================================================================================
                                  UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                    FORM 10-K
(Mark One)
     X        ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
                 SECURITIES EXCHANGE ACT OF 1934 [FEE REQUIRED]

                   For the fiscal year ended December 31, 1997

                                       OR

            TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
                SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]

                         Commission File Number: 0-18587

                        HECTOR COMMUNICATIONS CORPORATION
             (Exact name of registrant as specified in its charter)

           Minnesota                                       41-1666660
----------------------------------                     --------------------
(State or  other jurisdiction                           (Federal Employer
of incorporation  or organization)                      Identification No.)

                              211 South Main Street
                                Hector, MN 55342
              (Address of principal executive offices and zip code)

Registrant's telephone number, including area code: (320) 848-6611

Securities registered pursuant to Section 12(b) of the Act:

                               Title of each class
                          Common Stock, $.01 par value
                      8.5% Convertible Debentures due 2002

Securities registered pursuant to Section 12(g) of the Act:  None

Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the  preceding 12 months (or for such  shorter  period that the  registrant  was
required  to file  such  reports),  and  (2) has  been  subject  to such  filing
requirements for the past 90 days.
                              YES  X     NO
                                  ---      ---
Indicate by a check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation  S-K is not contained  herein,  and will not be contained,  to the
best of registrant's  knowledge,  in definitive proxy or information  statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. (X)

The  aggregate  market value of the voting stock held by  non-affiliates  of the
Registrant was  approximately  $17,237,000  based upon the closing sale price of
the Company's common stock on the American Stock Exchange on March 19, 1998.

As of March 19, 1998 there were outstanding 2,099,226 shares of the Registrant's
common stock.

Documents  Incorporated  by  Reference:  The Company's  Proxy  Statement for its
Annual Meeting of  Shareholders  to be held on May 19, 1998 is  incorporated  by
reference into Part III of this Form 10-K.

================================================================================

<PAGE>


                                     PART I.

ITEM 1.  BUSINESS

[a]    GENERAL DEVELOPMENT OF BUSINESS

       Hector  Communications  Corporation ("HCC" or "Company") is a diversified
telecommunications   holding  company  which,   through  its   wholly-owned  and
majority-owned subsidiaries, is principally engaged in providing local telephone
service. At December 31, 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
<PAGE>



(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:
<TABLE>
<CAPTION>

Telephone Company                                                               Access Lines*
                                                                                 December 31
                                                                   1997               1996                1995
                                                              -----------         -----------        ---------

<S>                                                              <C>                <C>                  <C>
Arrowhead Communications Corporation                                749                748                 738
Eagle Valley Telephone Company                                      685                678                 659
Granada Telephone Company                                           275                276                 263
Pine Island Telephone Company                                     2,919              2,775               2,663
Indianhead Telephone Company                                      2,076              2,057               2,008
Alliance Telecommunications Corporation:
       Loretel Systems, Inc.                                     12,023             11,852
       Sleepy Eye Telephone Company                               5,998              5,814
       Sioux Valley Telephone Company                             5,457              5,355
       Hills Telephone Company                                    2,545              2,465
                                                              ----------          --------
                                                                 32,727             32,020               6,331
                                                              ==========          ==========         =========
</TABLE>

------------------------------------
* 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.

                                       3
<PAGE>

       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


                                       4
<PAGE>

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

                                       5
<PAGE>

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.


                                       6
<PAGE>



         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: <TABLE> <CAPTION>

                                                              Total                                   Company's
                                                           Population            Percent              Share of
Name of Venture                  Service Area            Equivalents(1)         Ownership            Total POPs

<S>                              <S>                          <C>                 <C>                   <C>
Midwest Wireless                 Rochester, MN MSA            948,000              9.78%                92,714
  Communications LLC             and MN RSAs  7, 8,
                                 9, 10 and 11

Sioux Falls Cellular, Ltd.       Sioux Falls, SD MSA          120,000             12.25%                14,700

Red River Cellular, Inc.         ND RSA 3                      92,000              1.60%                 1,472

------------------------------------------------------------------
(1)   Estimated population based on the 1990 United States Census.
</TABLE>

         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.

                                       7
<PAGE>

         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.




                                       8
<PAGE>



       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.




                                       9
<PAGE>



(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.





                                       10
<PAGE>



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.  LEGAL PROCEEDINGS

       No material  litigation or other claims are presently pending against the
Company.

ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

       Not applicable.



                                       11
<PAGE>



                                     PART II

ITEM 5.       MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED
              STOCKHOLDER MATTERS

[a]    MARKET INFORMATION

       The  Company's  common  stock is  currently  being traded 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.



                                       12
<PAGE>



ITEM 6.  SELECTED FINANCIAL DATA
<TABLE>
<CAPTION>

                   SELECTED CONSOLIDATED FINANCIAL INFORMATION
                     (in thousands except per share amounts)

                             Year Ended December 31
                                                                    -------------------------------------------------------------
                                                                           1997        1996        1995         1994        1993
---------------------------------------------------------------------------------------------------------------------------------

Selected Income Statement Information

<S>                                                                    <C>         <C>          <C>          <C>         <C>
Revenues                                                               $ 28,866    $ 20,658     $ 5,844      $ 5,740     $ 5,354
Costs and Expenses                                                       19,113      14,066       4,992        4,175       4,037
---------------------------------------------------------------------------------------------------------------------------------
Operating Income                                                          9,753       6,592         852        1,565       1,317

Other Income (Expenses), net                                             (3,367)     (3,518)       (980)       2,055        (394)
---------------------------------------------------------------------------------------------------------------------------------
Income (Loss) Before Income Taxes                                         6,386       3,074        (128)       3,620         923

Income Tax Expense (Benefit)                                              2,867       1,540         (51)       1,415         354
---------------------------------------------------------------------------------------------------------------------------------
Income (Loss) Before Minority Interest                                    3,519       1,534         (77)       2,205         569

Minority Interest in Earnings of Alliance
  Telecommunications Corporation                                            798         325
---------------------------------------------------------------------------------------------------------------------------------
Income (Loss) Before Cumulative Effect of
  Change in Accounting Principle                                          2,721       1,209         (77)       2,205         569
Cumulative Effect of Change
  in Accounting Principle                                                                                                     51
---------------------------------------------------------------------------------------------------------------------------------
Net Income (Loss)                                                       $ 2,721     $ 1,209       $ (77)     $ 2,205       $ 620
---------------------------------------------------------------------------------------------------------------------------------
---------------------------------------------------------------------------------------------------------------------------------

Basic Net Income (Loss) Per Common Share:
  Before Cumulative Effect of Change
    in Accounting Principle                                              $ 1.44       $ .65      $ (.04)      $ 1.18       $ .27
  Cumulative Effect of Change in
    Accounting Principle                                                                                                     .02
---------------------------------------------------------------------------------------------------------------------------------
       Basic Net Income (Loss) Per Share                                 $ 1.44       $ .65      $ (.04)      $ 1.18       $ .29
---------------------------------------------------------------------------------------------------------------------------------
---------------------------------------------------------------------------------------------------------------------------------

Diluted Net Income (Loss) Per Common Share:
  Before Cumulative Effect of Change
    in Accounting Principle                                               $ .93       $ .53      $ (.04)       $ .97       $ .25
  Cumulative Effect of Change in
    Accounting Principle                                                                                                     .02
---------------------------------------------------------------------------------------------------------------------------------
       Diluted Net Income (Loss) Per Share                                $ .93       $ .53      $ (.04)       $ .97       $ .27
---------------------------------------------------------------------------------------------------------------------------------
---------------------------------------------------------------------------------------------------------------------------------

Average Shares Outstanding:
  Common shares only                                                      1,893       1,870       1,866        1,863       2,162
  Common and potential common shares                                      3,732       3,694       1,866        2,266       2,269
---------------------------------------------------------------------------------------------------------------------------------
---------------------------------------------------------------------------------------------------------------------------------

Selected Balance Sheet Information

Working Capital                                                         $ 8,504     $ 1,307     $ 9,679      $ 4,740     $ 2,202
Property, Plant and Equipment, net                                       45,927      47,039      14,609       13,019      12,894
Excess of Cost Over Net Assets Acquired, net                             51,170      52,510         907          839         723
Total Assets                                                            139,291     137,348      33,518       22,749      21,173
Long-Term Debt                                                           97,793      96,127      22,096       10,528      10,797
Stockholders' Equity                                                     14,447       9,946       8,134        8,230       6,006
---------------------------------------------------------------------------------------------------------------------------------

All net income per share numbers from prior years have been restated to comply with the provisions of SFAS No.
128, "Earnings Per Share".  All potential common shares are anti-dilutive for 1995 and are excluded from
calculation of net income per share

Operating results for 1996 include the operations of Ollig Utilities Company from the April 25, 1996 purchase date.
</TABLE>

                                       13
<PAGE>


           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:


                                       14
<PAGE>
<TABLE>
<CAPTION>
                                                                        Year Ended December 31
                                                          ------------------------------------------------
                                                              1997               1996                 1995
                                                          -----------        ----------          ---------
<S>                                                          <C>                <C>                  <C>
       Local network                                          16.9%              17.8%                18.4%
       Network access                                         58.0               55.8                 59.5
       Nonregulated telephone activities                      13.3               13.0                  4.9
       Billing and collecting                                  3.5                4.3                  3.9
       Cable television                                        8.3                9.1                 13.3
                                                          -----------       -----------          ---------
                                                             100.0  %           100.0%               100.0%
                                                          ===========       ==========           ==========
</TABLE>
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.
<TABLE>
<CAPTION>
                                   Alliance Telecommunications Corp.              Hector Communications Corp.
                                   Year Ended        Eight Months Ended             Year Ended  December 31
                                   December 31          December 31
                                      1997                  1996                  1997                  1996
                               ------------------    ------------------    ------------------    -----------------
<S>                           <C>                   <C>                   <C>                   <C>
Local network                 $        3,346,733    $         2,207,217   $         1,519,514   $        1,474,912
Network access                        12,845,426              7,817,153             3,892,682            3,717,729
Billing and collection                   820,540                656,706               209,642              224,908
Nonregulated activities                3,469,234              2,386,360               369,188              303,895
Cable television                       1,027,602                628,988             1,365,804            1,239,653
                               -----------------     ------------------    ------------------    -----------------
                              $       21,509,535    $        13,696,424   $         7,356,830   $        6,961,097
                               =================     ==================    ==================    =================
</TABLE>
         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. <TABLE> <CAPTION>
                                   Alliance Telecommunications Corp.              Hector Communications Corp.
                                   Year Ended        Eight Months Ended             Year Ended  December 31
                                   December 31          December 31
                                      1997                  1996                  1997                  1996
                               ------------------    ------------------    ------------------    -----------
<S>                           <C>                   <C>                   <C>                   <C>
Plant operations              $        2,714,192    $         1,869,098   $           916,638   $          838,787
Depreciation/amortization              5,336,031              3,493,668             1,973,699            1,934,117
Customer operations                    1,430,676                945,664               243,435              245,277
General and administrative             2,324,079              1,509,010             1,269,042            1,254,197
Other operating                        1,830,921              1,069,148             1,074,244              906,902
                               -----------------     ------------------    ------------------    -----------------
                              $       13,635,899    $         8,886,588   $         5,477,058   $        5,179,280
                               =================     ==================    ==================    =================
</TABLE>

                                       15
<PAGE>

       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. <TABLE> <CAPTION>

                                          Alliance Telecom. Corp.        Hector Communications Corp.
                                           Eight Months Ended         Twelve Months Ended December 31
                                            December 31, 1996               1996                 1995
                                          --------------------     -----------------    -------------
<S>                                         <C>                   <C>                   <C>
       Local network                        $        2,207,217    $        1,474,912    $        1,076,801
       Network access                                7,817,153             3,717,729             3,474,738
       Billing and collection                          656,706               224,908               228,038
       Nonregulated activities                       2,386,360               303,895               285,355
       Cable television                                628,988             1,239,653               779,391
                                            ------------------    ------------------    ------------------
              Total                         $       13,696,424    $        6,961,097    $        5,844,323
                                            ==================    ==================    ==================
</TABLE>

         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.


                                       16
<PAGE>
<TABLE>
<CAPTION>

                                          Alliance Telecom. Corp.        Hector Communications Corp.
                                          Eight Months Ended      Twelve Months Ended December 31
                                            December 31, 1996               1996                 1995
                                         --------------------      -----------------    -------------
<S>                                         <C>                   <C>                   <C>
     Plant operations                       $        1,869,098    $          838,787    $          825,263
     Depreciation and amortization                   3,493,668             1,934,117             1,706,495
     Customer operations                               945,664               245,277               287,185
     General and administrative                      1,509,010             1,254,197             1,520,370
     Nonregulated and miscellaneous                  1,069,148               906,902               652,609
                                            ------------------    ------------------    ------------------
              Total                         $        8,886,588    $        5,179,280    $        4,991,922
                                            ==================    ==================    ==================
</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.

                                       17
<PAGE>

         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.

                                       18
<PAGE>

       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.

                                       19
<PAGE>

         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.


                                       20
<PAGE>

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


                                       21
<PAGE>

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




                                       22
<PAGE>
<TABLE>
<CAPTION>

               HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
                           CONSOLIDATED BALANCE SHEETS

                                     ASSETS
                                                                                                         December 31
                                                                                             -----------------------------------
                                                                                                       1997                 1996
                                                                                             --------------       --------------
CURRENT ASSETS:
<S>                                                                                            <C>                   <C>
  Cash and cash equivalents                                                                    $ 12,455,399          $ 9,571,879
  Temporary cash investments                                                                        300,000            1,079,900
  Construction fund (Note 6)                                                                         77,690               74,337
  Accounts receivable                                                                             4,003,184            3,965,754
  Materials, supplies and inventories, at average cost                                              542,681              512,114
  Prepaid expenses                                                                                  216,351              160,291
                                                                                             --------------       --------------
      TOTAL CURRENT ASSETS                                                                       17,595,305           15,364,275

PROPERTY, PLANT AND EQUIPMENT,net  (Notes 1 and 5)                                               45,927,153           47,038,952

OTHER ASSETS:
  Excess of cost over net assets acquired, less amortization
    of $3,391,000 and $1,989,000 (Note 1)                                                        51,169,677           52,510,459
  Marketable securities (Note 3)                                                                  5,485,698            5,458,400
  Wireless telephone investments (Note 4)                                                        10,680,655           10,224,910
  Other investments (Notes 1 and 6)                                                               7,231,868            5,246,797
  Deferred debenture issue costs (Note 6)                                                           780,089              969,201
  Other assets (Note 1)                                                                             420,511              535,019
                                                                                             --------------       --------------
      TOTAL OTHER ASSETS                                                                         75,768,498           74,944,786
                                                                                             --------------       --------------

TOTAL ASSETS                                                                                  $ 139,290,956        $ 137,348,013
                                                                                             ==============       ==============

                      LIABILITIES AND STOCKHOLDERS' EQUITY

CURRENT LIABILITIES:
  Notes payable and current portion of long-term debt (Note 6)                                  $ 4,770,000         $ 10,047,000
  Accounts payable (Note 10)                                                                      1,591,546            1,860,579
  Accrued expenses                                                                                2,247,972            2,090,639
  Income taxes payable                                                                              481,831               59,015
                                                                                             --------------       --------------
    TOTAL CURRENT LIABILITES                                                                      9,091,349           14,057,233

LONG-TERM DEBT, less current portion (Note 6)                                                    97,793,195           96,127,379

DEFERRED INVESTMENT TAX CREDITS (Note 7)                                                            381,180              526,347

DEFERRED INCOME TAXES (Note 7)                                                                    7,594,092            7,457,907

DEFERRED COMPENSATION (Note 9)                                                                      940,425              987,944

COMMITMENTS AND CONTINGENCIES (Note 4)

MINORITY INTEREST IN ALLIANCE TELECOMMUNICATIONS, CORP.                                           9,043,593            8,245,365

STOCKHOLDERS' EQUITY: (Notes 1, 6 and 8)
  Preferred stock, par value $1.00 per share; 3,000,000 shares authorized:
    Convertible Series A, 378,100 and 389,487 shares issued and outstanding                         378,100              389,487
  Common stock, par value $.01 per share; 10,000,000 shares authorized;
    2,079,364 and 1,883,857 shares issued and outstanding                                            20,794               18,839
  Additional paid-in capital                                                                      1,712,954              102,003
  Retained earnings                                                                              11,726,521            9,005,768
                                                                                             --------------       --------------
                                                                                                 13,838,369            9,516,097
  Unearned employee stock ownership shares                                                          (69,724)            (101,312)
  Unrealized gains on marketable securities (Note 3)                                                678,477              531,053
                                                                                             --------------       --------------
    TOTAL STOCKHOLDERS' EQUITY                                                                   14,447,122            9,945,838
                                                                                             --------------       --------------

TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY                                                    $ 139,290,956        $ 137,348,013
                                                                                             ==============       ==============

                                        See  notes  to  consolidated   financial
statements.

</TABLE>


                                       23
<PAGE>
<TABLE>
<CAPTION>
               HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
                        CONSOLIDATED STATEMENTS OF INCOME

                                                                                             Year Ended December 31
                                                                           -----------------------------------------------------
                                                                                    1997                1996                1995
                                                                           -------------       -------------       -------------
REVENUES:
<S>                                                                        <C>                 <C>                 <C>
  Local network                                                            $   4,866,247       $   3,682,129       $   1,076,801
  Network access                                                              16,738,108          11,534,882           3,474,738
  Billing and collection                                                       1,030,182             881,614             228,038
  Nonregulated activities                                                      3,838,422           2,690,255             285,355
  Cable television revenues                                                    2,393,406           1,868,641             779,391
                                                                           -------------       -------------       -------------
    TOTAL REVENUES                                                            28,866,365          20,657,521           5,844,323

COSTS AND EXPENSES:
  Plant operations                                                             3,630,830           2,707,885             825,263
  Depreciation and amortization                                                7,309,730           5,427,785           1,706,495
  Customer operations                                                          1,674,111           1,190,941             287,185
  General and administrative                                                   3,593,121           2,763,207           1,520,370
  Other operating expenses                                                     2,905,165           1,976,050             652,609
                                                                           -------------       -------------       -------------
    TOTAL COSTS AND EXPENSES                                                  19,112,957          14,065,868           4,991,922
                                                                           -------------       -------------       -------------

OPERATING INCOME                                                               9,753,408           6,591,653             852,401

OTHER INCOME (EXPENSES):
  Interest expense                                                            (6,797,354)         (5,399,617)         (1,554,042)
  Partnership and LLC income (Note 4)                                          1,308,346             502,837             125,924
  Investment income                                                              625,582             691,215             645,781
  Gain on sale of marketable securities (Note 3)                               1,495,999             687,947
  Unrealized loss on trading marketable securities (Note 3)                                                             (197,603)
                                                                           -------------       -------------       -------------
    OTHER INCOME (EXPENSES), net                                              (3,367,427)         (3,517,618)           (979,940)
                                                                           -------------       -------------       -------------

INCOME (LOSS) BEFORE INCOME TAXES                                              6,385,981           3,074,035            (127,539)

INCOME TAX EXPENSE (BENEFIT) (Note 7)                                          2,867,000           1,540,000             (51,000)
                                                                           -------------       -------------       -------------

INCOME (LOSS) BEFORE MINORITY INTEREST                                         3,518,981           1,534,035             (76,539)

MINORITY INTEREST IN EARNINGS OF
  ALLIANCE TELECOMMUNICATIONS CORPORATION                                        798,228             325,365
                                                                           -------------       -------------       -------------

NET INCOME (LOSS)                                                          $   2,720,753       $   1,208,670       $     (76,539)
                                                                           =============       =============       =============

BASIC NET INCOME (LOSS) ~  PER COMMON SHARE (Note 1)                       $        1.44       $         .65       $        (.04)
                                                                           =============       =============       =============

DILUTED NET INCOME (LOSS) ~  PER COMMON SHARE (Note 1)                     $         .93       $         .53       $        (.04)
                                                                           =============       =============       =============

AVERAGE SHARES OUTSTANDING (Notes 1 and 8):
  Common shares only                                                           1,893,000           1,870,000           1,866,000
  Common and potential common shares                                           3,732,000           3,695,000           1,866,000

                                        See  notes  to  consolidated   financial
statements.
</TABLE>

                                       24
<PAGE>
<TABLE>
<CAPTION>
                                    HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
                                          CONSOLIDATED STATEMENTS OF CASH FLOWS

                             Year Ended December 31
                                                                          -------------------------------------------------
                                                                                   1997              1996             1995
                                                                          --------------    --------------    -------------
CASH FLOWS FROM OPERATING ACTIVITIES:
<S>                                                                       <C>               <C>               <C>
  Net Income (loss)                                                       $   2,720,753     $   1,208,670     $    (76,539)
  Adjustments to reconcile  net income  (loss) to net cash provided by operating
    activities:
      Depreciation and amortization                                           7,500,078         5,617,722        1,871,969
      Minority stockholders' interest in earnings
         of Alliance Telecommunications Corporation                             798,228           325,365
      Gain on sales of marketable securities                                 (1,495,999)         (687,947)
      Noncash patronge refunds                                                 (661,923)         (220,662)
      Income from partnership and LLC investments                            (1,308,346)         (502,837)        (125,924)
      Unrealized losses on investments                                                                             231,830
      Changes in assets and  liabilities  net of effects  from the  purchase  of
        Ollig Utilities, Inc.:
        Decrease in marketable securities                                                       1,499,072          437,521
        Decrease (increase) in accounts receivable                              (37,430)         (408,601)         211,145
        Decrease (increase) in materials, supplies and inventories              (30,567)           75,557          (23,854)
        Decrease (increase) in prepaid expenses                                 (56,060)           (6,057)           6,365
        Increase (decrease) in accounts payable                                (269,033)         (585,734)          55,000
        Increase in accrued expenses                                            157,333           708,528          358,231
        Increase (decrease) in income taxes payable                             422,816          (615,843)        (560,331)
        Decrease in deferred investment tax credits                            (145,167)         (129,000)         (39,000)
        Increase (decrease) in deferred income taxes                             25,394           380,000         (243,000)
        Decrease in deferred compensation                                       (47,519)          (31,679)
                                                                          --------------    --------------    -------------
          Net cash provided by operating activities                           7,572,558         6,626,554        2,103,413

CASH FLOWS FROM INVESTING ACTIVITIES:
  Purchases of property, plant and equipment                                 (4,695,301)       (5,168,997)      (3,123,547)
  Sales of temporary cash investments                                           779,900            94,806
  Sales of marketable securities                                              1,728,115           553,645
  Proceeds from wireless telephone investments                                  792,622           437,371
  Purchases of wireless telephone investments                                   (98,933)         (250,000)        (161,638)
  Decrease (increase) in construction fund                                       (3,353)          100,393           39,336
  Purchases of other investments                                             (1,193,105)       (1,274,443)        (457,250)
  Proceeds from other investments                                                27,667            29,911           17,057
  Increase in excess of cost over net assets acquired                           (61,107)          (88,517)        (141,453)
  Decrease (increase) in other assets                                            12,534           107,198          (51,938)
  Payment for purchase of Ollig Utilities Company,
      net of cash acquired                                                                    (69,189,692)      (2,790,236)
                                                                          --------------    --------------    -------------
         Net cash used in investing activities                               (2,710,961)      (74,648,325)      (6,669,669)

CASH FLOWS FROM FINANCING ACTIVITIES:
  Repayment of notes payable and long-term debt                              (5,637,184)       (2,607,031)      (1,769,634)
  Proceeds from issuance of notes payable and long-term debt                  2,026,000        63,168,775       13,064,150
  Minority interest in Alliance Telecommunications Corporation                                  7,920,000
  Convertible bond issue costs                                                                                  (1,323,787)
  Purchase of Hector Communications Corporation
    common stock                                                                                                   (30,272)
  Issuance of common stock                                                    1,575,107            21,768           22,872
  ESOP shares allocated (purchased), net                                         58,000            50,000          (11,683)
                                                                          --------------    --------------    -------------
         Net cash provided by (used in) financing activities                 (1,978,077)       68,553,512        9,951,646
                                                                          --------------    --------------    -------------

NET INCREASE IN CASH AND CASH EQUIVALENTS                                     2,883,520           531,741        5,385,390

CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR                                9,571,879         9,040,138        3,654,748
                                                                          --------------    --------------    -------------
CASH AND CASH EQUIVALENTS AT END OF YEAR                                  $  12,455,399     $   9,571,879     $  9,040,138
                                                                          ==============    ==============    =============

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
  Interest paid                                                           $   7,316,215     $   4,974,256     $  1,023,041
  Income taxes paid                                                           2,564,157         1,890,825          791,331

                                     See   notes   to   consolidated   financial
statements.
</TABLE>

                                       25
<PAGE>

<TABLE>
<CAPTION>


               HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
                 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
                                                                                                   Unearned
                                                                                                   Employee  Unrealized
                                                                            Additional               Stock    Gains on
                                      Preferred Stock      Common Stock       Paid-in   Retained  Ownership  Marketable
                                      Shares   Amount     Shares    Amount    Capital   Earnings     Shares  Securities     Total
                                  --------- ---------  --------- ---------  --------- ----------- ---------- ---------- ------------
<S>                                 <C>      <C>       <C>        <C>      <C>        <C>         <C>        <C>        <C>
BALANCE AT DECEMBER 31, 1994        392,287  $392,287  1,877,850  $ 18,778 $   48,001 $ 7,903,703 $(132,800) $    -     $ 8,229,969
  Net loss                                                                                (76,539)                          (76,539)
  Issuance of common stock under
    Employee Stock Purchase Plan                           3,844        39     22,833                                        22,872
  Purchase of common stock                                (4,200)      (42)      (164)    (30,066)                          (30,272)
  Issuance of common stock in
    exchange for preferred stock     (2,800)   (2,800)     2,800        28      2,772                                             0
  ESOP Shares Purchased,
    net of shares allocated                                                       773               (12,456)                (11,683)
                                  --------- ---------  --------- ---------  --------- ----------- ---------- ---------- ------------
BALANCE AT DECEMBER 31, 1995        389,487   389,487  1,880,294    18,803     74,215   7,797,098  (145,256)       -      8,134,347
  Net income                                                                            1,208,670                         1,208,670
  Issuance of common stock under
    Employee Stock Purchase Plan                           3,563        36     21,732                                        21,768
  ESOP Shares Allocated                                                         6,056                43,944                  50,000
  Unrealized gains on marketable
    securities                                                                                                  531,053     531,053
                                  --------- ---------  --------- ---------  --------- ----------- ---------- ---------- ------------
BALANCE AT DECEMBER 31, 1996        389,487   389,487  1,883,857    18,839    102,003   9,005,768  (101,312)    531,053   9,945,838
  Net income                                                                            2,720,753                         2,720,753
  Issuance of common stock                               171,425     1,714  1,488,255                                     1,489,969
  Issuance of common stock under
    Employee Stock Purchase Plan                           3,695        37     23,126                                        23,163
  Issuance of common stock under
    Employee Stock Option Plan                             9,000        90     61,885                                        61,975
  Issuance of common stock in
    exchange for preferred stock    (11,387)  (11,387)    11,387       114     11,273                                             0
  ESOP Shares Allocated                                                        26,412                31,588                  58,000
  Unrealized gains on marketable
    securities                                                                                                  147,424     147,424
                                  --------- ---------  --------- ---------  --------- ----------- ---------- ---------- ------------
BALANCE AT DECEMBER 31, 1997        378,100 $ 378,100  2,079,364  $ 20,794 $1,712,954 $11,726,521 $ (69,724)  $ 678,477 $14,447,122
                                  ========= =========  ========= =========  ========= =========== ========== ========== ============


                                                                   See  notes to
consolidated financial statements.

</TABLE>

                                       26
<PAGE>



               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

                                       27
<PAGE>

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
                                                              ==================

                                       28
<PAGE>

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.

                                       29
<PAGE>

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. <TABLE> <CAPTION>
                                                                                   December 31
                                                                   ---------------------------------------
                                                                              1997               1996
                                                                   -------------------  ------------------
<S>                                                               <C>                   <C>
Midwest Wireless LLC (9.78%)                                      $          8,741,586  $        7,882,493
Sioux Falls, South Dakota MSA (12.25%)                                       1,931,874           1,958,882
Wireless North (PCS partnerships) (11.66%)                                       2,317             378,578
Red River Cellular (1.6%)                                                        4,878               4,957
                                                                   -------------------  ------------------
       Total                                                      $         10,680,655  $       10,224,910
                                                                   ===================  ==================
</TABLE>

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:


                                       30
<PAGE>

                                    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:
<TABLE>
<CAPTION>

                                                 Estimated                         December 31
                                                useful life                   1997               1996
                                            ------------------    --------------------  ------------------
<S>                                                                   <C>                 <C>
         Land                                                         $        556,976    $        546,673
         Buildings                              5-40 years                   5,171,387           5,207,150
         Machinery and equipment                3-15 years                   2,089,598           1,864,666
         Furniture and fixtures                 5-10 years                     471,489             388,466
         Telephone plant                        5-33 years                  50,638,166          47,591,324
         Cable television plant                 10-15 years                  6,190,412           5,869,575
         Construction in progress                                              676,535             232,923
                                                                  --------------------  ------------------
                                                                            65,794,563          61,700,777
         Less accumulated depreciation                                      19,867,410          14,661,825
                                                                  --------------------  ------------------
                                                                      $     45,927,153    $     47,038,952
                                                                  ====================  ==================
</TABLE>

NOTE 6 - NOTES PAYABLE AND LONG-TERM DEBT
<TABLE>
<CAPTION>
                                                                                 December 31
                                                                              1997               1996
                                                                  --------------------  ------------------
<S>                                                              <C>                   <C>
Notes  payable to St.Paul Bank for Cooperatives, payable
  by Alliance Telecommunications Corporation in monthly
  installments, average interest rate of 7.4%,
  due 1998 to 2011                                                $         53,063,200  $       55,250,000
Note payable to St. Paul Bank for Cooperatives,
  payable by cable television subsidiary, interest rate
  of 8.0%, due 1998 - 2001                                                   4,000,000           6,000,000
Rural Utilities Service ("RUS") and Rural Telephone Bank ("RTB") mortgage notes,
  payable by telephone company subsidiaries in monthly and quarterly
  installments, average rate of 5.6%, due 1998 to 2026                      32,715,608          32,005,604
Convertible subordinated debentures, payable to
  bondholders, interest rate of 8.5%, due 2002                              12,650,000          12,650,000
Notes payable to former cable television system owners,
  payable annually by cable television subsidiary,
  interest rate of 6%, due 1998                                                134,387             268,775
                                                                  --------------------  ------------------
                                                                           102,563,195         106,174,379
Less current portion                                                         4,770,000          10,047,000
                                                                  --------------------  ------------------
                                                                  $         97,793,195  $       96,127,379
                                                                  ====================  ==================
</TABLE>

                                       31
<PAGE>

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.


                                       32
<PAGE>



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: <TABLE> <CAPTION>
                                                                           Year Ended December 31
                                                          --------------------------------------------------------
                                                                   1997                1996              1995
                                                          -----------------  ------------------  -----------------
Currently payable taxes:
<S>                                                       <C>                <C>                 <C>
     Federal                                              $       2,305,000  $          964,000  $         141,000
     State                                                          682,000             325,000             90,000
                                                          -----------------  ------------------  -----------------
                                                                  2,987,000           1,289,000            231,000

Deferred income taxes (benefit)                                      25,000             380,000           (243,000)
Deferred investment tax credits                                    (145,000)           (129,000)           (39,000)
                                                          ------------------ ------------------- ------------------
                                                          $       2,867,000  $        1,540,000  $         (51,000)
                                                          ================== =================== ==================
</TABLE>

Deferred  tax  assets  and  (liabilities)  as of  December  31  related  to  the
following:
<TABLE>
<CAPTION>
                                                                   1997               1996
                                                          ------------------  ------------------
<S>                                                       <C>                <C>
     Accelerated depreciation                             $      (6,329,092) $       (6,410,907)
     Alternative minimum tax credits                                 60,000             237,000
     Marketable securities                                       (1,824,000)         (1,724,000)
     Deferred compensation                                          381,000             400,000
     Other                                                          118,000              40,000
                                                          ------------------ -------------------
                                                          $      (7,594,092) $       (7,457,907)
                                                          ================== ===================
</TABLE>
The  provision  for income taxes varied from the federal  statutory  tax rate as
follows:
<TABLE>
<CAPTION>

                                                                           Year Ended December 31
                                                          -------------------------------------------------------
                                                                   1997                1996              1995
                                                          -----------------  ------------------  ----------------
<S>                                                                  <C>                 <C>              <C>
Tax (benefit) at U.S. statutory rate                                 35.0%               35.0%            (35.0)%
Surtax exemption                                                     (1.0)               (1.0)              1.0
State income taxes, net of federal benefit                            7.4                 7.5              11.4
Excess of cost over net assets acquired                               8.3                12.1              15.6  .
Investment tax credits                                               (2.3)               (4.2)            (29.5)
Other                                                                (2.5)                 .7              (3.5)
                                                          -----------------  ------------------  ----------------
Effective tax (benefit) rate                                         44.9%               50.1%            (40.0)%
                                                          =================  ==================  ================
</TABLE>

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:

                                       33
<PAGE>
<TABLE>
<CAPTION>
                                                                                        Average
                                                                         Number of  exercise price
                                                                           shares       per share
<S>                     <C> <C>                                            <C>      <C>
Outstanding at December 31, 1994                                           158,900  $        7.15
                  Granted                                                   46,150           7.02
                  Canceled                                                  (3,700)          7.17
                                                                  ----------------- -------------
Outstanding at December 31, 1995                                           201,350           7.12
                  Granted                                                   48,825           6.67
                  Canceled                                                 (38,000)          6.53
                                                                  ----------------- -------------
Outstanding at December 31, 1996                                           212,175           7.12
                  Granted                                                   69,775           7.87
                  Exercised                                                 (9,000)          6.89
                  Canceled                                                 (33,200)          7.69
                                                                  ----------------- -------------
Outstanding at December 31, 1997                                           239,750  $        7.27
                                                                  ================= =============
</TABLE>

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:
<TABLE>
<CAPTION>

                                                                  Year Ended December 31
                                            --------------------------------------------------------------
                                                        1997                  1996               1995
                                            --------------------  --------------------  ------------------
<S>                                         <C>                   <C>                   <C>
     Net income                             $          2,579,427  $          1,139,265  $        (115,710)
     Basic net income per share             $               1.36  $                .61  $            (.04)
     Diluted net income per share           $                .89  $                .51  $            (.04)
</TABLE>

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.

                                       34
<PAGE>

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.

                                       35
<PAGE>



NOTE 11 - SEGMENT INFORMATION

The  Company  operates  in  two  business  segments:  local  exchange  telephone
companies and cable television. Industry segment information is as follows:
<TABLE>
<CAPTION>

                                                                           Year Ended December 31
                                                          --------------------------------------------------------
                                                                   1997                1996              1995
                                                          -----------------  ------------------  -----------------
Revenues:
<S>                                                       <C>                <C>                 <C>
     Telephone                                            $      26,051,145  $       18,529,701  $       5,057,777
     Cable television                                             2,393,406           1,868,641            779,391
     Corporate                                                      421,814             259,179              7,155
                                                          -----------------  ------------------  -----------------
                                                          $      28,866,365  $       20,657,521  $       5,844,323
                                                          =================  ==================  =================
Operating income (loss):
     Telephone                                            $       9,929,345  $        6,644,455  $       1,314,828
     Cable television                                               114,884              (3,357)          (335,447)
     Corporate                                                     (290,821)            (49,445)          (126,980)
                                                          ------------------ ------------------- ------------------
                                                          $       9,753,408  $        6,591,653  $         852,401
                                                          =================  ==================  =================
Identifiable assets:
     Telephone                                            $     131,982,347  $      126,596,360  $      22,298,933
     Cable television                                             5,270,085           5,747,246          4,329,023
     Corporate                                                    2,038,524           5,004,407          6,890,488
                                                          -----------------  ------------------  -----------------
                                                          $     139,290,956  $      137,348,013  $      33,518,444
                                                          =================  ==================  =================
Depreciation and amortization:
     Telephone                                            $       6,517,836  $        4,744,780  $       1,204,614
     Cable television                                               780,916             679,473            455,130
     Corporate                                                      201,326             193,469            212,225
                                                          -----------------  ------------------  -----------------
                                                          $       7,500,078  $        5,617,722  $       1,871,969
                                                          =================  ==================  =================
Capital expenditures:
     Telephone                                            $       4,261,522  $        4,669,171  $         869,243
     Cable television                                               378,426             499,826          2,230,637
     Corporate                                                       55,353                                 23,667
                                                          -----------------  ------------------  -----------------
                                                          $       4,695,301  $        5,168,997  $       3,123,547
                                                          =================  ==================  =================
</TABLE>

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.



                                       36
<PAGE>




 (b)  SUPPLEMENTAL FINANCIAL INFORMATION
<TABLE>
<CAPTION>

                                        Unaudited Quarterly Operating Results
                                       (in thousands except per share amounts)


                                                                                Quarter Ended
                                                          ------------------------------------------------------
                                                               March 31      June 30      Sept 30        Dec 31
----------------------------------------------------------------------------------------------------------------
                           1997
<S>                                                           <C>          <C>          <C>             <C>
Revenues                                                      $   6,882    $   6,855    $   7,975       $  7,154
Operating income                                                  1,979        2,190        3,243          2,340
Net income                                                          131        1,080          696            814
Basic net income per share                                    $     .07    $     .58    $     .37       $    .43
Diluted net income per share                                  $     .06    $     .34    $     .24       $    .27


                           1996
Revenues                                                      $   1,666    $   5,165    $   7,218       $  6,609
Operating income                                                    373        1,597        2,497          2,125
Net income                                                          494          110          293            312
Basic net income per share                                    $     .27    $     .06    $     .16       $    .17
Diluted net income per share                                  $     .19    $     .05    $     .13       $    .14

Net income per share for the periods presented above has been restated in accordance with SFAS No. 128.
</TABLE>


                                       37
<PAGE>



ITEM 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
               AND FINANCIAL DISCLOSURE

Not applicable.


                                    PART III

ITEM 10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

The information called for by paragraphs (a), (c), (d), (e), and (f) of Item 401
under  Regulation  S-K,  to the extent  applicable,  will be set forth under the
caption  "Election of Directors" in the Company's  definitive proxy material for
its May 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.  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.  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.  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.


                                       38
<PAGE>



                                     PART IV

ITEM 14.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

(a)   (1)  Consolidated Financial Statements

The  following   Consolidated  Financial  Statements  of  Hector  Communications
Corporation and subsidiaries appear at pages 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.


                                       39
<PAGE>



                                   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


                                       40
<PAGE>

--------------------------------------------------------------------------------

                       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

--------------------------------------------------------------------------------

                                       41
<PAGE>





          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



                                       42
<PAGE>
<TABLE>
<CAPTION>
                                  HECTOR COMMUNICATIONS CORPORATION
                      SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
                          HECTOR COMMUNICATIONS CORPORATION (PARENT COMPANY)

                                            BALANCE SHEETS
                                                                                  December 31
                                                                       -------------------------------
                                                                                1997              1996
                                                                       -------------     -------------
Assets:
<S>                                                                    <C>               <C>
  Cash                                                                 $      49,969     $      57,965
  Investment in subsidiaries                                              27,620,410        24,533,032
  Other current assets                                                        69,056           255,922
  Property, plant and equipment, net                                         134,288           126,265
  Accounts with subsidiaries                                               2,873,495         2,445,201
  Other investments                                                          270,021         1,636,049
  Deferred bond issue costs                                                  780,089           969,201
                                                                       -------------     -------------
Total Assets                                                           $  31,797,328     $  30,023,635
                                                                       =============     =============

Liabilities and Stockholders' Equity:
  Accounts payable                                                     $     146,352     $     166,155
  Other current liabilities                                                  549,759           716,238
  Current portion of long-term debt                                          715,000         6,000,000
  Long-term debt                                                          15,935,000        12,650,000
  Deferred income taxes                                                        4,095           545,404
  Stockholders' equity:
    Preferred stock, par value $1.00 per share; 3,000,000 shares authorized:
      Convertible Series A, 378,100 and 389,487
        shares issued and outstanding                                        378,100           389,487
    Common stock, par value $.01 per share;
      10,000,000 shares authorized; 2,079,364 and
      1,883,857 shares issued and outstanding                                 20,794            18,839
    Additional paid-in capital                                             1,712,954           102,003
    Retained earnings                                                     11,726,521         9,005,768
    Unearned employee stock ownership shares                                 (69,724)         (101,312)
    Unrealized gains on marketable securities                                678,477           531,053
                                                                       -------------     -------------
Total Liabilities and Stockholders' Equity                             $  31,797,328     $  30,023,635
                                                                       =============     =============
</TABLE>

                                       43
<PAGE>
<TABLE>
<CAPTION>

                                            HECTOR COMMUNICATIONS CORPORATION
                               SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
                                   HECTOR COMMUNICATIONS CORPORATION (PARENT COMPANY)

                                                   STATEMENT OF INCOME

                             Year Ended December 31
                                                                       --------------------------------------------------
                                                                                1997              1996               1995
                                                                       -------------     -------------      -------------
Revenues:
<S>                                                                    <C>               <C>                <C>
  Sales                                                                $     287,345     $     285,799      $      49,345

Expenses:
  Operating expenses                                                          90,464            80,716            176,325
  Amortization of goodwill                                                    52,126            51,519             50,307
  Gain on sale of marketable securities                                   (1,464,409)         (484,553)
  Interest expense (income), net                                           1,571,655         1,396,393            641,363
  Income tax expense (benefit)                                                24,315          (272,257)          (302,437)
                                                                       -------------     -------------      -------------
    Total expenses                                                           274,151           771,818            565,558

Income (loss) before equity in earnings of
  subsidiaries                                                                13,194          (486,019)          (516,213)

Equity in earnings of subsidiaries                                         2,707,559         1,694,689            439,674
                                                                       -------------     -------------      -------------
Net income (loss)                                                      $   2,720,753     $   1,208,670      $     (76,539)
                                                                       =============     =============      =============

</TABLE>

                                       44
<PAGE>
<TABLE>
<CAPTION>

                                            HECTOR COMMUNICATIONS CORPORATION
                               SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
                                   HECTOR COMMUNICATIONS CORPORATION (PARENT COMPANY)

                                                STATEMENTS OF CASH FLOWS

                             Year Ended December 31
                                                                       --------------------------------------------------
                                                                                1997              1996               1995
                                                                       -------------     -------------      -------------
Cash flows from operating activities:
<S>                                                                    <C>               <C>                <C>
 Net income                                                            $   2,720,753     $   1,208,670      $     (76,539)
  Adjustments  to  reconcile  net  income  to net  cash  provided  by  operating
   activities:
    Gain on sale of marketable securities                                 (1,464,409)         (484,553)
    Equity in earnings of subsidiaries                                    (2,707,559)       (1,694,689)          (439,674)
    Depreciation and amortization                                            304,700           293,601            266,923
    Changes in assets and liabilities:
     Decrease (increase) in other current assets                             186,866          (178,633)            85,932
     Decrease (increase) in accounts with subsidiaries                      (428,294)        1,487,228            436,296
     Increase (decrease) in accounts payable                                 (19,803)          (17,027)           151,486
     Increase (decrease) in other current liabilities                       (166,479)              877           (140,791)
                                                                       -------------     -------------      -------------
 Net cash provided by (used in) operating activities                      (1,574,225)          615,474            283,633

Cash flows from investing activities:
  Purchases of property, plant and equipment                                 (71,485)          (16,286)           (23,666)
  Acquisition costs of stock of affiliate                                                  (12,346,388)        (2,790,236)
  Advance to subsidiaries                                                                                      (3,500,000)
  Dividends from subsidiaries                                                527,444
  Purchases of other investments                                            (169,737)                            (503,583)
  Cash proceeds from other investments                                     1,646,900           715,598
  Decrease in other deferred charges                                                                               82,092
                                                                       -------------     -------------      -------------
 Net cash provided by (used in) investing activities                       1,933,122       (11,647,076)        (6,735,393)

Cash flows from financing activities:
  Issuance of debt                                                                           6,000,000         12,650,000
  Repayment of long-term debt                                             (2,000,000)
  Deferred bond issue costs                                                                                    (1,323,787)
  Purchase of common stock                                                                                        (30,272)
  Issuance of common stock                                                 1,575,107            21,768             22,872
  ESOP shares allocated (purchased), net                                      58,000            50,000            (11,683)
                                                                       -------------     -------------      -------------
 Net cash provided by (used in) financing activities                        (366,893)        6,071,768         11,307,130
                                                                       -------------     -------------      -------------

Net increase (decrease) in cash and cash equivalents                          (7,996)       (4,959,834)         4,855,370

Beginning cash and cash equivalents                                           57,965         5,017,799            162,429
                                                                       -------------     -------------      -------------
Ending cash and cash equivalents                                       $      49,969     $      57,965      $   5,017,799
                                                                       =============     =============      =============

Supplemental disclosures of cash flow information:
  Interest paid                                                        $   1,420,884     $   1,248,308      $     516,906
  Income taxes paid                                                          450,000           300,000            773,307

</TABLE>

                                       45
<PAGE>





                     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





                                       46
<PAGE>


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



                                       47
<PAGE>



Midwest Wireless Communications L.L.C.
d/b/a Cellular 2000
Statements of Financial Position
as of December 31, 1997 and 1996
<TABLE>
<CAPTION>



                                  ASSETS                                             1997                    1996

Current assets:
<S>                                                                            <C>                     <C>
     Cash and cash equivalents                                                 $      2,063,280        $      1,318,098
     Marketable securities                                                            5,911,871                       -
     Accounts receivable, less allowance for doubtful
          accounts of $360,122 and $139,996 in 1997 and
          1996, respectively                                                          4,548,991               4,139,568
     Inventories                                                                        770,617                 425,266
     Other                                                                              327,417                 328,106
                                                                               -----------------       -----------------

          Total current assets                                                       13,622,176               6,211,038

Property, cellular plant and equipment, net                                          21,032,370              15,788,685
Investment in Switch 2000                                                             1,466,820               1,949,279
FCC license, net                                                                     16,832,224              17,281,088
Other                                                                                   398,195                 224,768
                                                                               -----------------       -----------------

          Total assets                                                         $     53,351,785        $     41,454,858
                                                                               =================       =================


                     LIABILITIES AND MEMBERS' EQUITY

Current liabilities:
     Current portion of long-term debt                                                2,767,000               1,569,000
     Accounts payable                                                                 2,106,461                 521,069
     Accrued commissions                                                                649,891                 821,311
     Accrued liabilities                                                              2,880,534               1,387,678
                                                                               -----------------       -----------------

          Total current liabilities                                                   8,403,886               4,299,058

Other liabilities                                                                       195,247                       -
Long-term debt                                                                       15,149,410              17,393,410
                                                                               -----------------       -----------------

          Total liabilities                                                          23,748,543              21,692,468

Members' equity                                                                      29,603,242              19,762,390
                                                                               -----------------       -----------------

          Total liabilities and members' equity                                $     53,351,785        $     41,454,858
                                                                               =================       =================

</TABLE>


                                       48
<PAGE>



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 <TABLE> <CAPTION>

                                                                                    1997                    1996
                                                                                (12 months)             (six months)

Operating revenues:
<S>                                                                           <C>                     <C>
     Retail service                                                           $     27,785,727        $     11,043,039
     Roamer service                                                                 10,374,827               5,824,188
     Equipment sales                                                                 2,123,505               1,079,355
                                                                              -----------------       -----------------

                                                                                    40,284,059              17,946,582
                                                                              -----------------       -----------------

Operating expenses:
     Operations and maintenance                                                      8,464,911               4,259,858
     Cost of equipment sold                                                          2,988,131               1,598,400
     Depreciation                                                                    3,068,687               1,245,068
     Amortization                                                                      448,864                 210,861
     Selling, general and administrative                                             9,517,110               4,949,103
     Management fees                                                                         -                 702,709
     Home roamer costs                                                                 804,709                 438,582
                                                                              -----------------       -----------------

                                                                                    25,292,412              13,404,581
                                                                              -----------------       -----------------

          Operating income                                                          14,991,647               4,542,001
                                                                              -----------------       -----------------

Other income (expense):
     Equity (loss) earnings on Switch 2000                                            (482,459)                 35,583
     Interest expense                                                               (1,106,380)               (566,034)
     Interest income                                                                   220,628                       -
                                                                              -----------------       -----------------

                                                                                    (1,368,211)               (530,451)
                                                                              -----------------       -----------------

Net income                                                                    $     13,623,436        $      4,011,550
                                                                              =================       =================

</TABLE>

                                       49
<PAGE>



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

<TABLE>
<CAPTION>

                                                                                                       Total
                                                    Capital                 Accumulated               Members'
                                                 Contributions                 Income                  Equity


<S>                                             <C>                       <C>                     <C>
Balance, June 30, 1996                          $     15,750,840          $              -        $     15,750,840

Net income                                                     -                 4,011,550               4,011,550
                                                -----------------         -----------------       -----------------

Balance, December 31, 1996                            15,750,840                 4,011,550              19,762,390

Redemption of units                                       (2,646)                  (24,468)                (27,114)

Distributions to members                                       -                (3,755,470)             (3,755,470)

Net income                                                     -                13,623,436              13,623,436
                                                -----------------         -----------------       -----------------

Balance, December 31, 1997                      $     15,748,194          $     13,855,048        $     29,603,242
                                                =================         =================       =================

</TABLE>

                                       50
<PAGE>



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 <TABLE> <CAPTION>

                                                                                         1997                   1996
                                                                                      (12 months)           (six months)

Cash flows from operating activities:
<S>                                                                                <C>                     <C>
     Net income                                                                    $       13,623,436      $      4,011,550
     Adjustments to  reconcile  net  income to net cash  provided  by  operating
               activities:
          Provision for bad debts                                                             769,330               364,245
          Depreciation                                                                      3,068,687             1,245,068
          Amortization                                                                        448,864               210,861
          Equity loss (earnings) on investments in Switch 2000                                482,459               (35,583)
          Accretion of discount                                                              (106,506)                    -
          Changes in assets and liabilities:
               Accounts receivable                                                         (1,178,753)           (4,384,193)
               Inventories                                                                   (345,351)             (425,266)
               Accounts payable                                                             1,166,996               324,740
               Accrued liabilities                                                          1,321,436             1,893,576
               Other                                                                          195,936              (106,518)
                                                                                   -------------------     -----------------

          Net cash provided by operating activities                                        19,446,534             3,098,480
                                                                                   -------------------     -----------------

Cash flows from investing activities:
     Payments for property, cellular plant and equipment                                   (7,893,976)           (2,466,775)
     Purchases of marketable securities                                                   (10,805,365)                    -
     Proceeds received upon maturity of marketable securities                               5,000,000                     -
     Other                                                                                   (173,427)              (97,536)
                                                                                   -------------------     -----------------

          Net cash used in investing activities                                           (13,872,768)           (2,564,311)
                                                                                   -------------------     -----------------

Cash flows from financing activities:
     Payments on long-term debt                                                            (1,046,000)                    -
     Distributions to members                                                              (3,755,470)                    -
     Redemption of units                                                                      (27,114)                    -
                                                                                   -------------------     -----------------

          Net cash used in financing activities                                            (4,828,584)                    -
                                                                                   -------------------     -----------------

Net change in cash and cash equivalents                                                       745,182               534,169

Cash and cash equivalents, beginning of period                                              1,318,098               783,929
                                                                                   -------------------     -----------------

Cash and cash equivalents, end of period                                           $        2,063,280      $      1,318,098
                                                                                   ===================     =================

Supplemental disclosure:
     Cash paid during the year for interest                                        $        1,116,505      $        328,520
                                                                                   ===================     =================
</TABLE>

                                       51
<PAGE>


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.



                                       52
<PAGE>



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:
<TABLE>
<CAPTION>

                                                                                       1997                     1996


<S>                                                                              <C>                      <C>
          Land                                                                   $       1,212,608        $       1,188,840
          Plant in service                                                              29,184,958               20,915,824
          Plant under construction                                                       1,273,872                1,254,402
                                                                                 ------------------       ------------------

                                                                                        31,671,438               23,359,066
          Less accumulated depreciation                                                (10,639,068)              (7,570,381)
                                                                                 ------------------       ------------------

                                                                                 $      21,032,370        $      15,788,685
                                                                                 ==================       ==================
</TABLE>

     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.



                                       53
<PAGE>



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.


                                       54
<PAGE>



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.



                                       55
<PAGE>



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.



                                       56
<PAGE>



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.



                                       57
<PAGE>



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.



                                       58
<PAGE>





--------------------------------------------------------------------------------




                       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



--------------------------------------------------------------------------------



                                       59
<PAGE>



               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.



                                       60
<PAGE>

<TABLE>
<CAPTION>

               HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
                        CALCULATION OF EARNINGS PER SHARE
                                   EXHIBIT 11

                                                                                              Year Ended December 31
                                                                               ---------------------------------------------------
Basic:                                                                                1997               1996               1995
-------                                                                        -------------      -------------      -------------

<S>                                                                            <C>                <C>                <C>
Net income (loss)                                                              $   2,720,753      $   1,208,670      $     (76,539)
                                                                               =============      =============      =============

Common shares:

  Weighted average number of common shares outstanding                             1,901,508          1,881,472          1,879,083
  Number of unallocated shares held by ESOP                                           (8,930)           (11,817)           (13,083)
                                                                               -------------      -------------      -------------
                                                                                   1,892,578          1,869,655          1,866,000
                                                                               =============      =============      =============

Basic net income (loss) per common share                                       $        1.44      $         .65      $        (.04)
                                                                               =============      =============      =============

Diluted:
-------------

Net income (loss)                                                              $   2,720,753      $   1,208,670      $     (76,539)
Interest on convertible debentures, net of tax (1)                                   758,616            758,616
                                                                               -------------      -------------      -------------
  Adjusted net income                                                          $   3,479,369      $   1,967,286      $     (76,539)
                                                                               =============      =============      =============

Common and potential common shares:

  Weighted average number of common shares outstanding                             1,901,508          1,881,472          1,879,083
  Assumed conversion of convertible debentures into common stock                   1,423,125          1,423,125
  Dilutive effect of convertible preferred shares outstanding                        378,100            389,487
  Dilutive effect of stock options outstanding after application of
     treasury stock method                                                            36,130             11,649
  Dilutive effect of Employee Stock Purchase Plan shares subscribed                    2,455                577
  Weighted average number of unallocated shares held by ESOP                          (8,930)           (11,817)           (13,083)
                                                                               -------------      -------------      -------------
                                                                                   3,732,388          3,694,493          1,866,000
                                                                               =============      =============      =============

Diluted net income (loss) per share                                            $         .93      $         .53      $        (.04)
                                                                               =============      =============      =============

(1)  All potential common shares are anti-dilutive for 1995 and are excluded from the calculation of earnings per share.
</TABLE>

                                       61
<PAGE>



                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.


                                       62
<PAGE>



                                   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


                                       63