------ ------------
123,055,879 112,519,881 87,800,445
------------ ------------ ------------
Operating income 39,641,304 28,018,634 24,545,298
------------ ------------ ------------
Other income (expense):
Interest expense (8,078,374) (9,416,290) (8,651,813)
Interest and dividend income 92,915 136,870 312,229
Other 34,669 (41,784) (6,186)
------------ ------------ ------------
(7,950,790) (9,321,204) (8,345,770)
------------ ------------ ------------
Net income before minority interest 31,690,514 18,697,430 16,199,528
Minority interest (3,576,994) (2,109,070) (1,902,457)
------------ ------------ ------------
Net income $ 28,113,520 $ 16,588,360 $ 14,297,071
============ ============ ============
The accompanying notes are an integral part of the consolidated financial
statements.
62
Midwest Wireless Holdings L.L.C.
Consolidated Statements of Changes in Members' Equity For the years ended
December 31, 2002, 2001 and 2000
- -----------------------------------------------------------------------------------------------------
Total
Capital Accumulated Members'
Contributions Income Equity
Balance, December 31, 1999 $ 13,317,553 $ 16,120,317 $ 29,437,870
Issuance of units related to the acquisition
of Iowa properties 51,418,250 - 51,418,250
Issuance of units related to the acquisition
of Wisconsin properties 20,061,217 - 20,061,217
Distributions to members - (6,439,687) (6,439,687)
Net income - 14,297,071 14,297,071
------------ ------------ ------------
Balance, December 31, 2000 84,797,020 23,977,701 108,774,721
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
Redemption (83,921) (374,030) (457,951)
Distributions to members - (8,343,869) (8,343,869)
Net income - 28,113,520 28,113,520
------------ ------------ ------------
Balance, December 31, 2002 $ 84,713,099 $ 51,786,783 $136,499,882
============ ============ ============
The accompanying notes are an integral part of the consolidated financial
statements.
63
Midwest Wireless Holdings L.L.C.
Consolidated Statements of Cash Flows
For the years ended December 31, 2002, 2001 and 2000
- -----------------------------------------------------------------------------------------------------------------
2002 2001 2000
Cash flows from operating activities:
Net income $ 28,113,520 $ 16,588,360 $ 14,297,071
Adjustments to reconcile net income to net cash provided by
operating activities:
Net income allocated to minority interest 3,576,994 2,109,070 1,902,457
Provision for bad debts 928,358 1,115,719 623,261
Depreciation 19,318,449 17,822,738 12,278,169
Amortization of FCC licenses - 4,505,851 3,780,643
(Gain) loss on disposal of fixed assets (3,645) (2,124) 27,278
Writeoff of Cellular 2000, Inc. investment 25,000 - -
Patronage received in form of cooperative stock (310,848) (132,785) -
Changes in assets and liabilities:
Accounts receivable 1,851,263 (3,299,942) (2,665,409)
Inventories 796,314 510,885 (122,081)
Other assets (277,868) (546,637) (322,733)
Accounts payable 1,674,214 (2,156,106) 1,471,296
Accrued expenses 863,987 1,888,444 3,253,070
Other liabilities (425,552) (689,617) 946,340
--------------- -------------- ---------------
Net cash provided by operating activities 56,130,186 37,713,856 35,469,362
--------------- -------------- ---------------
Cash flows from investing activities:
Acquisition of cellular properties - - (96,215,489)
Payments for property, cellular plant and equipment (31,901,881) (33,804,163) (28,636,271)
Proceeds from the disposal of fixed assets - 37,571 -
Purchase of FCC licenses (7,400,239) (22,400,000) (354,900)
Purchases of cooperative stock (22,440) (1,176,440) (5,329,209)
Redemption of cooperative stock 72,970 68,313 -
Payments for deferred acquisition costs - (192,511) -
Release of restricted cash - - 1,000,000
--------------- -------------- ---------------
Net cash used in investing activities (39,251,590) (57,467,230) (129,535,869)
--------------- -------------- ---------------
Cash flows from financing activities:
Proceeds on revolving loan 5,000,000 17,500,000 500,000
Proceeds from debt borrowings - 23,473,686 107,706,887
Payments on debt (13,679,659) (11,016,802) (6,130,602)
Distributions to members (8,343,869) (8,174,899) (6,439,687)
Distribution from subsidiary to minority interest (1,062,371) (1,039,851) (904,737)
Redemption of units (457,951) - -
--------------- -------------- ---------------
Net cash (used in) provided by financing activities (18,543,850) 20,742,134 94,731,861
--------------- -------------- ---------------
Net change in cash and cash equivalents (1,665,254) 988,760 665,354
Cash and cash equivalents, beginning of year 3,032,464 2,043,704 1,378,350
--------------- -------------- ---------------
Cash and cash equivalents, end of year $ 1,367,210 $ 3,032,464 $ 2,043,704
=============== ============= ===============
Supplemental disclosure:
Cash paid during the year for interest $ 8,828,483 $ 10,540,203 $ 7,587,435
Equity units issued for acquisitions - - 71,479,467
64
Midwest Wireless Holdings L.L.C.
Notes to Consolidated Financial Statements
1. Business Description
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.
2. Summary of Significant Accounting Policies
Basis of Presentation
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.
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.
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
Communications and network equipment 7 - 15 years
Vehicles 3 years
Computer equipment 3 years
Major renewals or betterments are capitalized, while repair and
maintenance expenditures are charged to operations as incurred. Interest
incurred on external borrowings during construction is capitalized. The
cost and accumulated depreciation of property, cellular plant and
equipment disposed of or sold are eliminated from their respective
accounts, and the resulting gain or loss is recorded in operations.
65
Midwest Wireless Holdings L.L.C.
Notes to Consolidated Financial Statements
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. The Company ceased amortization of its
licenses effective January 1, 2002, with the adoption of Statement of
Financial Accounting Standards (SFAS) No. 142 (see Note 3).
Long-Lived Assets
The Company periodically reviews long-lived assets 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.
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 and the
Company recognizes equipment revenue when the equipment is delivered and
accepted by customers.
Roaming Revenue Reclassification
The Company generates revenue from charges to its customers when they use
their cellular phones in other wireless providers' markets (Incollect
Revenue). Until 2002, the Company included Incollect Revenue on a net
basis as a component of Home Roamer Costs as an operating expense in its
statement of operations. Expense associated with Incollect Revenue,
charged by third-party wireless providers, is also included in Home
Roamer Costs. The Company used this method because, historically, it has
passed through to its customers most of the costs related to Incollect
Revenue. However, the wireless industry and the Company have increasingly
been using pricing plans that include flat rate pricing and larger home
service areas. Under these types of plans, amounts charged to the Company
by other wireless providers may not necessarily be passed through to its
customers.
In 2002, the Company adopted a policy to include Incollect Revenue as
Subscriber Service revenue rather than in Home Roamer Costs on a net
basis. Roamer Service Revenue includes only the revenue from other
wireless providers' customers who use the Company's network (Outcollect
Revenue). Subscriber Service Revenue and Home Roamer Costs in the 2001
and 2000 consolidated financial statements were reclassified to conform
to this presentation. This change in presentation has no impact on
operating income, net income or members' equity.
The Company reclassified Incollect Revenue of $8,434,482, $7,549,289 and
$8,153,662 for the years ended December 31, 2002, 2001 and 2000,
respectively.
Income Taxes
No provision for income taxes has been recorded since all income, losses
and tax credits are allocated to the members for inclusion in their
respective income tax returns.
Advertising
Advertising costs are expensed as incurred. Total advertising expenses
were $3,317,280, $4,448,949 and $3,021,650 for the years ended December
31, 2002, 2001 and 2000, respectively.
Stock-Based Compensation
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 years ended December 31,
2002, 2001 and 2000.
66
Midwest Wireless Holdings L.L.C.
Notes to Consolidated Financial Statements
If the Company had elected to recognize compensation expense for options
granted using the fair value method, net income would have been as
follows:
2002 2001 2000
Net income as reported $ 28,113,520 $ 16,588,360 $ 14,297,071
Less: Total stock-based employee
compensation expense determined
under fair value based method for
all awards (337,615) (214,783) (45,873)
------------ ------------ -------------
Pro forma net income $ 27,775,905 $ 16,373,577 $ 14,251,198
============ ============ =============
3. FCC Licenses
Effective January 1, 2002, the Company adopted SFAS No. 142, "Goodwill
and Other Intangible Assets." Effective with the adoption of this
standard, the Company is no longer amortizing FCC licenses (licenses),
which consist of licenses that provide the Company with the exclusive
right to utilize certain radio frequency spectrum to provide wireless
communication services. Although the licenses are issued for only a fixed
time, generally ten years, they are subject to renewal by the FCC; but
the renewals of licenses have occurred routinely and at nominal cost.
Moreover, there are currently no legal, regulatory, contractual,
competitive, economic, or other factors that limit the useful lives of
the licenses. As a result, licenses are treated as indefinite-lived
intangible assets and will not be amortized but rather are tested
annually for impairment.
In connection with the adoption of SFAS No. 142, the Company has
completed transitional and annual impairment tests for its licenses and
determined that there was no impairment. The Company utilized a fair
value approach, primarily using discounted cash flows, to complete the
impairment tests.
2002 2001
FCC licenses $ 204,534,427 $ 197,134,188
Less accumulated depreciation (9,922,264) (9,922,264)
------------- -------------
$ 194,612,163 $ 187,211,924
============= =============
The changes in the carrying amounts of FCC licenses for the year ended
December 31, 2002 are as follows:
Balance as of January 1, 2002 $ 187,211,924
Licenses acquired during the year 7,400,239
-------------
Balance as of December 31, 2002 $ 194,612,163
=============
The adjusted amounts shown below reflect the effect of retroactive
application of discontinuance of the amortization of licenses as if the
new method of accounting had been in effect during 2001 and 2000.
2002 2001 2000
Net income:
Reported net income $ 28,113,520 $ 16,588,360 $ 14,297,071
Amortization - 4,505,851 3,780,643
------------ ------------ ------------
Adjusted net income $ 28,113,520 $ 21,094,211 $ 18,077,714
============ ============ ============
67
Midwest Wireless Holdings L.L.C.
Notes to Consolidated Financial Statements
4. Select Account Information
Property, Cellular Plant and Equipment
2002 2001
Land $ 3,643,696 $ 2,666,041
Plant in service 153,533,992 128,305,172
Plant under construction 6,815,295 5,777,756
------------- -------------
163,992,984 136,748,969
Less accumulated depreciation (61,773,480) (47,116,542)
------------- -------------
$ 102,219,504 $ 89,632,427
============= =============
The Company capitalized interest in the amount of $443,911, $581,879 and
$608,199 for the years ended December 31, 2002, 2001 and 2000,
respectively. At December 31, 2002 and 2001, accounts payable included
$2,100,831 and $1,269,501, respectively, related to the purchase of
property, cellular, plant and equipment.
5. Acquisitions
On February 29, 2000, the Company, through its wholly-owned subsidiary,
Midwest Wireless Iowa, L.L.C., completed its acquisition of cellular
communications properties providing services to a 28-county area of Iowa
(the Iowa properties).
On March 17, 2000, the Company through its wholly-owned subsidiary,
Midwest Wireless Wisconsin, L.L.C., completed its acquisition of cellular
communications properties providing services to a 4-county area of
Wisconsin and Minnesota (the Wisconsin properties).
The Company allocated the excess purchase price over the fair value of
the net tangible assets acquired to FCC licenses and began amortizing it
over 39.5 years until January 1, 2002 (see Note 3). 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.
68
Midwest Wireless Holdings L.L.C.
Notes to Consolidated Financial Statements
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 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.
In July 2002, the Company acquired three digital PCS licenses for
$7,385,058. 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.
6. 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.
69
Midwest Wireless Holdings L.L.C.
Notes to Consolidated Financial Statements
7. Debt
Debt consists of the following:
Rate at Balance at
December 31 December 31
------------------ ----------------------------
Maturity 2002 2001 2002 2001
RTFC note, variable rate 5/12/09 5.50% 5.25% $ 9,735,315 $ 10,928,336
RTFC, variable rate 4/30/09 5.50% 5.25% 20,375,286 22,872,168
RTFC note, fixed rate 7/29/08 5.75% 5.75% 5,882,114 6,696,207
RTFC note, variable rate 7/28/08 5.50% 5.25% 5,381,438 6,126,238
RTFC note, variable rate 3/2/10 5.50% 5.25% 80,191,775 88,254,536
RTFC note, variable rate 2/3/15 5.50% 5.25% 7,548,707 7,916,809
CoBank note, variable rate 10/20/03 5.00% 4.85% 25,000,000 20,000,000
------------- -------------
$ 154,114,635 $ 162,794,294
============= =============
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 plus one and one-half percent. The outstanding principal
and interest are due upon maturity. At December 31, 2002 and 2001, the
Company had no borrowings outstanding under the RTFC revolving loan.
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 current ratio of not less than 1.25. At
December 31, 2002, 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 original agreement provided 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 bore interest at LIBOR
plus 2.5% or 4.85%. On November 22, 2002, the Company amended the
agreement to provide for borrowings of up to $65,000,000, amended the
interest rate pricing, and extended the expiration date to October 20,
2003. At December 31, 2002, the Company had drawn $25,000,000 on the
revolving loan. At December 31, 2002, borrowings under the agreement bore
interest at LIBOR plus 3.5% or 5.0%. 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.
70
Midwest Wireless Holdings L.L.C.
Notes to Consolidated Financial Statements
Maturities of debt are as follows:
2003 $ 39,655,912
2004 15,702,400
2005 16,826,497
2006 18,027,422
2007 19,317,148
Thereafter 44,585,166
-------------
$ 154,114,635
=============
8. 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, 2002, are as follows:
2003 $ 1,130,983
2004 933,886
2005 520,744
2006 391,605
2007 247,086
Thereafter 328,571
-------------
$ 3,552,875
=============
Rental expense was $1,645,524, $955,514 and $773,324 for the years ended
December 31, 2002, 2001 and 2000, respectively.
9. Employee Benefits
The Company established the Midwest Wireless Holdings L.L.C. and
Subsidiary Companies 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 $473,644, $376,783 and
$292,508 for the years ended December 31, 2002, 2001 and 2000,
respectively. Profit sharing contribution expenses were $544,981,
$455,778 and $309,312 for the years ended December 31, 2002, 2001 and
2000, 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 $1,287,172, $1,053,863 and
$1,137,500 in compensation expense related to the Plan for the years
ended December 31, 2002, 2001 and 2000, respectively.
71
10. 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, 2002, there were 33,131 units available for
issuance under this plan.
Options Outstanding
-------------------
Weighted
Available Average
for Number Price Per
Grant of Units Unit
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
Granted (4,809) 4,809 $344.00
----------- -----------
Balance, December 31, 2002 33,131 13,611 $321.60
=========== ===========
The weighted average fair value of options at the date of grant was
$66.12, $52.73 and $80.71 in 2002, 2001 and 2000, respectively.
The following table summarizes information about stock options
outstanding and exercisable at December 31, 2002:
Options Outstanding Options Exercisable
--------------------------- ---------------------
Weighted
Average Weighted Weighted
Remaining Average Average
Contractual Exercise Exercise
Exercise Prices Number Life Price Number Price
$299.06 4,092 7.59 $299.06 4,092 $299.06
$318.32 4,285 7.01 $318.32 - -
$318.32 425 7.65 $318.32 - -
$344.00 4,809 9.01 $344.00 - -
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
---------------------------------------------
2002 2001 2000
Dividend yield 2.33% 2.47% 2.07%
Risk-free interest rate 5.20% 4.73% 6.19%
Expected lives 10 years 10 years 10 years
72
- --------------------------------------------------------------------------------
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, 2002
--------------
EXHIBITS
- --------------------------------------------------------------------------------
73
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
Exhibit Index To
Form 10-K for the Year Ended December 31, 2002
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.
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 75.
Per Share
21 Subsidiaries of the Registrant Filed herewith at page 76.
23 Independent Auditors' Consent Filed herewith at page 77.
24 Power of Attorney Included in signatures at page 51.
99.1 Certification under 18 U.S.C. Filed herewith at page 77.
ss. 1350
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.
74
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
EXHIBIT 11
CALCULATION OF EARNINGS PER SHARE
Year Ended December 31
------------------------------------------------
Basic: 2002 2001 2000
- ------- ----------- ----------- -----------
Income before cumulative effect of change in accounting
principle $ 3,654,889 $ 4,616,154 $ 3,309,423
Cumulative effect of accounting change (3,146,569)
----------- ----------- -----------
Net income $ 508,320 $ 4,616,154 $ 3,309,423
=========== =========== ===========
Common shares:
Weighted average number of common shares outstanding 3,498,284 3,465,086 3,544,349
=========== =========== ===========
Net income per common share
Before cumulative effect of change in accounting principle $ 1.05 $ 1.33 $ .93
Cumulative effect of accounting change (.90)
----------- ----------- -----------
$ .15 $ 1.33 $ .93
=========== =========== ===========
Diluted:
- -------------
Income before cumulative effect of change in accounting
principle $ 3,654,889 $ 4,616,154 $ 3,309,423
Cumulative effect of accounting change (3,146,569)
----------- ----------- -----------
Net income $ 508,320 $ 4,616,154 $ 3,309,423
=========== =========== ===========
Common and common equivalent shares:
Weighted average number of common shares outstanding 3,498,284 3,465,086 3,544,349
Dilutive effect of convertible preferred shares outstanding 220,100 221,195 222,863
Dilutive effect of stock options outstanding after
application of treasury stock method 45,413 76,122 82,512
Dilutive effect of Employee Stock
Purchase Plan shares subscribed 5,885 1,042
----------- ----------- -----------
3,769,682 3,762,403 3,850,766
=========== =========== ===========
Diluted net income per share:
Before cumulative effect of change in accounting principle $ .97 $ 1.23 $ .86
Cumulative effect of accounting change (.84)
----------- ----------- ----------
$ .13 $ 1.23 $ .86
=========== =========== ==========
75
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 Alliance Communications Cooperative, Inc. 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.
76
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 12, 2003,
appearing in this Annual Report on Form 10-K of Hector Communications
Corporation and its subsidiaries for the year ended December 31, 2002.
/s/ Olsen Thielen and Co., Ltd.
Olsen Thielen and Co., Ltd.
March 28, 2003
St. Paul, Minnesota
EXHIBIT 99.1
Certification
The undersigned officers of Hector Communications Corporation (the" Company")
certify pursuant to 18 U.S.C. ss. 1350, that:
(1) The Company's Annual Report on Form 10-K for the year ended December 31,
2002 fully complies with the requirements of Section 13(a) or 15(d) of the
Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all material
respects, the financial condition and results of operations of the Company as of
the date of the Report.
Date: March 28, 2003 /s/ Curtis A. Sampson
---------------------------------
Chief Executive Officer
Date: March 28, 2003 /s/ Charles A. Braun
---------------------------------
Chief Financial Officer
77