Nuvera Communications, Inc. - Quarter Report: 2008 March (Form 10-Q)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

Commission File Number 0-3024

NEW ULM TELECOM, INC.

(Exact Name of Registrant as Specified in Its Charter)

27 North Minnesota Street

New Ulm, Minnesota 56073

(Address of Principal Executive Offices, Including Zip Code)

(507) 354-4111

(Registrant’s Telephone Number, Including Area Code)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or 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  o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

o  Large Accelerated Filer     x  Accelerated Filer     o  Non-Accelerated Filer     o  Smaller Reporting Company

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes  o    No  x

Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of May 9, 2008: 5,115,435 shares of common stock outstanding.

NEW ULM TELECOM, INC. AND SUBSIDIARIES

MARCH 31, 2008

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PART I. FINANCIAL INFORMATION

ITEM I. FINANCIAL STATEMENTS

NEW ULM TELECOM, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

ASSETS

The accompanying notes are an integral part of the financial statements.

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NEW ULM TELECOM, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS (continued)

LIABILITIES AND STOCKHOLDERS’ EQUITY

The accompanying notes are an integral part of the financial statements.

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NEW ULM TELECOM, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

The accompanying notes are an integral part of the financial statements.

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NEW ULM TELECOM, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY AND OTHER COMPREHENSIVE INCOME/(LOSS)

YEAR ENDED DECEMBER 31, 2007 AND

THREE MONTHS ENDED MARCH 31, 2008

The accompanying notes are an integral part of the financial statements.

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NEW ULM TELECOM, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

The accompanying notes are an integral part of the financial statements.

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NEW ULM TELECOM, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

NOTE 1 – CONSOLIDATED FINANCIAL STATEMENTS

The consolidated financial statements include the accounts of New Ulm Telecom, Inc. and its wholly owned subsidiaries (the “Company”), which includes Hutchinson Telephone Company that was acquired on January 4, 2008. All material intercompany transactions and accounts have been eliminated.

The balance sheets and statement of stockholders’ equity as of March 31, 2008, and statements of income and the statements of cash flows for the periods ended March 31, 2008 and 2007 have been prepared by the Company without audit. In the opinion of management, all adjustments (which include only normal recurring adjustments) necessary to present fairly the financial position, results of operations, and changes in cash flows at March 31, 2008 and for the three-month periods ended March 31, 2008 and 2007 have been made.

The accompanying unaudited interim financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted. These condensed financial statements should be read in conjunction with the financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2007. The results of operations for the period ended March 31, 2008 are not necessarily indicative of the operating results to be expected for the entire year.

The presentation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, and disclosure of contingent assets and liabilities at the balance sheet date, and the reported amounts of revenues and expenses during the reporting period. The estimates and assumptions used in the accompanying consolidated financial statements are based upon management’s evaluation of the relevant facts and circumstances as of the time of the financial statements. Actual results could differ from those estimates.

Revenues are recognized when earned, regardless of the period in which they are billed. Interstate network access revenues are received in conjunction with interexchange carriers and are determined by cost separation studies and nationwide average schedules. Revenues include estimates pending finalization of cost studies. Interstate network access revenues are based upon interstate tariffs filed with the Federal Communications Commission by the National Exchange Carrier Association and state tariffs filed with state regulatory agencies. Management believes recorded revenues are reasonable based on estimates of cost separation studies, which are typically settled within two years. Local network and intrastate access revenues are based on tariffs filed with the state regulatory commissions. Revenues from system sales and services are derived from the sale, installation, and servicing of communication systems. In accordance with EITF 00-21, each of these deliverables are separately accounted for. Customer contracts of sales and installations are recognized using the completed-contract method, which recognizes income when the contract is substantially complete. Rental revenues are recognized over the rental period.

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The provision for income taxes consists of an amount for taxes currently payable and a provision for tax consequences deferred to future periods. Deferred income taxes are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. Significant components of the Company’s deferred taxes arise from differences in the basis of property, plant and equipment due to the use of accelerated depreciation methods for tax purposes and partnerships due to the difference between book and tax income. The Company’s effective income tax rate is higher than the U.S. rate due to the effect of state income taxes.

Effective January 1, 2007, New Ulm Telecom, Inc. adopted FASB Interpretation No. 48 (FIN 48), Accounting for Uncertainty in Income Taxes - an Interpretation of FASB Statement 109. As required by FIN 48, the Company recognized the financial statement benefit of tax positions only after determining that the relevant tax authority would more-likely-than-not sustain the position following an audit. For tax positions meeting the more-likely-than-not threshold, the amount recognized in the financial statements is the largest benefit that has a greater than 50 percent likelihood of being realized upon ultimate settlement with the relevant tax authority. 

At the adoption date of January 1, 2007, the Company had no unrecognized tax benefits that needed to be adjusted. The Company recognizes interest and penalties accrued on unrecognized tax benefits as well as interest received from favorable tax settlements within income tax expense. At March 31, 2008, the Company had approximately $203,800 of net unrecognized tax benefits that, if recognized, would favorably affect the income tax provision when recorded. The Company expects to record additional unrecognized tax benefits within the next year.

The Company is primarily subject to U.S., Minnesota, Iowa, Nebraska and Wisconsin income tax. Tax years subsequent to 2003 remain open to examination by U.S. federal and state tax authorities. The Company’s policy is to recognize interest and penalties related to income tax matters in income tax expense. As of December 31, 2007, and March 31, 2008, the Company had no accrual for interest or penalties related to income tax matters.

On January 1, 2008, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 157, Fair Value Measurements, for its financial assets and liabilities. The Company’s adoption of SFAS No. 157 did not impact its financial position, results of operations, liquidity or disclosures, as there were no financial assets or liabilities that are measured at fair value on a recurring basis as of January 1, 2008. In accordance with FASB Staff Position (FSP) No. 157-2, Effective Date of FASB Statement No. 157, the Company elected to defer until January 1, 2009, the adoption of SFAS No. 157 for all non-financial assets and liabilities that are not recognized or disclosed at fair value in the financial statements on a recurring basis. This includes goodwill and non-financial long-lived assets that are measured at fair value in impairment testing. The Company cannot predict the impact on the Company’s financial position, results of operations or liquidity due to the adoption of SFAS No. 157 for those non-financial assets and liabilities within the scope of FSP 157-2.

SFAS 157 defines fair value as the price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. SFAS 157 also describes three levels of inputs that may be used to measure fair value:

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The fair value of the Company’s interest-rate swap agreements discussed in Financial Statements Note 5, were determined based on Level 2 inputs.

NOTE 2 – SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION

Cash paid during the three months ended March 31:

Noncash investing activities included $105,195 and $163,901 during the periods ended March 31, 2008 and 2007, relating to plant and equipment additions placed in service, which are reflected in accounts payable at March 31, 2008 and 2007, respectively.

NOTE 3 – ACQUISITION OF HUTCHINSON TELEPHONE COMPANY

On January 4, 2008, New Ulm Telecom, Inc. (“New Ulm”) completed the acquisition of Hutchinson Telephone Company (“HTC”) for approximately $78 million pursuant to the terms of the Agreement and Plan of Merger dated as of August 3, 2007, as amended. The transaction was structured as a reverse triangular merger under which a newly formed subsidiary of New Ulm merged into HTC at closing, with HTC continuing as a subsidiary of New Ulm. The acquisition has resulted in a combined company that provides phone, video and Internet services with over 50,000 connections in a number of Minnesota and Iowa communities.

Under the Merger Agreement, approximately $72 million of the $78 million was distributed to former shareholders of HTC immediately. An additional $5.7 million was placed in an escrow account covering (i) indemnification of New Ulm in the amount of $5.2 million covering the representations and warranties of HTC for a period of 15 months from closing and (ii) a “True-Up Reserve” and “Shareholder Fund Amount” in the aggregate amount of $500,000.

The allocation of the purchase price to HTC’s assets and liabilities has been based on preliminary estimates of fair values. This allocation is preliminary and further refinements are likely to be made, and may be significant. Criteria have been established in Statement of Financial Accounting Standards No. 141, “Business Combinations,” for determining whether intangible assets should be recognized separately from goodwill. Statement of Financial Accounting Standards No., 142, “Goodwill and Other Intangible Assets,” provides that goodwill and intangible assets with indefinite lives are not amortized, but rather are tested for impairment on at least an annual basis.

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The preliminary allocation of the net purchase price of HTC is shown below:

The acquisition was accounted for using the purchase method of accounting for business combinations and, accordingly, the acquired assets and liabilities were recorded at their estimated fair values as of the date of acquisition. Based upon the Company’s estimated purchase price allocation, the excess of the purchase price and acquisition costs over the fair value of the net identifiable assets acquired was approximately $54 million. The Company recorded an intangible asset related to the acquired company’s customer relationships of $15,000,000, trade name intangible of $3,400,000, and regulatory rights intangible of $3,000,000. The estimated useful life of the customer relationship intangible asset is 12 years and regulatory rights intangible is 12 years. The trade name intangible has an indefinite life and is not subject to amortization. Goodwill on this transaction will not be deductible for income tax purposes.

Pro Forma Financial Information

On January 4, 2008, New Ulm Telecom, Inc. (“New Ulm”) completed the acquisition of Hutchinson Telephone Company (“HTC”). The following pro forma results presented are for 2007 as if the acquisition had been completed on January 1, 2007. No pro forma results have been presented for 2008 as the closing occurred on January 4, 2008.

NEW ULM TELECOM, INC. AND SUBSIDIARIES

UNAUDITED PRO FORMA COMBINED CONDENSED STATEMENT OF INCOME

* These adjustments include Amortization and Interest Expense, net of the related tax benefit.

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NOTE 4 –SECURED CREDIT FACILITY

In connection with its acquisition of Hutchinson Telephone Company (“HTC”), New Ulm Telecom, Inc. (“New Ulm”) and HTC as New Ulm’s new subsidiary entered into a credit facility with CoBank, ACB. Under the credit facility, each of New Ulm and HTC entered into a separate Master Loan Agreement (“MLA”) and a series of supplements to the respective MLAs.

Under the terms of the two MLA and supplements, New Ulm and HTC have borrowed approximately $59.7 million and entered into promissory notes on the following terms:

New Ulm

MLA: $15,000,000 term note with interest payable monthly. Twelve quarterly principal payments of $125,000 are due commencing March 31, 2008 through December 31, 2010. Sixteen quarterly principal payments of $250,000 are due commencing March 31, 2011 through December 31, 2014. A final balloon payment of $9,500,000 is due at maturity of the note on December 31, 2014.

Supplement: $10,000,000 revolving note with interest payable monthly. Final maturity of the note is December 31, 2014.

Each New Ulm note initially bears interest at a “LIBOR Margin” rate equal to 2.50 percent over the applicable LIBOR rate. The LIBOR Margin decreases as New Ulm’s “Leverage Ratio” decreases.

Hutchinson Telephone Company

MLA: $29,700,000 term note with interest payable monthly. Twenty quarterly principal payments of $609,500 are due commencing March 31, 2010 through December 31, 2014. A final balloon payment of $17,510,000 is due at maturity of the note on December 31, 2014.

Supplement: $2,000,000 revolving note with interest payable monthly. Final maturity of the note is December 31, 2014.

Supplement: $3,000,000 term note with interest payable monthly. Final maturity of the note is April 3, 2008.

Each HTC note initially bears interest at a “LIBOR Margin” rate equal to 2.75 percent over the applicable LIBOR rate. The LIBOR Margin decreases as HTC’s “Leverage Ratio” decreases.

New Ulm and HTC and their respective subsidiaries also have entered into security agreements under which substantially all the assets of New Ulm, HTC and their respective subsidiaries have been pledged to CoBank for performance under the loans. In addition, New Ulm, HTC and their respective subsidiaries have guaranteed all the obligations under the credit facility.

The loan agreements also put restrictions on the ability of New Ulm to pay cash dividends to its shareholders, but New Ulm is allowed to pay dividends (a) (i) in an amount up to $2,050,000 in any year and (ii) in any amount if New Ulm’s “Total Leverage Ratio,” that is, the ratio of its “Indebtedness” to “EBITDA” (in each case as defined in the loan documents) is equal to or less than 3:50 to 1:00, and (b) in either case if New Ulm is not in default or potential default under the loan agreements.

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Principal payments for the next five years are as follows:

NOTE 5 – INTEREST RATE SWAP

The Company assesses interest rate cash flow risk by continually identifying and monitoring changes in interest rate exposures that may adversely affect expected future cash flows and by evaluating hedging opportunities.

The Company uses variable-rate debt to finance its operations, capital expenditures and acquisitions. These variable-rate debt obligations expose the Company to variability in interest payments due to changes in interest rates. The Company, in consultation with its primary lender, CoBank, ACB, has agreed it is prudent for the Company to limit the variability of a portion of its interest payments. To meet this objective, the Company entered into interest rate swap agreements covering $39.0 million of its aggregate indebtedness to CoBank, ACB. Separate interest rate swap agreements were entered by New Ulm and CoBank, ACB and by HTC and CoBank, ACB, in each instance pursuant to an Agreement dated February 26, 2008 that became effective March 19, 2008.

These swaps change the variable-rate cash flow exposure on the debt obligations to fixed cash flows. Under the terms of these interest rate swaps, the Company pays a fixed contractual interest rate plus an additional payment if the LIBOR variable rate payment is below a contractual rate and receives a payment if the LIBOR variable rate payment is above the contractual rate.

As of March 31, 2008, the Company had the following interest rate swaps in effect.

(1)   As noted above in Note 4, Secured Credit Facility, each note initially bears interest at a LIBOR rate determined by the maturity of the note, plus a “LIBOR Margin” rate equal to 2.50% % over the applicable LIBOR rate for New Ulm and 2.75% in the case of HTC. The LIBOR Margin decreases as the borrower’s “Leverage Ratio” decreases.

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These interest rate swaps qualify as a cash flow hedge for accounting purposes under SFAS No. 133. The effect of these hedging transactions on net earnings was insignificant for the period ending March 31, 2008.

The Company determined the fair value of its interest rate swap agreements at March 31, 2008 from valuation received from CoBank, ACB. The fair value indicates an estimated amount the Company would be required to pay if the contracts were canceled or transferred to other parties. At March 31, 2008, the fair value loss of the swaps was $27,331, which has been recorded, net of deferred tax of $11,061, as a decrease in comprehensive income. The fair value loss of the swaps has been included as a current liability in accrued expenses.

NOTE 6 – GOODWILL AND INTANGIBLE ASSETS

The Company accounts for goodwill and other intangible assets under SFAS No. 142, “Goodwill and Other Intangible Assets.” Under the provisions of this accounting standard, goodwill and intangible assets with indefinite useful lives are not amortized but are instead tested for impairment on at least an annual basis and when changes in circumstances indicate that the value of goodwill may be below its carrying value. At March 31, 2008, the Company’s goodwill totaled $35,545,342 and is the result of the wireline acquisitions, including $32,326,436 from the January 4, 2008 purchase of HTC by the Company. The Company annually tests its goodwill as required under SFAS 142 and has determined that the goodwill was not impaired at the last assessment.

The Company’s other intangible assets consist of acquired customer relationships, regulatory rights and trade name. Accumulated amortization on customer relationships was $13,510 at December 31, 2007 and $389,023 at March 31, 2008. Amortization expense is estimated to be $1,502,052 each year for the next five years.

Intangible assets with definite lives are amortized over their useful lives. The components of the Company’s identified intangible assets are as follows:

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NOTE 7 – OTHER INVESTMENTS

Other Investments at March 31, 2008 and December 31, 2007 are as follows:

NOTE 8 – GUARANTEES

On January 30, 2004, the Company guaranteed a portion of the indebtedness of FiberComm, LC (a 25.18% owned partnership, which is being accounted for by the equity method) in connection with the refinancing of a 15-year loan made by American State Bank to FiberComm, LC. The Company had recorded a liability of $375,000 in connection with this guarantee, which was the maximum potential liability under the terms of the guarantee. As of March 31, 2008, the Company has recorded a liability of $323,747 in connection with this guarantee. This was the potential liability under the terms of the guarantee at March 31, 2008.

The Company also has the following loan guarantees, due to the acquisition of HTC:

The Company has a 33.33% ownership in SHAL Networks, Inc. and SHAL, LLC (SHAL) that were formed to provide fiber optic cable facilities. The Company, along with the other members of SHAL, has agreed to guarantee a portion of SHAL’s debt. The Company would be required to pay guaranteed portions if SHAL cannot make payments or if the debt is called. At December 31, 2007, SHAL owed $5,872,204 on the guaranteed debt. The note is due in 2014. The Company’s potential liability under the guarantee is not to exceed $2,577,809. As a result of the guarantee the Company has recorded on the balance sheet an increase in other investments at March 31, 2008 of $1,903,316 with corresponding increases to loan guarantees.

The Company has a 33.33% ownership in En-Tel Communications, LLC (En-Tel) that was formed to provide competitive local exchange services. The Company, along with some of the other members of En-Tel, has agreed to guarantee two of En-Tel’s debt instruments. The Company would be required to pay guaranteed portions if En-Tel cannot make payments or if the debt is called.

At March 31, 2008, En-Tel owed $8,484,498 on the first note payable. The note is due in 2015. The Company’s potential liability under the guarantee of this note is not to exceed $2,121,125. This guarantee is not currently recorded on the balance sheet because it was entered into by HTC before the requirement to record guarantees. In the future, the recording of this guarantee will be considered, pending a purchase acquisition valuation of HTC.

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At March 31, 2008, En-Tel owed $4,816,641 on a second note payable. The note is due in 2018. The Company’s potential liability under this guarantee is not to exceed $2,750,000. As a result of the guarantee, the Company’s balance sheet at March 31, 2008, shows an increase in other investments of $2,408,320 with corresponding increases to loan guarantees.

NOTE 9 – OTHER DEFERRED CREDITS

The Company, due to the acquisition of HTC, has recorded other deferred credits relating to the estimated present value of executive compensation payable to certain past executives of HTC.

NOTE 10 – SEGMENT INFORMATION

The Company and its subsidiaries are organized into three business segments as follows:

Telecom Segment

Cellular Segment

Phonery Segment

No single customer accounted for a material portion of the Company’s revenues in any of the last three years.

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Segment information is as follows: