- --------------------------------------------------------------------------------
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2004
-------------------------------------------------
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: 001-13891
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 April 30, 2004
- -------------------------------------- -----------------------------
Common Stock, par value $.01 per share 3,622,553
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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 4
Consolidated Statements of Comprehensive Income 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 11
Item 3. Quantitative and Qualitative Disclosures
About Market Risk 15
Item 4. Controls and Procedures 15
Part II. Other Information 16
2
PART I. FINANCIAL INFORMATION
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
Item 1. Financial Statements
CONSOLIDATED BALANCE SHEETS
(unaudited)
March 31 December 31
Assets: 2004 2003
------------ ------------
Current assets:
Cash and cash equivalents $ 18,770,271 $ 16,581,315
Construction fund 5,270,180 3,240,073
Accounts receivable, net 3,300,768 4,140,052
Materials, supplies and inventories 964,290 944,099
Other current assets 116,847 285,071
------------ ------------
Total current assets 28,422,356 25,190,610
Property, plant and equipment 98,638,855 98,174,546
less accumulated depreciation (56,849,948) (55,086,440)
------------ ------------
Net property, plant and equipment 41,788,907 43,088,106
Other assets:
Excess of cost over net assets acquired 31,691,927 31,691,927
Investment in Midwest Wireless Holdings, LLC 13,834,467 13,349,155
Investment in other unconsolidated affiliates 2,817,221 2,796,035
Other investments 6,454,396 6,533,858
Other assets 397,754 409,664
------------ ------------
Total other assets 55,195,765 54,780,639
------------ ------------
Total Assets $ 125,407,028 $ 123,059,355
============ ============
Liabilities and Stockholders' Equity:
Current liabilities:
Notes payable and current portion
of long-term debt $ 6,611,000 $ 6,537,800
Accounts payable 1,593,244 1,557,969
Accrued expenses 2,270,300 2,238,587
Income taxes payable 1,125,289 1,541,830
------------ ------------
Total current liabilities 11,599,833 11,876,186
Long-term debt, less current portion 57,903,028 57,529,378
Deferred investment tax credits 5,484 8,999
Deferred income taxes 4,911,357 4,902,870
Deferred compensation 703,224 698,254
Stockholders' Equity 50,284,102 48,043,668
------------ ------------
Total Liabilities and Stockholders' Equity $ 125,407,028 $ 123,059,355
============ ============
See notes to consolidated financial statements.
3
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(unaudited)
Three Months Ended March 31
------------------------------
2004 2003
------------ ------------
Revenues from continuing operations:
Local network $ 1,492,851 $ 1,461,788
Network access 4,013,613 4,059,240
Video services 818,253 963,448
Internet services 741,148 570,277
Other nonregulated services 879,788 978,204
------------ ------------
Total revenues 7,945,653 8,032,957
Costs and expenses:
Plant operations, excluding depreciation 1,054,215 1,296,400
Customer operations 351,018 373,752
General and administrative 1,159,049 1,120,686
Depreciation and amortization 2,008,269 1,992,807
Other operating expenses:
Operating taxes 102,490 85,632
Video service expenses 678,536 786,864
Internet expenses 236,880 234,357
Other 374,003 310,518
------------ ------------
Total costs and expenses 5,964,460 6,201,016
Operating income from continuing operations 1,981,193 1,831,941
Other income and (expenses):
Interest expense (771,469) (893,121)
Interest and dividend income 53,526 80,931
Income from investment in Midwest Wireless
Holdings, LLC 682,129 622,761
Income (loss) from investments in other
unconsolidated affiliates 45,186 (96,556)
------------ ------------
Other income (expense), net 9,372 (285,985)
Income from continuing operations before
income taxes and minority interest 1,990,565 1,545,956
Income tax expense 797,000 619,000
------------ ------------
Income from continuing operations
before minority interest 1,193,565 926,956
Minority interest in continuing operations
of Alliance Telecommunications Corporation (194,681)
------------ ------------
Income from continuing operations 1,193,565 732,275
Discontinued operations:
Income from operations of asset group distrib-
uted in split-up of Alliance Telecommun-
ications Corporation, net of income taxes 579,769
Minority interest in discontinued operations
of Alliance Telecommunications Corporation (185,526)
------------ ------------
Income from discontinued operations - 394,243
------------ ------------
Net income $ 1,193,565 $ 1,126,518
============ ============
Basic net income per share:
Continuing operations $ .34 $ .21
Discontinued operations .11
------------ ------------
$ .34 $ .32
============ ============
Diluted net income per share:
Continuing operations $ .31 $ .20
Discontinued operations .10
------------ ------------
$ .31 $ .30
============ ============
See notes to consolidated financial statements.
4
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(unaudited)
Three Months Ended March 31
------------------------------
2004 2003
------------ ------------
Net income $ 1,193,565 $ 1,126,518
Other comprehensive income (loss):
Unrealized holding gains (losses) on
marketable securities 21,232 (3,453)
Income tax (expense) benefit related to
unrealized holding gains (losses) on
marketable securities (8,499) 1,365
Minority interest in other comprehensive income
(loss)of Alliance Telecommunications
Corporation 686
------------ ------------
Other comprehensive income (loss) 12,733 (1,402)
------------ ------------
Comprehensive income $ 1,206,298 $ 1,125,116
============ ============
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 Total
------- --------- --------- -------- ----------- ----------- ------------- ------------
BALANCE AT DECEMBER 31, 2003 220,100 $ 220,100 3,515,482 $ 35,155 $13,828,414 $33,908,774 $ 51,225 $ 48,043,668
Net income 1,193,565 1,193,565
Issuance of common stock to ESOP 20,467 205 286,753 286,958
Issuance of common stock under
Employee Stock Option Plan 80,914 809 746,369 747,178
Change in unrealized gains on
marketable securities, net of
deferred taxes 12,733 12,733
------- --------- --------- -------- ------------ ----------- ------------- ------------
BALANCE AT MARCH 31, 2004 220,100 $ 220,100 3,616,863 $ 36,169 $14,861,536 $35,102,339 $ 63,958 $ 50,284,102
======= ========= ========= ======== ============ =========== ============= ============
See notes to consolidated financial statements.
5
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
Three Months Ended March 31
-----------------------------
2004 2003
----------- ------------
Cash Flows from Operating Activities:
Net income $ 1,193,565 $ 1,126,518
Adjustments to reconcile net income to net
cash provided by operating activities:
Minority interest in earnings of Alliance
Telecommunications Corporation 380,207
Depreciation and amortization 2,012,673 2,479,181
Income from Midwest Wireless Holdings, LLC (682,129) (806,364)
Cash distributions from Midwest Wireless
Holdings, LLC 196,817 233,155
Income from other unconsolidated affiliates (45,186) (8,641)
Cash distributions other unconsolidated
affiliates 24,000
Changes in assets and liabilities net of
effects of discontinued operations:
Accounts receivable 729,703 503,943
Materials, supplies and inventories (20,191) 18,008
Other current assets 168,224 (15,518)
Accounts payable 35,275 (304,467)
Accrued expenses 318,671 461,633
Income taxes payable (416,541) (69,508)
Deferred investment credits (3,515) (4,640)
Deferred taxes (42,409)
Deferred compensation 4,970 (6,085)
----------- ------------
Net cash provided by operating activities 3,516,336 3,945,013
Cash Flows from Investing Activities:
Capital expenditures, net (703,209) (565,027)
Increase in construction fund (2,030,107) (3,860,152)
Investments in other unconsolidated affiliates (23,191)
Purchases of other investments (5,429) (80,997)
Proceeds from other investments 215,692
Decrease in other assets 1,645 6,799
----------- ------------
Net cash used in investing activities (2,521,408) (4,522,568)
Cash Flows from Financing Activities:
Repayment of long-term debt (1,587,057) (1,768,681)
Proceeds from issuance of notes payable and
long-term debt 2,033,907 5,654,154
Issuance of common stock 747,178 93,769
Purchase of stock (2,891)
----------- ------------
Net cash provided by financing activities 1,194,028 3,976,351
----------- ------------
Net Increase in Cash and Cash Equivalents 2,188,956 3,398,796
Cash and Cash Equivalents at Beginning of Period 16,581,315 12,020,186
----------- ------------
Cash and Cash Equivalents at End of Period $ 18,770,271 $ 15,418,982
=========== ============
Supplemental disclosures of cash flow information:
Interest paid during the period $ 894,585 $ 1,281,314
Income taxes paid during the period 1,217,056 1,080,148
See notes to consolidated financial statements.
6
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SIGNIFICANT ACCOUNTING POLICIES AND ESTIMATES
The consolidated financial statements include the accounts of Hector
Communications Corporation ("HCC" or "Company") and its 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 balance sheet and statement of stockholders' equity as of March 31, 2004 and
the statements of income, comprehensive income (loss) and cash flows for the
periods ended March 31, 2004 and 2003 have been prepared by the Company without
audit. In the opinion of management, all adjustments (which include only normal
recurring adjustments) necessary to present fairly the financial position,
results of operations, and changes in cash flows at March 31, 2004 and 2003 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, 2003 Annual Report to
Shareholders. The results of operations for the periods ended March 31 are not
necessarily indicative of the operating results for the entire year.
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.
The Company's operating results for the period ended March 31, 2003 have been
restated pursuant to the discontinued operations rules of SFAS 144, "Accounting
for the Impairment or Disposal of Long-Lived Assets" to reflect the effects of
the split-up of Alliance Telecommunications Corporation. Certain other amounts
in the 2003 financial statements have been reclassified to conform to the 2004
financial statement presentation. These reclassifications had no effect on net
income or stockholders' equity as previously reported.
7
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 March 31
2004 2003
------------ -------------
Net income as reported $ 1,193,565 $ 1,126,518
Less: Total stock-based employee compensation
expense determined under the fair value
method for all awards (104,902) (84,065)
------------ -------------
Pro forma net income $ 1,088,663 $ 1,042,453
Basic net income per share:
As reported $ .34 $ .32
Pro forma $ .31 $ .30
Diluted net income per share:
As reported $ .31 $ .30
Pro forma $ .28 $ .28
SPLIT-UP OF ALLIANCE TELECOMMUNICATIONS CORPORATION
Prior to July 7, 2003 Alliance Telecommunications Corporation ("Alliance") was
68% owned by HCC. Golden West Telecommunications Cooperative, Inc. ("Golden
West") of Wall, South Dakota and Alliance Communications Cooperative, Inc.
("ACCI") of Garretson, South Dakota owned the remaining interests in Alliance.
Effective July 7, 2003 Alliance was reorganized under Section 355 of the
Internal Revenue Code ("the split-up transactions'). In the split-up
transactions, Golden West exchanged its minority ownership interest in Alliance
for all of the outstanding stock of Sioux Valley Telephone Company, which
included a pro rata share of Alliance's ownership interest in Midwest Wireless
Holdings, LLC and certain other Alliance assets. ACCI exchanged its minority
ownership interest in Alliance for all of the outstanding stock of Hills
Telephone Company, which included a pro rata share of Alliance's ownership
interest in Midwest Wireless Holdings, LLC and certain other Alliance assets.
HCC became the 100% owner of all remaining Alliance assets and operations.
The Company believes the split-up transactions are tax-free under Section 355 of
the Internal Revenue Code. The Company also believes that related internal stock
and asset transfers that occurred prior to the split-up are 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.
8
Operating results for the discontinued operations in the 2003 period was as
follows:
Revenues $ 2,460,630
Operating costs and expenses 1,471,239
------------
Operating income 989,391
Other income and (expense):
Interest expense (325,111)
Interest and dividend income 13,689
Income from investment in Midwest Wireless Holdings, LLC 183,603
Income from investment in other unconsolidated affiliates 105,197
------------
Other expense, net (22,622)
Income before income taxes and minority interest 966,769
Income tax expense 387,000
------------
Income before minority interest 579,769
Minority interest in discontinued operations of
Alliance Telecommunications Corporation (185,526)
------------
Income from discontinued operations $ 394,243
============
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 and when changes in circumstances indicate that the value of
goodwill may be below its carrying value.
Goodwill is tested using a two step process based upon a fair value approach. In
the first step, the fair values of the reporting units underlying the Company's
segments are estimated. The valuation method used by the Company includes an
average of access line and customer valuations and cash flow multiple valuations
it considers appropriate in the current marketplace. If the fair value of a
reporting unit is less than its carrying value, a second step is required to
measure the amount of goodwill impairment. For 2003, the Company performed its
annual impairment test of goodwill during the third quarter. The determined fair
value of the reporting units was sufficient to pass the first step impairment
test, and no impairment was recorded. The Company believes the valuations placed
on the reporting units in the test were consistent with values placed on other
similar properties in recent comparable transactions and that valuation of the
reporting units using different methods would have yielded similar results.
The carrying value of HCC's goodwill was $31,692,000 at March 31, 2004 and
December 31, 2003. $30,187,000 of goodwill is related to the Company's telephone
operations. $1,505,000 of goodwill is related to other operations.
9
Changes in the Company's intangible and other assets are as follows:
Loan
Origination Customer Other
Fees Lists Assets Total
--------- -------- --------- ----------
Balance December 31, 2003 $ 162,687 $ 83,306 $ 163,671 $ 409,664
Disposals (1,645) (1,645)
Amortization (4,404) (5,861) (10,265)
--------- -------- --------- ----------
Balance March 31, 2004 $ 158,283 $ 77,445 $ 162,026 $ 397,754
========= ======== ========= ==========
MIDWEST WIRELESS HOLDINGS, LLC
At March 31, 2004 the Company owned 8.0% 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 included in
continuing operations was $682,000 and $623,000 in the three-month periods ended
March 31, 2004 and 2003, respectively. Cash distributions received by continuing
operations from Midwest Wireless were $197,000 and $233,000 in the same
respective periods.
Discontinued operations of the Company include a 2.4% ownership interest in
Midwest Wireless Holdings, LLC. Income from this investment included in
discontinued operations in the three-month period ended March 31, 2003 was
$184,000.
Income statement information for Midwest Wireless Holdings, LLC for the
three-month periods ended March 31, 2004 and 2003 was as follows:
Three Months Ended March 31
------------------------------
2004 2003
------------ ------------
Revenues $ 48,427,000 $ 38,416,758
Expenses (38,819,540) (29,675,491)
Minority interest (1,080,843) (987,763)
Net income 8,526,617 7,753,504
SEGMENT INFORMATION
The Company has changed its segment data presentation to match its new
organization subsequent to the split-up of Alliance Telecommunications
Corporation. Segment information is presented on a product line basis. The
majority of the Company's operations consist of providing basic telephone
services (often referred to as "plain old telephone service" or "POTS") to
residential and business customers within its service territories. POTS revenues
consist mainly of fees for local service which are billed directly to customers
and access revenues which are received for intrastate and interstate exchange
services provided to long distance carriers. POTS revenues are subject to
regulation by a number of state and federal government agencies.
The Company also provides a number of nonregulated telecommunications services
to customers. These services include cable television or video service, 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. Segment information provided presents only continuing
operations except where noted.
10
POTS Other Services Total
------------- ------------- -------------
Three Months Ended March 31, 2004
Revenues from continuing operations $ 5,506,464 $ 2,439,189 $ 7,945,653
Costs and expenses 3,969,507 1,994,953 5,964,460
------------ ------------- -------------
Operating income from continuing operations 1,536,957 444,236 1,981,193
============ ============= =============
Depreciation and amortization $ 1,542,104 $ 466,165 $ 2,008,269
============ ============= =============
Total assets $ 94,399,899 $ 31,007,129 $ 125,407,028
============ ============= =============
Capital expenditures $ 601,040 $ 102,169 $ 703,209
============ ============= =============
Three Months Ended March 31, 2003
Revenues from continuing operations $ 5,521,028 $ 2,511,929 $ 8,032,957
Costs and expenses 4,157,587 2,043,429 6,201,016
------------- ------------- -------------
Operating income from continuing operations 1,363,441 468,500 1,831,941
============= ============= =============
Depreciation and amortization $ 1,564,035 $ 428,772 $ 1,992,807
============= ============= =============
Total assets:
Continuing operations $ 108,046,901 $ 34,361,695 $ 142,408,596
Discontinued operations 14,901,643 2,689,869 17,591,512
------------- ------------- -------------
Total assets $ 122,948,544 $ 37,051,564 $ 160,000,108
============= ============= =============
Capital expenditures:
Continuing operations $ 331,171 $ 157,206 $ 488,377
Discontinued operations 76,650 76,650
------------- ------------- -------------
$ 407,821 $ 157,206 $ 565,027
============= ============= =============
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 March 31, 2004 HCC operated nine wholly-owned local exchange company
subsidiaries (generally referred to as "local exchange carriers" or "LECs")
serving 29,793 access lines in 28 rural communities in Minnesota, Wisconsin and
North Dakota. HCC, through its subsidiaries, also provides cable television
service to 9,009 subscribers in Minnesota and Wisconsin.
Prior to July 7, 2003 Alliance Telecommunications Corporation ("Alliance") was
68% owned by HCC. ("Golden West") of Wall, South Dakota and Alliance
Communications Cooperative, Inc. ("ACCI") of Garretson, South Dakota owned the
remaining interests in Alliance. Effective July 7, 2003 Alliance was reorganized
under Section 355 of the Internal Revenue Code ("the split-up transactions'). In
the split-up transactions, Golden West exchanged its minority ownership interest
in Alliance for all of the outstanding stock of Sioux Valley Telephone Company,
which included a pro rata share of Alliance's ownership interest in Midwest
Wireless Holdings, LLC and certain other Alliance assets. ACCI exchanged its
minority ownership interest in Alliance for all of the outstanding stock of
Hills Telephone Company, which included a pro rata share of Alliance's ownership
interest in Midwest Wireless Holdings, LLC and certain other Alliance assets.
HCC became the 100% owner of all remaining Alliance assets and operations.
11
The Company has changed its discussion format to conform to the presentation of
its segment information. Disclosures in the discussion relate to the Company's
continuing operations.
Three Months Ended March 31, 2004 Compared to Three Months Ended March 31, 2003
- --------------------------------------------------------------------------------
Revenues from continuing operations decreased 1% to $7,946,000 in 2004 from
$8,033,000 in 2003. The revenue breakdown was as follows:
Three Months Ended March 31
-------------------------------
2004 2003
----------- ------------
Plain old telephone service ("POTS"):
Local network $ 1,492,851 $ 1,461,788
Network access revenues:
Long distance providers (including NECA) 3,526,926 3,571,546
Universal service fund support 486,687 487,694
----------- ------------
Total network access revenues 4,013,613 4,059,240
----------- ------------
Total POTS revenues 5,506,464 5,521,028
----------- ------------
Other services:
Video services 818,253 963,448
Internet services 741,148 570,277
Other nonregulated services:
Fiber leases 197,083 251,591
Cellular sales commissions 124,298 55,525
Directory revenues 119,671 120,758
Retail sales 112,065 92,886
Long distance resale 96,558 99,498
Customer equipment installation and repair 90,224 94,493
Engineering services 21,755 98,549
All other revenues 118,134 164,904
----------- -----------
Total nonregulated services revenue 879,788 978,204
----------- -----------
Total other service revenues 2,439,189 2,511,929
----------- -----------
Total revenue $ 7,945,653 $ 8,032,957
=========== ===========
Overall POTS revenues decreased $15,000. Local network revenues increased
$31,000 or 2%. The increase was primarily due to increased revenues from CLASS
service features (which include caller identification, call-waiting, call
forwarding and other related services) and increased extended area service
("EAS") revenues in one exchange. EAS enables customers to call neighboring
telephone systems toll free in exchange for a flat monthly fee. The Company
increased the rates charged for CLASS services during the 2003 period. Access
lines served were 29,793 at March 31, 2004, a decrease of 1% from March, 2003.
The number of access lines the Company serves fell due to increased substitution
of cellular phones for landline phones by customers and the reduced number of
second lines being used for dial-up internet service.
Network access revenues decreased $46,000 or 1%. Access revenues in 2003
benefited from greater than anticipated recovery of bankruptcy reserves the
Company established against its WorldCom receivables in 2002. Increases in
universal service fund support the Company received in areas where it has newly
installed Next Level equipment were offset by decreases in support for other
areas.
Total revenues from other services decreased $73,000 or 3%. Revenues from video
(cable television) services declined $145,000 or 15%. Video service revenues in
2004 were reduced by the sales of seven systems serving 2,080 subscribers during
the second quarter of 2003. Revenues from internet services increased $171,000
or 30%, due to a 46% increase in the number of DSL customers it serves. At March
31, 2004 the Company had 2,991 digital subscriber line ("DSL") customers and
7,399 dial-up internet customers, compared to 2,051 DSL customers and 7,633
dial-up customers in March 2003. The DSL customer growth was facilitated by the
deployment of broadband equipment manufactured by Next Level Communications,
Inc. in the Company's Sleepy Eye, MN exchange in 2002 and 2003. This equipment
makes it possible to deliver voice, video and high speed internet services to
the customer over the same circuit.
12
Revenues from other nonregulated services declined $98,000 or 10%. The revenue
decline was due to lower revenues from leases of fiber optic facilities and
lower fees from engineering services which offset higher cellular commissions
and higher retail sales.
Operating costs and expenses were $5,964,000 in 2004, a decrease of 4% from
$6,201,000 in 2003. The breakdown of costs and expenses was as follows:
Three Months Ended March 31
-------------------------------
2004 2003
----------- -----------
Plain old telephone service ("POTS"):
Plant operations, excluding depreciation $ 1,054,215 $ 1,296,400
Customer operations 313,575 340,700
General and administrative 957,123 870,820
Depreciation and amortization 1,542,104 1,564,035
Operating taxes 102,490 85,632
----------- -----------
Total POTS costs and expenses 3,969,507 4,157,587
----------- -----------
Other services:
Customer operations 37,443 33,052
General and administrative 201,926 249,866
Depreciation and amortization 466,165 428,772
Other costs and expenses:
Video service expenses 678,536 786,864
Internet expenses 236,880 234,357
Other 374,003 310,518
----------- -----------
Total Other service costs and expenses 1,994,953 2,043,429
----------- -----------
Total costs and expenses $ 5,964,460 $ 6,201,016
=========== ===========
Total POTS costs and expenses decreased $188,000 or 5%. Plant operations
expenses decreased $242,000 or 19% due to reduced headcount - 2003 included
severance charges for employee headcount reductions. Customer operations
expenses decreased $27,000 or 8% due to employee headcount reductions. General
and administrative expenses increased $86,000 or 10%. Operating income in 2004
from POTS was $1,537,000, an increase of 13% from $1,363,000 in 2003.
Total costs and expenses for other services declined $48,000 or 2%. Video
service expenses declined $108,000 or 14% due to sales of cable television
systems in 2003. Internet expenses were flat. General and administrative
expenses decreased $48,000 or 19% from 2003, which included expenses incurred in
breaking up Alliance. Depreciation expense increased $37,000 or 9% due to
depreciation on new plant investments. Operating income in 2004 from other
services was $444,000, a decrease of 5% from $468,000 in 2003. Total operating
income from continuing operations increased 8% to $1,981,000.
Interest expenses decreased $122,000 due to lower interest rates on borrowings
from CoBank. A significant portion of the Company's CoBank debt moved from a
higher fixed interest rate to lower floating market rates during the fourth
quarter of 2003. Interest and dividend income decreased $27,000 due to lower
interest rates paid on invested cash balances.
13
Income from the Company's investment in Midwest Wireless Holdings, LLC increased
10% to $682,000. Midwest Wireless benefited from determinations by regulators
that its operations were eligible to receive universal service high cost support
funds. The Company had income from other unconsolidated investments of $45,000
in 2004 compared to losses of $97,000 in 2003.
Income from continuing operations before income taxes and minority interest
increased 29% to $1,991,000. Income tax expense increased to $797,000 in 2004
from $619,000 in 2003. Income before minority interest in Alliance's earnings
was $1,194,000 in 2004 compared to $927,000 in 2003. Minority interests in
earnings of Alliance from continuing operations in the first three months of
2003 were $195,000. Income from continuing operations totaled $1,194,000
compared to $732,000 in 2003.
Income from discontinued operations before minority interest in 2003 was
$580,000. Minority interests in those earnings were $186,000. The Company had
net income of $1,194,000 in 2004 compared to $1,127,000 in 2003.
Liquidity and Capital Resources
-------------------------------
Cash flows from consolidated operating activities (including the activities of
discontinued operations in 2003) for the three-month periods were $3,516,000 and
$3,945,000 in 2004 and 2003, respectively. At March 31, 2004, the Company's cash
and cash equivalents totaled $18,770,000 compared to $16,581,000 at December 31,
2003. Working capital at March 31, 2004 was $16,823,000 compared to $13,314,000
at December 31, 2003. The current ratio was 2.5 to 1 at March 31, 2004.
The improvement in the Company's working capital and current ratio at March 31
was due to several factors. The Company received $2,034,000 of loan funds from
the Rural Utilities Service and Rural Telephone Bank during the first quarter to
finance plant additions in the Indianhead and Pine Island telephone exchanges.
At March 31, 2004, construction funds available totaled $5,270,000. The Company
received $747,000 of cash during the first quarter from the exercise of employee
stock options.
Plant additions in support of the Company's continuing operations in the 2004
and 2003 periods were $703,000 and $488,000, respectively. Plant additions in
the first quarter went primarily to upgrade the Company's central offices to
enable local number portability ("LNP"). The Company's LEC subsidiaries are
subject to FCC rules requiring wireline telephone numbers to be "ported" to
wireless carriers. The process makes it possible for customers to change their
telephone service from wireline to wireless without changing their telephone
numbers. The FCC has not established final rules covering payments of the costs
of LNP. One of the Company's LECs became subject to the LNP rules in November,
2003. The others will become subject to the rules in May, 2004.
The Company makes periodic improvements to its facilities to provide up-to-date
services to its customers. Plant additions for 2004 are expected to total
$4,400,000 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 borrowing to finance
Alliance's acquisition of Ollig Utilities Company. Prior to the split-up
transaction, Alliance and its subsidiaries carried this debt. In July 2003 the
Company repaid the acquisition loan with proceeds from a new term loan provided
to HCC by CoBank. The loan is secured by a pledge of the stock of HCC's
subsidiary companies. Interest rates on long-term portions of the loan are fixed
through 2007, while the non-fixed portion floats at short-term market rates. The
average rate on the total loan was approximately 4.4% at March 31, 2004.
Principal payments are made quarterly and will continue until April 2013. The
outstanding balance on this loan at March 31, 2004 was $25,438,000.
14
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
March 31, 2004, 215,000 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.
However, competition for properties that become available remains intense. 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.
New Accounting Principles
In December 2003, the FASB issued a revised Financial Interpretation ("FIN") No.
46, "Consolidation of Variable Interest Entities". FIN No. 46 requires the
assets, liabilities and results of operations of variable interest entities to
be included in the Company's financial statements if the entities have certain
financial characteristics. FIN No. 46 is effective for investments in
special-purpose entities for periods ending after December 15, 2003, and for
other types of entities for periods ending after March 15, 2004. Adoption of FIN
No. 46 did not result in consolidation or change the Company's disclosures for
any of the entities in which it maintains investments.
In December 2003, the FASB issued a revision of SFAS No. 132, "Employers'
Disclosures about Pensions and Other Postretirement Benefits". The statement
revises the disclosures required for pension and other post-retirement benefit
plans. The new disclosure requirements are reflected in the Company's Notes to
Consolidated Financial Statements in this report as appropriate.
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
The Company, with the participation of management, including the Chief Executive
Officer ("CEO") and Chief Financial Officer ("CFO"), evaluated the effectiveness
of the Company's disclosure controls and procedures as of the end of the period
covered by this report. HCC's disclosure controls and procedures are designed to
provide a reasonable level of assurance that information required to be
disclosed in the Company's reports under the Securities Exchange Act of 1934 is
recorded and reported within the appropriate time periods. Based upon that
evaluation, the CEO and CFO concluded that the Company's disclosure controls and
procedures are effective. During the period covered by this report, there have
been no changes in internal control over financial reporting that have
materially affected or are reasonably likely to materially affect the Company's
internal control over financial reporting.
15
- --------------------------------------------------------------------------------
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 - 5. Not Applicable
Item 6(a). Exhibits Filed Herewith
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 March 12, 2004, the Company filed a current report on Form 8-K with the
Securities and Exchange Commission, reporting under Items 7 and 12 its fourth
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: May 13, 2004 Chief Executive Officer
By /s/Charles A. Braun
-----------------------------
Charles A. Braun
Date: May 13, 2004 Chief Financial Officer
16