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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2003
-------------------------------------------------
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR
15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
--------------------- ------------------------
Commission File Number: 0-18587
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HECTOR COMMUNICATIONS CORPORATION
.................................................................................
(Exact name of registrant as specified in its charter)
MINNESOTA 41-1666660
(State or other jurisdiction of (Federal Employer
incorporation or organization) Identification No.)
211 South Main Street, Hector, MN 55342
.................................................................................
(Address of principal executive offices) (Zip Code)
(320) 848-6611
.................................................................................
Registrant's telephone number, including area code
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 whether the registrant is an accelerated filer (as
defined by Rule 12b-2 of the Act). YES [ ] NO [X]
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
CLASS Outstanding at July 31, 2003
- ----------------------------------- ----------------------------
Common Stock, par value 3,483,378
$.01 per share
Total Pages (27)
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HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
INDEX
Page No.
Part I. Financial Information
Item 1. Financial Statements
Consolidated Balance Sheets 3
Consolidated Statements of Income (Loss) 4
Consolidated Statements of Comprehensive Income (Loss) 5
Consolidated Statement of Stockholders' Equity 5
Consolidated Statements of Cash Flows 6
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 12
Item 3. Quantitative and Qualitative Disclosures
About Market Risk 21
Item 4. Controls and Procedures 21
Part II. Other Information 22
Exhibits
Exhibit 11 - Calculation of Earnings Per Share 24
Exhibit 31.1 - Certification Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002 25
Exhibit 31.2 - Certification Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002 26
Exhibit 32 - Certification pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 27
2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(unaudited)
June 30 December 31
Assets: 2003 2002
------------ ------------
Current assets:
Cash and cash equivalents $ 19,848,854 $ 12,020,186
Construction fund 4,528,372 662,232
Accounts receivable, net 4,060,914 4,819,174
Materials, supplies and inventories 1,294,634 1,175,587
Other current assets 126,294 231,685
------------ ------------
Total current assets 29,859,068 18,908,864
Property, plant and equipment 115,770,987 115,546,596
less accumulated depreciation (62,615,877) (58,880,798)
------------ ------------
Net property, plant and equipment 53,155,110 56,665,798
Other assets:
Excess of cost over net assets acquired, net 48,104,320 49,074,993
Marketable securities 164,671 114,234
Investment in Midwest Wireless Holdings, LLC 17,502,877 16,232,707
Investment in other unconsolidated affiliates 4,349,880 4,373,597
Other investments 8,404,954 8,704,268
Other assets 400,426 411,499
------------ ------------
Total other assets 78,927,128 78,911,298
------------ ------------
Total Assets $ 161,941,306 $ 154,485,960
============ ============
Liabilities and Stockholders' Equity:
Current liabilities:
Notes payable and current portion of long-term debt $ 7,877,000 $ 7,364,600
Accounts payable 2,224,740 2,523,878
Accrued expenses 2,771,300 2,422,986
Income taxes payable 1,421,364 879,417
------------ ------------
Total current liabilities 14,294,404 13,190,881
Long-term debt, less current portion 77,492,479 75,147,560
Deferred investment tax credits 13,743 27,554
Deferred income taxes 5,888,782 5,866,754
Deferred compensation 964,010 976,179
Minority stockholders interest in Alliance
Telecommunications Corp. 18,009,817 17,027,697
Stockholders' Equity 45,278,071 42,249,335
------------ ------------
Total Liabilities and Stockholders' Equity $ 161,941,306 $ 154,485,960
============ ============
See notes to consolidated financial statements.
3
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME (LOSS)
(unaudited)
Three Months Ended June 30 Six Months Ended June 30
------------------------------ -------------------------------
2003 2002 2003 2002
------------- ------------- ------------- -------------
Revenues:
Local network $ 1,946,172 $ 1,899,251 $ 3,801,900 $ 3,688,381
Network access 5,632,467 4,906,148 11,361,833 10,326,402
Video services 1,000,893 1,097,737 2,136,999 2,153,251
Internet services 790,409 591,565 1,502,835 1,153,431
Other nonregulated services 974,756 1,062,746 2,034,717 2,094,578
------------- ------------- ------------- -------------
Total revenues 10,344,697 9,557,447 20,838,284 19,416,043
Costs and expenses:
Plant operations 1,542,704 1,296,497 3,175,625 2,603,368
Customer operations 556,623 684,601 1,072,013 1,279,093
Other operating expenses:
Operating taxes 175,912 129,715 333,647 262,109
Video service expenses 740,987 790,389 1,527,178 1,630,167
Internet expenses 263,341 359,219 541,878 691,594
Other 334,794 444,870 715,993 757,453
General and administrative 1,659,267 1,346,311 3,100,368 2,687,984
Depreciation and amortization 2,409,302 2,399,586 4,888,483 4,841,264
------------- ------------- ------------- -------------
Total costs and expenses 7,682,930 7,451,188 15,355,185 14,753,032
Operating income 2,661,767 2,106,259 5,483,099 4,663,011
Other income and (expenses):
Interest expense (1,230,679) (1,217,267) (2,448,911) (2,346,733)
Interest and dividend income 86,757 73,253 181,377 168,534
Income from investments in unconsolidated affilates:
Midwest Wireless Holdings, LLC 885,654 726,869 1,692,018 1,520,217
Other unconsolidated affiliates 122,629 20,461 131,270 106,932
Gain on sale of cable television systems 1,080,723 1,080,723
------------- ------------- ------------- -------------
Other income (expense), net 945,084 (396,684) 636,477 (551,050)
Income before income taxes and minority interest 3,606,851 1,709,575 6,119,576 4,111,961
Income tax expense 1,443,000 677,000 2,449,000 1,597,000
------------- ------------- ------------- -------------
Income before minority interest 2,163,851 1,032,575 3,670,576 2,514,961
Minority interest in earnings of
Alliance Telecommunications Corporation 595,816 294,870 976,023 692,531
------------- ------------- ------------- -------------
Income before cummulative effect of change
in accounting principle 1,568,035 737,705 2,694,553 1,822,430
Cumulative effect of change in accounting principle,
net of income taxes and minority interest (3,146,569)
------------- ------------- ------------- -------------
Net income (loss) $ 1,568,035 $ 737,705 $ 2,694,553 $ (1,324,139)
------------- ------------- ------------- -------------
Basic net income (loss) per share:
Before cumulative effect of change in accounting principle $ .45 $ .21 $ .78 $ .52
Cumulative effect of change in accounting principle (.90)
------------- ------------- ------------- -------------
$ .45 $ .21 $ .78 $ (.38)
============= ============= ============= =============
Diluted net income (loss) per share:
Before cumulative effect of change in accounting principle $ .42 $ .19 $ .72 $ .48
Cumulative effect of change in accounting principle (.83)
------------- ------------- ------------- -------------
$ .42 $ .19 $ .72 $ (.35)
============= ============= ============= =============
See notes to consolidated financial statements.
4
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(unaudited)
Three Months Ended June 30 Six Months Ended June 30
------------------------------ -------------------------------
2003 2002 2003 2002
------------- ------------- ------------- -------------
Net income (loss) $ 1,568,035 $ 737,705 $ 2,694,553 $ (1,324,139)
Other comprehensive income (loss):
Unrealized holding gains (losses) on
marketable securities 53,890 (57,205) 50,437 (252,036)
------------- ------------- ------------- -------------
Other comprehensive income (loss) before income taxes 53,890 (57,205) 50,437 (252,036)
Income tax benefit related to unrealized holding gains
(losses) on marketable securities 21,555 (22,882) 20,190 (100,815)
Minority interest in other comprehensive income (loss)
of Alliance Telecommunications Corporation 6,781 (6,153) 6,095 (41,820)
------------- ------------- ------------- -------------
Other comprehensive income (loss) 25,554 (28,170) 24,152 (109,401)
------------- ------------- ------------- -------------
Comprehensive income (loss) $ 1,593,589 $ 709,535 $ 2,718,705 $ (1,433,540)
============= ============= ============= =============
See notes to consolidated financial statements.
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(unaudited)
Accumulated
Preferred Stock Common Stock Additional Other
------------------ ------------------ Paid-in Retained Comprehensive
Shares Amount Shares Amount Capital Earnings Income (Loss) Total
-------- --------- --------- -------- ----------- ----------- ---------- -----------
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
Net income 1,126,518 1,126,518
Issuance of common stock to ESOP 11,000 110 139,040 139,150
Issuance of common stock under
Employee Stock Option Plan 17,663 177 176,197 176,374
Purchase and retirement of
common stock (352) (4) (1,368) (4,121) (5,493)
Change in unrealized loss on
marketable securities, net of
deferred taxes 24,152 24,152
-------- --------- --------- -------- ----------- ----------- ---------- -----------
BALANCE AT JUNE 30, 2003 220,100 $ 220,100 3,483,378 $ 34,834 $13,576,838 $31,433,264 $ 13,035 $45,278,071
======== ========= ========= ======== =========== =========== ========== ===========
See notes to consolidated financial statements.
5
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
Six Months Ended June 30
-------------------------
2003 2002
----------- -----------
Cash Flows from Operating Activities:
Net income (loss) $ 2,694,553 $ (1,324,139)
Adjustments to reconcile net income (loss) to
net cash provided by operating activities:
Noncash cumulative effect of change in accounting principle 3,146,569
Depreciation and amortization 4,888,483 4,841,264
Minority stockholders' interest in earnings of Alliance
Telecommunications Corporation 976,023 692,531
Income from Midwest Wireless Holdings, LLC (1,692,018) (1,520,217)
Income from other unconsolidated affiliates (131,270) (106,932)
Gain on sales of cable television systems (1,080,723)
Cash distributions from Midwest Wireless Holdings, LLC 421,848 376,877
Changes in assets and liabilities:
Accounts receivable 758,260 444,812
Materials, supplies and inventories (119,047) (448,876)
Prepaid income taxes (47,218)
Other current assets 105,391 132,585
Accounts payable (299,138) 69,708
Accrued expenses 487,464 (137,211)
Income taxes payable 541,947 (722,797)
Deferred investment credits (13,811) (28,325)
Deferred taxes 1,839
Deferred compensation (12,169) 4,479
----------- -----------
Net cash provided by operating activities 7,527,632 5,373,110
Cash Flows from Investing Activities:
Capital expenditures, net (1,720,438) (3,345,661)
Increase in construction fund (3,866,140) (108,588)
Proceeds from sales of cable television systems 1,665,782
Investments in other unconsolidated affiliates 154,987
Purchases of other investments (206,764)
Proceeds from other investments 1,235,328 67,561
(Increase) decrease in other assets 10,081 (34,149)
----------- -----------
Net cash used in investing activities (2,727,164) (3,420,837)
Cash Flows from Financing Activities:
Repayment of long-term debt (2,796,835) (3,109,995)
Proceeds from issuance of notes payable and long-term debt 5,654,154 625,176
Issuance of common stock 176,374 197,166
Purchase of stock (5,493)
----------- -----------
Net cash provided by (used in) financing activities 3,028,200 (2,287,653)
----------- -----------
Net Increase in Cash and Cash Equivalents 7,828,668 (335,380)
Cash and Cash Equivalents at Beginning of Period 12,020,186 13,083,481
----------- -----------
Cash and Cash Equivalents at End of Period $ 19,848,854 $ 12,748,101
=========== ===========
Supplemental disclosures of cash flow information:
Interest paid during the period $ 2,565,590 $ 2,342,019
Income taxes paid during the period 1,916,332 2,395,341
See notes to consolidated financial statements.
6
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SIGNIFICANT ACCOUNTING POLICIES AND ESTIMATES
The balance sheet and statement of stockholders' equity as of June 30, 2003 and
the statements of income (loss), comprehensive income (loss) and cash flows for
the periods ended June 30, 2003 and 2002 have been prepared by the Company
without audit. In the opinion of management, all adjustments (which include only
normal recurring adjustments) necessary to present fairly the financial
position, results of operations, and changes in cash flows at June 30, 2003 and
2002 have been made.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted. It is suggested these condensed financial
statements be read in conjunction with the financial statements and notes
thereto included in the Company's December 31, 2002 Annual Report to
Shareholders. The results of operations for the periods ended June 30 are not
necessarily indicative of the operating results for the entire year.
The consolidated financial statements include the accounts of Hector
Communications Corporation and its wholly and majority owned subsidiaries. All
material intercompany transactions and accounts have been eliminated. 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).
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.
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 cost separation studies, which are
typically settled within two years.
Income taxes have been calculated in proportion to the earnings and tax credits
generated by operations. Investment tax credits have been deferred and are
included in income over the estimated useful lives of the related assets. The
Company's effective income tax rate is higher than the U.S. rate due to the
effect of state income taxes.
In January 2003 the Company issued 11,000 shares of the Company's common stock
to the Employee Stock Ownership Plan in payment of its 2002 obligation. In a
noncash transaction, the Company recorded additional stockholders' equity of
$139,150 (reflecting the market value of the stock at the time of the
contribution) and reduced accrued expenses by the same amount.
7
Certain amounts in the 2002 financial statements have been reclassified to
conform to the 2003 financial statement presentation. These reclassifications
had no effect on net income or stockholders' equity as previously reported.
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. 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 net income (loss); and net income (loss) per share would have been as
follows:
Three Months Ended June 30
--------------------------------------
2003 2002
--------------- ---------------
Net income as reported $ 1,568,035 $ 737,705
Less: Total stock-based employee compensation expense
determined under the fair value method for all awards (180,569) (157,095)
Pro forma net income $ 1,387,466 $ 580,610
Basic net income per share:
As reported $ .45 $ .21
Pro forma $ .40 $ .17
Diluted net income per share:
As reported $ .42 $ .19
Pro forma $ .37 $ .15
Six Months Ended June 30
--------------------------------------
2003 2002
--------------- ---------------
Net income (loss) as reported $ 2,694,553 $ (1,324,139)
Less: Total stock-based employee compensation expense
determined under the fair value method for all awards (264,634) (245,142)
Pro forma net income (loss) $ 2,429,919 $ (1,569,281)
Basic net income (loss) per share:
As reported $ .78 $ (.38)
Pro forma $ .70 $ (.45)
Diluted net income (loss) per share:
As reported $ .72 $ (.35)
Pro forma $ .65 $ (.41)
GOODWILL AND INTANGIBLE ASSETS
The Company accounts for goodwill and other intangible assets under 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.
8
During 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 in the first
quarter of 2002.
In calculating the impairment charge, the fair value of the impaired reporting
units underlying the segments were estimated using the same valuation
methodology the Company is using to negotiate the split-up 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. The
Company performs its annual impairment test as of August 31. Changes in the
Company's goodwill and intangible assets by segment are as follows:
Hector Alliance Consolidated
---------- ------------- -------------
Goodwill:
Balance December 31, 2002 $ 395,274 $ 48,679,719 $ 49,074,993
Cable television system sales (970,673) (970,673)
---------- ------------- -------------
Balance June 30, 2003 $ 395,274 $ 47,709,046 $ 48,104,320
========== ============= =============
Hector Alliance
----------- ------------------------
Intangible Intangible Other
Assets Assets Assets Consolidated
---------- --------- ----------- ------------
Balance December 31, 2002 $ 8,393 $ 98,358 $ 304,748 $ 411,499
Additions 998 998
Disposals (11,078) (11,078)
Amortization (993) (993)
--------- ---------- ---------- ------------
Balance June 30, 2003 $ 7,400 $ 98,358 $ 294,668 $ 400,426
========= ========== ========== ============
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.
9
MIDWEST WIRELESS HOLDINGS, LLC
At June 30, 2003 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 was $1,692,000
and $1,520,000 in the six-month periods ended June 30, 2003 and 2002,
respectively. Cash distributions received from Midwest Wireless were $422,000
and $377,000 in the same respective periods. Income statement information for
Midwest Wireless Holdings, LLC for the three-month and six-month periods ended
June 30, 2003 and 2002 was as follows:
Three Months Ended June 30 Six Months Ended June 30
--------------------------- ----------------------------
2003 2002 2003 2002
------------ ------------ ------------ ------------
Revenues $ 43,150,492 $ 40,952,036 $ 81,567,250 $ 77,672,169
Expenses (33,531,557) (32,965,589) (63,207,048) (61,126,275)
Minority Interest (1,103,029) (972,413) (2,090,792) (1,937,919)
Net income 8,515,906 7,014,034 16,269,410 14,607,975
SALES OF CABLE TELEVISION SYSTEMS
Alliance completed sales of two groups of cable television systems during the
second quarter of 2003. Effective April 30, 2003, Alliance sold four systems in
rural North Dakota serving 930 subscribers to MLGC, LLC for $200,000 of cash and
a note receivable of $650,000. Effective June 2, 2003, Alliance sold systems
serving 1,150 subscribers in three communities surrounding the Fargo, ND -
Moorhead, MN area to Cable One, Inc. for $1,545,000 of cash (including $80,000
of escrowed funds).
Effect of the asset sales was as follows:
Sales Price $ 2,395,032
Less: Property, plant and equipment (net) (343,636)
Less: Intangible assets (goodwill) (970,673)
--------------------
Gain on sale of cable assets $ 1,080,723
====================
SEGMENT INFORMATION
The Company is organized into two business segments: Hector Communications
Corporation and its subsidiaries, which are 100% owned, and Alliance
Telecommunications Corporation and its subsidiaries, which are 68% owned.
Segment information is as follows:
10
Hector Alliance Consolidated
--------------- --------------- ---------------
Six Months Ended June 30, 2003
Revenues $ 4,953,529 $ 15,884,755 $ 20,838,284
Costs and expenses 4,036,144 11,319,041 15,355,185
--------------- --------------- ---------------
Operating income 917,385 4,565,714 5,483,099
Interest expense (446,320) (2,002,591) (2,448,911)
Interest and dividend income 39,396 141,981 181,377
Gain on sale of cable television systems 1,080,723 1,080,723
Income from Midwest Wireless Holdings LLC 488,082 1,203,936 1,692,018
Income from other unconsolidated affiliates 28,960 102,310 131,270
--------------- --------------- ---------------
Income before income taxes and
minority interest $ 1,027,503 $ 5,092,073 $ 6,119,576
=============== =============== ===============
Depreciation and amortization $ 1,527,004 $ 3,361,479 $ 4,888,483
=============== =============== ===============
Total assets $ 31,479,960 $ 130,461,346 $ 161,941,306
=============== =============== ===============
Capital expenditures $ 603,132 $ 1,117,306 $ 1,720,438
=============== =============== ===============
Hector Alliance Consolidated
--------------- --------------- ---------------
Six Months Ended June 30, 2002
Revenues $ 4,753,657 $ 14,662,386 $ 19,416,043
Costs and expenses 4,220,043 10,532,989 14,753,032
--------------- --------------- ---------------
Operating income 533,614 4,129,397 4,663,011
Interest expense (460,172) (1,886,561) (2,346,733)
Interest and dividend income 51,375 117,159 168,534
Income from Midwest Wireless Holdings LLC 438,524 1,081,693 1,520,217
Income from unconsolidated affiliates 21,462 85,470 106,932
--------------- --------------- ---------------
Income before income taxes and
minority interest $ 584,803 $ 3,527,158 $ 4,111,961
=============== =============== ===============
Depreciation and amortization $ 1,550,957 $ 3,290,307 $ 4,841,264
=============== =============== ===============
Total assets $ 30,683,298 $ 122,065,842 $ 152,749,140
=============== =============== ===============
Capital expenditures $ 547,653 $ 2,798,008 $ 3,345,661
=============== =============== ===============
Hector Alliance Consolidated
--------------- --------------- ---------------
Three Months Ended June 30, 2003
Revenues $ 2,476,232 $ 7,868,465 $ 10,344,697
Costs and expenses 2,050,394 5,632,536 7,682,930
--------------- --------------- ---------------
Operating income 425,838 2,235,929 2,661,767
Interest expense (226,338) (1,004,341) (1,230,679)
Interest and dividend income 21,091 65,666 86,757
Gain on sale of cable television systems 1,080,723 1,080,723
Income from Midwest Wireless Holdings LLC 255,477 630,177 885,654
Income from other unconsolidated affiliates 18,858 103,771 122,629
--------------- --------------- ---------------
Income before income taxes and
minority interest $ 494,926 $ 3,111,925 $ 3,606,851
=============== =============== ===============
Depreciation and amortization $ 762,160 $ 1,647,142 $ 2,409,302
=============== =============== ===============
Capital expenditures $ 475,804 $ 679,607 $ 1,155,411
=============== =============== ===============
11
Hector Alliance Consolidated
--------------- --------------- ---------------
Three Months Ended June 30, 2002
Revenues $ 2,362,289 $ 7,195,158 $ 9,557,447
Costs and expenses 2,189,341 5,261,847 7,451,188
--------------- --------------- ---------------
Operating income 172,948 1,933,311 2,106,259
Interest expense (230,444) (986,823) (1,217,267)
Interest and dividend income 23,590 49,663 73,253
Income from Midwest Wireless Holdings LLC 210,706 516,163 726,869
Income from unconsolidated affiliates 8,307 12,154 20,461
--------------- --------------- ---------------
Income before income taxes and
minority interest $ 185,107 $ 1,524,468 $ 1,709,575
=============== =============== ===============
Depreciation and amortization $ 775,701 $ 1,623,885 $ 2,399,586
=============== =============== ===============
Capital expenditures $ 262,334 $ 2,081,499 $ 2,343,833
=============== =============== ===============
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
- --------------------------------------------------------------------------------
Hector Communications Corporation ("HCC" or "Company") is a telecommunications
holding company which, through its subsidiaries, primarily provides local
telephone and cable television service. The Company also invests in other
companies providing wireless telephone and other telecommunications related
services.
At June 30, 2003 HCC operated five wholly-owned local exchange company
subsidiaries (generally referred to as "local exchange carriers" or "LECs")
serving 7,597 access lines in 9 rural communities in Minnesota and Wisconsin.
HCC, through its subsidiaries, also provides cable television service to 4,457
subscribers in Minnesota and Wisconsin.
At June 30, 2003 HCC owned a 68% interest in Alliance Telecommunications
Corporation ("Alliance"), a holding company that owned and operated six
additional LEC subsidiaries serving 31,241 access lines in 28 rural communities
in Minnesota, Wisconsin, Iowa and South Dakota and 7,033 cable television
subscribers in Minnesota, North Dakota, South Dakota and Iowa. At June 30, 2003,
Golden West Telecommunications Cooperative, Inc. of Wall, South Dakota ("Golden
West"), and Alliance Communications Cooperative, Inc. of Garretson, South Dakota
("ACCI") owned the remaining interests in Alliance. On July 7, 2003 Alliance was
the subject of a split-up transaction in which the assets and operations of
Alliance were divided among the Company, Golden West and ACCI. (See "Split-up of
Alliance Telecommunications Corporation" below.)
Six Months Ended June 30, 2003 Compared to
Six Months Ended June 30, 2002
Consolidated revenues increased to $20,838,000 in 2003 from $19,416,000 in 2002.
The revenue breakdown by operating group was as follows:
Hector Alliance
------------------------------------ -----------------------------------
2003 2002 2003 2002
---------------- ---------------- --------------- ---------------
Local network $ 830,672 $ 797,825 $ 2,971,228 $ 2,890,556
Network access 2,588,716 2,617,902 8,773,117 7,708,500
Nonregulated activities:
Video services 828,179 758,888 1,308,820 1,394,363
Internet 320,577 222,187 1,182,258 931,244
Other 385,385 356,855 1,649,332 1,737,723
---------------- ---------------- --------------- ---------------
$ 4,953,529 $ 4,753,657 $ 15,884,755 $ 14,662,386
---------------- ---------------- --------------- ---------------
12
Consolidated local service revenues increased $114,000 or 3%. The increase was
primarily due to increased revenues from CLASS service features and custom
calling. The Company increased the rates charged for these services during the
2003 period. Access lines served were 38,838 at June 30, 2003 compared to 39,028
at June 30, 2002. The number of access lines the Company serves fell due to the
reduced number of second lines being used for dial-up internet service and
increased substitution of cellular phones for landline phones by customers.
Network access revenues increased $1,035,000 or 10%. Access revenues in 2003
benefited from greater than anticipated recovery of bankruptcy reserves the
Company established against its WorldCom receivables in 2002. Establishment of
reserves for the bankruptcy losses negatively impacted access revenues in 2002.
Revenues from video services declined $16,000 or 1%. Video service revenues in
2003 were reduced by the sales of seven systems serving 2,080 subscribers during
the second quarter. Revenues from internet services increased $349,000 or 30%.
Revenues increased due to the deployment of broadband equipment manufactured by
Next Level Communications, Inc. in the Company's Sleepy Eye, MN exchange. This
equipment makes it possible to deliver POTS, video and high speed Internet
services to the customer over the same circuit. At June 30, 2003 the Company had
2,610 DSL customers and 9,646 dial-up internet customers, compared to 1,695 DSL
customers and 9,469 dial-up customers in June 2002. Nonregulated revenues from
all other sources decreased $60,000 or 3%.
Consolidated operating costs and expenses were $15,355,000 in 2003 compared to
$14,753,000 in 2002. Costs and expenses by operating group were as follows:
Hector Alliance
------------------------------------ -----------------------------------
2003 2002 2003 2002
---------------- ---------------- --------------- ---------------
Plant operations $ 731,397 $ 779,036 $ 2,444,228 $ 1,824,332
Customer operations 200,674 195,734 871,339 1,083,359
Other operating expenses:
Operating taxes 76,028 74,242 257,619 187,867
Video services 537,006 565,136 990,172 1,065,031
Internet 143,338 95,275 398,540 596,319
Other 112,742 164,596 603,251 592,857
General and administrative 707,955 795,067 2,392,413 1,892,917
Depreciation and amortization 1,527,004 1,550,957 3,361,479 3,290,307
---------------- ---------------- --------------- ---------------
$ 4,036,144 $ 4,220,043 $ 11,319,041 $ 10,532,989
---------------- ---------------- --------------- ---------------
Consolidated plant operations expenses increased $572,000 or 22% due to reduced
capitalization of labor expenditures for new construction projects and severance
charges for employee headcount reductions. Customer operations expenses
decreased $207,000 or 16% due to employee headcount reductions. Other operating
expenses decreased $223,000 or 7% due to lower maintenance expenses for video
services and lower internet operating expenses. General and administrative
expenses increased $412,000 or 15% due to expenses incurred in breaking up
Alliance. Depreciation expense increased $47,000 or 1% due to depreciation on
new plant additions. Consolidated operating income increased 18% to $5,483,000.
Interest expenses increased $102,000 due to charges on new loan funds drawn down
from the Rural Utilities Service and the Rural Telephone Bank. Interest and
dividend income increased $13,000 due to the increase in cash balances available
for investment. Income from the Company's investment in Midwest Wireless
Holdings, LLC increased 11% to $1,692,000. Income from other unconsolidated
13
investments increased to $131,000 in 2003 from $107,000 in 2002. Alliance
recorded gains on sales of cable television systems totaling $1,081,000 in the
2003 period.
Income before income taxes and minority interest increased to $6,120,000 in 2003
from $4,112,000 in 2002. The Company's effective income tax rate increased to
40% in 2003 from 39% in 2002 due to the effect of state income taxes. Income
before minority interest in Alliance's earnings increased to $3,671,000 in 2003
from $2,515,000 in 2002. Minority interests in earnings of Alliance were
$976,000 compared to $693,000 in 2002. Income before change in accounting
principle increased to $2,695,000 compared to $1,822,000 in 2002. 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 of $3,147,000, net
of income taxes and minority interest. The Company had net income of $2,695,000
in 2003 compared to a net loss of $1,324,000 in 2002.
Three Months Ended June 30, 2003 Compared to
Three Months Ended June 30, 2002
Consolidated revenues increased to $10,345,000 in 2003 from $9,557,000 in 2002.
Revenues by operating group were as follows:
Hector Alliance
------------------------------------ -----------------------------------
2003 2002 2003 2002
---------------- ---------------- --------------- ---------------
Local network $ 426,972 $ 409,094 $ 1,519,200 $ 1,490,157
Network access 1,272,408 1,281,344 4,360,059 3,624,804
Nonregulated activities:
Video services 413,707 384,963 587,186 712,774
Internet 172,406 111,177 618,003 480,388
Other 190,739 175,711 784,017 887,035
---------------- ---------------- --------------- ---------------
$ 2,476,232 $ 2,362,289 $ 7,868,465 $ 7,195,158
---------------- ---------------- --------------- ---------------
Consolidated local service revenues increased $47,000 or 2%. The increase was
primarily due to increased revenues from CLASS service features and custom
calling. The Company increased the rates charged for these services during the
first quarter of 2003. Network access revenues increased $726,000 or 15%.
Network access reserves were lower than normal in 2002 due to establishment of
reserves for the losses due to the bankruptcy of two large interexchange
carriers.
Revenues from video services declined $97,000 or 9%. Video service revenues in
2003 were reduced by the sales of seven systems serving 2,080 subscribers during
the second quarter. Revenues from internet services increased $199,000 or 34%.
Revenues increased due to the deployment of broadband equipment manufactured by
Next Level Communications, Inc. in the Company's Sleepy Eye, MN exchange, which
has greatly increased the number of customers using DSL services. Nonregulated
revenues from all other sources decreased $88,000 or 8% due to lower fees from
engineering services.
Consolidated operating costs and expenses were $7,683,000 in 2003 compared to
$7,451,000 in 2002. Costs and expenses by operating group were as follows:
14
Hector Alliance
------------------------------------ -----------------------------------
2003 2002 2003 2002
---------------- ---------------- --------------- ---------------
Plant operations $ 369,908 $ 395,442 $ 1,172,796 $ 901,055
Customer operations 94,774 116,563 461,849 568,038
Other operating expenses:
Operating taxes 37,132 37,500 138,780 92,215
Video services 282,901 297,656 458,086 492,733
Internet 85,226 44,810 178,115 314,409
Other 45,082 121,292 289,712 323,578
General and administrative 373,211 400,377 1,286,056 945,934
Depreciation and amortization 762,160 775,701 1,647,142 1,623,885
---------------- ---------------- --------------- ---------------
$ 2,050,394 $ 2,189,341 $ 5,632,536 $ 5,261,847
---------------- ---------------- --------------- ---------------
Consolidated plant operations expenses increased $246,000 or 19% due to reduced
capitalization of labor expenditures for new construction projects and severance
charges for employee headcount reductions. Customer operations expenses
decreased $128,000 or 19% due to employee headcount reductions. Other operating
expenses decreased $209,000 or 12% due to lower maintenance expenses for video
services and lower internet operating expenses. General and administrative
expenses increased $313,000 or 23% due to expenses incurred in breaking up
Alliance. Depreciation expense increased $10,000 due to depreciation on new
plant additions. Consolidated operating income increased 26% to $2,662,000.
Interest expenses increased $13,000 due to charges on new loan funds drawn down
from the Rural Utilities Service and the Rural Telephone Bank. Interest and
dividend income increased $13,000 due to the increase in cash balances available
for investment. Income from the Company's investment in Midwest Wireless
Holdings, LLC increased 22% to $886,000. Income from other unconsolidated
investments increased to $123,000 in 2003 from $20,000 in 2002. Alliance
recorded gains on sales of cable television systems totaling $1,081,000 in the
2003 period.
Income before income taxes and minority interest increased to $3,607,000 in 2003
from $1,710,000 in 2002. The Company's effective income tax rate was 40% in 2003
and 2002. The income tax rate is higher than the federal rate due to the effect
of state income taxes. Income before minority interest in Alliance's earnings
increased to $2,164,000 in 2003 from $1,033,000 in 2002. Minority interests in
earnings of Alliance were $596,000 compared to $295,000 in 2002. Net income
increased to $1,568,000 in 2003 compared to $738,000 in 2002.
Liquidity and Capital Resources
Cash flows from consolidated operating activities for the six-month periods were
$7,528,000 and $5,373,000 in 2003 and 2002, respectively. At June 30, 2003, the
Company's cash, cash equivalents and marketable securities totaled $20,014,000
compared to $12,134,000 at December 31, 2002. Alliance's cash and securities
were $13,838,000 of this total. Working capital at June 30, 2003 was $15,565,000
compared to $5,718,000 at December 31, 2002. The current ratio was 2.1 to 1 at
June 30, 2003.
The improvement in the Company's working capital and current ratio at June 30
was due to several factors. The Company received $5,654,000 of loan funds from
the Rural Utilities Service and Rural Telephone Bank during the first quarter to
finance plant additions in the Sleepy Eye and Pine Island exchanges. At June 30,
2003, construction funds remaining totaled $4,528,000. The second quarter
principal payments on the Company's loan from CoBank were pushed out in
anticipation of closing the Alliance split-up transactions discussed below,
which conserved cash. The Company also received $1,666,000 of cash during the
second quarter from the sales of cable television systems.
15
The Company makes periodic improvements to its facilities to provide up-to-date
services to its customers. Plant additions in the 2003 and 2002 six-month
periods were $1,720,000 and $3,346,000, respectively. Plant additions for 2003
are expected to total $6,300,000 and will expand usage of high capacity fiber
optics in the telephone network and provide customers with additional advanced
telecommunications services.
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 June 30, 2003 interest rates on the loan averaged 6.8%. The
outstanding balance on this loan at June 30, 2003 was $37,311,000. 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 $3,945,000 at June 30, 2003.
Subsequent to June 30, 2003 the Company retired the CoBank loan to Alliance with
proceeds from a new loan from CoBank directly to the Company. See "Split-up of
Alliance Telecommunications Corporation" below regarding new loan arrangements.
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. At
June 30, 2003 216,000 shares could be repurchased under outstanding Board
authorizations.
The Company is always looking to acquire properties that advance its plan to be
a provider of top quality telecommunications services to rural customers. In
2001, the Company acquired several small cable systems in South Dakota. In 2000,
the Company acquired Hager TeleCom, Inc. In 1998, the Company acquired Felton
Telephone Company and eight cable television systems from Spectrum Cablevision
Limited Partnership. The Company cannot predict if it will be successful in
acquiring additional properties in the future and does not currently have
financing plans in place to pay for possible acquisitions.
By utilizing cash flow from operations, current cash and investment balances,
and other available financing sources, the Company feels it has adequate
resources to meet its anticipated operating, debt service and capital
expenditure requirements.
Split-up of Alliance Telecommunications Corporation
In July 2001, Golden West Telecommunications Cooperative, Inc. and Alliance
Communications Cooperative, Inc ("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 completed the Alliance split-up transactions on July 7, 2003, which
was subsequent to the financial periods reported herein. As agreed among the
parties, in the split-up, Golden West exchanged its 20% ownership interest in
Alliance for all of the outstanding stock of Sioux Valley Telephone Company and
16
certain other Alliance assets. ACCI exchanged its 12% ownership interest in
Alliance for all of the outstanding stock of Hills Telephone Company and certain
other Alliance assets. At June 30, 2003, Sioux Valley Telephone Company and
Hills Telephone Company collectively served 8,650 telephone access lines and
2,400 cable television customers. In addition, as a result of the split-up, 32%
of Alliance's ownership interest in Midwest Wireless Holdings LLC was
transferred to Golden West and ACCI, reducing Hector's total ownership from
10.4% to 8%. Immediately prior to the split-up Sioux Valley and Hills paid a
dividend to Alliance of approximately $13,145,000 to equalize post split-up
values in proportion to the 68%-20%-12% stock ownership percentages. The
dividend proceeds were used to reduce Alliance's debt to its primary lender,
CoBank. Concurrent with the split-up, the balance of Alliance's debt to CoBank
and the balance of the Company's debt to Rural Telephone Finance Cooperative
($3,047,000 at June 30, 2003) were retired using proceeds from a new $26,813,000
loan from CoBank to the Company. A number of other stock and asset transfers
also occurred among Alliance and its subsidiaries prior to the split-up in order
to satisfy various tax, regulatory and lender requirements.
Alliance expects the split-up transactions to be tax-free under Section 355 of
the Internal Revenue Code. Alliance also expects the related internal stock and
asset transfers that occurred prior to the split-up to be tax-free under Section
355, related Code provisions and the consolidated return regulations, although
no private letter ruling was sought from the IRS in connection with the
split-up. Prior to conducting the split-up transactions, the parties entered
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 split-up
transactions which relate to commitments, events or circumstances in effect as
of the date of the split-up transactions.
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
split-up occurred January 1, 2003. The pro forma balance sheet and explanatory
notes show the effect on the Company's financial position as if the split-up
occurred June 30, 2003.
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 split-up 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.
17
Pro forma income statement - Six Months Ended June 30, 2003
Eliminate
Sioux Valley
Hector and Hills Other
Communications Telephone Pro forma Pro forma
Corporation Companies Adjustments Combined
------------- ------------- ------------- -------------
REVENUES:
Local network $ 3,801,900 $ (791,977) $ 3,009,923
Network access 11,361,833 (3,272,891) 8,088,942
Video services 2,136,999 (263,502) 1,873,497
Internet services 1,502,835 (260,636) 1,242,199
Other nonregulated services 2,034,717 (161,871) 1,872,846
------------- ------------- -------------
TOTAL REVENUES 20,838,284 (4,750,877) 16,087,407
COSTS AND EXPENSES:
Plant operations 3,175,625 (680,177) 2,495,448
Depreciation and amortization 4,888,483 (938,095) 3,950,388
Customer operations 1,072,013 (269,130) 802,883
General and administrative 3,100,368 (402,463) 2,697,905
Other operating expenses 3,118,696 (551,941) 2,566,755
------------- ------------- -------------
TOTAL COSTS AND EXPENSES 15,355,185 (2,841,806) 12,513,379
------------- ------------- -------------
OPERATING INCOME 5,483,099 (1,909,071) 3,574,028
OTHER INCOME (EXPENSES):
Interest expense (2,448,911) 216,388 $ 409,546 (a)(b) (1,822,977)
Interest and dividend income 181,377 (45,911) 135,466
Income from investments in unconsolidated
affiliates:
Midwest Wireless Holdings, LLC 1,692,018 (385,260)(c) 1,306,758
Other unconsolidated affiliates 131,270 (176,618) (45,348)
Gain on sale of cable television systems 1,080,723 1,080,723
------------- ------------- ------------- -------------
OTHER INCOME (EXPENSES), net 636,477 (6,141) 24,286 654,622
------------- ------------- ------------- -------------
INCOME BEFORE INCOME TAXES AND
MINORITY INTEREST 6,119,576 (1,915,212) 24,286 4,228,650
Income tax expense 2,449,000 (766,085) 9,715 (d) 1,692,630
------------- ------------- ------------- -------------
INCOME BEFORE MINORITY INTEREST 3,670,576 (1,149,127) 14,572 2,536,021
Minority interest in earnings of
Alliance Telecommunications Corporation 976,023 (976,023)(e) 0
------------- ------------- ------------- -------------
NET INCOME $ 2,694,553 $ (1,149,127) $ 990,595 $ 2,536,021
============= ============= ============= =============
NET INCOME PER COMMON SHARE:
Basic $ .78 $ .73
Diluted .72 .68
AVERAGE SHARES OUTSTANDING
Common shares only 3,475,000 3,475,000
Common and potential common shares 3,754,000 3,754,000
The following is a summary of adjustments required under generally accepted
accounting principles:
(a) Interest adjustment on CoBank loan at average
interest rate (6.8%) $ 446,934
(b) Interest adjustment on CoBank loan for accrued
patronage (37,389)
(c) Adjust income from Midwest Wireless Holdings for
ownership transfer (385,260)
(d) Income tax effect of above adjustments (40% rate) 9,715
(e) Eliminate minority interest in earnings of Alliance (976,023)
18
Pro forma income statement - Three Months Ended June 30, 2003
Eliminate
Sioux Valley
Hector and Hills Other
Communications Telephone Pro forma Pro forma
Corporation Companies Adjustments Combined
------------- ------------- ------------- -------------
REVENUES:
Local network $ 1,946,172 $ (398,037) $ 1,548,135
Network access 5,632,467 (1,602,765) 4,029,702
Video services 1,000,893 (90,844) 910,049
Internet services 790,409 (118,487) 671,922
Other nonregulated services 974,756 (80,114) 894,642
------------- ------------- -------------
TOTAL REVENUES 10,344,697 (2,290,247) 8,054,450
COSTS AND EXPENSES:
Plant operations 1,542,704 (343,996) 1,198,708
Depreciation and amortization 2,409,302 (451,721) 1,957,581
Customer operations 556,623 (127,492) 429,131
General and administrative 1,659,267 (197,143) 1,462,124
Other operating expenses 1,515,034 (250,215) 1,264,819
------------- ------------- -------------
TOTAL COSTS AND EXPENSES 7,682,930 (1,370,567) 6,312,363
------------- ------------- -------------
OPERATING INCOME 2,661,767 (919,680) 1,742,087
OTHER INCOME (EXPENSES):
Interest expense (1,230,679) 99,302 $ 212,897 (a)(b) (918,480)
Interest and dividend income 86,757 (32,222) 54,535
Income from investments in unconsolidated
affiliates:
Midwest Wireless Holdings, LLC 885,654 (127,224)(c) 758,430
Other unconsolidated affiliates 122,629 (71,421) 51,208
Gain on sale of cable television systems 1,080,723 1,080,723
------------- ------------- ------------- -------------
OTHER INCOME (EXPENSES), net 945,084 (4,341) 85,673 1,026,416
------------- ------------- ------------- -------------
INCOME BEFORE INCOME TAXES AND
MINORITY INTEREST 3,606,851 (924,021) 85,673 2,768,503
Income tax expense 1,443,000 (369,609) 34,270 (d) 1,107,660
------------- ------------- ------------- -------------
INCOME BEFORE MINORITY INTEREST 2,163,851 (554,412) 51,404 1,660,843
Minority interest in earnings of
Alliance Telecommunications Corporation 595,816 (595,816)(e) 0
------------- ------------- ------------- -------------
NET INCOME $ 1,568,035 $ (554,412) $ 647,220 $ 1,660,843
============= ============= ============= =============
NET INCOME PER COMMON SHARE:
Basic $ .45 $ .48
Diluted .42 .44
AVERAGE SHARES OUTSTANDING
Common shares only 3,481,000 3,481,000
Common and potential common shares 3,764,000 3,764,000
The following is a summary of adjustments required under generally accepted
accounting principles:
(a) Interest adjustment on CoBank loan at average
interest rate (6.8%) $ 223,467
(b) Interest adjustment on CoBank loan for accrued patronage (10,570)
(c) Adjust income from Midwest Wireless Holdings
for ownership transfer (127,224)
(d) Income tax effect of above adjustments (40% rate) 34,270
(e) Eliminate minority interest in earnings of Alliance (595,816)
19
Pro forma balance sheet - June 30, 2003
Eliminate
Sioux Valley
Hector and Hills Other
Communications Telephone Pro forma Pro forma
Assets Corporation Companies Adjustments Combined
------------- ------------- ------------- -------------
Current assets:
Cash and cash equivalents $ 19,848,854 $ (5,214,465) $ 14,634,389
Construction fund 4,528,372 (3) 4,528,369
Accounts receivable, net 4,060,914 (1,069,379) 2,991,535
Materials, supplies and inventories 1,294,634 (167,039) 1,127,595
Other current assets 126,294 (10,744) 115,550
Accounts with affiliates (98,440) (98,440)
------------- ------------- -------------
Total Current Assets 29,859,068 (6,560,070) 23,298,998
Property, plant and equipment, net 53,155,110 (9,339,880) 43,815,230
Investments and other assets:
Excess of cost over net assets acquired, net 48,104,320 (122,569) $ (13,192,878)(e) 34,788,873
Marketable securities 164,671 0 164,671
Investment in Midwest Wireless Holdings LLC 17,502,877 0 (4,500,496)(a) 13,002,381
Investments in other unconsolidated affiliates 4,349,880 (1,634,127) 2,715,753
Other investments 8,404,954 (819,708) (1,389,786)(c) 6,195,460
Other assets 400,426 (122,635) 277,791
------------- ------------- ------------- -------------
Total investments and other assets 78,927,128 (2,699,039) (19,083,160) 57,144,929
------------- ------------- ------------- -------------
Total Assets $ 161,941,306 $ (18,598,989) $ (19,083,160) $ 124,259,157
============= ============= ============= =============
Liabilities and Stockholders Equity
Current liabilities:
Notes payable and current
portion of long-term debt $ 7,877,000 $ (364,000) $ 7,513,000
Accounts payable 2,224,740 (587,537) 1,637,203
Accrued expenses 2,771,300 (574,397) 2,196,903
Income taxes payable 1,421,364 (665,888) 755,476
------------- ------------- -------------
Total current liabilities 14,294,404 (2,191,822) 12,102,582
Long-term debt, less current portion 77,492,479 (5,228,822) (13,145,132)(d) 59,118,525
Deferred investment tax credits 13,743 0 13,743
Deferred income taxes 5,888,782 (1,345,693) (42,301)(a)(b) 4,500,788
Deferred compensation 964,010 0 (308,483)(b) 655,527
Minority interest in Alliance
Telecommunications Corporation 18,009,817 (18,009,817)(f) 0
Stockholders' equity 45,278,071 (9,832,652) 12,422,573 (a)(b)(c) 47,867,992
(d)(e)(f)
------------- ------------- ------------- -------------
Total Liabilities and Stockholders' Equity $ 161,941,306 $ (18,598,989) $ (19,083,160) $ 124,259,157
============= ============= ============= =============
The following is a summary of adjustments required under generally accepted
accounting principles:
(a) Transfer of 32% of Alliance's ownership interest in Midwest
Wireless and related deferred tax liabilities of $162,523 $ 4,500,496
(b) Transfer of 32% of deferred compensation obligations and
related deferred tax assets of $120,222 308,483
(c) Transfer of 32% of investment in CoBank stock 1,389,786
(d) Repayment of CoBank debt thru dividend from
Sioux Valley and Hills 13,145,132
(e) Eliminate goodwill value of investment
in Sioux Valley and Hills 13,192,878
(f) Eliminate minority interest in Alliance
Telecommunications Corp. 18,009,817
20
New Accounting Principles
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's Accounting
and Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others" (FIN 45). FIN 45 establishes accounting and disclosure
requirements for a company's obligations under certain guarantees that it has
issued. A guarantor is required to recognize a liability for the obligation it
has undertaken in issuing a guarantee, including the ongoing obligation to stand
ready to perform over the term of the guarantee in the event that the specified
triggering events or conditions occur. The objective of the initial measurement
of that liability is the fair value of the guarantee at its inception. The
initial recognition and measurement provisions of this Interpretation are
applicable on a prospective basis to guarantees issued or modified after
December 31, 2002. FIN 45 also requires expanded disclosure of information
related to product warranty amounts recorded in the financial statements. The
disclosure provisions are effective for interim and annual periods ending after
December 15, 2002. The Company has not issued any guarantees to date that are
subject to the new provisions.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure", an amendment to SFAS No. 123. This
standard provides alternative methods of transition for any voluntary changes to
the fair value based method of accounting for stock-based employee compensation.
It also amends the disclosure requirements to require prominent disclosure in
both the 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 new disclosure requirements are effective for interim
periods beginning after December 15, 2002 and are included in this report. The
Company will continue to apply the principles of APB Opinion No. 25 and related
interpretations in accounting for its stock based compensation plans.
In May 2003, the FASB issued Statement of Financial Accounting Standards No.
150, "Accounting for Certain Financial Instruments with Characteristics of Both
Liabilities and Equities", which becomes effective for the Company during the
third quarter of 2003. Adoption of this statement will not have a material
impact on the Company's consolidated results of operations and financial
position.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
The Company does not use derivative financial instruments in its operations or
investment portfolio. Its operations are not subject to risks associated with
changes in the value of foreign currencies. Portions of the Company's long-term
debt have variable interest rates based on the lenders' cost of money. The
Company has investments in money market funds that earn interest at prevailing
market rates. In the opinion of management, the Company does not have a material
exposure to loss caused by market risk.
Item 4. Controls and Procedures
(a) Evaluation of Disclosure Controls and Procedures
The Company's Chief Executive Officer, Curtis A. Sampson, and Chief Financial
Officer, Charles A, Braun, have evaluated the Company's disclosure controls and
procedures as of the end of the period covered by this report. Based upon that
review, they have concluded that these controls and procedures are effective in
ensuring that material information related to the Company is made known to them
by others within the Company.
21
(b) Changes in Internal Control Over Financial Reporting
There have been no significant changes in internal control over financial
reporting that occurred during the fiscal quarter covered by this report that
have materially affected, or are reasonably likely to materially affect, the
registrant's internal control over financial reporting.
- --------------------------------------------------------------------------------
From time to time in reports filed with the Securities and Exchange Commission,
in press releases, and in other communications to shareholders and the investing
public, the Company may make statements regarding the Company's future financial
performance. Such forward looking statements are subject to risks and
uncertainties, including but not limited to, the effects of the
Telecommunications Act, new technological developments which may reduce barriers
for competitors entering the Company's local exchange or cable television
markets, higher than expected expenses and other risks involving the
telecommunications industry generally. All such forward-looking statements
should be considered in light of such risks and uncertainties.
- --------------------------------------------------------------------------------
PART II. OTHER INFORMATION
Items 1 - 3. Not Applicable
Item 4. Submission of Matters to a Vote of Security Holders
- ------------------------------------------------------------
The Annual Meeting of the Shareholders of the Registrant was held on May 21,
2003 in Eden Prairie, MN. The total number of shares outstanding and entitled to
vote at the meeting was 3,473,029 of which 2,930,221 were present either in
person or by proxy. Shareholders re-elected board members Paul A. Hoff, Luella
Gross Goldberg and Gerald D. Pint to three-year terms expiring at the 2006
Annual Meeting of Shareholders.
In Favor Abstaining
Paul A. Hoff 2,912,159 18,062
Luella Gross Goldberg 2,912,109 18,112
Gerald D. Pint 2,912,009 18,212
Board members continuing in office are Curtis A. Sampson, Steven H. Sjogren and
Ronald J. Bach (whose terms expire at the 2005 Annual Meeting of Shareholders)
and James O. Ericson, Paul N. Hanson and Wayne E. Sampson (whose terms expire at
the 2004 Annual Meeting of Shareholders).
Shareholders approved an amendment to the Company's 1999 Stock Plan increasing
the number of shares available for awards under the plan from 300,000 to
600,000. The vote to approve the plan was 1,223,444 in favor, 359,226 against
and 7,950 abstaining.
Shareholders approved the Company's 2003 Employee Stock Purchase Plan which
authorizes the Company to issue up to 100,000 shares of common stock to
employees, who contribute a percentage of their payroll to the plan and receive
the stock at a discounted price. The vote to approve the plan was 1,271,864 in
favor, 311,846 against and 6,910 abstaining.
Shareholders defeated a shareholder proposal that would have eliminated the
Company's Rights Plan. Rights Plans are also known as poison pills and are used
by companies as a defense against unsolicited takeovers. 428,346 shares voted in
favor of the proposal to eliminate the Rights Plan, 1,126,846 shares voted
against and 35,428 shares abstained.
22
Item 5. Not applicable
Item 6(a). Exhibits
The following exhibits are included herein:
11 Calculation of Earnings Per Share
31.1 Certification of Chief Executive Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002 (Rules 13a-14 and 15d-14 of the Exchange Act)
31.2 Certification of Chief Financial Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002 (Rules 13a-14 and 15d-14 of the Exchange Act)
32 Certification pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 (18 USCss.1350).
Item 6(b). Reports on Form 8-K.
On May 14, 2003, the Company filed a current report on Form 8-K with the
Securities and Exchange Commission, reporting under Item 9 its first quarter
2003 earnings release to shareholders.
Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereto duly authorized.
Hector Communications Corporation
By /s/Curtis A. Sampson
------------------------
Curtis A. Sampson
Date: August 14, 2003 Chief Executive Officer
By /s/Charles A. Braun
------------------------
Charles A. Braun
Date: August 14, 2003 Chief Financial Officer
23
EXHIBIT 11
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CALCULATION OF EARNINGS PER SHARE
Three Months Ended June 30 Six Months Ended June 30
Basic: 2003 2002 2003 2002
- ------- ----------- ------------- ------------- -------------
Income before cumulative effect of change in
accounting principle $ 1,568,035 $ 737,705 $ 2,694,553 $ 1,822,430
Cumulative effect of accounting change (3,146,569)
----------- ------------- ------------- -------------
Net income (loss) $ 1,568,035 $ 737,705 $ 2,694,553 $ (1,324,139)
=========== ============= ============= =============
Common shares:
Weighted average number of common shares outstanding 3,480,858 3,511,737 3,475,423 3,502,896
----------- ------------- ------------- -------------
Net income (loss) per common share:
Before cumulative effect of change in accounting principle $ .45 $ .21 $ .78 $ .52
Cumulative effect of accounting change .00 (.90)
----------- ------------- ------------- -------------
$ .45 $ .21 $ .78 $ (.38)
=========== ============= ============= =============
Diluted:
- -------------
Income before cumulative effect of change in
accounting principle $ 1,568,035 $ 737,705 $ 2,694,553 $ 1,822,430
Cumulative effect of accounting change 0 (3,146,569)
----------- ------------- ------------- -------------
Net income (loss) $ 1,568,035 $ 737,705 $ 2,694,553 $ (1,324,139)
=========== ============= ============= =============
Common and common equivalent shares:
Weighted average number of common shares outstanding 3,480,858 3,511,737 3,475,423 3,502,896
Dilutive effect of convertible preferred shares outstanding 220,100 220,100 220,100 220,100
Dilutive effect of stock options outstanding after
application of treasury stock method 56,805 69,637 51,994 87,266
Dilutive effect of Employee Stock
Purchase Plan shares subscribed 6,428 1,506 6,223 1,833
----------- ------------- ------------- -------------
3,764,191 3,802,980 3,753,740 3,812,095
=========== ============= ============= =============
Diluted net income (loss) per share:
Before cumulative effect of change in accounting principle $ .42 $ .19 $ .72 $ .48
Cumulative effect of accounting change .00 (.83)
----------- ------------- ------------- -------------
$ .42 $ .19 $ .72 $ (.35)
=========== ============= ============= =============
24
Exhibit 31.1
------------
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
Certifications Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
Chief Executive Officer Certification
I, Curtis A. Sampson certify that:
1. I have reviewed this Form 10-Q of Hector Communications Corporation;
2. Based on my knowledge, this quarterly 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 quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly 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 report;
4. The registrant's other certifying officer(s) and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:
(a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our supervision,
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 report is being
prepared;
(b) Evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end of
the period covered by this report based on such evaluation; and
(c) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the registrant's
most recent fiscal quarter (the registrant's fourth fiscal quarter in the
case of an annual report) that has materially affected, or is reasonably
likely to materially affect, the registrant's internal control over
financial reporting; and
5. The registrant's other certifying officer(s) and I have disclosed, based on
our most recent evaluation of internal control over financial reporting, to the
registrant's auditors and the audit committee of the registrant's board of
directors (or persons performing the equivalent functions):
(a) All significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal control
over financial reporting.
By /s/Curtis A. Sampson
------------------------
Curtis A. Sampson
Date: August 14, 2003 Chief Executive Officer
25
Exhibit 31.2
- - ------------
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
Chief Financial Officer Certification
I, Charles A. Braun, certify that:
1. I have reviewed this Form 10-Q of Hector Communications Corporation;
2. Based on my knowledge, this quarterly 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 quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly 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 report;
4. The registrant's other certifying officer(s) and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:
(a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our supervision,
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 report is being
prepared;
(b) Evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end of
the period covered by this report based on such evaluation; and
(c) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the registrant's
most recent fiscal quarter (the registrant's fourth fiscal quarter in the
case of an annual report) that has materially affected, or is reasonably
likely to materially affect, the registrant's internal control over
financial reporting; and
5. The registrant's other certifying officer(s) and I have disclosed, based on
our most recent evaluation of internal control over financial reporting, to the
registrant's auditors and the audit committee of the registrant's board of
directors (or persons performing the equivalent functions):
(a) All significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to record,
process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal control
over financial reporting.
By /s/Charles A. Braun
-----------------------
Charles A. Braun
Date: August 14, 2003 Chief Financial Officer
26
Exhibit 32
-----------
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
Certifications Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
Certification
The undersigned certify pursuant to 18 U.S.C.ss.1350, that:
(1) The accompanying Quarterly Report on Form 10-Q for the period ended June 30,
2003 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.
Date: August 14, 2003 /s/ Curtis A. Sampson
----------------------
Chief Executive Officer
Date: August 14, 2003 /s/ Charles A. Braun
----------------------
Chief Financial Officer
27