Back to GetFilings.com
=======================+========================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
--- SECURITIES EXCHANGE ACT OF 1934 [FEE REQUIRED]
For the fiscal year ended December 31, 1996
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
Commission File Number: 0-18587
HECTOR COMMUNICATIONS CORPORATION
(Exact name of registrant as specified in its charter)
Minnesota 41-1666660
(State or other jurisdiction (Federal Employer
of incorporation or organization) Identification No.)
211 South Main Street
Hector, MN 55342
(Address of principal executive offices and zip code)
Registrant's telephone number, including area code: (320) 848-6611
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Title of each class
Common Stock, $.01 par value
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES X NO
--- ---
Indicate by a check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. ( )
The aggregate market value of the voting stock held by non-affiliates of the
Registrant was approximately $10,054,000 based upon the closing sale price of
the Company's common stock on the NASDAQ National Market System on March 19,
1997.
As of March 19, 1997 there were outstanding 1,883,857 shares of the Registrant's
common stock.
Documents Incorporated by Reference: The Company's Proxy Statement for its
Annual Meeting of Shareholders to be
held on May 22, 1997 is
incorporated by reference into
Part III of this Form 10-K.
========================================+=======================================
PART I.
ITEM 1. BUSINESS
[a] GENERAL DEVELOPMENT OF BUSINESS
Hector Communications Corporation ("HCC" or "Company") is a diversified
telecommunications holding company which, through its wholly-owned and
majority-owned subsidiaries, is principally engaged in providing local telephone
service. At December 31, 1996, the Company's wholly and majority owned telephone
subsidiaries (generally referred to as "local exchange carriers" or "LECs")
served approximately 32,000 access lines and provided telephone service to 34
rural communities in Minnesota, Wisconsin, South Dakota and Iowa. In addition,
at such date, through its cable television subsidiaries and one LEC subsidiary,
the Company provided cable television services to approximately 8,100
subscribers in Minnesota, South Dakota and Wisconsin. The Company is also an
investor in partnerships and corporations providing cellular telephone and other
telecommunications related services.
Since becoming a publicly-held company in 1990, HCC has owned and
operated five wholly owned-owned local exchange company subsidiaries which
served 6,331 access lines at December 31, 1995. On April 25, 1996, HCC, through
its 68% owned subsidiary, Alliance Telecommunications Corporation ("Alliance"),
acquired Ollig Utilities Company ("Ollig"), a privately owned telecommunications
holding company for $80 million. At the time of the acquisition, Ollig
subsidiaries served approximately 25,000 access lines and 3,400 cable television
subscribers in Minnesota, Iowa, North Dakota and South Dakota. In addition to
the Company's 68% ownership position, the remaining interests in Alliance are
owned by Golden West Telecommunications Cooperative, Inc. of Wall, South Dakota,
and Split Rock Telecom Cooperative, Inc. of Garretson, South Dakota. Further
information with regard to the acquisition of Ollig through Alliance can be
obtained by reference to the Company's Form 8-K report for April 25, 1996, as
amended by a Form 8 amendment filed July 9, 1996.
[b] FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS
The Company operates in two business segments, operation of local
exchange telephone companies and cable television. Information regarding
industry segments is provided in Note 10 to the financial statements found under
Item 8 of this report.
[c] NARRATIVE DESCRIPTION OF BUSINESS
(1) Business Strategy
The Company's business strategy is to expand its existing operations
through internal growth and acquisitions, particularly the acquisition of
additional rural telephone exchanges, and to explore other communications
business opportunities, including the acquisition of cable television
properties.
Future growth in existing telephone and cable operations is expected to
come from providing service to new or presently unserved homes and businesses,
from upgrading existing customers to higher grades of service and from providing
new services made possible by improvements in technology.
The Company continually assesses acquisition opportunities. Competition
to acquire attractive telephone or cable television properties is intense.
Further, acquisitions of rural telephone exchanges are subject to the approval
of regulatory agencies in some states and, in some cases, to federal waivers
that may affect the form of regulation or amount of interstate cost recovery of
acquired telephone exchanges. While management will aggressively pursue
acquisitions of telephone exchanges, there can be no assurance that the Company
will be able to negotiate acquisitions on acceptable terms or that regulatory
approvals, where required, will be received.
2
(2) Telephone Operations
The Company provides modern, high-quality local telephone service and
access to long distance telephone service through its five wholly owned and four
majority owned local exchange carrier subsidiaries. Local service is directly
provided by the Company's LECs and long distance or toll service is provided
through connections with interexchange carriers ("IXCs"), primarily AT&T, MCI
and Sprint. All subscribers have private line service. The Company's customer
base is approximately 81% residential and approximately 19% commercial and
industrial.
The following chart presents the number of access lines served by the
Company's wholly owned LEC subsidiaries at December 31, 1996, 1995 and 1994 and
by the LEC subsidiaries of Alliance at December 31, 1996:
Telephone Company Access Lines*
December 31
1996 1995 1994
----------- ----------- ---------
Arrowhead Communications Corporation 748 738 716
Eagle Valley Telephone Company 678 659 658
Granada Telephone Company 276 263 264
Pine Island Telephone Company 2,775 2,663 2,590
Indianhead Telephone Company 2,057 2,008 2,010
Alliance Telecommunications Corporation:
Loretel Systems, Inc. 11,852
Sleepy Eye Telephone Company 5,814
Sioux Valley Telephone Company 5,355
Hills Telephone Company 2,465
--------- ---------- ---------
32,020 6,331 6,238
========== ========== =========
* An "access line" is a single or multi-party circuit between the customer's
establishment and the central switching office.
It is the Company's policy, insofar as possible, to maintain local
management in each of its local exchange carrier subsidiaries. The Company
provides its wholly owned LEC subsidiaries with centralized purchasing, general
management and other services. These services afford the subsidiaries expertise
in the following areas: finance, accounting and treasury services, marketing,
customer service, traffic, engineering and construction, customer billing, rate
administration, credit and collection, and development of administrative and
procedural practices.
Regulation
The Company's LEC subsidiaries are subject to regulation by Minnesota,
South Dakota, Iowa and Wisconsin regulatory agencies with respect to intrastate
toll rates, intrastate access charges billed to intrastate IXCs, service areas,
service standards, accounting and related matters. In some cases, local rates,
rate of return, depreciation rates, construction plans and borrowings and
certain other financial transactions may be subject to regulatory approval.
Local service rates are not directly determined by regulatory authorities, but
are limited by regulation of these other areas. The Company has sought and will
continue to seek appropriate increases in local and other service rates and
changes in rate structures to achieve reasonable rates and earnings.
A bill passed by the 1995 Minnesota legislature allows telephone
companies serving fewer than 50,000 access lines to elect to provide service
under an alternate form of regulation. Companies choosing alternative regulation
agree not to increase rates for two years (other than in extraordinary
circumstances) and are not subject to rate of return review by the Public
Utilities Commission for the same period. All of the Company's Minnesota based
LEC subsidiaries elected to be covered by alternative rate regulation election
effective January 1, 1996.
3
The Federal Communications Commission ("FCC") regulates interstate toll
rates, interstate access charges paid by IXCs to local exchange carriers and
other matters relating to interstate telephone service. The FCC also regulates
the use of radio frequencies in telephone operations. The Company's telephone
subsidiaries use common line and traffic sensitive tariffs set by the National
Exchange Carriers Association ("NECA") and participate in the access revenue
pools administered by NECA for interstate services. Where applicable, the
Company's subsidiaries also participate in intrastate access tariffs approved by
state regulatory authorities for intrastate intra-LATA (Local Access Transport
Area) and inter-LATA services. Such interstate and intrastate arrangements are
intended to compensate LECs, such as the Company's local exchange carrier
subsidiaries, for the costs, including a fair rate of return, of facilities
furnished in originating and terminating interstate and intrastate long distance
services.
A number of the telephone subsidiaries recover a portion of their costs
via interstate and intrastate support mechanisms. Reevaluation and probable
modification of these mechanisms is expected. The interstate universal service
fund, which is administered by NECA, has been capped and indexed as an interim
measure pending regulatory proceedings. The Telecommunications Act of 1996
includes provisions to widen the base of providers contributing support for
universal service, but also requires development of new mechanisms and
eligibility criteria. There is no assurance cost recovery through direct and
indirect interstate mechanisms will remain at current levels. Support and rate
structures are in the process of being reduced in Minnesota and have been
recently changed in Wisconsin. There is no assurance the states will continue to
provide for cost recovery from current sources at current levels. The Company
expects to seek higher local service rates to recover costs for which current
interstate or intrastate recovery may become unavailable. The Company's
Wisconsin based LEC subsidiary implemented a local service rate increase
December 1, 1995 to compensate for changes in Wisconsin's support structure.
Construction and Development Program
The Company's policy is to upgrade plant and equipment of its local
exchange carrier subsidiaries to maintain modern, high quality telephone
service. The Company makes plant additions to upgrade service and replace
existing facilities and provides for routine service expansions. This program
also allows the Company to improve service, increase revenues and reduce costs
by taking advantage of technological developments in the telecommunications
industry. The Company has converted 100% of its access lines to digital
switching technology and is installing high-capacity fiber optic cable
facilities where appropriate. The Company expects to finance its telephone
construction program with internally generated cash, supplemented by long-term
financing from federal financing programs.
Federal Financing Programs and Other Financing Sources
The Company's primary sources of long-term financing for additions to
telephone plant and equipment have been the Rural Utilities Service (RUS) and
the Rural Telephone Bank (RTB). The RUS has made long-term loans to telephone
companies since 1949, at interest rates of 2% and 5%, for the purpose of
improving telephone service in rural areas. Since October 1, 1991 the RUS is
also authorized to make hardship loans at a 5% interest rate and cost-of-money
loans at a rate reflecting the government's cost of money for a like term. The
RTB advances funds under loan applications approved prior to October 1, 1991 at
interest rates based on the RTB's average cost-of-money For RTB loan
applications approved after October 1, 1991, advances are at the average U.S.
government cost-of-money for the year for like maturities. In some cases RTB
loans are made concurrently with RUS loans.
Substantially all of the telephone plant of the local exchange carrier
subsidiaries is pledged or is subject to mortgages to secure obligations to the
RUS and RTB. In addition, the amount of dividends on common stock that may be
paid by the Company's local exchange carrier subsidiaries is limited by certain
financial covenants set forth in the mortgages.
At December 31, 1996, the Company's local exchange carrier subsidiaries
had unadvanced loan commitments under the RUS and RTB programs aggregating
approximately $4,616,000 to finance specific construction activities in future
years. The Company's LEC subsidiaries have applied for additional loans from RUS
and RTB for their respective five year capital requirements and have received
preliminary approvals on some of the loans. However, there is no assurance the
Company will be able to draw down funds on these loans and no guarantee the loan
terms or interest rates will be acceptable to the Company. If the Company is
unable to borrow funds through the RUS and RTB programs and the LEC subsidiaries
were to borrow instead from conventional lenders, the cost of new loans might
increase significantly.
4
In 1996, the Company's 68% owned subsidiary, Alliance
Telecommunications Corporation negotiated a term loan agreement with the St.
Paul Bank for Cooperatives ("St. Paul Bank") to provide financing for the
acquisition of Ollig Utilities Company. Face amount of the loan was $55,250,000.
The Company has fixed interest rates on $30,000,000 on this loan for periods
ranging from five to seven years at rates of approximately 7.6%. The interest
rate on the balance of the loan floats at St. Paul Bank's cost of money plus 130
basis points, and was 6.71% at December 31, 1996. The Company made only interest
payments on the loan in 1996. Principal payments began in January 1997 and will
continue until March, 2011.
In 1996, the Company and one of its cable television subsidiaries,
North American Communications Corporation, negotiated a loan agreement with the
St. Paul Bank for Cooperatives to provide additional financing for the
acquisition of Ollig Utilities Company. Face amount of the loan was $6,000,000,
payable March 31, 1997. Interest rate on the loan, which varies according to St.
Paul Bank's cost of money, was 7.4% at December 31, 1996. The loan is secured by
a pledge of the assets of North American and the stock of one of the Company's
telephone subsidiaries.
St. Paul Bank is a cooperative, owned and controlled by its customers.
As a condition to receiving the loans, the Company purchased stock in the bank.
The Company's investment in St. Paul Bank stock at December 31, 1996 was
$1,614,000. Each customer borrowing from the bank on a patronage basis shares in
the bank's net income through payment of patronage refunds. The Company's 1996
patronage refund from St. Paul Bank was $221,000, $66,000 was received in cash
and $155,000 in stock of St. Paul Bank. The patronage refund is shown in the
Company's operating statement as a reduction of interest expense. The Company
cannot predict what patronage refunds will be in future years.
In February 1995 the Company completed a public offering of convertible
subordinated debentures. The debentures carry an interest rate of 8.5% and
mature February 15, 2002. The debentures are convertible into common stock of
the Company at a rate of 112.5 common shares per $1,000 par value debenture. The
debentures are callable under certain circumstances and include restrictions on
payment of dividends to the Company's shareholders. The debentures are
subordinated to $4,000,000 of senior indebtedness owed by the Company to St.
Paul Bank. Total value of the offering was $12,650,000. Proceeds to the Company,
after underwriting, accounting and legal expenses were approximately
$11,300,000. The underwriters also received warrants to purchase 123,750 shares
of the Company's common stock at a price of $8.70 per share. The warrants are
exercisable beginning February 15, 1996 and expire February 15, 2000. The
offering proceeds were used to pay down debt associated with cable television
acquisitions, finance cable television plant additions, purchase additional
cable television systems and as a portion of HCC's equity contribution to
Alliance to acquire Ollig Utilities Company.
Competition
In February 1996, President Clinton signed into law the
Telecommunications Act of 1996. The new law represents the biggest change in
legislation governing local service since Congress imposed federal regulation
and established the FCC in 1934. Under its provisions, the monopoly on local
service enjoyed by LECs is eliminated and LECs must allow competitors access to
the local network facilities. Among other provisions, the new law mandates
changes in the rules governing universal service supports, permits LECs to enter
the long distance business, and changes many of the provisions of the 1984
consent decree which broke apart AT&T and still restricts the activities of AT&T
and the Regional Bell Operating Companies. The final results of the changes made
by the new law will not be known for some time until new rule making by the FCC
and state regulatory agencies is complete. The Company is monitoring
developments regarding the new regulatory climate closely, and expects its
operations will be materially affected by the new rules, but cannot predict what
effect the new law and regulations adopted pursuant to the new law will have on
its business.
5
Prior to passage of the new telecommunications law, a series of FCC,
court and state regulatory agency decisions had served to introduce competition
into many sectors of the telephone industry, including interstate and intrastate
long distance services, special access services and customer premises equipment.
The Company is presently the only provider of local telephone service in the
areas it serves. The Company does not know to what extent it will be subject to
local competition in the markets it serves in the new regulatory environment
created by the new telecommunications law. Technological developments in
competing technologies such as cellular telephone, digital microwave, coaxial
cable, fiber optics and other wireless and wired technologies may result in
other forms of competition to the Company's landline services. The Company and
many other members of the local exchange carrier industry are seeking to
maintain a strong, universally affordable public telecommunications network
through policies and programs that are sensitive to the needs of small
communities and rural areas served by the Company's telephone subsidiaries.
Certain providers and users of long distance service may seek to bypass
LEC switching services and local distribution facilities, particularly if these
services are not strategically priced. There are many ways these customers may
bypass the Company's switching services. Users may construct and operate or
lease facilities to transmit their traffic to an interexchange carrier. Certain
interexchange carriers provide services which allow users to divert their
traffic from the LEC's usage sensitive services to flat-rate services. Users may
also choose to use cellular telephone service to bypass the LEC's switching
service. The Company's telephone subsidiaries have experienced only a small loss
of traffic due to bypass. The Company and the local exchange carrier industry
are seeking to address bypass problems by advocating flexible pricing, including
reduced pricing of access and long distance services where appropriate.
The new telecommunications law and recent FCC rulings which are
intended to promote competition in voice and video communications may provide
the Company with increased business opportunities. Recent changes permit local
telephone companies to offer video dial tone services, permitting greater
telephone company participation in the video marketplace. The rules against
cross-ownership of telephone and cable television systems have also been
somewhat relaxed. The FCC has also authorized cellular telephone, personal
communications services and other technologies which may compete with
traditional telephone services and provide new business opportunities. The
Company actively monitors legislative and regulatory changes to protect its own
interests and evaluate new opportunities.
The Clinton administration has actively promoted a national
communications policy directed toward creation of a broadband, interactive
national information infrastructure. The administration has advocated
legislation based on five principles: encouraging private investment, providing
and protecting competition, providing open access to the telecommunications
network, avoiding a society of information "haves" and "have nots", and
encouraging flexible and responsive government action. Given the
Administration's initiatives as well as recent Congressional actions, the
Company expects that eventually there may be open access to every aspect of the
communications industry. However, the new telecommunications law also mandates
continuing support for universal service and bans discrimination in toll rates
based on geography. The Company believes high-cost support funds and similar
cost-averaging methods should continue to be employed to ensure that advanced
communications services reach rural areas. The Company plans to compete by
providing advanced, high-quality voice, data and video services.
Cellular Telephone Services
Cellular telephone services provide high quality, high capacity
communications to and from vehicle mounted or hand held radio telephones
("cellular telephones"). Cellular technology is a major improvement over earlier
mobile telephone technologies. Cellular telephone systems are designed to allow
for maximum mobility of the customer. In addition to mobility, cellular
telephone systems provide access through system interconnects to local,
regional, national and worldwide telecommunications networks. Cellular telephone
systems also offer a full range of ancillary services such as conference
calling, call waiting, call forwarding, voice mail, facsimile and data
transmission.
6
The FCC has established 733 cellular service areas in the United
States, consisting of 305 Metropolitan Statistical Areas ("MSAs") and 428 Rural
Service Areas ("RSAs"). The FCC has granted two licenses to provide cellular
service in each territory. One license was granted to a company or affiliated
group of companies providing local telephone service in the area ("Wireline
Carriers"). The other license was granted to a company not providing local
telephone service and not affiliated with a local telephone company in the
service area ("Non-Wireline Carriers"). The Company acquired its interests in
cellular telephone as part of the Wireline Carrier group in the RSA markets in
which it owns a telephone operating company.
At December 31, 1996, the Company was an investor in four ventures
which provide cellular telephone service in ten RSAs in Minnesota, one RSA in
North Dakota and the Sioux Falls, South Dakota MSA and serve approximately
65,000 customers. The following table provides the Company's percentage of
ownership in each venture and the Company's proportionate share of the
population served by each venture at December 31, 1996.
Total Company's
Population Percent Share of
Name of Venture Service Area Equivalents(1) Ownership Total POPs
Rural Cellular Corporation MN RSAs 1, 2, 3, 610,000 4.19% 25,559
5 and 6
Midwest Wireless MN RSAs 7, 8, 9, 928,000 9.75% 90,480
Communications, LLC 10 and 11
Sioux Falls Cellular, Ltd. Sioux Falls, SD MSA 120,000 12.25% 14,700
Red River Cellular, Inc. ND RSA 3 92,000 1.60% 1,472
(1) Estimated population based on the 1990 United States Census.
In February, 1996, Rural Cellular Corporation completed an initial
offering of its common stock to the public. As part of the offering, HCC sold
61,133 shares of Rural Cellular Corporation and recorded a gain on sale of
$485,000.
In addition to competition between the two cellular licensees in each
territory, competition for cellular customers includes competing communications
technologies such as conventional land-line and mobile telephone, SMR systems
and radio paging. In addition, emerging technologies such as enhanced
specialized mobile radio ("ESMR"), mobile satellite communications systems,
second generation cordless telephones ("CT-2") and personal communications
services ("PCS") offer competition with cellular services.
There are a number of recent technological developments in the cellular
industry. Currently most cellular telephone systems use equipment which
processes information digitally but does radio transmission on an analog basis.
Digital radio technology offers advantages, including less transmission noise,
greater system capacity and lower incremental costs for additional customers.
The conversion from analog to digital radio technology is expected to be an
industry wide process that will take a number of years.
The cellular telephone industry is characterized by high initial fixed
costs. Accordingly, when system revenues less variable operating costs exceed
fixed costs, the system should generate an operating profit. Cellular profits,
if any, are dependent on service prices and variable marketing costs which are
affected by the amount and extent of competition. Until technological
limitations on total capacity are approached, additional cellular system
capacity can normally be added in increments that closely match demand and cost
proportionately less than the initial fixed costs.
The Company recorded income on its cellular partnership investments of
$502,000, $126,000 and $54,000 in 1996, 1995 and 1994, respectively. In 1994,
the Company recognized a gain of $2,188,000 on the sale of its investment in the
cellular system serving the Rochester, MN MSA. The Company cannot predict if its
cellular properties will require additional cash investments.
7
The licensing (including renewal of licenses), construction, operation,
sale, interconnection arrangements and acquisition of cellular systems are
regulated by the FCC and various state public utility commissions. Changes in
the regulation of cellular operators or their activities and of other mobile
service providers (such as the recent FCC issuances of PCS licenses) could have
a material adverse effect on the Company's investment in cellular operations.
Other Telecommunications Investments
The Company also has investments in several other telecommunications
related businesses, including a 12% ownership interest in Minnesota Equal Access
Network Services, Inc. ("MEANS"). MEANS was formed in 1988 to bring
state-of-the-art telecommunications to rural areas of Minnesota. MEANS is owned
by shareholders who represent more than two-thirds of the local exchange
carriers in Minnesota. MEANS operates a fiber optic communications network
linking communities throughout the state, including all the major metropolitan
areas. MEANS also owns a subsidiary, MEANS Telcom, which provides long-distance
telecommunications services to business and residential customers in rural
Minnesota. These services include (i) toll-free telephone numbers providing
access from anywhere in the Unites States and Canada, (ii) cellular telephone
service, (iii) prepaid calling cards and (iv) video conferencing.
The Company is also an investor in four limited partnerships which have
acquired licenses to provide personal communications services (PCS) in Minnesota
and North Dakota. These PCS companies are in the process of obtaining financing
and constructing PCS systems and are not yet providing service to customers.
(3) Cable Television Operations
The Company, through its cable television and local exchange carrier
subsidiaries, owns and operates 33 cable television systems serving
approximately 8,100 subscribers in 50 communities in Minnesota, South Dakota and
Wisconsin. All of its cable television systems offer one or more channels of
premium programming, typically feature motion pictures which are presented
without commercial interruption.
The Company's cable television revenues are derived almost exclusively
from monthly fees for basic and premium programming. The Company's fees for
basic services range from $9.75 to $22.50 per month. Basic service generally
includes the major television networks, non-network independent stations, sports
programming, news services and automated information channels, children's
programming, access channels for public, governmental, educational and leased
use, senior citizens' programming and religious programming. Premium programming
services are provided to subscribers for an additional fee of $4.95 to $10.95
per month per channel. Approximately one-third of the Company's cable television
customers subscribe to a premium channel. The Company obtains its premium
programming from suppliers for a flat monthly fee per subscriber and/or a fee
based on the monthly charge to subscribers for the service. Subscribers are free
to discontinue the cable service at any time without penalty. The Company
periodically increases its basic and premium programming subscriber fees to
reflect the addition of new cable television services and increased costs due to
inflation.
The Company's cable television systems are operated under 15 year,
non-exclusive franchises granted by local government authorities. These
franchises contain many conditions, including time limitations on commencement
or completion of construction, approval of initial fees charged to subscribers
for basic service, the number of channels offered and the types of programming.
The Company does not anticipate it will experience any difficulty in obtaining
renewal of its franchises at the expiration of their current terms.
8
Maintaining and expanding the Company's cable television subscriber base
depends on numerous factors, including the quality and quantity of signals
available from "off-air" television stations, demand for satellite and premium
television channels and average household income in the area. Cable television
also competes, in varying degrees, with other entertainment and leisure time
activities. Promotional efforts for cable television include telephone and
door-to-door solicitation and local media advertising.
All of the Company's franchises are non-exclusive and the Company
competes with a municipally owned cable system in one community it serves. In
addition to competition from off-air television, other technologies also supply
services provided by cable television. These include low power television
stations, multi-point distribution systems, over-the-air subscription television
and direct broadcast satellite ("DBS"). The Company believes that cable
television presently offers a wider variety of programming at lower cost than
any competing technology. However, the Company is unable to predict the effect
current or developing sources of competition may have on its business.
The Company's cable television systems are regulated by the FCC. FCC
regulations contain many detailed provisions including: "must carry" rules
regarding the broadcast television and translator signals the operator must
include in its channel offerings to subscribers, exclusivity provisions
(requiring the deletion of certain programming carried by out-of-area stations
where it would duplicate programming carried by local stations), technical
standards and performance testing requirements, and franchise fees applicable to
state and local cable television franchises. To date, the Company has not
experienced any difficulty in complying with the FCC rules.
The Company's basic service rates were frozen by the FCC from 1992 until
May 15, 1994 when FCC rules were issued exempting cable systems like those owned
by the Company from rate regulation. Under provisions of the Cable Television
Consumer Protection Act of 1992, the Company's systems could have become subject
to local rate regulation if the franchising city went though a certifying
process with the FCC. It is the Company's understanding that the recently passed
Telecommunications Act of 1996 has substantially eliminated local rate
regulation for small cable systems.
In Minnesota, the award of cable franchises and certain aspects of cable
operations are subject to rules of the Minnesota Cable Communications Board. To
date, the Company has not experienced significant difficulties in complying with
the requirements of Minnesota authorities.
The regulation of cable television at the federal, state and local levels
is subject to the political process and has been in constant flux over the past
decade. This process continues in the context of legislative proposals for new
laws and the adoption or deletion of administrative regulations and policies.
Further material developments in these areas are to be anticipated, but their
direction and impact on the Company's cable television operations cannot be
predicted.
(4) Employees
At March 1, 1997, the Company had 130 employees, of which 113 employees
work in the telephone operations, 12 work in cable television and 5 hold
administrative positions. None of the Company's employees are represented under
collective bargaining agreements. HCC believes its employee relations to be
good.
9
(5) Executive Officers of Registrant
The executive officers of the Company and their ages at March 1, 1997
were as follows:
Name Age Position
Curtis A. Sampson 63 Chairman of the Board and Chief
Executive Officer
Steven H. Sjogren 54 President and Chief Operating Officer
Paul N. Hanson 50 Vice President and Treasurer
Charles A. Braun 39 Chief Financial Officer
Executive officers serve at the pleasure of the Board of Directors and
are elected annually for one year terms.
Curtis A. Sampson has been Chairman of the Board and Chief Executive
Officer of the Company since 1990. Mr. Sampson is principally employed as
Chairman and Chief Executive Officer of Communications Systems, Inc. ("CSI") and
serves as the Chairman of the Board of Canterbury Park Holding Corporation, a
Shakopee, Minnesota based corporation which owns and operates the Canterbury
Downs racetrack. Mr. Sampson is also a director of the Rural Telephone Bank,
Minnesota Independent Interexchange Corp., a director and Vice President of
National Rural Telecom Association and a member of the Finance and Audit and
Compensation Committees of Minnesota Equal Access Network Services, Inc.
("MEANS"), of which Mr. Sampson was a director from 1989 to 1991.
Steven H. Sjogren has been the President, Chief Operating Officer and a
director of the Company since 1990. From 1979 to 1990, Mr. Sjogren was the Chief
Operating Officer of CSI's telephone companies. Mr. Sjogren serves on the
Industry Planning Committee of the Minnesota Telephone Association and the
Network Committee of MEANS and serves the industry in other capacities.
Paul N. Hanson has been Vice President, Treasurer and a director of the
Company since 1990. Mr. Hanson is also the Chief Financial Officer, Vice
President of Finance and Treasurer of CSI, in which position he has served since
1982.
Charles A. Braun has been the Chief Financial Officer of the Company
since 1990. Since 1980, Mr. Braun has also served in several capacities of CSI,
of which he is currently Controller. From 1986 to 1988, Mr. Braun was treasurer
of North American Communications, a cable television operating company that,
prior to 1986, was a subsidiary of CSI.
Mr. Sjogren devotes his full time to the Company's business. Messrs.
Sampson, Hanson and Braun each devote approximately 40% of their working time to
the Company's business with the balance devoted to CSI.
[d] FINANCIAL INFORMATION ABOUT FOREIGN AND DOMESTIC OPERATIONS AND
EXPORT SALES
Not Applicable.
10
ITEM 2. PROPERTIES
Telephone property consists mainly of central office switching equipment,
together with the land and buildings in which such equipment is housed, and
connecting lines which consist of aerial and underground cable, conduit, and
poles and wires, substantially all of which are located within the Company's
operating territories. Substantially all of the customer-leased telephones and
related terminal equipment, including private branch exchanges and a small
amount of connecting lines, are located on customers' premises. These telephones
and related equipment constitute approximately 2% of the Company's telephone
property. The lines, which connect customers' premises with central offices,
constitute approximately 58% of telephone plant. These facilities are located
under or above public rights of way or land owned, for the most part, by others
pursuant to consents of various governmental bodies or to leases, permits,
easements, agreements or licenses, express or implied through use without
objection by the owners.
Central office switching equipment represents approximately 32% of the
Company's telephone property in service. Buildings, land and miscellaneous
property constitute the remaining 8%. The Company owns substantially all the
land and buildings in which its central office equipment is located. HCC's
principal general offices, administrative services department and business
office are located in Hector, Minnesota and leased to HCC from CSI.
The principal physical assets of the Company's cable television system
operations consist of signal reception equipment and distribution electronics
and cables. The receiving equipment is comprised of a tower and antennas for
reception of broadcast television signals and one or more satellite dishes for
reception of satellite signals. The Company owns or leases the land on which the
towers for its cable systems and the buildings containing other receiving
equipment are located. Pole attachment space is leased from utilities serving
the community.
See Note 5 of "Notes to Consolidated Financial Statements for additional
information regarding pledged assets.
ITEM 3. LEGAL PROCEEDINGS
No material litigation or other claims are presently pending against the
Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
11
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS
[a] MARKET INFORMATION
The Company's common stock is currently being traded in the National
Market System of the National Association of Securities Dealers Automated
Quotation System ("NASDAQ").
The table below presents the range of high and low trading prices for the
Company's stock for each period as reported by NASDAQ.
______1996______ ______1995______
Quarter High Low High Low
First $8.75 $6.38 $8.75 $6.25
Second 8.50 6.00 8.50 6.38
Third 8.38 6.88 7.75 5.63
Fourth 8.00 7.00 7.25 5.75
[b] HOLDERS
At March 1, 1997 there were approximately 530 holders of record of
Hector Communications Corporation common stock.
[c] DIVIDENDS
HCC has not paid cash dividends on its common stock or preferred stock
since it began operating as a public company in 1990, nor does HCC have any
obligations to pay dividends on its preferred stock. At the present time, HCC
intends to retain earnings to finance the expansion of its business, and does
not anticipate any cash dividends will be paid in the foreseeable future. The
financing agreements between HCC's subsidiaries and their lenders restrict their
ability to pay dividends to HCC, thereby limiting HCC's ability to pay dividends
to its shareholders. See Management's Discussion and Analysis of Financial
Condition and Results of Operations. See also Note 5 to the Consolidated
Financial Statements under Item 8 herein for a description of restrictions on
dividends.
12
ITEM 6. SELECTED FINANCIAL DATA
SELECTED CONSOLIDATED FINANCIAL INFORMATION
(in thousands except per share amounts)
Year Ended December 31
-----------------------------------------------------------
1996 1995 1994 1993 1992
- --------------------------------------------------------------------------------------------------------------------------------
Selected Income Statement Information
Revenues $20,658 $5,844 $5,740 $5,354 $4,674
Costs and Expenses 14,066 4,992 4,175 4,037 3,453
- --------------------------------------------------------------------------------------------------------------------------------
Operating Income 6,592 852 1,565 1,317 1,221
Other Income (Expenses), net (3,518) (980) 2,055 (394) (340)
- --------------------------------------------------------------------------------------------------------------------------------
Income (Loss) Before Income Taxes 3,074 (128) 3,620 923 881
Income Tax Expense (Benefit) 1,540 (51) 1,415 354 320
- --------------------------------------------------------------------------------------------------------------------------------
Income (Loss) Before Minority Interest 1,534 (77) 2,205 569 561
Minority Interest in Earnings of Alliance
Telecommunications Corporation 325
- --------------------------------------------------------------------------------------------------------------------------------
Income (Loss) Before Cumulative Effect of
Change in Accounting Principle 1,209 (77) 2,205 569 561
Cumulative Effect of Change
in Accounting Principle 51
- --------------------------------------------------------------------------------------------------------------------------------
Net Income (Loss) $1,209 ($77) $2,205 $620 $561
- --------------------------------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------------------------------
Net Income (Loss) Per Common and Common Equivalent Share:
Before Cumulative Effect of Change
in Accounting Principle $.53 ($.04) $.97 $.25 $.25
Cumulative Effect of Change in
Accounting Principle .02
- --------------------------------------------------------------------------------------------------------------------------------
Net Income (Loss) Per Share $.53 ($.04) $.97 $.27 $.25
- --------------------------------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------------------------------
Average Common and Common Equivalent
Shares Outstanding 2,271 1,866 2,265 2,268 2,258
- --------------------------------------------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------------------------------------------
Selected Balance Sheet Information
Working Capital $1,307 $9,679 $4,740 $2,202 $1,157
Property, Plant and Equipment, net 47,039 14,609 13,019 12,894 12,371
Excess of Cost Over Net Assets Acquired, net 52,510 907 839 723 782
Total Assets 137,348 33,518 22,749 21,173 18,158
Long-Term Debt 96,127 22,096 10,528 10,797 9,957
Stockholders' Equity 9,946 8,134 8,230 6,006 5,328
- --------------------------------------------------------------------------------------------------------------------------------
Operating results for 1996 include the operations of Ollig Utilities
Company from the April 25, 1996 purchase date.
All common stock equivalents and potentially dilutive securities are
anti-dilutive for 1995 and are excluded from calculation of earnings per share
13
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Hector Communications Corporation ("HCC") owns a 100% interest in five local
exchange telephone subsidiaries and one cable television subsidiary. Effective
April 25, 1996, a new 68% owned subsidiary of the Company, Alliance
Telecommunications Corporation, acquired Ollig Utilities Company for
$80,000,000. The acquisition represents a huge expansion of the Company's
operations. At December 31, 1996, the Company's wholly and majority owned
subsidiaries provided telephone service to 32,000 access lines in 34 rural
communities in Minnesota, Wisconsin, South Dakota and Iowa. Its cable television
operations provided cable television services to approximately 8,100 subscribers
in Minnesota, South Dakota and Wisconsin. The Company is also an investor in
partnerships and corporations providing cellular telephone and other
telecommunications related services.
Results of Operations
General
The Company's telephone revenues are principally derived from the local
service and access revenues received by its local exchange carrier ("LEC")
subsidiaries. Local service revenues are earned by providing customers with
local service to connecting points within the local exchange boundaries and, in
certain cases, to nearby local exchanges under extended area service ("EAS")
plans which eliminate long distance charges to the neighboring exchanges.
Monthly rates for telephone service differ among the LECs depending upon the
cost of providing service, the type and grade of service, the number of
customers and calling patterns within the toll free calling area and other
factors.
Access revenues are received by LECs for intrastate and interstate
exchange services provided to long distance carriers (generally referred to as
interexchange carriers or "IXCs") which enable IXCs to provide long distance
service to end users in the local exchange network. Access revenues are
determined, in the case of interstate calls, according to rules promulgated by
the Federal Communications Commission ("FCC") and administered by the National
Exchange Carriers Association ("NECA") and, in the case of intrastate calls, by
state regulatory agencies. A relatively small portion of the Company's access
revenues are derived from subscriber line fees determined by the FCC and billed
directly to end users for access to long distance carriers. The balance of the
Company's interstate access revenues are received from NECA, which collects
payments from IXCs and distributes settlement payments to LECs based on a number
of factors, including the cost of providing service and the amount of time the
local network is utilized to provide long distance services. A variety of
factors, including increased subscriber counts, cultural and technological
changes, and rate reductions by IXCs, have resulted in a consistent pattern of
increasing use of the nation's telephone network since 1984. This growth has
produced higher revenues for NECA and increased settlements for its
participating LECs. The Company's settlements from NECA have increased every
year since the pool was established in 1984.
The Company's LECs also sell and lease customer premise telephone
equipment, provide inside wiring services and custom calling features and sell
and lease other facilities for private line, teletype, data transmission and
other communications services. The Company's LECs also provide billing and
collection services for certain IXCs in lieu of such IXCs directly billing
customers within the LECs service area.
The Company's cable television revenues are derived almost exclusively
from monthly fees for basic and premium services.
The following table presents the percentage of revenues derived from
local service revenues, access revenues, billing and collection services,
nonregulated telephone activities and cable television operations for the last
three years:
14
Year Ended December 31
------------------------------------------------
1996 1995 1994
----------- ---------- ---------
Local network 17.8 % 18.4% 17.0%
Network access 55.8 59.5 64.1
Nonregulated telephone activities 13.0 4.9 5.4
Billing and collecting 4.3 3.9 4.6
Cable television 9.1 13.3 8.9
----------- ----------- ---------
100.0 % 100.0% 100.0%
=========== ========== ==========
1996 Compared to 1995
Effective April 25, 1996, the Company's 68% owned subsidiary, Alliance
Telecommunications Corporation ("Alliance") purchased Ollig Utilities Company
("Ollig"), a privately owned telecommunications company which served
approximately 25,000 telephone access lines and 3,400 cable television customers
in Minnesota, Iowa, North Dakota and South Dakota for $80,000,000. Prior to the
acquisition, the Company served approximately 6,300 access lines and 4,200 cable
television customers. The operations of Ollig, which were substantially larger
than those of the Company prior to the acquisition, had a huge impact on the
Company's operating results over the last eight months of the year. The
Company's consolidated revenues increased $14,813,000 in 1996. The following
table shows revenues from Ollig's operations separate from those of the Company.
Ollig Utilities Hector Communications Corp.
8 Months Ended Twelve Months Ended December 31
December 31,1996 1996 1995
------------------- ------------------ ------------------
Local network $ 2,207,217 $ 1,474,912 $ 1,076,801
Network access 7,817,153 3,717,729 3,474,738
Billing and collection 656,706 224,908 228,038
Nonregulated activities 2,386,360 303,895 285,355
Cable television 628,988 1,239,653 779,391
------------------ ------------------ ------------------
Total $ 13,696,424 $ 6,961,097 $ 5,844,323
================== ================== ==================
Revenues from the Company's existing operations increased $1,117,000 or
19%. Local network revenues increased $398,000 or 37%. The increase was due to
local service rate increases imposed in the Company's Wisconsin telephone
exchanges in December, 1995 to offset revenue lost to the extended community
calling (ECC) program. Network access revenues increased $243,000 or 7% due to
increased interstate settlements from NECA. Cable television revenue increased
$460,000 or 59%, reflecting the full year impact of the August, 1995 acquisition
of cable systems from Lake Cable Partnerships.
Operating cost and administrative expenses increased $9,074,000 or 182%
over 1995. Operating costs and administrative expenses for Ollig operations and
existing company operations were as follows:
Ollig Utilities Hector Communications Corp.
8 Months Ended Twelve Months Ended December 31
December 31,1996 1996 1995
------------------ ------------------- ------------------
Plant operations $ 1,869,098 $ 838,787 $ 825,263
Depreciation and amortization 3,493,668 1,934,117 1,706,495
Customer operations 945,664 245,277 287,185
General and administrative 1,274,010 1,489,197 1,520,370
Nonregulated and miscellaneous 1,069,148 906,902 652,609
------------------ ------------------ ------------------
Total $ 8,651,588 $ 5,414,280 $ 4,991,922
================== ================== ==================
15
Operating costs and expenses for existing operations increased $422,000
or 8%. Expense increases were due primarily to increased operating expenses and
depreciation and amortization associated with the Lake Cable acquisition.
Consolidated operating income increased $5,739,000. Operating income from
existing operations increased $694,000 or 81%.
Consolidated interest expense, net of investment income increased
$3,800,000. Net interest expense for HCC increased $775,000, reflecting interest
on $6,000,000 of short-term borrowing from St. Paul Bank used in the acquisition
of Ollig, the full year effect on interest expense of the convertible debentures
issued in 1995, and reduced income due to decreased cash available for
investment. Interest expense on Alliance consists mainly of a $55,250,000
acquisition loan from St. Paul Bank for Cooperatives associated with the
purchase of Ollig Utilities Company, and interest on RUS and RTB loans existing
prior to the acquisition. HCC's investment income benefited from gains on sales
of marketable securities of $687,000 made during the first quarter of 1996.
Income from investments in cellular telephone partnerships increased $377,000 or
299%, due to the Company's increased ownership percentages of these operations
from the Ollig acquisition and also due to the increasing profitability of these
operations.
Consolidated income before income taxes was $3,074,000 compared to a loss
of $128,000 in 1995. HCC's income before income taxes, excluding Alliance, was
$885,000 in 1996. Income tax expense was $1,540,000 compared to a benefit of
$51,000 in 1995. The Company's effective tax rate of 50.1% in 1996 is higher
than the standard tax rate because the amortization expenses associated with
excess of cost over net assets acquired in the acquisition of Ollig ($836,000 in
1996) are not tax deductible. The 32% minority shareholders' interest in
earnings of Alliance was $325,000 in 1996. Net income was $1,209,000 compared to
a loss of $77,000 in 1995.
1995 Compared to 1994
Consolidated revenues increased $105,000, or 2% over 1994. Local service
revenues increased $102,000 or 10%. The number of access lines served by the
Company increased 1% to 6,331. Local service increased due to local revenues
generated by extended community calling ("ECC") in the Company's Wisconsin
exchanges and the addition of EAS service to Duluth from the Company's Cotton,
Minnesota exchange. However, these service changes reduced the number of
intrastate long distance calls handled by the Company, reducing intrastate
access revenues, which declined $250,000. In addition to the loss of toll calls
to ECC and EAS services, the Company's intrastate access rates in Minnesota were
reduced effective January 1, 1995, causing an additional revenue decline.
Intrastate access rates were reduced again effective January 1, 1996. Revenues
from interstate access increased $42,000 or 2% due to increased settlements from
NECA. Revenues from billing and collection services provided to long distance
carriers declined $35,000, or 13% due to the reduced volume of intrastate toll
calls discussed above. Revenues from nonregulated telephone services declined
$25,000, or 8%.
Cable television revenues increased $270,000, or 53%. In August, 1995,
the Company acquired 22 rural Minnesota cable television systems, serving
approximately 2,000 subscribers, from Lake Cable Partnerships, effectively
doubling the size of the Company's cable operations. The Company served
approximately 4,200 cable customers at December 31, 1995.
Operating costs and expenses increased $817,000 or 20% over 1994.
Telephone operating costs and administration expenses increased $229,000, or 7%,
due to increased corporate administration expenses, increased depreciation
expenses and the write-off of costs associated with the Company's unsuccessful
attempt to purchase additional telephone exchanges from U.S. West. Cable
television operating expenses increased $487,000, or 77% due to increased
operating costs and depreciation expenses associated with the acquisition of the
Lake Cable systems and $171,000 in write-off expenses associated with the
unsuccessful development of a proposed cable system and plant retirements in the
one cable system which is being rebuilt. Operating income declined $712,000, or
46%.
Interest expense, net of investment income, increased $492,000 due to
interest and amortization expenses associated with the Company's February 1995
public offering of $12,650,000 in 8.5% convertible debentures. Income from
cellular telephone partnerships increased $72,000. Unrealized losses on the
Company's marketable securities portfolio were $198,000 in 1995, compared to
$86,000 in 1994, due to reduced market valuation of the Company's holdings in
Telephone and Data Systems ("TDS"). The Company sold its TDS stock in the first
quarter of 1996. 1994 income also included a $2,188,000 pretax gain on sale of
the Company's investment in a cellular telephone system and recognition of a
deferred $315,000 gain on marketable securities.
16
The Company recorded a loss before income taxes of $128,000 in 1995,
compared to income of $3,620,000 in 1994. The Company's income tax benefit of
$51,000 was due primarily to amortization of deferred investment tax credits.
Net loss for 1995 was $77,000 compared to net income of $2,205,000 in 1994. In
1994, net income included $1,450,000, after income taxes, in gains on marketable
securities transactions and sale of the cellular telephone interest.
Liquidity and Capital Resources
On April 25, 1996, a newly formed subsidiary of the Company, Alliance
Telecommunications Corporation ("Alliance"), purchased Ollig Utilities Company
("Ollig") for $80,000,000 in cash. The Company owns 68% of Alliance with the
remaining interest owned by Golden West Telecommunications Cooperative, Inc. of
Wall, South Dakota and Split Rock Telecom Cooperative, Inc. of Garretson, South
Dakota. Alliance financed the acquisition using the combined equity investments
of its shareholders and $55,250,000 of long-term debt financing provided by St.
Paul Bank for Cooperatives ("St. Paul Bank"). The Company has locked in the
interest rates on $30,000,000 of this debt for periods of 5 - 7 years at rates
of 7.61% - 7.67%. Interest on the remaining $25,250,000 floats at St. Paul
Bank's cost of money plus 130 basis points (6.71% at December 31, 1996).
The Company's investment in Alliance is approximately $16,903,000, which
includes $6,000,000 of short term borrowing by the Company from St. Paul Bank,
purchase price deposits made by the Company in 1995, and $73,000 of acquisition
costs. The Company is exploring alternatives to repay or refinance the
$6,000,000 of short-term financing. These alternatives could include asset
sales, new debt borrowings if feasible, or pubic equity offerings.
St. Paul Bank is a cooperative, owned and controlled by its customers. As
a condition to receiving the loans, the Company purchased stock in the bank. The
Company's investment in St. Paul Bank stock at December 31, 1996 was $1,614,000.
Each customer borrowing from the bank on a patronage basis shares in the bank's
net income through payment of patronage refunds. The Company's 1996 patronage
refund from St. Paul Bank was $221,000, $66,000 was received in cash and
$155,000 in stock of St. Paul Bank. The Company cannot predict what patronage
refunds will be in future years.
The Company's LEC subsidiaries serve its telephone customers with a
100%-digital switching network and almost 100% buried outside plant. Telephone
plant additions in 1996, 1995 and 1994 were $4,669,000, $869,000 and $976,000,
respectively. Telephone plant additions for 1997 are expected to total
$4,100,000 and will provide customers with additional advanced switching
services as well as expand the Company's use of high capacity fiber optics in
its telephone network. Investments in cellular telephone partnerships were
$162,000 and $264,000 in 1995 and 1994, respectively.
The Company has financed its telephone asset additions from internally
generated funds and drawdowns of Rural Utilities Service ("RUS") and Rural
Telephone Bank ("RTB") loan funds. Proceeds from long-term borrowings by the
telephone companies were $411,000, $414,000, and $497,000 in 1996, 1995 and
1994, respectively. The Company's average interest rate on outstanding RUS and
RTB loans is 5.6%. Substantially all of the Company's telephone assets are
pledged or are subject to mortgages to secure obligations of its LECs to the RUS
and RTB. In addition, the amount of dividends on common stock that may be paid
by the Company's LEC subsidiaries is limited by covenants in the mortgages. The
Company is currently applying to the RUS and RTB for new loans, some of which
have received preliminary approval. At December 31, 1996, unadvanced loan
commitments from the RUS and RTB totaled $4,616,000.
In February 1995 the Company completed a public offering of convertible
subordinated debentures. The debentures carry an interest rate of 8.5% and
mature February 15, 2002. The debentures are convertible into common stock of
the Company at a rate of 112.5 common shares per $1,000 par value bond. The
bonds are callable under certain circumstances and include restrictions on
payment of dividends to the Company's shareholders. The debentures are
subordinated to $4,000,000 of the Company's short-term debt owed to St. Paul
Bank. Total value of the offering was $12,650,000. Proceeds to the Company,
after underwriting, accounting and legal expenses were approximately
$11,300,000. The underwriters also received warrants to purchase 123,750 shares
of the Company's common stock at a price of $8.70 per share. The warrants are
exercisable beginning February 15, 1996 and expire February 15, 2000. The
Company utilized the bond funds to pay down debt associated with its cable
television operation, finance cable television plant additions, purchase
additional cable television systems and acquire Ollig Utilities Company.
17
In 1994, the Wisconsin public service commission ("WPSC") implemented a
rule for interexchange calls to nearby communities (Extended Community Calling
or "ECC") which significantly reduced the Company's intrastate access revenues
in Wisconsin. Revenues from long distance and access services in 1995 in
Wisconsin declined $188,000 from 1994 levels. To compensate for the revenue
loss, the Company applied for and received a local service rate increase for its
Wisconsin exchanges, which went into effect in December, 1995.
In August 1995, the Company acquired 22 rural Minnesota cable systems,
serving approximately 2,000 customers, from Lake Cable Partnership for $2.2
million. In September, 1996, the Company acquired two additional cable systems
serving 320 subscribers for $319,000. Other capital additions to support the
Company's cable systems totaled $270,000, $263,000, and $486,000 in 1996, 1995
and 1994, respectively. Total cable television capital additions for 1997 are
estimated at $175,000.
Operating income from the Company's cable television operations neared
breakeven in 1996 after being unprofitable in earlier years. The operating
improvements have been due to the cable acquisitions made in 1995 and 1996,
which have allowed the Company to spread its costs over a larger number of
subscribers. 1995 operating results were adversely affected by write-downs on
some cable plant due to the necessary replacement of obsolete cable and
electronics and the write-off of development expenses associated with a plan to
build a cable system in Garrison, MN. The Company's cable operations continue to
suffer from a lack of scale economies in all its systems, which necessitates a
higher than industry average ratio of employees to customers. Continuing
improvement of cable operating results depends on increasing the Company's
subscriber base, achieving lower operating expense ratios and increasing system
revenues.
The Company's investment income has been derived almost exclusively from
interest earned on its cash and cash equivalents. Interest income earned by the
Company has fluctuated in relation to changes in interest rates and availability
of cash for investment. In the first quarter of 1996, the Company received
$1,499,000 from the sale of its remaining shares of Telephone and Data Systems,
Inc., obtained in the 1994 sale of its Rochester, MN cellular MSA interest. The
Company also sold 61,133 shares of Rural Cellular Corporation in that company's
initial public offering of its common stock in February, 1996. Proceeds to the
Company after selling expenses were $554,000. At December 31, 1996, the
Company's marketable securities portfolio consisted primarily of the remaining
shares of Rural Cellular Corp. (Nasdaq National Market: RCCC) which the Company
received in exchange for its investment in the cellular RSA partnerships in
northern Minnesota and shares of Rural Cellular Corp., U.S. West Communications,
Inc. and U.S. West Media, Inc. owned by Ollig Utilities Company prior to the
acquisition.
The Company produced cash from operating activities of $6,847,000,
$2,103,000 and $2,151,000 in 1996, 1995, and 1994, respectively. At December 31,
1996, the Company's cash, cash equivalents, temporary cash investments and
marketable securities totaled $16,110,000. Working capital at December 31, 1996
was just $1,307,000 due to the Company's need to refinance its short-term debt
with St. Paul Bank. 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
18
Effects of Inflation
The Company's local exchange telephone companies are subject to the
jurisdiction of Minnesota, Iowa, South Dakota and Wisconsin regulatory
authorities with respect to a variety of matters, including rates for intrastate
access services, the conditions and quality of service, issuance of debt,
depreciation rates and accounting methods. Rates for local telephone service are
not established directly by regulatory authorities, but their authority over
other matters limits the Company's ability to implement rate increases. In
addition, the regulatory process inherently restricts the Company's ability to
immediately pass cost increases along to customers unless the cost increases are
anticipated and the rate increases implemented prospectively.
At December 31, 1996, approximately $25,200,000 of the Company's
acquisition loan for the purchase of Ollig Utilities Company was on a floating
interest rate based on St. Paul Bank's cost of money. Should inflation rates
significantly exceed the Company's expectations it could increase interest rates
and the Company's debt service expenses beyond acceptable limits or make St.
Paul Bank unwilling to continue extending credit to the Company.
Regulation
The Minnesota legislature passed a law in 1995 which allows telephone
companies serving fewer than 50,000 access lines to elect an alternative form of
regulation. A company electing alternative regulation would no longer be subject
to rate of return review by state regulators, but instead would be subject to
review of pricing of services. All of the Company's Minnesota subsidiaries have
elected alternative regulation as of January 1, 1996. A requirement of the
election was a commitment that local service rates would be frozen for two
years, other than in extraordinary circumstances.
Competition
In February 1996, President Clinton signed into law the
Telecommunications Act of 1996. The new law represents the biggest change in the
rules governing local service since Congress imposed federal regulation and
established the FCC in 1934. Under its provisions, the monopoly on local service
enjoyed by LECs is eliminated and LECs must allow competitors access to the
local network facilities. The Company does not know to what extent it will be
subject to local competition in the markets it serves under the new rules. The
final results of the changes made by the new law will not be known for some time
until new rule making by the FCC and state regulatory agencies is complete. The
Company is monitoring developments regarding the new regulatory climate closely,
and expects its operations will be materially affected by the new rules, but
cannot predict what effect the new rules will have on its business.
The Company is presently the only provider of local telephone service in
the areas it serves. Technological developments in competing technologies such
as cellular telephone, digital microwave, coaxial cable, fiber optics and other
wireless and wired technologies may result in new forms of competition to the
Company's landline services. The Company and many other members of the local
exchange carrier industry are seeking to maintain a strong, universally
affordable public telecommunications network through policies and programs that
are sensitive to the needs of small communities and rural areas served by the
Company's telephone subsidiaries.
All of the Company's cable television franchises are non-exclusive and
the Company competes with a municipally owned cable system in one community it
serves. In addition to competition from off-air television, other technologies
also supply services provided by cable television. These include low power
television stations, multi-point distribution systems, over-the-air subscription
television and direct broadcast satellite ("DBS"). The Company believes that
cable television presently offers a wider variety of programming at lower cost
than any competing technology. However, the Company is unable to predict the
effect current or developing sources of competition may have on its business.
19
Changes in Accounting Standards
Effective January 1, 1996, the Company has adopted Statement of Financial
Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to be Disposed Of" (SFAS 121). This statement
requires that assets to be held and used be reviewed for impairment whenever
events or changes in circumstances indicate that the carrying value of an asset
may not be recoverable. An impairment loss should be recognized when the
estimated future cash flows from the asset are less than the carrying value of
the asset. Assets to be disposed of should be reported at the lower of their
carrying amount of fair value less cost to sell. Adoption of this statement did
not have a material effect on the Company's results of operations or financial
position.
Effective January 1, 1996, the Company adopted the pro forma disclosure
provisions of SFAS No. 123, "Accounting for Stock-Based Compensation". This
statement requires the Company to disclose the fair value of stock-based
compensation to employees. The Company has elected to continue to apply APB
Opinion No. 25, "Accounting for Stock Issued to Employees" for measurement and
recognition of stock-based transactions with its employees.
Factors Affecting Future Performance
From time to time in reports filed with the Securities and Exchange
Commission, in press releases, and in other communications to shareholders and
the investing public, the Company may make statements regarding the Company's
future financial performance. Such forward looking statements are subject to
risks and uncertainties, including but not limited to, the effects of the
Telecommunications Act of 1996, 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.
20
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
(a) FINANCIAL STATEMENTS
INDEPENDENT AUDITORS REPORT
Shareholders and Board of Directors
Hector Communications Corporation
We have audited the accompanying consolidated balance sheets of Hector
Communications Corporation and subsidiaries as of December 31, 1996 and 1995 and
the related consolidated statements of operations, stockholders' equity, and
cash flows for each of the three years in the period ended December 31, 1996.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Hector
Communications Corporation and subsidiaries as of December 31, 1996 and 1995 and
the results of their operations and their cash flows for each of the three years
in the period ended December 31, 1996 in conformity with generally accepted
accounting principles.
As discussed in Note 3 to the consolidated financial statements, Hector
Communications Corporation adopted Statement of Financial Accounting Standards
No. 115, "Accounting for Certain Investments in Debt and Equity Securities" in
1994.
/s/ Olsen Thielen & Co., Ltd.
Olsen Thielen & Co., Ltd.
February 20, 1997
St. Paul, Minnesota
21
REPORT OF MANAGEMENT
The management of Hector Communications Corporation and its subsidiary companies
is responsible for the integrity and objectivity of the financial statements and
other financial information contained in the annual report. The financial
statements and related information were prepared in accordance with generally
accepted accounting principles and include amounts that are based on
management's informed judgments and estimates.
In fulfilling its responsibilities for the integrity of financial information,
management maintains accounting systems and related controls. These controls
provide reasonable assurance, at appropriate costs, that assets are safeguarded
against losses and that financial records are reliable for use in preparing
financial statements. Management recognizes its responsibility for conducting
the Company's affairs according to the highest standards of personal and
corporate conduct.
The Audit Committee of the Board of Directors, composed solely of outside
directors, meets with the independent auditors and management periodically to
review accounting, auditing, financial reporting and internal control matters.
The independent auditors have free access to this committee, without management
present to discuss the results of their audit work and their opinion on the
adequacy of internal financial controls and the quality of financial reporting.
/s/ Curtis A. Sampson
Curtis A. Sampson
President and Chief Executive Officer
/s/ Charles A. Braun
Charles A. Braun
March 18, 1997 Chief Financial Officer
22
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
ASSETS
December 31
__________________________________
1996 1995
______________ ______________
CURRENT ASSETS:
Cash and cash equivalents $ 9,571,879 $ 9,040,138
Temporary cash investments 1,079,900
Marketable securities (Note 3) 1,459,266
Construction fund (Note 5) 74,337 108,828
Accounts receivable 3,965,754 723,081
Materials, supplies and inventories, at average cost 512,114 120,641
Prepaid expenses 160,291 35,992
______________ ______________
TOTAL CURRENT ASSETS 15,364,275 11,487,946
PROPERTY, PLANT AND EQUIPMENT,net (Notes 1 and 4) 47,038,952 14,608,876
OTHER ASSETS:
Excess of cost over net assets acquired, less amortization
of $1,989,000 and $1,027,000 (Note 1) 52,510,459 906,950
Acquisition costs - Ollig Utilities (Note 2) 2,790,236
Marketable securities (Note 3) 5,458,400
Cellular telephone investments (Note 1) 9,777,801 1,260,448
Other investments (Notes 1 and 5) 5,693,906 1,038,545
Deferred debenture issue costs (Note 5) 969,201 1,158,313
Other assets (Note 1) 535,019 267,130
______________ ______________
TOTAL OTHER ASSETS 74,944,786 7,421,622
______________ ______________
TOTAL ASSETS $ 137,348,013 $ 33,518,444
______________ ______________
______________ ______________
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Notes payable and current portion of long-term debt (Note 5) $ 10,047,000 $ 492,900
Accounts payable (Note 9) 1,860,579 530,248
Accrued expenses 2,090,639 653,681
Income taxes payable 59,015 132,522
______________ ______________
TOTAL CURRENT LIABILITES 14,057,233 1,809,351
LONG-TERM DEBT, less current portion (Note 5) 96,127,379 22,096,419
DEFERRED INVESTMENT TAX CREDITS (Note 6) 526,347 128,339
DEFERRED INCOME TAXES (Note 6) 7,457,907 1,349,988
DEFERRED COMPENSATION (Note 8) 987,944
MINORITY INTEREST IN ALLIANCE TELECOMMUNICATIONS, CORP. 8,245,365
STOCKHOLDERS' EQUITY: (Notes 1, 5 and 7)
Preferred stock, par value $1.00 per share; 3,000,000 shares authorized:
Convertible Series A, 389,487 shares issued and outstanding 389,487 389,487
Common stock, par value $.01 per share; 10,000,000 shares authorized;
1,883,857 and 1,880,294 shares issued and outstanding 18,839 18,803
Additional paid-in capital 102,003 74,215
Retained earnings 9,005,768 7,797,098
______________ ______________
9,516,097 8,279,603
Unearned employee stock ownership shares (101,312) (145,256)
Unrealized gains on marketable securities (Note 3) 531,053
______________ ______________
TOTAL STOCKHOLDERS' EQUITY 9,945,838 8,134,347
______________ ______________
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 137,348,013 $ 33,518,444
______________ ______________
______________ ______________
See notes to consolidated financial statements.
23
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
Year Ended December 31
_____________________________________________________
1996 1995 1994
_____________ _____________ _____________
REVENUES:
Local network $ 3,682,129 $ 1,076,801 $ 974,650
Network access 11,534,882 3,474,738 3,682,260
Billing and collection 881,614 228,038 263,492
Nonregulated activities 2,690,255 285,355 309,882
Cable television revenues 1,868,641 779,391 509,244
_____________ _____________ _____________
TOTAL REVENUES 20,657,521 5,844,323 5,739,528
COSTS AND EXPENSES:
Plant operations 2,707,885 825,263 863,927
Depreciation and amortization 5,427,785 1,706,495 1,408,145
Customer operations 1,190,941 287,185 350,341
General and administrative 2,763,207 1,520,370 1,069,184
Other operating expenses 1,976,050 652,609 483,265
_____________ _____________ _____________
TOTAL COSTS AND EXPENSES 14,065,868 4,991,922 4,174,862
_____________ _____________ _____________
OPERATING INCOME 6,591,653 852,401 1,564,666
OTHER INCOME (EXPENSES):
Interest expense (5,399,617) (1,554,042) (586,517)
Partnership and LLC income 502,837 125,924 53,771
Investment income 691,215 645,781 170,530
Gain on sale of marketable securities (Note 3) 687,947 315,000
Gain on sale of cellular partnership interest (Note 3) 2,188,355
Unrealized loss on holding marketable securities (Note 3) (197,603) (86,227)
_____________ _____________ _____________
OTHER INCOME (EXPENSES), net (3,517,618) (979,940) 2,054,912
_____________ _____________ _____________
INCOME (LOSS) BEFORE INCOME TAXES 3,074,035 (127,539) 3,619,578
INCOME TAX EXPENSE (BENEFIT) (Note 6) 1,540,000 (51,000) 1,415,000
_____________ _____________ _____________
INCOME (LOSS) BEFORE MINORITY INTEREST 1,534,035 (76,539) 2,204,578
MINORITY INTEREST IN EARNINGS OF
ALLIANCE TELECOMMUNICATIONS CORPORATION 325,365
_____________ _____________ _____________
NET INCOME (LOSS) $ 1,208,670 $ (76,539) $ 2,204,578
_____________ _____________ _____________
_____________ _____________ _____________
NET INCOME (LOSS) PER COMMON AND COMMON
EQUIVALENT SHARE (Note 1): $ .53 $ (.04) $ .97
_____________ _____________ _____________
_____________ _____________ _____________
NET INCOME (LOSS) PER COMMON SHARE - ASSUMING
FULL DILUTION (Note 1): $ .53 $ (.04) $ .97
_____________ _____________ _____________
_____________ _____________ _____________
AVERAGE SHARES OUTSTANDING (Notes 1 and 7):
Common and Common Equivalent 2,271,000 1,866,000 2,265,000
Assuming Full Dilution 3,694,000 1,866,000 2,265,000
See notes to consolidated financial statements.
24
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31
________________________________________________
1996 1995 1994
_____________ ______________ _____________
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income (loss) $ 1,208,670 $ (76,539) $ 2,204,578
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Depreciation and amortization 5,617,722 1,871,969 1,408,145
Minority stockholders' interest in earnings
of Alliance Telecommunications Corporation 325,365
Gain on sale of cellular telephone investment (2,188,355)
Gain on sales of marketable securities (687,947) (315,000)
Income from partnership and LLC investments (502,837) (125,924) (53,771)
Unrealized losses on investments 231,830 86,227
Changes in assets and liabilities net of effects from
the purchase of Ollig Utilities, Inc.:
Decrease in marketable securities 1,499,072 437,521 679,627
Decrease (increase) in accounts receivable (408,601) 211,145 (255,931)
Decrease (increase) in materials, supplies and inventories 75,557 (23,854) (2,041)
Decrease (increase) in prepaid expenses (6,057) 6,365 (6,185)
Increase (decrease) in accounts payable (585,734) 55,000 (570,233)
Increase in accrued expenses 708,528 358,231 15,143
Increase (decrease) in income taxes payable (615,843) (560,331) 583,451
Decrease in deferred investment tax credits (129,000) (39,000) (40,000)
Increase (decrease) in deferred income taxes 380,000 (243,000) 605,000
Decrease in deferred compensation (31,679)
_____________ _____________ _____________
Net cash provided by operating activities 6,847,216 2,103,413 2,150,655
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property, plant and equipment (5,168,997) (3,123,547) (1,118,105)
Sales of temporary cash investments 94,806
Sales of marketable securities 553,645
Proceeds from (investments in) cellular telephone partnerships 437,371 (161,638) (263,504)
Decrease in construction fund 100,393 39,336 46,878
Purchases of other investments (1,745,105) (457,250) (53,646)
Proceeds from other investments 29,911 17,057 35,182
Increase in excess of cost over net assets acquired (88,517) (141,453) (70,000)
Decrease (increase) in other assets 107,198 (51,938) (85,545)
Decrease (increase) in restricted investment funds,
net of investment fund obligations 349,220
Payment for purchase of Ollig Utilities Company, net of cash acquired (69,189,692) (2,790,236)
_____________ _____________ _____________
Net cash used in investing activities (74,868,987) (6,669,669) (1,159,520)
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of notes payable and long-term debt (2,607,031) (1,769,634) (723,697)
Proceeds from issuance of notes payable and long-term debt 63,168,775 13,064,150 496,563
Minority interest in Alliance Telecommunications Corporation 7,920,000
Convertible bond issue costs (1,323,787)
Purchase of Hector Communications Corporation
common stock (30,272)
Issuance of common stock 21,768 22,872 39,214
ESOP shares allocated (purchased), net 50,000 (11,683) (20,000)
_____________ _____________ _____________
Net cash provided by (used in) financing activities 68,553,512 9,951,646 (207,920)
_____________ _____________ _____________
NET INCREASE IN CASH AND CASH EQUIVALENTS 531,741 5,385,390 783,215
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 9,040,138 3,654,748 2,871,533
_____________ _____________ _____________
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 9,571,879 $ 9,040,138 $ 3,654,748
_____________ _____________ _____________
_____________ _____________ _____________
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Interest paid $ 4,753,594 $ 1,023,041 $ 564,113
Income taxes paid 1,890,825 791,331 266,549
See notes to consolidated financial statements.
25
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Unearned Unrealized
Preferred Stock Common Stock Additional Employee Gains On
--------------------------------------- Paid-in Retained Stock Owner- Marketable
Shares Amount Shares Amount Capital Earnings ship Shares Securities Total
_________ _________ _________ _________ _________ __________ __________ __________ ___________
BALANCE AT DECEMBER 31, 1993 393,187 $ 393,187 1,870,498 $ 18,705 $ 7,960 $ 5,699,125 $(112,800) $6,006,177
Net income 2,204,578 2,204,578
Issuance of common stock under
Employee Stock Purchase Plan 3,652 36 20,528 20,564
Issuance of common stock under
Employee Stock Option Plan 2,800 28 18,622 18,650
Issuance of common stock in
exchange for preferred stock (900) (900) 900 9 891 0
ESOP Shares Purchased,
net of shares allocated (20,000) (20,000)
_________ _________ _________ _________ _________ __________ __________ __________ ___________
BALANCE AT DECEMBER 31, 1994 392,287 392,287 1,877,850 18,778 48,001 7,903,703 (132,800) 8,229,969
Net loss (76,539) (76,539)
Issuance of common stock under
Employee Stock Purchase Plan 3,844 39 22,833 22,872
Purchase of common stock (4,200) (42) (164) (30,066) (30,272)
Issuance of common stock in
exchange for preferred stock (2,800) (2,800) 2,800 28 2,772 0
ESOP Shares Purchased,
net of shares allocated 773 (12,456) (11,683)
_________ _________ _________ _________ _________ __________ __________ __________ ___________
BALANCE AT DECEMBER 31, 1995 389,487 389,487 1,880,294 18,803 74,215 7,797,098 (145,256) 8,134,347
Net income 1,208,670 1,208,670
Issuance of common stock under
Employee Stock Purchase Plan 3,563 36 21,732 21,768
ESOP Shares Allocated 6,056 43,944 50,000
Unrealized gains on marketable
securities $ 531,053 531,053
_________ _________ _________ _________ _________ __________ __________ __________ ___________
BALANCE AT DECEMBER 31, 1996 389,487 $ 389,487 1,883,857 $ 18,839 $102,003 $ 9,005,768 $(101,312) $ 531,053 $9,945,838
_________ _________ _________ _________ _________ __________ __________ __________ ___________
_________ _________ _________ _________ _________ __________ __________ __________ ___________
See notes to consolidated financial statements.
26
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Description of business: Hector Communications Corporation owns a 100% interest
in five local exchange telephone subsidiaries and one cable television
subsidiary. The Company also owns a 68% interest in Alliance Telecommunications
Corporation, which owns and operates four local exchange telephone companies,
two cable companies, an engineering company, and a credit card communications
company. At December 31, 1996, the Company's wholly and majority owned
subsidiaries provided telephone service to 32,000 access lines in 34 rural
communities in Minnesota, Wisconsin, South Dakota and Iowa. Its cable television
operations provided cable television services to approximately 8,100 subscribers
in Minnesota, South Dakota and Wisconsin. The Company is also an investor in
partnerships and corporations providing cellular telephone and other
telecommunications related services.
Principles of consolidation: The consolidated financial statements include the
accounts of Hector Communications Corporation and its wholly and majority owned
subsidiaries ("HCC" or the "Company"). All material intercompany transactions
and accounts have been eliminated.
Regulatory accounting: Accounting practices prescribed by regulatory authorities
have been considered in the preparation of the financial statements and
formulation of accounting policies for telephone subsidiaries. These policies
conform to generally accepted accounting principles as applied to regulated
public utilities in accordance with Statement of Financial Accounting Standards
No. 71, "Accounting for the Effects of Certain Types of Regulation" (SFAS 71).
As part of the rate-making process, regulators may require recording of an asset
or liability that would not be recognized in an unregulated enterprise. These
costs are recovered through rates authorized in the rate-making process. The
Company's financial statements are also affected by depreciation rates
prescribed by regulators, which may result in different depreciation rates than
in an unregulated enterprise.
Accounting estimates: The presentation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets,
liabilities, and disclosure of contingent assets and liabilities. Actual results
could differ from those estimates.
Property, plant and equipment: Property, plant and equipment is recorded at
cost. Depreciation is computed using principally the straight-line method.
Depreciation included in costs and expenses was $4,305,212, $1,533,240 and
$1,246,695 for 1996, 1995 and 1994, respectively. Maintenance and repairs are
charged to operations and additions or betterments are capitalized. Items of
property sold, retired or otherwise disposed of are removed from assets and any
gains or losses are included in accumulated depreciation.
Other assets: The excess of cost over net assets of subsidiaries acquired in
purchase transactions is being amortized on the straight-line method principally
over forty years. Amortization included in costs and expenses was $961,981,
$73,865 and $66,088 in 1996, 1995 and 1994, respectively.
Investments in cellular telephone partnerships and limited liability companies
are recorded on the equity method of accounting which reflects original cost and
recognition of the Company's share of income or losses. At December 31, 1996,
the Company owned 9.75% of Midwest Wireless Communications LLC, which is made up
of the former RSA partnerships which served southern Minnesota and 12.25% of
Sioux Falls Cellular, Ltd., which serves the Sioux Falls, South Dakota MSA. At
December 31, 1996, the Company's cumulative share of income from cellular
investments was $738,000, of which $478,000 was undistributed. The excess of
cost over the Company's share of equity in the cellular partnerships is being
amortized on the straight line method over forty years. Amortization expense
(included as an offset to partnership and LLC income) in 1996 was $117,280. The
Company also owns 4.2% of Rural Cellular Corporation, (Nasdaq National Market:
RCCC) which is comprised of the former RSA partnerships which served northern
Minnesota. Investments in Rural Cellular Corporation are recorded at market
value in 1996 and at cost in 1995 (Note 3).
27
Deferred bond issue costs are the underwriting, legal and accounting fees
incurred by the Company in completing its February, 1995 public offering of
convertible subordinated debentures. The bond issue costs are being amortized
over the seven year life of the bonds (Note 5). Amortization cost included in
interest expense for 1996 and 1995 was $189,112 and $165,474, respectively.
Accumulated amortization was $354,586 and $165,474 at December 31, 1996 and
1995, respectively.
Other investments consist of Rural Telephone Bank stock, Minnesota Equal Access
Network Services, Inc. stock, St. Paul Bank for Cooperatives stock, and
investments in stock companies and partnerships of other telecommunications
service providers. Long-term investments in companies that are not intended for
resale or are not readily marketable are valued at cost, which does not exceed
net realizable value. Investments in joint ventures, partnerships and limited
liability companies are recorded on the equity method of accounting which
reflects original cost and recognition of the Company's share of operating
income or losses from the respective operations.
Other assets are cable television franchises owned by the Company, deferred
retirements and other deferred charges. Amortization included in expenses was
$161,417, $91,530 and $91,530 for 1996, 1995 and 1994, respectively.
Financial instruments: The fair value of the Company's financial instruments
approximates carrying value except for long-term investments in other companies
and long-term debt payable to the Rural Utilities Service ("RUS") and Rural
Telephone Bank ("RTB"). Other long-term investments are not intended for resale
and not readily marketable, thus a reasonable estimate of fair value is not
practicable. The fair value of long-term debt owed to RUS and RTB was
$29,574,000 and $8,673,000 at December 31, 1996 and 1995, respectively. Fair
values were estimated based on current rates offered to the Company for debt
with similar terms and maturities.
Revenue recognition: Revenues are recognized when earned, regardless of the
period in which they are billed. Network access revenues are furnished in
conjunction with interexchange carriers and are determined by cost separation
studies and nationwide average schedules. Revenues include estimates pending
finalization of cost studies. Network access revenues are based upon interstate
tariffs filed with the Federal Communications Commission by the National
Exchange Carriers Association and state tariffs filed with state regulatory
agencies. Management believes recorded revenues are reasonable based on
estimates of final cost separation studies which are typically settled within
two years.
Income taxes and investment tax credits: The provision for income taxes consists
of an amount for taxes currently payable and a provision for tax consequences
deferred to future periods. For financial statement purposes, deferred
investment tax credits are being amortized as a reduction of the provision for
income taxes over the estimated useful lives of the related property, plant and
equipment.
Net income per share: Net income per share is computed by dividing net income by
the weighted average number of common shares, dilutive common stock equivalents
(convertible preferred stock, stock options and warrants) and potentially
dilutive securities (convertible debentures) outstanding during the period.
Earnings per share for 1995 is based on common stock outstanding as all common
stock equivalents and potentially dilutive securities were anti-dilutive for
that period. The income used for 1996 fully diluted earnings per share has been
adjusted for interest on convertible debentures, net of related income taxes.
28
Statement of cash flows: The Company considers temporary cash investments with
an original maturity of three months or less to be cash equivalents.
Effective April 25, 1996, the Company's 68% owned subsidiary, Alliance
Telecommunications Corporation, purchased all of the capital stock of Ollig
Utilities Company. In the acquisition, the following assets were acquired and
liabilities assumed:
Property, plant and equipment $ 31,566,292
Excess of cost over net assets acquired 52,404,243
Cellular telephone investments 8,704,392
Marketable securities 4,334,814
Long-term debt (23,023,316)
Deferred credits (7,028,096)
Other assets and liabilities 13,041,671
-----------------
Total purchase price 80,000,000
Acquisition costs 72,730
-----------------
Total acquisition expenditures 80,072,730
Less cash and cash equivalents acquired (8,092,802)
Less deposits and acquisition costs paid in 1995 (2,790,236)
------------------
Payment for purchase of Ollig Utilities
Company, net of cash acquired $ 69,189,692
==================
Change of presentation: Certain amounts in the 1994 and 1995 financial
statements have been reclassified to conform with the 1996 financial statement
presentation. These reclassifications had no effect on net income or
stockholders' equity as previously reported.
NOTE 2 - ACQUISITION OF OLLIG UTILITIES COMPANY, INC.
On April 25, 1996, a newly formed subsidiary of the Company, Alliance
Telecommunications Corporation ("Alliance"), purchased Ollig Utilities Company
("Ollig") for $80,000,000 in cash. The Company owns 68% of Alliance with the
remaining interest owned by Golden West Telecommunications Cooperative, Inc. of
Wall, South Dakota and Split Rock Telecom Cooperative, Inc. of Garretson, South
Dakota. Alliance financed the acquisition using the combined equity investments
of its shareholders and debt financing provided by St. Paul Bank for
Cooperatives ("St. Paul Bank"). The Company's investment in Alliance is
approximately $16,903,000, which includes $6,000,000 of short term borrowing by
the Company from St. Paul Bank, purchase price deposits made by the Company in
1995, and $73,000 of acquisition costs.
The acquisition is being accounted for as a purchase. The excess of cost over
net assets acquired in the transaction was $51,948,000 (including $6,272,000
allocated to cellular telephone partnerships) which is being amortized on a
straight line basis over 40 years. The results of operations of Ollig have been
included in the Company's financial results subsequent to April 25, 1996.
Unaudited consolidated results of operations on a pro forma basis as though
Ollig was acquired January 1, 1995 are as follows:
Year Ended December 31
------------------------------------
1996 1995
--------------- ----------------
Revenues $ 27,260,512 $ 24,766,580
Income (loss) before minority interest 1,446,644 (473,419)
Net income (loss) 1,097,805 (510,374)
Net income (loss) per share $ .48 $ (.27)
Pro forma financial information is 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.
29
NOTE 3 - MARKETABLE SECURITIES AND GAINS ON SALES OF INVESTMENTS
Marketable securities consist principally of equity securities obtained by the
Company in sales of its investments in cellular telephone partnerships and
equity securities of other telecommunications companies. The Company's
marketable securities portfolio is classified as available-for-sale at December
31, 1996. The Company's marketable securities were classified as trading in 1995
and 1994. Those securities were sold in 1996. The cost and fair values of
available-for-sale investment securities was as follows:
Gross Gross
Unrealized Unrealized Fair
Cost Gains Losses Value
----------- ---------- ---------- -----------
December 31, 1996 $4,680,892 $1,390,273 $(612,765) $ 5,458,400
Stockholders' equity at December 31, 1996 includes a change of $777,508 less
deferred taxes of $246,455 for net unrealized holding gain on investments. These
amounts have no cash effect and are not included in the statement of cash flows.
Net income includes unrealized holding losses on trading marketable securities
of $197,603 and $86,227 in 1995 and 1994, respectively.
In February, 1996, Rural Cellular Corporation ("RCC") completed an initial
offering of its common stock to the public. As part of the offering, the Company
sold 61,133 shares of RCC. Gross proceeds from the sale were $554,000 and gain
on the sale was $485,000.
Effective January 3, 1994 the Company sold its investment in the cellular
telephone system serving the Rochester, Minnesota Metropolitan Statistical Area
("MSA") to Telephone and Data Systems, Inc. ("TDS"). Book value of the
investment was $220,576. HCC received 47,802 shares of TDS common stock and
recorded a gain on sale of the investment of $2,188,355 ($1,313,000 net of
income taxes). The Company sold a portion of the TDS shares it received in 1993
as a hedge against the value of the transaction. The balance of the TDS shares
were sold in 1996. Gross proceeds from the 1996 sales were $1,499,000 and gains
on the sales were $203,000.
In 1992, the Company exchanged its partnership interest in Wisconsin RSA #2 for
14,584 shares of Pacific Telecom, Inc. (PTI) common stock. The transaction was a
tax free exchange and the stock acquired was restricted from sale for two years.
At the time of the exchange, the $350,000 market value of the stock received was
recognized as an asset and a deferred gain of $315,000 was recorded. In 1994,
the restrictions on sale of the stock were removed and the deferred gain was
recorded in income. The Company sold the stock in 1995.
NOTE 4 - PROPERTY, PLANT AND EQUIPMENT
The cost of property, plant and equipment and the estimated useful lives are as
follows:
December 31
Estimated ------------------------------------
useful life 1996 1995
------------------ ---------------- -------------
Land $ 546,673 $ 157,084
Buildings 5-40 years 5,207,150 1,456,438
Machinery and equipment 3-15 years 1,864,666 987,206
Furniture and fixtures 5-10 years 388,466 154,662
Telephone plant 5-33 years 47,591,324 16,742,295
Cable television plant 10-15 years 5,869,575 4,621,922
Construction in progress 232,923 527,646
--------------- -------------
61,700,777 24,647,253
Less accumulated depreciation 14,661,825 10,038,377
--------------- -------------
$ 47,038,952 $ 14,608,876
=============== =============
30
NOTE 5 - NOTES PAYABLE AND LONG-TERM DEBT
December 31
--------------------------------------
1996 1995
---------------- ---------------
Notes payable to St. Paul Bank for Cooperatives,
payable by Alliance Telecommunications Corporation
in monthly installments, secured by stock of Alliance,
average rate of 7.2%, due 1997 to 2011 $ 55,250,000
Note payable to St. Paul Bank for Cooperatives,
payable by cable television subsidiary, interest rate
of 7.4%, due 1997 6,000,000
Rural Utilities Service ("RUS") and Rural Telephone Bank
("RTB") mortgage notes, payable by telephone company
subsidiaries in monthly and quarterly installments,
average rate of 5.6%, due 1997 to 2026 32,005,604 $ 9,939,319
Convertible subordinated debentures, payable to
bondholders, interest rate of 8.5%, due 2002 12,650,000 12,650,000
Notes payable to former cable television system owners,
payable annually by cable television subsidiary,
interest rate of 6%, due 1997 to 1998 268,775
---------------- --------------
106,174,379 22,589,319
Less current portion 10,047,000 492,900
---------------- --------------
$ 96,127,379 $ 22,096,419
================ ==============
In 1996, the Company's 68% owned subsidiary, Alliance Telecommunications
Corporation negotiated a term loan agreement with the St. Paul Bank for
Cooperatives ("St. Paul Bank") to provide financing for the acquisition of Ollig
Utilities Company. Face amount of the loan was $55,250,000. The Company has
fixed interest rates on $30,000,000 on this loan for periods ranging from five
to seven years at rates of approximately 7.6%. Interest on the balance of the
loan floats at St. Paul Bank's cost of money plus 130 basis points (6.71% at
December 31, 1996). The Company made only interest payments on the loan in 1996.
Principal payments began in January 1997 and will continue until March, 2011.
In 1996, the Company and one of its cable television subsidiaries, North
American Communications Corporation, negotiated a loan agreement with the St.
Paul Bank for Cooperatives to provide additional financing for the acquisition
of Ollig Utilities Company. Face amount of the loan was $6,000,000, payable
March 31, 1997. Interest rate on the loan, which varies according to St. Paul
Bank's cost of money, was 7.4% at December 31, 1996. The loan is secured by a
pledge of the assets of North American and the stock of one of the Company's
telephone subsidiaries.
St. Paul Bank is a cooperative, owned and controlled by its customers. As a
condition to receiving the loans, the Company purchased stock in the bank. The
Company's investment in St. Paul Bank stock at December 31, 1996 was $1,614,000.
Each customer borrowing from the bank on a patronage basis shares in the bank's
net income through payment of patronage refunds. The Company's 1996 patronage
refund from St. Paul Bank was $221,000, $66,000 was received in cash and
$155,000 in stock of St. Paul Bank. The patronage refund is shown in the
Company's operating statement as a reduction of interest expense. The Company
cannot predict what patronage refunds will be in future years.
Substantially all assets of the Company's telephone subsidiaries are pledged as
collateral under the RUS and RTB debt agreements. The telephone company
subsidiaries also have various restrictions on distributions of capital to the
parent company relative to their outstanding indebtedness.
In February 1995 the Company completed a public offering of convertible
subordinated debentures. The debentures carry an interest rate of 8.5% and
mature February 15, 2002. The bonds are callable under certain circumstances and
include restrictions on payment of dividends to the Company's shareholders. The
debentures are subordinated to $4,000,000 of senior indebtedness owed by the
Company to St. Paul Bank. Total value of the offering was $12,650,000. Proceeds
to the Company, after underwriting, accounting and legal expenses were
approximately $11,300,000.
31
The annual requirements for principal payments on notes payable and long-term
debt are as follows:
1997 $10,047,000
1998 4,086,000
1999 4,180,000
2000 4,428,000
2001 4,706,000
The Company is continuing its construction program to upgrade the central office
equipment and outside plant of its telephone subsidiaries. Planned expenditures
for telephone plant additions in 1997 are $4,100,000. The Company intends to use
RUS and RTB loan funds to help finance these projects. Loan funds received are
deposited in construction fund accounts and disbursements are restricted,
subject to RUS approval, to construction costs authorized by the loan
agreements. The Company has unadvanced loan funds available from RUS and RTB of
$4,616,000 and is in the process of applying for new loans. Planned cable
television plant additions and improvements for 1997 are $175,000.
NOTE 6 - INCOME TAXES
Hector Communications Corporation and its wholly owned subsidiaries file a
consolidated tax return separate from the consolidated return for Alliance
Telecommunications Corporation and its subsidiaries. Income tax expenses
(benefits) consist of the following:
Year Ended December 31
--------------------------------------------------------
1996 1995 1994
----------------- ------------------ -----------------
Currently payable taxes:
Federal $ 964,000 $ 141,000 $ 674,000
State 325,000 90,000 176,000
----------------- ------------------ -----------------
1,289,000 231,000 850,000
Deferred income taxes (benefit) 380,000 (243,000) 605,000
Deferred investment tax credits (129,000) (39,000) (40,000)
------------------ ------------------- ------------------
$ 1,540,000 $ (51,000) $ 1,415,000
================= =================== =================
Deferred tax assets and (liabilities) as of December 31 related to the
following:
1996 1995
----------------- ------------------
Accelerated depreciation $ (6,410,907) $ (1,693,988)
Alternative minimum tax credits 237,000 173,000
Marketable securities (1,724,000) 143,000
Deferred compensation 400,000
Other 40,000 28,000
----------------- ------------------
$ (7,457,907) $ (1,349,988)
================== ===================
The provision for income taxes varied from the federal statutory tax rate as
follows:
Year Ended December 31
------------------------------------------------------
1996 1995 1994
----------------- ------------------ ---------------
Tax (benefit) at U.S. statutory rate 35.0% (35.0)% 35.0%
Surtax exemption (1.0) 1.0 (1.0)
State income taxes, net of federal benefit 7.5 11.4 5.9
Excess of cost over net assets acquired 12.1 15.6 .5
Investment tax credits (4.2) (29.5) (1.1)
Other .7 (3.5) (.2)
----------------- ------------------ ---------------
Effective tax (benefit) rate 50.1% (40.0)% 39.1%
================= ================== ===============
32
NOTE 7 - STOCKHOLDERS' EQUITY
Preferred stock is entitled to share ratably with common shareholders in any
dividends or distributions paid by the Company, but are not entitled to any
dividend distribution separate from common shareholders. Preferred shareholders
have no voting rights. Each share of preferred stock is convertible into one
share of common stock.
Common shares are reserved for issuance in connection with a stock option plan
(1990 Plan) under which 250,000 shares may be issued to key employees. The plan
was effective August 1, 1990 and expires July 31, 2000. The term of the stock
options may not exceed ten years. The exercise price of options issued will not
be less than fair market value at the time of the grant. Another provision of
the 1990 plan automatically grants 500 shares of nonqualified stock options per
year to each nonemployee director. Options issued under this provision have a
ten year term and an exercise price not less than fair market value at date of
grant.
A summary of changes in outstanding employee and director stock options during
the three years ended December 31, 1996 is as follows:
Average
Number of exercise price
shares per share
----------------- -------------
Outstanding at December 31, 1993 117,100 $ 7.09
Granted 44,600 7.67
Exercised (2,800) 6.66
----------------- -------------
Outstanding at December 31, 1994 158,900 7.15
Granted 46,150 7.02
Canceled (3,700) 7.17
----------------- -------------
Outstanding at December 31, 1995 201,350 7.12
Granted 48,825 6.67
Canceled (38,000) 6.53
----------------- -------------
Outstanding at December 31, 1996 212,175 $ 7.12
================ =============
Exercise prices of outstanding stock options range from $6.50 to $8.25 per
share. The weighted average remaining life of outstanding stock options at
December 31, 1996 was 2.74 years. Options exercisable at December 31, 1996 are
167,242.
Effective August 1, 1990, the 1990 Employee Stock Purchase Plan ("ESPP") was
adopted, for which 100,000 shares were reserved. Under terms of the plan,
participating employees may acquire shares of common stock through payroll
deductions of not more than 10% of compensation. The price of shares purchased
by the employees is 85% of the lower of fair market value for such shares on one
of two specified dates in each plan year. A participant is limited to the
acquisition in any plan year to the number of shares which their payroll
deductions for the year would purchase based on the market price on the first
day of the year or $25,000, whichever is less. Shares issued to employees under
the plan were 3,563, 3,844 and 3,652 for the plan years ended August 31, 1996,
1995 and 1994, respectively. At December 31, 1996 employees had subscribed to
purchase an additional 3,703 shares in the current plan cycle ending August 31,
1997.
The Company has adopted the disclosure provisions of SFAS No. 123, "Accounting
for Stock-Based Compensation" , but applies APB Opinion No. 25, "Accounting for
Stock Issued to Employees" for measurement and recognition of stock-based
transactions with its employees. If the Company had elected to recognize
compensation cost for its stock based transactions using the method prescribed
by SFAS No. 123, net income and earnings per share would have been as follows:
33
Year Ended December 31
----------------------------
1996 1995
------------- --------------
Net Income (Loss) $ 1,139,265 $ (115,710)
Net Income (Loss) Per Share $ .50 $ (.06)
The fair value of the Company's stock options and Employee Stock Purchase Plan
transactions used to compute pro forma net income and net income per share
disclosures is the estimated present value at grant date using the Black-Scholes
option-pricing model with the following assumptions for 1996 and 1995: expected
volatility of 21.2%, a risk free interest rate of 6.8%, an expected holding
period of four years for key employee options and seven years for director
options, and no dividend yield. Pro forma stock-based compensation cost was
$69,405 and $39,171 in 1996 and 1995, respectively.
In February 1995 the Company completed a public offering of $12,650,000 (par
value) convertible subordinated debentures. The debentures carry an interest
rate of 8.5% and mature February 15, 2002. The debentures are convertible into
common stock of the Company at a rate of 112.5 common shares per $1,000 par
value bond. If all the outstanding bonds were converted into common stock, they
would represent an additional 1,423,175 common shares. The offering's
underwriters also received warrants to purchase 123,750 shares of the Company's
common stock at a price of $8.70 per share. The warrants are exercisable
beginning February 15, 1996 and expire February 15, 2000.
Effective August 1, 1990, the Board of Directors adopted a leveraged employee
stock ownership plan ("ESOP"). Contributions to the ESOP are determined by the
Board on an annual basis and can be made in cash or by issuing shares of the
Company's common stock. During 1995 and 1994, the Company advanced $62,000 and
$70,000, respectively, to the ESOP to purchase the Company's common stock on the
open market. Advances bear interest at 85% of prime and are repaid through
contributions to the plan. ESOP expense reflects the market value of company
stock contributed to the accounts of eligible employees at the time of the
contribution. ESOP expense was $50,000 for each of the last three years. At
December 31, 1996, the ESOP held 56,098 shares of the Company's common stock, of
which 44,271 shares had been allocated to the accounts of participating
employees. All eligible employees of the Company participate in the plan after
completing one year of service. Contributions are allocated to each participant
based on compensation and vest 30% after three years of service and
incrementally thereafter, with full vesting after seven years. At December 31,
1996, the cost of unallocated ESOP assets was $101,312, which approximates fair
value.
NOTE 8 - EMPLOYEE BENEFIT PLANS
The Company has 401(k) savings plans for its employees. Employees who meet
certain age and service requirements may contribute up to 10% of their salaries
to the plan on a pretax basis. The Company matches a portion of employee
contributions. Contributions to the plan by the Company for 1996, 1995 and 1994
were approximately $85,700, $21,800 and $19,100, respectively.
Employees of Alliance Telecommunications Corporation who meet certain age and
service requirements are eligible to participate in a profit sharing plan.
Contributions are determined annually by Alliance's Board of Directors and are
allocated proportionately to the participants in each allocation group.
Contributions to the plan by the Company in 1996 were $128,900.
Ollig Utilities Company had a deferred compensation agreement with two of its
former officers which the Company has assumed. Under the agreement, the salaries
of these officers was continued after their retirement based on a formula stated
in the agreement. The Company incurred no expense under this agreement in 1996.
Payments made under the agreement in 1996 were $31,700.
34
NOTE 9 - TRANSACTIONS WITH COMMUNICATIONS SYSTEMS, INC.
Transactions between the Company and Communications Systems, Inc. (CSI), the
Company's former parent, are based on a distribution agreement, which provides
for the Company's use of certain of CSI's staff and facilities, with related
costs paid by the Company. Services provided by CSI aggregated approximately
$258,000, $279,000 and $267,000 in 1996, 1995 and 1994, respectively.
Since 1995, employees of Hector Communications Corporation and its wholly owned
subsidiaries have participated in a joint self-funded medical insurance program
with employees of CSI. Costs paid by the Company into this program were $157,000
and $140,000 in 1996 and 1995, respectively.
Costs of services from CSI may not be indicative of the costs of such services
had they been obtained from a different party. Intercompany accounts with CSI
are handled on an open account basis. Outstanding amounts payable to CSI were
$307,000 and $209,000 at December 31, 1996 and 1995, respectively.
NOTE 10 - SEGMENT INFORMATION
The Company operates in two business segments: local exchange telephone
companies and cable television. Industry segment information is as follows:
Year Ended December 31
--------------------------------------------------------
1996 1995 1994
----------------- ------------------ -----------------
Revenues:
Telephone $ 18,529,701 $ 5,057,777 $ 5,223,104
Cable television 1,868,641 779,391 509,244
Corporate 259,179 7,155 7,180
----------------- ------------------ -----------------
$ 20,657,521 $ 5,844,323 $ 5,739,528
================= ================== =================
Operating income (loss):
Telephone $ 6,644,455 $ 1,314,828 $ 1,709,415
Cable television (3,357) (335,447) (118,858)
Corporate (49,445) (126,980) (25,891)
------------------ ------------------- ------------------
$ 6,591,653 $ 852,401 $ 1,564,666
================== =================== ==================
Identifiable assets:
Telephone $ 126,596,360 $ 22,298,933 $ 19,974,320
Cable television 5,747,246 4,329,023 2,176,164
Corporate 5,004,407 6,890,488 598,166
------------------ ------------------- -----------------
$ 137,348,013 $ 33,518,444 $ 22,748,650
================== ================== =================
Depreciation and amortization:
Telephone $ 4,744,780 $ 1,204,614 $ 1,135,093
Cable television 679,473 455,130 222,817
Corporate 193,469 212,225 50,235
----------------- ------------------- -----------------
$ 5,617,722 $ 1,871,969 $ 1,408,145
================= =================== =================
Capital expenditures:
Telephone $ 4,669,171 $ 869,243 $ 976,212
Cable television 499,826 2,230,637 106,698
Corporate 23,667 35,195
----------------- ------------------ -----------------
$ 5,168,997 $ 3,123,547 $ 1,118,105
================= =================== =================
35
NOTE 11 - ACQUISITION OF CABLE PROPERTIES
Effective August 15, 1995, the Company acquired 22 rural Minnesota cable
systems, serving approximately 2,000 subscribers, from Lake Cable Partnership of
Arlington, Virginia. The acquisition was accounted for as a purchase and the
purchase price of $2,215,000 was allocated to the assets acquired. Excess of
cost over net assets acquired was $141,000, which is being amortized over 15
years on a straight line basis. Results of the systems acquired were included in
Company operations beginning August 15, 1995. In 1996, the Company purchased 2
small cable systems for $319,000
(b) SUPPLEMENTAL FINANCIAL INFORMATION
Unaudited Quarterly Operating Results
(in thousands except per share amounts)
Quarter Ended
----------------------------------------------------
March 31 June 30 Sept 30 Dec 31
- -----------------------------------------------------------------------------------------------
1996
Revenues $ 1,666 $ 5,165 $ 7,218 $ 6,609
Operating income 373 1,597 2,497 2,125
Net income 494 110 293 312
Net income per share $ .21 $ .05 $ .13 $ .14
1995
Revenues $ 1,334 $ 1,410 $ 1,438 $ 1,662
Operating income 270 206 297 79
Net income (loss) (77) (18) 115 (97)
Net income (loss) per share $ (.03) $ (.01) $ .05 $ (.05)
36
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information called for by paragraphs (a), (c), (d), (e), and (f) of Item 401
under Regulation S-K, to the extent applicable, will be set forth under the
caption "Election of Directors" in the Company's definitive proxy material for
its May 22, 1997 Annual Meeting of Shareholders to be filed within 120 days from
the end of the Registrant's fiscal year, which information is expressly
incorporated by reference herein. The information called for by paragraph (b) of
Item 401 is set forth under Item 1(c) herein. The information called for by Item
405 under Regulation S-K, to the extent applicable, will be set forth under the
caption "Certain Transactions" in the Company's above referenced definitive
proxy material.
ITEM 11. EXECUTIVE COMPENSATION
The information called for by Item 402 under Regulation S-K to the extent
applicable, will be set forth under the caption "Executive Compensation" in the
Company's definitive proxy materials for its May 22, 1997 Annual Meeting to be
filed within 120 days from the end of the Registrant's fiscal year, which
information is expressly incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information called for by Item 403 under Regulation S-K will be set forth
under the captions "Security Ownership of Certain Beneficial Owners and
Management" and "Election of Directors" in the Company's definitive proxy
materials for its May 22, 1997 Annual Meeting to be filed within 120 days from
the end of the Registrant's fiscal year, which information is expressly
incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information called for by Item 404 under Regulation S-K will be set forth
under the caption "Certain Transactions" in the Company's definitive proxy
materials for its May 22, 1997 Annual Meeting to be filed within 120 days from
the end of the Registrant's fiscal year, which information is expressly
incorporated herein by reference.
37
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) (1) Consolidated Financial Statements
The following Consolidated Financial Statements of Hector
Communications Corporation and subsidiaries appear at pages 21 to 36 herein:
Independent Auditors' Report for the years ended
December 31, 1996, 1995 and 1994
Consolidated Balance Sheets as of December 31, 1996 and 1995
Consolidated Statements of Operations for the years ended
December 31, 1996, 1995 and 1994
Consolidated Statements of Stockholders' Equity for the years ended
December 31, 1996, 1995 and 1994
Consolidated Statements of Cash Flows for the years ended
December 31, 1996, 1995 and 1994
Notes to Consolidated Financial Statements
(a) (2) Consolidated Financial Statement Schedule Page Herein
----------------------------------------- -----------
The following financial statement schedule is being
filed as part of this Form 10-K Report:
Independent Auditors' Report on financial
statement schedules for the years ended
December 31, 1996, 1995 and 1994 41
Schedule I - Condensed Financial Information of Registrant 42-44
All other schedules are omitted as the required information is
inapplicable or the information is presented in the financial statements or
related notes.
(a) (3) Exhibits
The exhibits which accompany or are incorporated by reference in this
report, including all exhibits required to be filed with this report, are
described on the Exhibit Index, which begins on page 46 of the sequential
numbering system used in this report.
(b) REPORTS ON FORM 8-K FILED DURING THE THREE MONTHS ENDED DECEMBER 31, 1996
Not Applicable.
38
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
HECTOR COMMUNICATIONS CORPORATION
Dated: March 27, 1997 /s/ Curtis A. Sampson
----------------------------------------
Curtis A. Sampson, Chairman of the Board
of Directors and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant in the capacities and on the dates indicated:
Each person whose signature appears below constitutes and appoints
CURTIS A. SAMPSON and PAUL N. HANSON as his true and lawful attorneys-in-fact
and agents, each acting alone, with full power of substitution and
resubstitution, for him and in his name, place and stead, in any and all
capacities, to sign any or all amendments to this Annual Report on Form 10-K and
to file the same, with all exhibits thereto, and other documents in connection
therewith, with the Securities and Exchange Commission, granting unto said
attorneys-in-fact and agents, each acting alone, full power and authority to do
and perform each and every act and thing requisite and necessary to be done in
and about the premises, as fully to all intents and purposes as he might or
could do in person, hereby ratifying and confirming all said attorneys-in-fact
and agents, each acting alone, or his substitute or substitutes, may lawfully do
or cause to be done by virtue thereof.
Signature Title Date
/s/ Curtis A. Sampson Chairman of the Board of Directors, March 27, 1997
- -------------------------- Chief Executive Officer and Director
Curtis A. Sampson
/s/ Steven H. Sjogren President, Chief Operating Officer, March 27, 1997
- -------------------------- and Director
Steven H. Sjogren
/s/ Paul N. Hanson Vice President, Treasurer and March 27, 1997
- -------------------------- Director
Paul N. Hanson
/s/ Charles A. Braun Chief Financial Officer and March 27, 1997
- -------------------------- Principal Accounting Officer
Charles A. Braun
- -------------------------- Director March 27, 1997
Charles R. Dickman
/s/ James O. Ericson Director March 27, 1997
- --------------------------
James O. Ericson
- -------------------------- Director March 27, 1997
Paul A. Hoff
/s/ Wayne E. Sampson Director March 27, 1997
- --------------------------
Wayne E. Sampson
/s/ Edward E. Strickland Director March 27, 1997
- --------------------------
Edward E. Strickland
39
================================================================================
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
OF
HECTOR COMMUNICATIONS CORPORATION
FOR
YEAR ENDED DECEMBER 31, 1996
--------------------------------------------
FINANCIAL STATEMENT SCHEDULE
================================================================================
40
INDEPENDENT AUDITORS' REPORT ON FINANCIAL STATEMENT SCHEDULES
Shareholders and Board of Directors
Hector Communications Corporation
The audit of the consolidated financial statements of Hector Communications
Corporation and subsidiaries referred to in our opinion dated February 20, 1997,
included the related financial statement schedules as listed in item 14(a)2. In
our opinion, these financial statement schedules, when considered in relation to
the basic consolidated financial statements, present fairly in all material
respects the information set forth therein.
/s/ Olsen Thielen and Co., Ltd.
Olsen Thielen and Co., Ltd.
St. Paul, Minnesota
February 20, 1997
41
HECTOR COMMUNICATIONS CORPORATION
SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
HECTOR COMMUNICATIONS CORPORATION (PARENT COMPANY)
BALANCE SHEET
December 31
________________________________
1996 1995
_____________ _____________
Assets:
Cash $ 57,965 $ 5,017,799
Investment in subsidiaries 24,533,032 8,040,292
Other current assets 255,922 77,289
Property, plant and equipment, net 126,265 162,949
Accounts with subsidiaries 2,445,201 3,932,429
Other investments 1,636,049 503,583
Deferred acquisition costs 2,790,236
Deferred bond issue costs 969,201 1,158,313
Other deferred charges
_____________ _____________
Total Assets $ 30,023,635 $ 21,682,890
_____________ _____________
_____________ _____________
Liabilities and Stockholders' Equity:
Accounts payable $ 166,155 $ 183,182
Other current liabilities 716,238 715,361
Notes payable 6,000,000
Long-term debt 12,650,000 12,650,000
Deferred income taxes 545,404
Stockholders' equity:
Preferred stock, par value $1.00 per share;
3,000,000 shares authorized:
Convertible Series A, 389,487 shares issued
and outstanding 389,487 389,487
Common stock, par value $.01 per share;
10,000,000 shares authorized; 1,883,857 and
1,880,294 shares issued and outstanding,
respectively 18,839 18,803
Additional paid-in capital 102,003 74,215
Retained earnings 9,005,768 7,797,098
Unearned employee stock ownership shares (101,312) (145,256)
Unrealized gains on marketable securities 531,053
_____________ _____________
Total Liabilities and Stockholders' Equity $ 30,023,635 $ 21,682,890
_____________ _____________
_____________ _____________
42
HECTOR COMMUNICATIONS CORPORATION
SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
HECTOR COMMUNICATIONS CORPORATION (PARENT COMPANY)
STATEMENT OF INCOME
Year Ended December 31
______________________________________________________
1996 1995 1994
_____________ _____________ _____________
Revenues:
Sales $ 285,799 $ 49,345 $ 45,451
Expenses:
Operating expenses 80,716 176,325 71,342
Amortization of goodwill 51,519 50,307 50,307
Gain on sale of marketable securities (484,553)
Interest expense (income), net 1,396,393 641,363 (9,461)
Income tax benefit (272,257) (302,437) (34,309)
_____________ _____________ _____________
Total expenses 771,818 565,558 77,879
Loss before equity in earnings of
subsidiaries (486,019) (516,213) (32,428)
Equity in earnings of subsidiaries 1,694,689 439,674 2,237,006
_____________ _____________ _____________
Net income (loss) $ 1,208,670 $ (76,539) $ 2,204,578
_____________ _____________ _____________
_____________ _____________ _____________
43
HECTOR COMMUNICATIONS CORPORATION
SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
HECTOR COMMUNICATIONS CORPORATION (PARENT COMPANY)
STATEMENT OF CASH FLOWS
Year Ended December 31
____________________________________________________
1996 1995 1994
_____________ _____________ _____________
Cash flows from operating activities:
Net income $ 1,208,670 $ (76,539) $ 2,204,578
Adjustments to reconcile net
income to net cash provided by
operating activities:
Gain on sale of marketable securities (484,553)
Equity in earnings of subsidiaries (1,694,689) (439,674) (2,237,006)
Dividends from subsidiaries
Depreciation and amortization 293,601 266,923 100,542
Changes in assets and liabilities:
Decrease (increase) in other current assets (178,633) 85,932 (101,070)
Decrease (increase) in accounts with subsidiaries 1,487,228 436,296 (136,277)
Decrease in notes and advances
payable to Communications Systems, Inc. (245,499)
Increase (decrease) in accounts payable (17,027) 151,486 31,696
Increase (decrease) in other current liabilities 877 (140,791) 590,919
_____________ _____________ _____________
Net cash provided by operating activities 615,474 283,633 207,883
Cash flows from investing activities:
Purchases of property, plant and equipment (16,286) (23,666) (35,192)
Acquisition costs of stock of affiliate (12,346,388) (2,790,236)
Advance to subsidiaries (3,500,000)
Purchases of other investments (503,583)
Cash proceeds from other investments 715,598
Decrease (increase) in other deferred charges 82,092 (82,092)
_____________ _____________ _____________
Net cash used in investing activities (11,647,076) (6,735,393) (117,284)
Cash flows from financing activities:
Issuance of notes payable 6,000,000
Issuance of long-term debt 12,650,000
Deferred bond issue costs (1,323,787)
Purchase of common stock (30,272)
Issuance of common stock 21,768 22,872 39,214
Payments from (contributions to) employee
stock ownership plan, net 50,000 (11,683) (20,000)
_____________ _____________ _____________
Net cash provided by financing activities 6,071,768 11,307,130 19,214
_____________ _____________ _____________
Net increase (decrease) in cash and cash equivalents (4,959,834) 4,855,370 109,813
Beginning cash and cash equivalents 5,017,799 162,429 52,616
_____________ _____________ _____________
Ending cash and cash equivalents $ 57,965 $ 5,017,799 $ 162,429
_____________ _____________ _____________
_____________ _____________ _____________
Supplemental disclosures of cash flow information:
Interest paid $ 1,248,308 $ 516,906 $ -
Income taxes paid 300,000 773,307 236,000
44
================================================================================
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
OF
HECTOR COMMUNICATIONS CORPORATION
FOR
YEAR ENDED DECEMBER 31, 1996
EXHIBITS
================================================================================
45
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
Exhibit Index To
Form 10-K for the Year Ended December 31, 1996
Regulation S-K Location in Consecutive Numbering
Exhibit Table System as Filed With the
Reference Title of Document Securities and Exchange Commission
3.1 Articles of Incorporation, Filed as Exhibit 3.1 to the Form 10
as amended of the Company, File No. 0-18587
(the "Form 10") and incorporated
hereby by reference
3.2 Bylaws, as amended Filed as Exhibit 3.2 to the Form 10
of the Company and incorporated
hereby by reference.
4.1 Indenture dated Filed as Exhibit 4.1 to the
February 24, 1995 between Company's Registration Statement on
Hector Communications Corp. Form S-2 File No. 33-87888 and
and National City Bank of incorporated herein by reference
Minneapolis, trustee
10.1 1990 Stock Plan Filed as Exhibit 10.1 to the Form 10
of the Company and incorporated
herein by reference.
10.2 Employee Stock Purchase Plan Filed as Exhibit 10.2 to the Form 10
of the Company and incorporated
herein by reference.
10.3 Employee Stock Ownership Plan Filed as Exhibit 10.3 to the Form 10
of the Company and incorporated
herein by reference.
10.4 Employee Savings Plan and Trust Filed as Exhibit 10.4 to the Form 10
of the Company and incorporated
herein by reference.
10.5 Distribution Agreement Filed as Exhibit 10.5 to the Form 10
of the Company and incorporated
herein by reference.
10.7 Flexible Benefit Plan Filed as Exhibit 10.7 to the 1993
Form 10-K and incorporated herein
by reference.
11 Calculation of Earnings Filed herewith at page 46.
Per Share
21 Subsidiaries of the Registrant Filed herewith at page 47.
23 Independent Auditors' Consent Filed herewith at page 48.
24 Power of Attorney Included in signatures at page 38.
The exhibits referred to in this Exhibit Index will be supplied to a shareholder
at a charge of $.25 per page upon written request directed to HCC's Assistant
Secretary at the executive offices of the Company.
46
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CALCULATION OF EARNINGS PER SHARE
EXHIBIT 11
Year Ended December 31
--------------------------------------------------------
Primary: 1996 1995 1994
_______ _____________ _____________ _____________
Net income (loss) $ 1,208,670 $ (76,539) $ 2,204,578
_____________ _____________ _____________
_____________ _____________ _____________
Common and common equivalent shares:
Weighted average number of common
shares outstanding 1,881,472 1,879,083 1,874,094
Dilutive effect of convertible preferred
shares outstanding 389,487 392,963
Dilutive effect of stock options outstanding after
application of treasury stock method 11,858 8,943
Weighted average number of unallocated shares
held by the employee stock ownership plan (11,817) (13,083) (11,000)
_____________ _____________ _____________
2,271,000 1,866,000 2,265,000
_____________ _____________ _____________
_____________ _____________ _____________
Primary net income per common
and common equivalent share: $ .53 $ (.04) $ .97
_____________ _____________ _____________
_____________ _____________ _____________
Fully Diluted:
_____________
Net income $ 1,208,670 $ (76,539) $ 2,204,578
Interest on convertible debentures, net of tax 758,617
_____________ _____________ _____________
Fully diluted income $ 1,967,287 $ (76,539) $ 2,204,578
_____________ _____________ _____________
_____________ _____________ _____________
Common and common equivalent shares:
Weighted average number of common
shares outstanding 1,881,472 1,879,083 1,874,094
Dilutive effect of convertible preferred
shares outstanding 389,487 392,963
Dilutive effect of stock options outstanding after
application of treasury stock method 11,858 8,943
Dilutive effect of outstanding convertible
debentures 1,423,125
Weighted average number of unallocated shares
held by the employee stock ownership plan (11,817) (13,083) (11,000)
_____________ _____________ _____________
3,694,125 1,866,000 2,265,000
_____________ _____________ _____________
_____________ _____________ _____________
Fully diluted net income per common
and common equivalent share: $ .53 $ (.04) $ .97
_____________ _____________ _____________
_____________ _____________ _____________
All common stock equivalents and potentially dilutive securities are anti-dilutive for 1995 and are
excluded from the calculation of earnings per share. Primary and fully diluted earnings per share
are substantially the same.
47
SUBSIDIARIES OF HECTOR COMMUNICATIONS CORPORATION
EXHIBIT 21
Subsidiaries Jurisdiction of Incorporation
Arrowhead Communications Corporation Minnesota
Eagle Valley Telephone Company Minnesota
Granada Telephone Company Minnesota
Indianhead Telephone Company Wisconsin
North American Communications Corporation Minnesota
Pine Island Telephone Company Minnesota
Alliance Telecommunications Corporation Minnesota
Ollig Utilities Company Minnesota
Loretel Systems, Inc. Minnesota
Sleepy Eye Telephone Company Minnesota
Sioux Valley Telephone Company South Dakota
Hills Telephone Company Minnesota
OU Connection, Inc. Minnesota
Aurora Cable T.V., Inc. South Dakota
Loretel Financial Systems, Inc. Minnesota
Hastad Engineering Co. Minnesota
Valley Cablevision of SD, Inc. South Dakota
Arrowhead Communications Corporation, Eagle Valley Telephone Company, Granada
Telephone Company, Indianhead Telephone Company and North American
Communications Corporation are 100% owned by Hector Communications Corporation.
Pine Island Telephone Company is 69% owned by Hector Communications Corporation
and 31% owned by Indianhead Telephone Company.
Alliance Telecommunications Corporation ("ATC") is 68% owned by Hector
Communications Corporation, 20% owned by Golden West Telecommunications
Cooperative, Inc. of Wall, South Dakota and 12% owned by Split Rock Telecom
Cooperative of Garretson, South Dakota.
Loretel Systems, Inc., Sleepy Eye Telephone Company, Sioux Valley Telephone
Company, Sioux Valley Telephone Company, Hills Telephone Company, OU Connection,
Inc., Aurora Cable T.V., Inc., Loretel Financial Systems, Inc., Hastad
Engineering Co. and Valley Cablevision of SD, Inc. are 100% owned by Alliance
Telecommunications Corporation (which is 68% owned by Hector Communications
Corporation).
The financial statements of these subsidiaries are included in the Consolidated
Financial Statements of Hector Communications Corporation.
48
EXHIBIT 23
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in Registration Statements No.
33-39865, 33-39866 and 33-65176 of Hector Communications Corporation of our
report dated February 20, 1997, appearing in this Annual Report on Form 10-K of
Hector Communications Corporation and its subsidiaries for the year ended
December 31, 1996.
/s/ Olsen Thielen and Co., Ltd.
Olsen Thielen and Co., Ltd.
March 27, 1997
St. Paul, Minnesota
49