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, 1997, the Company's wholly and majority owned telephone subsidiaries (generally referred to as "local exchange carriers" or "LECs") served approximately 32,700 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 two LEC subsidiaries, the Company provided cable television services to approximately 8,300 subscribers in Minnesota, South Dakota and Wisconsin. The Company is also an investor in entities providing wireless telephone and other telecommunications related services.
Since becoming a publicly-held company in 1990, HCC has owned and operated five wholly owned local exchange company subsidiaries which served 6,700 access lines at December 31, 1997. 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.
[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 11 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) 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, 1997, 1996 and 1995 and by the LEC subsidiaries of Alliance at December 31, 1997 and 1996:
- ------------------------------------ * An "access line" is a single or multi-party circuit between the customer's establishment and the central switching office.
The Company's policy, insofar as possible, is to maintain local management in each of its local exchange carrier subsidiaries. The Company provides its 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 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. Local rate increases after January 1, 1998 are not subject to review by the Minnesota Public Utilities Commission unless the lower of 500 or five percent of customers file a petition requesting such review.
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. Interstate universal service fund support accounted for $656,000, $617,000 and $484,000 of the Company's network access revenues in 1997, 1996 and 1995, respectively. 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's Wisconsin based LEC subsidiary implemented a local service rate increase December 1, 1995 to compensate for changes in Wisconsin's support structure. The Company expects to seek higher local service rates to recover costs for which current interstate or intrastate recovery may become unavailable.
Construction and Development Program
The Company's policy is to upgrade the plant and equipment of its local exchange carrier subsidiaries to maintain modern, high quality telephone service. Plant additions are made to upgrade service, replace existing facilities and provide for 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. Financing for the telephone construction program is expected to come from internally generated funds, 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 LEC subsidiaries is pledged or is subject to mortgages to secure obligations to the RUS and RTB. In addition, the amount of dividends on common stock that may be paid by the LEC subsidiaries to the Company is limited by certain financial covenants set forth in the mortgages.
The LEC subsidiaries have applied for and, in 1997, received approval for additional loans totaling $14,888,000 from RUS and RTB to meet their respective capital requirements . At December 31, 1997, the Company's local
exchange carrier subsidiaries had unadvanced loan commitments under the RUS and RTB programs aggregating approximately $17,478,000 to finance specific construction activities in future years. 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.
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. The face amount of the loan was $55,250,000. The loan is secured by a pledge of substantially all the assets of Alliance and its subsidiaries. The Company has fixed interest rates on this loan for periods ranging from one to ten years at rates averaging 7.4%. 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. The outstanding loan balance at December 31, 1997 was $4,000,000. The loan is payable in quarterly installments of $143,000, with a final balloon payment due December 31, 2001. Interest rate on the loan, which varies according to St. Paul Bank's cost of money, was 8.0% at December 31, 1997. 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, 1997 was $2,749,000. 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 patronage refund from St. Paul Bank was $694,000 and $221,000 in 1997 and 1996, respectively. Approximately 30% of the patronage refund is received in cash, with the balance 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. As of February 15, 1997, the Company has the right to call the debentures at a price (depending on the trading price of the Company's common stock) ranging from 100% to 104% of par. The debentures 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 currently exercisable 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. Several provisions of the new law are also being contested in the courts, making applications of the new law subject to the judicial process. 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.
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 wireless 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 wireless 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.
Wireless 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.
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, 1997, the Company was an investor in limited partnerships and limited liability corporations which provide cellular telephone service in five RSAs in Minnesota, one RSA in North Dakota, the Rochester, Minnesota MSA and the Sioux Falls, South Dakota MSA and serve approximately 90,000 customers. The Company accounts for these investments using the equity method. Income recognized on these wireless investments was $1,580,000, $502,000, and $126,000 in 1997, 1996 and 1995, respectively. 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, 1997:
The Company is also an investor in Rural Cellular Corporation ("RCC"), a publicly traded company providing cellular telephone services in Minnesota and New England. In February, 1996, RCC completed an initial offering of its common stock to the public. As part of the offering, HCC sold 61,133 shares of RCC and recorded a gain on sale of $485,000. In June, 1997, HCC sold an additional 161,469 shares of RCC and recorded a gain on sale of $1,464,000. At December 31, 1997, the Company owned 2.4% of RCC's common stock.
In addition to competition between the two cellular licensees in each territory, competition for wireless 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.
The Company owns 11.66% of Wireless North, a consortium of three limited partnerships and one limited liability corporation which have acquired 16 licenses to operate PCS systems in 13 markets in Minnesota, Wisconsin, North Dakota and South Dakota. The Company has invested $510,000 of cash and guaranteed debt of $1,373,000 in these entities. The PCS systems are in start-up mode and have not been profitable to date. Losses recorded by the Company on its PCS investments were $435,000 and $73,000 in 1997 and 1996, respectively. The Company has committed to providing $1,486,000 of additional capital to these entities. It cannot predict if additional funding beyond this amount will be required.
There are a number of recent technological developments in the wireless telephone 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 was expected to take a number of years, but is being accelerated by competition from digital PCS systems.
The wireless 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. Wireless 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 wireless system capacity can normally be added in increments that closely match demand and cost proportionately less than the initial fixed costs.
The licensing (including renewal of licenses), construction, operation, sale, interconnection arrangements and acquisition of wireless systems are regulated by the FCC and various state public utility commissions. Changes in the regulation of wireless 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 wireless operations.
Other Telecommunications Investments The Company also has investments in several other telecommunications related businesses, including an 11.7% 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 provides long-distance telecommun-ications services to business and residential customers in rural Minnesota. These services include toll-free telephone numbers providing access from anywhere in the Unites States and Canada, cellular telephone service, prepaid calling cards, video conferencing and internet access.
(3) Cable Television Operations
The Company, through its cable television and local exchange carrier subsidiaries, owns and operates 34 cable television systems serving approximately 8,300 subscribers in 51 communities in Minnesota, South Dakota and Wisconsin. All of its cable television systems offer one or more channels of premium programming, featuring 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.
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.
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, 1998, the Company had 135 employees, of which 120 employees work in the telephone operations, 10 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.
(5) Executive Officers of Registrant
The executive officers of the Company and their ages at March 1, 1998 were as follows:
Name Age Position
Curtis A. Sampson 64 Chairman of the Board and Chief Executive Officer
Steven H. Sjogren 55 President and Chief Operating Officer
Paul N. Hanson 51 Vice President and Treasurer
Charles A. Braun 40 Chief Financial Officer
Executive officers serve at the pleasure of the Board of Directors and are elected annually for one year terms. Each officer above has served the Company in the indicated capacity since 1990.
Mr. Sjogren devotes his full time to the Company's business. Messrs. Sampson, Hanson and Braun each devote approximately 40% of their working time to the Company's business with the balance devoted to management responsibilities at Communications Systems, Inc. ("CSI"), a diversified telecommunications holding company also located in Hector, Minnesota, for which they are separately compensated by CSI.
[d] FINANCIAL INFORMATION ABOUT FOREIGN AND DOMESTIC OPERATIONS AND EXPORT SALES
Not Applicable.
ITEM 2.
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 1% of the Company's telephone property. The lines, which connect customers' premises with central offices, constitute approximately 54% 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 30% of the Company's telephone property in service. Land, buildings, data processing equipment, service vehicles and construction equipment constitute the remaining 15%. 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 6 of "Notes to Consolidated Financial Statements for additional information regarding pledged assets.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
No material litigation or other claims are presently pending against the Company.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
PART II
ITEM 5.
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 on the American Stock Exchange. Prior to February, 20, 1998, the Company's common stock traded on 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.
______1997______ ______1996______ Quarter High Low High Low
First $8.50 $7.25 $8.75 $6.38 Second 9.75 7.38 8.50 6.00 Third 10.50 7.88 8.38 6.88 Fourth 10.13 8.50 8.00 7.00
[b] HOLDERS
At March 1, 1998 there were approximately 1,100 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, and also Note 6 to the Consolidated Financial Statements under Item 8 herein for a description of restrictions on dividends.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
ITEM 7.
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 ("Alliance"), acquired Ollig Utilities Company ("Ollig") for $80,000,000. At December 31, 1997, the Company's wholly and majority owned subsidiaries provided telephone service to 32,700 access lines in 34 rural communities in Minnesota, Wisconsin, South Dakota and Iowa. Its cable television operations provided cable television services to approximately 8,300 subscribers in Minnesota, South Dakota and Wisconsin. The Company is also an investor in businesses 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.
LECs also sell and lease customer premise telephone equipment, provide inside wiring services and custom calling features, provide internet access and sell and lease other facilities for private line, teletype, data transmission and other communications services. 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:
1997 Compared to 1996
Consolidated revenues increased 40% to $28,866,000. Most of the increase was due to the 1996 acquisition by Alliance Telecommunications Corporation of Ollig Utilities Company. The operations of Alliance, which are substantially larger than those of HCC prior to the acquisition, had a huge impact on operating results. 1997 results include twelve months of Alliance operations compared to just eight months included in 1996. The following table shows revenues from Alliance's operations separate from those of HCC.
Revenues from HCC's operations increased $396,000 or 6%. Revenues from telephone operations increased $270,000, or 5%. Local network revenues increased $45,000 or 3%, due to increases in the number of access lines served. Network access revenues increased $175,000 or 5% due to increased interstate settlements from NECA, which offset lower intrastate access revenues. Billing and collection revenues decreased $15,000 or 7% as IXCs are continuing to reduce their reliance on LECs to provide these services. Revenues from nonregulated sources increased $65,000 or 21% due to increased internet revenues. Cable television revenue increased $126,000 or 10%. The increase was due to increases in subscriber rates and the full year effect of the acquisition of two small cable systems in September, 1996.
Alliance's 1997 revenues benefited from a one-time retroactive network access settlement of $560,000 received from NECA by one of its subsidiaries. This settlement included $390,000 related to 1995 and 1996 settlements.
Operating costs and administrative expenses increased $5,047,000 or 36% over 1996. 1997 results include twelve months of Alliance operating expenses compared to just eight months included in 1996. The following table shows operating expenses from Alliance's operations separate from those of the Company.
Operating costs and expenses for HCC's operations increased $298,000 or 6%. Expense increases were due to higher maintenance expenses on telephone plant and higher cable television expenses due to the acquisition of two new cable systems in 1996. Consolidated operating income increased $3,162,000, or 48%. Operating income from HCC's operations increased 98,000 or 5%.
Consolidated interest expense, net of investment income increased $1,463,000. Net interest expense for HCC increased $207,000, reflecting the full year effect of interest on borrowings from St. Paul Bank used in the acquisition of Ollig and reduced income due to decreased cash available for investment. Net interest expense on Alliance increased $1,256,000 due to the full year effect of interest on the acquisition loan from St. Paul Bank for Cooperatives associated with the purchase of Ollig Utilities Company. HCC's investment income benefited from gains on sales of marketable securities of $1,496,000 and $688,000 in 1997 and 1996, respectively. Income from wireless telephone investments increased $806,000 or 160%, due primarily to the Company's equity interest in the increased profits of Midwest Wireless LLC. These earnings were more than enough to offset start-up losses of $435,000 incurred by PCS partnerships in which the Company holds equity interests.
Consolidated income before income taxes increased 108% to $6,386,000. HCC's income before income taxes, excluding Alliance, was $1,745,000 in 1997 compared to $885,000 in 1996. Income tax expense increased to $2,867,000 from $1,540,000 in 1996. The effective income tax rate of 44.9% in 1997 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 ($1,254,000 in 1997) are not tax deductible. The 32% minority shareholders' interest in earnings of Alliance was $798,000 in 1997 compared to $325,000 in 1996. Net income increased 125% to $2,721,000.
1996 Compared to 1995
Effective April 25, 1996, the Company's 68% owned subsidiary, Alliance Telecommunications Corporation purchased Ollig Utilities Company, 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, HCC served approximately 6,300 access lines and 4,200 cable television customers. The operations of Alliance, which are substantially larger than those of HCC prior to the acquisition, had a huge impact on operating results over the last eight months of the year. Consolidated revenues increased $14,813,000 in 1996. The following table shows revenues from Alliance's operations separate from those of HCC.
Revenues from HCC's 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 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 Alliance operations and HCC operations are presented separately in the following table.
Operating costs and expenses for HCC's operations increased $187,000 or 4%. 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 $929,000 or 109%.
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 wireless telephone investments increased $377,000 or 299%, due to the Company's increased ownership percentages of these operations due to 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.
Liquidity and Capital Resources
On April 25, 1996, a newly formed subsidiary of the Company, Alliance Telecommunications Corporation, purchased Ollig Utilities Company 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"). Interest rates on this debt have been locked for periods of one to ten years at rates averaging 7.4%. The outstanding balance on this loan at December 31, 1997 was $53,063,000.
The Company's cash investment in Alliance is approximately $16,903,000, which included $6,000,000 of short term borrowing from St. Paul Bank, purchase price deposits made in 1995, and $73,000 of acquisition costs. In 1997, the Company repaid principal of $2,000,000 on the loan and converted the remaining balance into a five year term loan.
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. In 1997, as a condition of maintaining its loan, the Company invested an additional $649,000 of cash in the stock of St. Paul Bank. 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 patronage refund from St. Paul Bank was $694,000 and $221,000 in 1997 and 1996, respectively. Approximately 30% of the patronage refund is received in cash, with the balance in stock of St. Paul Bank. Total investment in the bank was $2,749,000 at December 31, 1997.
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 1997, 1996 and 1995 were $4,262,000, $4,669,000 and $869,000, respectively. Telephone plant additions for 1998 are expected to total $5,371,000 and will provide customers with additional advanced switching services, upgrade the switching system to Year 2000 compliance and expand usage of high capacity fiber optics in the telephone network.
The Company is an investor in Wireless North, a consortium of three limited partnerships and one limited liability corporation which have acquired licenses to operate PCS systems in 13 markets in Minnesota, Wisconsin, North Dakota and South Dakota. The Company invested $510,000 of cash and guaranteed debt of $1,373,000 in these entities in 1997 and 1996. The PCS systems are in start-up mode and have not been profitable to date. The Company has committed to providing $1,486,000 of additional capital to these entities. It cannot predict if additional funding beyond this amount will be required.
Telephone asset additions have been financed by 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 $2,026,000, $411,000, and $414,000 in 1997, 1996 and 1995, respectively. The average interest rate on outstanding RUS and RTB loans is 5.6%. Substantially all of the 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 to the Company by the LEC subsidiaries is limited by covenants in the mortgages. In 1997, the LEC subsidiaries received approval from the RUS and RTB for new loans to finance future capital additions. At December 31, 1997 unadvanced loan commitments from the RUS and RTB totaled $17,478,000.
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 at a rate of 112.5 common shares per $1,000 par value bond. As of February 15, 1997, the Company has the right to call the debentures at a price (depending on the trading price of the Company's common stock) ranging from 100% to 104% of par. The debentures include restrictions on payment of dividends to the Company's shareholders. The debentures are subordinated to $4,000,000 of senior 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 common stock at a price of $8.70 per share. The warrants are currently exercisable and expire February 15, 2000. The offering proceeds were used to pay down debt associated with its cable television operation, 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.
In December, 1997, the Company sold 171,425 shares of new common stock in a private placement. Proceeds from the sale, net of issue costs, were $1,490,000. Proceeds were used to pay down debt and provide additional working capital.
Cable television operations have been supported through capital additions and by purchasing additional systems. In 1995, the Company purchased 22 rural Minnesota cable systems, serving approximately 2,000 customers, from Lake Cable Partnership for $2.2 million. In September, 1996, two additional cable systems serving 320 subscribers were acquired for $319,000. In 1997, one small system was acquired for $120,000. Other capital additions to support the Company's cable systems totaled $378,000, $270,000, and $263,000 in 1997, 1996 and 1995, respectively. Total cable television capital additions for 1998 are estimated at $250,000.
Cable television provided operating income of $115,000 in 1997 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. The 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 subscriber base, achieving lower operating expense ratios and increasing system revenues.
Investment income has been derived almost exclusively from interest earned on the Company's cash and cash equivalents. Interest income has fluctuated in relation to changes in interest rates and availability of cash for investment. In 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. In 1997, an additional 161,469 shares of Rural Cellular Corporation were sold for $1,728,000. At December 31, 1997, the Company's marketable securities portfolio consisted primarily of shares of Rural Cellular Corporation, U.S. West Communications, Inc. and U.S. West Media, Inc. owned by Ollig Utilities Company prior to its acquisition by the Company.
Cash flows from operating activities were $7,573,000, $6,627,000 and $2,103,000 in 1997, 1996, and 1995, respectively. At December 31, 1997, the Company's cash, cash equivalents, temporary cash investments and marketable securities totaled $18,241,000 compared to $16,110,000 at December 31, 1996. Working capital at December 31, 1997 was $8,504,000 compared to $1,307,000 at December 31, 1996. The current ratio was 1.9 to 1. 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.
Acquisitions
Alliance Telecommunications Corporation has entered into a definitive agreement to purchase all the outstanding common stock of Felton Telephone Company ("Felton"), a rural telephone company located in northwestern Minnesota adjacent to areas already served by the Company's telephone subsidiaries. Felton serves approximately 700 access lines and holds significant portfolio of marketable securities, including investments in Rural Cellular Corporation, U.S. West Communications, Inc. and U.S. West Media, Inc. Purchase price is $3,650,000, which includes a cash downpayment and seller financing of the balance. The Company is awaiting regulatory approval of the purchase and expects it to be completed in April, 1998.
Alliance has also entered into a definitive agreement to purchase Spectrum Cablevision Limited Partnership ("Spectrum"). Spectrum serves 4,600 cable television customers in 20 communities in Minnesota and North Dakota, including several communities also served by the Company's telephone subsidiaries. Purchase price is approximately $5,200,000. The Company expects to use its cash reserves and obtain additional outside financing to make this purchase. The Company expects to complete this acquisition in the second quarter of 1998.
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.
Year 2000 Issues
The software used by the Company's data processing and central office equipment was originally designed to use references to calendar dates on an abbreviated basis. Under this system, references to the calendar year are abbreviated to the last two digits of the year, i.e. 1997 is abbreviated as "97". Most software using this system does not recognize that the year 2000, abbreviated as "00", follows 1999. This causes computing errors in date sensitive processes. The Company has surveyed its telephone and data processing systems to locate computer systems which may be subject to this error.
The Company has determined that the central office switching equipment used in its local telephone exchanges to connect customer calls and record telephone usage is not Year 2000 compliant. The Company will be upgrading its equipment in the third and fourth quarters of 1998 to attain compliance. Estimated cost is $658,000. No retirements of equipment currently in service will be required. The Company does not expect Year 2000 problems to cause any interruption of service to customers.
Changes in Accounting Standards
Effective December 15, 1997, the Company adopted the provisions of Statement of Financial Accounting Standards No. 128, "Earnings per Share". The Statement requires the Company to present its net income per share in basic and diluted forms and to restate net income per share from prior periods to conform with the new statement. Basic net income per common share is based on the weighted average number of common shares outstanding during each year. Diluted net income per common share - takes into effect the dilutive effect of potential common shares outstanding. The Company's potential common shares outstanding include preferred stock, stock options, warrants and convertible debentures. The calculation of the Company's net income per share is included in Exhibit 11 of this form 10-K.
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.
The Financial Accounting Standards Board ("FASB") has issued SFAS No. 130, "Reporting Comprehensive Income". This statement establishes standards for reporting and presenting comprehensive income and its components in the financial statements. SFAS No. 130 is effective for fiscal years beginning after December 15, 1997. Reclassification of financial statements for earlier periods provided for comparative purposes is required. Adoption of this standard will have no effect on the Company's results of operations or financial position.
The FASB has also issued SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information". This statement establishes standards for the way public enterprises report information about operating segments in annual financial statements and requires those enterprises to report selected information about operating segments in interim financial reports to shareholders. It also establishes standards for related disclosures about products and services, geographic areas and major customers. SFAS No. 131 is effective for fiscal years beginning after December 15, 1997. Financial statement disclosures from prior periods are required to be restated. Adoption of this standard will have no effect on the Company's results of operations or financial position.
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.
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 Chairman and Chief Executive Officer
/s/ Charles A. Braun ------------------------------------- Charles A. Braun March 27, 1998 Chief Financial Officer
ITEM 8.
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, 1997 and 1996 and the related consolidated statements of income, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1997. 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, 1997 and 1996 and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1997 in conformity with generally accepted accounting principles.
/s/ Olsen Thielen & Co., Ltd. - ----------------------------- Olsen Thielen & Co., Ltd. February 18, 1998 St. Paul, Minnesota
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, 1997, the Company's wholly and majority owned subsidiaries provided telephone service to 32,700 access lines in 34 rural communities in Minnesota, Wisconsin, South Dakota and Iowa. Its cable television operations provided cable television services to approximately 8,300 subscribers in Minnesota, South Dakota and Wisconsin. The Company is also an investor in partnerships and corporations providing wireless telephone and other telecommunications related services.
Principles of consolidation: The consolidated financial statements include the accounts of Hector Communications Corporation and its wholly and majority owned subsidiaries ("HCC" or the "Company"). All material intercompany transactions and accounts have been eliminated.
Regulatory accounting: Accounting practices prescribed by regulatory authorities have been considered in the preparation of the financial statements and formulation of accounting policies for telephone subsidiaries. These policies conform to generally accepted accounting principles as applied to regulated public utilities in accordance with Statement of Financial Accounting Standards No. 71, "Accounting for the Effects of Certain Types of Regulation" (SFAS 71). 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 for 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. The estimates and assumptions used in the accompanying consolidated financial statements are based upon management's evaluation of the relevant facts and circumstances as of the time of the financial statements. Actual results could differ from those estimates.
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 $5,807,103, $4,305,212 and $1,533,240 for 1997, 1996 and 1995, 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 $1,401,889, $961,981 and $73,865 in 1997, 1996 and 1995, respectively.
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 6). Amortization cost included in interest expense was $189,112, $189,112 and $165,474 in 1997, 1996 and 1995, respectively. Accumulated amortization was $543,698 and $354,586 at December 31, 1997 and 1996, 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 and other deferred charges. Amortization included in expenses was $100,738, $161,417 and $91,530 for 1997, 1996 and 1995, 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 $30,215,000 and $29,574,000 at December 31, 1997 and 1996, 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: Effective December 15, 1997, the Company adopted the provisions of Statement of Financial Accounting Standards No. 128, "Earnings per Share". The Statement requires the Company to present its net income per share in basic and diluted forms and to restate net income per share from prior periods to conform with the new statement. Basic net income per common share is based on the weighted average number of common shares outstanding during each year. Diluted net income per common share takes into effect the dilutive effect of potential common shares outstanding. The Company's potential common shares outstanding include preferred stock, stock options, warrants and convertible debentures. The calculation of the Company's net income per share is included in Exhibit 11 of this form 10-K.
Statement of cash flows: The Company considers temporary cash investments with an original maturity of three months or less to be cash equivalents.
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 Wireless 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 1995 and 1996 financial statements have been reclassified to conform with the 1997 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 cash investment in Alliance is approximately $16,903,000.
The acquisition was 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 wireless telephone investments) 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, 1996 are as follows:
Year Ended December 31, 1996 ------------------- Revenues $ 27,260,512 Income before minority interest 1,446,644 Net income 1,097,805 Basic net income per share $ .59 Diluted net income per share $ .50
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.
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 wireless telephone partnerships and equity securities of other telecommunications companies. The Company's marketable securities portfolio is classified as available-for-sale at December 31, 1997 and December 31, 1996. The Company classified its marketable securities as trading in 1995 and sold the related securities 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, 1997 $ 4,449,976 $ 1,035,722 $ - $ 5,485,698 December 31, 1996 4,680,892 1,390,273 (612,765) 5,458,400
Net unrealized gains on marketable securities, net of related deferred taxes, are included in stockholders' equity at December 31, 1997 and 1996 as follows:
Net Deferred Unrealized Income Stockholders' Gains Taxes Equity -------------- -------------- -------------- December 31, 1997 $ 1,035,722 $ (357,245) $ 678,477 December 31, 1996 777,508 (246,455) 531,053
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 in 1995.
Gross proceeds from sales of available-for-sale securities were $1,728,000 and $554,000 in 1997 and 1996, respectively. Gross realized gains on sales of these securities were $1,496,000 and $485,000 in 1997 and 1996, respectively. Realized gains on sales are based on the difference between net sales proceeds and the book value of the securities sold, using the specific identification method.
Gross proceeds from sales of trading securities were $1,499,000 and $438,000 in 1996 and 1995, respectively. Gross realized gains on these sales were $203,000 in 1996.
NOTE 4 - WIRELESS TELEPHONE INVESTMENTS
Investments in wireless telephone partnerships and limited liability companies are recorded on the equity method of accounting which reflects original cost and recognition of the Company's share of income or losses. At December 31, 1997, the Company owned 9.78% of Midwest Wireless Communications LLC, which is made up of the former RSA partnerships which served southern Minnesota and the Rochester, Minnesota MSA, 12.25% of Sioux Falls Cellular, Ltd., which serves the Sioux Falls, South Dakota MSA, and 11.66% of Wireless North, a consortium of three limited partnerships and one LLC with licenses to provide personal communications services in Minnesota, Wisconsin, North Dakota and South Dakota. At December 31, 1997, the Company's cumulative share of income from wireless investments was $1,924,000, of which $883,000 was undistributed. The excess of cost over the Company's share of equity in the wireless companies, net of amortization reserves, was $7,174,000 and $7,357,000 at December 31, 1997 and 1996, respectively. Excess cost is being amortized on the straight line method over forty years. Amortization expense (included as an offset to partnership and LLC income) was $182,651 and $117,280 in 1997 and 1996, respectively.
The Company invested $510,000 of cash and guaranteed debt of $1,373,000 in Wireless North in 1997 and 1996. Its PCS systems are in start-up mode and have not been profitable to date. The Company has committed to providing $1,486,000 of additional capital to these entities. It cannot predict if additional funding beyond this amount will be required.
Income recognized on cellular telephone investments was $1,580,000, $502,000, and $126,000 in 1997, 1996 and 1995, respectively. Losses from PCS investments were $435,000 and $73,000 in 1997 and 1996, respectively. The following table shows the carrying value of the Company's wireless telephone investments at December 31, 1997 and 1996. The Company's ownership percentage at December 31, 1997 is in brackets.
Midwest Wireless LLC was created in June, 1996 from the merger of five RSA partnerships serving southern Minnesota and the Rochester, Minnesota MSA. Income recognized from the Company's investment in Midwest Wireless LLC is material to the Company's operating results. The Company is the largest shareholder of Midwest Wireless LLC and has the ability to influence the operating and financial policies of this corporation. Summarized audit information for Midwest Wireless, LLC for 1997 and 1996 is as follows:
Year Ended Six Months Ended December 31,1997 December 31, 1996 ---------------- ----------------- Current assets $ 13,622,176 $ 6,211,038 Noncurrent assets 39,729,609 35,243,820 Current liabilities 8,403,886 4,299,058 Noncurrent liabilities 15,344,657 17,393,410 Members' equity 29,603,242 19,762,390 Revenues 40,284,059 17,982,165 Expenses 26,660,623 13,970,615 Net income 13,623,436 4,011,550
NOTE 5 - PROPERTY, PLANT AND EQUIPMENT
The cost of property, plant and equipment and the estimated useful lives are as follows:
NOTE 6 - NOTES PAYABLE AND LONG-TERM DEBT
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. The face amount of the loan was $55,250,000. The loan is secured by a pledge of substantially all the assets of Alliance and its subsidiaries. The Company has fixed interest rates on this loan for periods ranging from one to ten years at rates averaging approximately 7.4%. 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. The Company made principal payments of $2,000,000 on this loan in 1997 and converted the remaining balance into a five year term loan with quarterly installment payments. Interest rate on the loan, which varies according to St. Paul Bank's cost of money, was 8.0% at December 31, 1997. 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, 1997 was $2,749,000. 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 patronage refund from St. Paul Bank was $694,000 and $221,000 in 1997 and 1996, respectively. Approximately 30% of the patronage refund is received in cash, with the balance 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. As of February 15, 1997, the Company has the right to call the debentures at a price (depending on the trading price of the Company's common stock) ranging from 100% to 104% of par. The debentures 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 annual requirements for principal payments on notes payable and long-term debt are as follows:
1998 $4,770,000 1999 4,781,000 2000 5,084,000 2001 6,924,000 2002 17,722,000
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 1998 are $5,371,000. 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 $17,478,000. Planned cable television plant additions and improvements for 1998 are $250,000.
NOTE 7 - INCOME TAXES
Hector Communications Corporation and its wholly owned subsidiaries file a consolidated tax return separate from the consolidated return for Alliance Telecommunications Corporation and its subsidiaries. Income tax expenses (benefits) consist of the following:
Deferred tax assets and (liabilities) as of December 31 related to the following:
The provision for income taxes varied from the federal statutory tax rate as follows:
NOTE 8 - STOCKHOLDERS' EQUITY
Preferred stock is entitled to share ratably with common shareholders in any dividends or distributions paid by the Company, but are not entitled to any dividend distribution separate from common shareholders. Preferred shareholders have no voting rights. Each share of preferred stock is convertible into one share of common stock.
Common shares are reserved for issuance in connection with a stock option plan (1990 Plan) under which 500,000 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 1,000 shares of nonqualified stock options per year to each nonemployee director. Options issued under this provision have a ten year term and an exercise price not less than fair market value at date of grant.
A summary of changes in outstanding employee and director stock options during the three years ended December 31, 1997 is as follows:
Exercise prices of outstanding stock options range from $6.50 to $8.50 per share. The weighted average remaining life of outstanding stock options at December 31, 1997 was 2.9 years. Options exercisable at December 31, 1997 are 183,692.
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 3,695, 3,563 and 3,844 for the plan years ended August 31, 1997, 1996 and 1995, respectively. At December 31, 1997 employees had subscribed to purchase an additional 11,942 shares in the current plan cycle ending August 31, 1998.
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:
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 1997 expected volatility of 21.4%, a risk free interest rate of 6.5%, an expected holding period of four years for key employee options and seven years for director options, and no dividend yield. 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 $141,326, $69,405 and $39,171 in 1997, 1996 and 1995, respectively. Fair value of all options issued was $180,134, $98,040, and $94,439 in 1997, 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 debentures were converted into common stock, they would represent an additional 1,423,125 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 currently exercisable 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 1997 and 1995, the Company advanced $2,000 and $62,000, 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 $60,000, $50,000 and $50,000 for 1997, 1996 and 1995, respectively. At December 31, 1997, the ESOP held 55,748 shares of the Company's common stock, of which 49,696 shares had been allocated to the accounts of participating employees. All eligible employees of Hector Communications Corporation participate in the plan after completing one year of service. Employees of Alliance Telecommunications Corporation do not participate in the plan. Contributions are allocated to each participant based on compensation and vest 30% after three years of service and incrementally thereafter, with full vesting after seven years. At December 31, 1997, the fair value of unallocated ESOP assets was $69,724.
NOTE 9 - EMPLOYEE BENEFIT PLANS
The Company has 401(k) savings plans for its employees. Employees who meet certain age and service requirements may contribute up to 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 1997, 1996 and 1995 were approximately $121,400, $85,700 and $21,800, 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 1997 and 1996 were $166,000 and $128,900, respectively.
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 were continued after their retirement based on a formula stated in the agreement. The Company incurred no expense under this agreement in 1997 or 1996. Payments made under the agreement in 1997 and 1996 were $47,500 and $31,700, respectively.
NOTE 10 - TRANSACTIONS WITH COMMUNICATIONS SYSTEMS, INC.
Transactions between the Company and Communications Systems, Inc. (CSI), the Company's former parent, are based on a distribution agreement, which provides for the Company's use of certain of CSI's staff and facilities, with related costs paid by the Company. Services provided by CSI aggregated approximately $264,000, $258,000 and $279,000 in 1997, 1996 and 1995, respectively.
Since 1995, employees of the Company have participated in a joint self-funded medical insurance program with employees of CSI. Costs paid by the Company into this program were $535,000, $157,000 and $140,000 in 1997, 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 $357,000 and $307,000 at December 31, 1997 and 1996, respectively.
NOTE 11 - SEGMENT INFORMATION
The Company operates in two business segments: local exchange telephone companies and cable television. Industry segment information is as follows:
NOTE 12 - PENDING ACQUISITIONS
Alliance Telecommunications Corporation has entered into a definitive agreement to purchase all the outstanding common stock of Felton Telephone Company ("Felton"), a rural telephone company located in northwestern Minnesota adjacent to areas already served by the Company's telephone subsidiaries. Felton serves approximately 700 access lines and holds significant portfolio of marketable securities, including investments in Rural Cellular Corporation, U.S. West Communications, Inc. and U.S. West Media, Inc. Purchase price is $3,650,000, which includes a cash downpayment and seller financing of the balance. The Company is awaiting regulatory approval of the purchase and expects it to be completed in April, 1998.
Alliance has also entered into a definitive agreement to purchase Spectrum Cablevision Limited Partnership ("Spectrum"). Spectrum serves 4,600 cable television customers in 20 communities in Minnesota and North Dakota, including several communities also served by the Company's telephone subsidiaries. Purchase price is approximately $5,200,000. The Company expects to use its cash reserves and obtain additional outside financing to make this purchase. The Company expects to complete this acquisition in the second quarter of 1998.
(b) SUPPLEMENTAL FINANCIAL INFORMATION
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 10.
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 19, 1998 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.
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 19, 1998 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.
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 19, 1998 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.
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 19, 1998 Annual Meeting to be filed within 120 days from the end of the Registrant's fiscal year, which information is expressly incorporated herein by reference.
PART IV
ITEM 14.
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 22 to 36 herein:
Independent Auditors' Report for the years ended December 31, 1997, 1996 and 1995
Consolidated Balance Sheets as of December 31, 1997 and 1996
Consolidated Statements of Income for the years ended December 31, 1997, 1996 and 1995
Consolidated Statements of Stockholders' Equity for the years ended December 31, 1997, 1996 and 1995
Consolidated Statements of Cash Flows for the years ended December 31, 1997, 1996 and 1995
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, 1997, 1996 and 1995 42
Schedule I - Condensed Financial Information of Registrant 43-45
Separate financial statements of Midwest Wireless Communications LLC, a 50 percent or less owned equity method investment, included as this entity constitutes a "significant subsidiary" pursuant to the provisions of Regulation S-X, Article 3-09. 46-58
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 60 of the sequential numbering system used in this report.
(b) REPORTS ON FORM 8-K FILED DURING THE THREE MONTHS ENDED DECEMBER 31, 1997
Not Applicable.
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, 1998 /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, 1998 - --------------------- Chief Executive Officer and Director Curtis A. Sampson
/s/Steven H. Sjogren President, Chief Operating Officer, March 27, 1998 - -------------------- and Director Steven H. Sjogren
/s/Paul N. Hanson Vice President, Treasurer and March 27, 1998 - -------------------- Director Paul N. Hanson
/s/Charles A. Braun Chief Financial Officer and March 27, 1998 - -------------------- Principal Accounting Officer Charles A. Braun
/s/Charles R. Dickman Director March 27, 1998 - --------------------- Charles R. Dickman
/s/James O. Ericson Director March 27, 1998 - --------------------- James O. Ericson
/s/Paul A. Hoff Director March 27, 1998 - --------------------- Paul A. Hoff
/s/Wayne E. Sampson Director March 27, 1998 - ------------------- Wayne E. Sampson
Director March 27, 1998 - ----------------------- Edward E. Strickland
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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, 1997
----------------------------------------- FINANCIAL STATEMENT SCHEDULES
- --------------------------------------------------------------------------------
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 18, 1998, 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 18, 1998
MIDWEST WIRELESS COMMUNICATIONS L.L.C. d/b/a Cellular 2000
REPORT ON AUDIT OF FINANCIAL STATEMENTS FOR THE YEAR ENDED DECEMBER 31, 1997 AND FOR THE PERIOD FROM JULY 1, 1996 (DATE OF INCEPTION) TO DECEMBER 31, 1996
Report of Independent Accountants
To the Board of Managers Midwest Wireless Communications L.L.C. d/b/a Cellular 2000:
We have audited the accompanying statements of financial position of Midwest Wireless Communications L.L.C. d/b/a Cellular 2000 as of December 31, 1997 and 1996, and the related statements of operations, changes in members' equity and cash flows for the year ended December 31, 1997, and the period from July 1, 1996 (date of inception) to 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 financial statements referred to above present fairly, in all material respects, the financial position of Midwest Wireless Communications L.L.C. d/b/a Cellular 2000 as of December 31, 1997 and 1996, and the results of its operations and its cash flows for the year ended December 31, 1997, and the period from July 1, 1996 (date of inception) to December 31, 1996, in conformity with generally accepted accounting principles.
COOPERS & LYBRAND L.L.P.
Minneapolis, Minnesota February 27, 1998
Midwest Wireless Communications L.L.C. d/b/a Cellular 2000 Statements of Financial Position as of December 31, 1997 and 1996
Midwest Wireless Communications L.L.C. d/b/a Cellular 2000 Statements of Operations for the year ended December 31, 1997 and the period from July 1, 1996 (date of inception) to December 31, 1996
Midwest Wireless Communications L.L.C. d/b/a Cellular 2000 Statements of Changes in Members' Equity for the year ended December 31, 1997 and the period from July 1, 1996 (date of inception) to December 31, 1996
Midwest Wireless Communications L.L.C. d/b/a Cellular 2000 Statements of Cash Flows for the year ended December 31, 1997 and the period from July 1, 1996 (date of inception) to December 31, 1996
Midwest Wireless Communications L.L.C. d/b/a Cellular 2000 Notes to Financial Statements
1. Organization and Significant Accounting Policies:
Organization:
Midwest Wireless Communications L.L.C. (the Company) is a Delaware limited liability company organized to provide cellular communications services in certain service areas within the State of Minnesota. The latest date the Company may be dissolved is December 31, 2034.
Effective June 29, 1996, pursuant to the Consolidation Agreement dated May 16, 1995, the following entities combined and contributed substantially all their assets and liabilities to the Company in exchange for all 1,000,000 ownership units of the Company: Cellular Seven Partnership, Hiawathaland Cellular Limited Partnership, Marshall Cellular Partnership, Minnesota RSA #9 Limited Partnership and Minnesota RSA #10 Limited Partnership (the Partnerships). Units were assigned to the Partnerships based upon their pro rata share of fair market values of the assets contributed as determined by an appraisal performed as of January 1, 1995. This transaction was accounted for using the pooling of interests method of accounting, and as such, the Company recorded the assets and liabilities contributed by the Partnerships at carrying value.
Effective June 28, 1996, the Company acquired all the operating assets of Rochester Cellular Telephone Company, L.P. (RCTC) in exchange for cash totaling $18,846,000. This transaction was accounted for using the purchase method of accounting, and as such, the assets acquired, principally cellular plant and equipment and a FCC license, were recorded at fair value.
Estimates:
The Company prepares its financial statements in conformity with generally accepted accounting principles, which require management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses during the period presented. They also affect the disclosure of contingencies. Actual results could differ from those estimates.
Cash and Cash Equivalents:
For the purpose of the statements of cash flows, the Company considers all investments purchased with original maturities of three months or less to be cash equivalents.
Marketable Securities:
Marketable securities which the Company has the positive intent and ability to hold to maturity are stated at cost adjusted for accretion of discounts computed under a method which approximates the interest method.
The marketable securities have maturity dates ranging from January 1998 to August 1998. The market value approximated amortized cost at December 31, 1997. Unrealized gains and losses were not significant.
Midwest Wireless Communications L.L.C. d/b/a Cellular 2000 Notes to Financial Statements, Continued
1. Organization and Significant Accounting Policies, continued:
Cellular Telephone Inventories:
Inventories consist primarily of cellular phones and accessories held for resale with cost determined using the specific identification method. Consistent with industry practice, losses on sales of cellular phones are recognized in the period in which sales are made as a cost of acquiring subscribers.
Property, Cellular Plant and Equipment:
Property, cellular plant and equipment is stated at its original cost. Depreciation is provided on a straight-line basis over the estimated useful lives of the cellular plant and equipment, which range from three to fifteen years. Property, cellular plant and equipment consists of the following:
At December 31, 1997 and 1996, accounts payable includes $418,396 and $53,276, respectively, related to the purchase of property, cellular plant and equipment. The Company capitalized interest in the amount of $151,361 and $81,396 for the year ended December 31, 1997, and the six-month period ended December 31, 1996, respectively.
Income Taxes:
No provision for income taxes has been recorded since all income, losses and tax credits are allocated to the members for inclusion in their respective income tax returns.
Advertising:
Advertising costs are expensed as incurred. Total advertising expenses were $1,049,000 and $759,000 for the year ended December 31, 1997, and the six-month period ended December 31, 1996, respectively.
Midwest Wireless Communications L.L.C. d/b/a Cellular 2000 Notes to Financial Statements, Continued
1. Organization and Significant Accounting Policies, continued:
Federal Communications Commission (FCC) License:
The Company acquired a FCC license to provide cellular service in FCC market NO. 288B in conjunction with the purchase of the Rochester service area. This license was recorded at fair market value and is being amortized on a straight-line basis over 39 years.
Reclassifications:
Certain reclassifications have been made to 1996 amounts to conform to the 1997 presentation. These reclassifications had no effect on net income or members' equity.
2. Investment in Switch 2000:
Switch 2000 L.L.C. (Switch 2000) is an entity that provides switching and interconnection services to the Company. As a result of the combination described in Note 1, the Company gained ownership and voting interests in Switch 2000 of 54.93% and 45.55%, respectively. Accordingly, this investment is accounted for using the equity method of accounting. Effective with the date of combination, the Company retroactively recorded its share of undistributed earnings of Switch 2000.
Effective June 30, 1997, Switch 2000 and the Company entered into a Management Agreement which expired on December 31, 1997. Under the terms of the Management Agreement, Switch 2000 retained the services of the Company to manage the operations of Switch 2000, including administration of transport and switching services and other general business operations. Switch 2000 is required to pay a management fee equal to the total costs incurred by the Company related to the management of Switch 2000. Total management fees paid to the Company in 1997 were $119,000. The Company had management fees due from Switch 2000 of $18,000 as of December 31, 1997.
Switch 2000, in turn, allocates management fees and certain other expenses, primarily network costs, to its owners, which include the Company. Amounts billed to the Company totaled approximately $2,879,000 and $2,101,000 for the year ended December 31, 1997, and the six-month period ended December 31, 1996, respectively. The Company had an amount due to Switch 2000 of $227,000 and $78,000 at December 31, 1997 and 1996, respectively.
The change in the investment relates to the Company's proportionate ownership share of Switch 2000's net (loss) earnings. Switch 2000 had assets of $3,376,866 and $4,519,969 and liabilities of $708,893 and $971,309 at December 31, 1997 and 1996, respectively.
Midwest Wireless Communications L.L.C. d/b/a Cellular 2000 Notes to Financial Statements, Continued
3. Members' Capital:
Members' capital includes capital contributions made by the members and the accumulated income resulting from operations. Company income or loss is allocated to the individual members based upon their ownership percentage, as defined in the Limited Liability Company Agreement (the Agreement). Pursuant to the Agreement, members are not obligated for the debts and obligations of the Company, including accumulated losses in excess of capital contributions.
Each member is entitled to one vote for each unit owned. Certain restrictions on voting rights exist when units are sold to an acquiring person as defined in the Agreement.
4. Debt:
Long-term debt at December 31, 1997 and 1996 consists of a term note with principal and interest payable quarterly beginning June 30, 1997, with final maturity on March 31, 2004. The note bears interest at a rate equal to the bank's 30 day cost of funds plus 1.25%. This rate is reset on the first business day of each month and was 6.88% and 6.61% at December 31, 1997 and 1996, respectively. The Company has the option to fix the interest rate for periods of up to seven years at rates set forth in the Term Loan Agreement.
The Term Loan Agreement contains covenants which restrict distributions to members and require the Company to maintain certain minimum levels of equity, as well as debt to operating cash flow and debt service ratios. Substantially all assets of the Company are pledged as collateral under the Agreement.
Maturities of long-term debt are as follows:
1998 $ 2,767,000 1999 2,428,000 2000 2,628,000 2001 2,844,000 2002 3,080,000 Thereafter 4,169,410 ------------- $ 17,916,410 =============
The Agreement also provides for a $10,000,000 line of credit expiring May 31, 1998, which is renewable at the option of the bank. This line of credit bears interest at the varying rates as defined in the Agreement. The Company had no amounts outstanding under this line of credit as of December 31, 1997 and 1996.
Midwest Wireless Communications L.L.C. d/b/a Cellular 2000 Notes to Financial Statements, Continued
5. Commitments:
Future minimum rental payments required under operating leases, principally for real estate related to tower sites, that have initial or remaining noncancellable lease terms in excess of one year as of December 31, 1997, are as follows:
1998 $ 224,219 1999 200,069 2000 195,070 2001 168,627 2002 121,111 Thereafter 55,585 -------------- $ 964,681 ==============
Rental expense was $424,554 and $161,093 for the year ended December 31, 1997, and the six-month period ended December 31, 1996, respectively.
The Company has entered into an agreement with a third party to purchase certain equipment in the amounts of $5,027,813 and $1,270,000 during 1998 and 1999, respectively.
6. Cell Site Sharing Agreements:
Hiawathaland Limited Partnership, one of the combining entities described in Note 1, entered into an agreement in 1993 with a partnership located in Wisconsin, to jointly construct and operate common cellular base station facilities (Cell Sites) in Nelson, Wisconsin and Red Wing, Minnesota. Under the agreement, both parties agreed to share the costs to construct the Cell Sites, selected ongoing costs of operation and roamer revenues attributable to the Cell Sites. The term of the agreement is for a period of five years unless terminated by mutual agreement of the parties. Additionally, the agreement automatically renews for successive five-year terms unless either party gives prior notice of non-renewal.
The Company has included its proportionate share of the assets, liabilities, revenues and expenses of the Cell Sites in these financial statements. As of December 31, 1997 and 1996, these assets were approximately $766,000 and $588,000 and liabilities were approximately $2,700 and $6,000, respectively. For the year ended December 31, 1997, and the six-month period ended December 31, 1996, these operating revenues were approximately $521,000 and $279,000 and expenses were $165,000 and $77,000, respectively.
Midwest Wireless Communications L.L.C. d/b/a Cellular 2000 Notes to Financial Statements, Continued
7. Management of the Company:
Under an agreement effective October 25, 1995, the Company contracted with Pacific Telecom Cellular, Inc. (the Manager), formerly North-West Cellular, Inc., to construct, operate and manage the cellular system. All services were provided at cost, including reasonable and necessary overhead expenses of the Manager.
The management agreement provides for payment of a monthly management fee equal to 3.75% of adjusted income (as defined in the agreement) plus 3.25% of adjusted retail revenue. The agreement expired on December 31, 1996, and was not renewed. During 1997, the Company performed the services formerly provided by the Manager. In 1996, the Manager also engaged other parties, including its affiliates, to provide goods or services directly to the Company. The amount of goods and services provided by the Manager and its affiliates totaled approximately $4,080,000 for the six-month period ended December 31, 1996. Accounts payable includes approximately $248,000 due to the Manager and its affiliates at December 31, 1996. At December 31, 1996, the Manager had collected $468,000 of roamer receivables subsequently remitted to the Company.
8. Concentration of Credit Risk:
The Company provides cellular service and sells cellular telephones to a diversified group of consumers within a concentrated geographical area. The Company performs credit evaluations of its customers and requires a deposit when deemed necessary. Receivables are generally due within 30 days. Credit losses related to customers have been within management's expectations.
9. Employee Benefits:
Effective September 1, 1996, the Company established the Midwest Wireless Communications L.L.C. 401(k) Profit Sharing Plan and Trust (the 401(k) Plan) for all employees who meet certain service and age requirements. The 401(k) Plan is comprised of a matching contribution component and a profit sharing component. Participating employees may contribute a maximum of 15% of their annual compensation and the Company will match between 33.33% and 75% of the participant contribution. An eligible employee may begin participating in the plan on the first day of the plan fiscal quarter after date of employment. Company contributions are 100% vested after one year of participation. Employer contributions to this component of the plan were $91,968 and $5,867 for the year ended December 31, 1997, and the six-month period ended December 31, 1996, respectively. The profit sharing component of the plan allows for an annual discretionary contribution to the tax deferred accounts of all eligible employees. Profit sharing contributions are 100% vested after five years of employment. Profit sharing contribution expenses were $118,411 and $0 for the year ended December 31, 1997, and the six-month period ended December 31, 1996, respectively.
Midwest Wireless Communications L.L.C. d/b/a Cellular 2000 Notes to Financial Statements, Continued
9. Employee Benefits, continued:
Effective January 1, 1997, the Company established the Midwest Wireless Communications L.L.C. Appreciation Rights Plan (the Plan) for certain key employees. The Plan is designed to create two classes of appreciation rights, Class A and Class B, which become fully vested three years and five years after the first day of the year the rights are granted, respectively. Participants in the Plan are eligible to receive awards based on the change in members' equity from the date of grant through the end of the vesting period. The Board of Managers granted both Class A and Class B appreciation rights in 1997. Under the terms of the Plan, no additional Class B appreciation rights will be granted, and additional Class A appreciation rights will be granted at the discretion of the Board of Managers. During 1997, the Company recognized $195,247 in compensation expense related to the Plan.
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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, 1997
---------------------------
EXHIBITS
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HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
Exhibit Index To Form 10-K for the Year Ended December 31, 1997
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 as amended 10 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 February Filed as Exhibit 4.1 to the 24, 1995 between Hector Company's Registration Statement Communications Corporation on Form S-2 File No. 33-87888 and and National City Bank incorporated herein by reference of 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 Filed as Exhibit 10.2 to the Form Plan 10 of the Company and incorporated herein by reference.
10.3 Employee Stock Ownership Filed as Exhibit 10.3 to the Form Plan 10 of the Company and incorporated herein by reference.
10.4 Employee Savings Plan Filed as Exhibit 10.4 to the Form and Trust 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 Net Income Filed herewith at page 61. Per Share
21 Subsidiaries of the Filed herewith at page 62. Registrant
23 Independent Auditors' Filed herewith at page 63. Consent
24 Power of Attorney Included in signatures at page 40.
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.
SUBSIDIARIES OF HECTOR COMMUNICATIONS CORPORATION EXHIBIT 21
Subsidiaries Jurisdiction of Incorporation
Arrowhead Communications Corporation Minnesota Eagle Valley Telephone Company Minnesota Granada Telephone Company Minnesota Indianhead Telephone Company Wisconsin North American Communications Corporation Minnesota Pine Island Telephone Company Minnesota Indianhead Communications Corporation Wisconsin 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 TV, 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, North American Communications Corporation and Indianhead Communications Corporation are 100% owned by Hector Communications Corporation. Pine Island Telephone Company is 69% owned by Hector Communications Corporation and 31% owned by Indianhead Telephone Company.
Alliance Telecommunications Corporation is 68% owned by Hector Communications Corporation, 20% owned by Golden West Telecommunications Cooperative, Inc. of Wall, South Dakota and 12% owned by Split Rock Telecom Cooperative of Garretson, South Dakota.
Loretel Systems, Inc., Sleepy Eye Telephone Company, Sioux Valley Telephone Company, Hills Telephone Company, OU Connection, Inc., Aurora Cable TV, Inc., Loretel Financial Systems, Inc., Hastad Engineering Co. and Valley Cablevision of SD, Inc. are 100% owned by Alliance Telecommunications Corporation.
The financial statements of these subsidiaries are included in the Consolidated Financial Statements of Hector Communications Corporation.
EXHIBIT 23
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in Registration Statements No. 33-39865, 33-39866, 33-65176, 33-87888, 333-45971 and 333-45975 of Hector Communications Corporation of our report dated February 18, 1998, appearing in this Annual Report on Form 10-K of Hector Communications Corporation and its subsidiaries for the year ended December 31, 1997.
/s/ Olsen Thielen and Co., Ltd. - ------------------------------- Olsen Thielen and Co., Ltd. March 27, 1998 St. Paul, Minnesota