Nuvera Communications, Inc. - Quarter Report: 2014 September (Form 10-Q)

PART I – FINANCIAL INFORMATION

 

Item 1. Financial Statements

  

NEW ULM TELECOM, INC. CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
	Three Months Ended September 30,						Nine Months Ended September 30,
	2014			2013			2014			2013
OPERATING REVENUES:
Local Service	$	1,598,021		$	1,675,238		$	4,873,361		$	5,022,386
Network Access		2,782,650			3,206,275			8,876,997			9,198,096
Video		2,138,824			1,865,303			6,155,510			5,410,824
Data		2,372,304			1,906,897			6,294,160			5,616,416
Long Distance		191,524			206,438			605,882			626,837
Other Non-Regulated		989,152			1,068,740			3,122,753			3,063,750
Total Operating Revenues		10,072,475			9,928,891			29,928,663			28,938,309
OPERATING EXPENSES:
Plant Operations (Excluding Depreciation and Amortization)		1,884,463			1,851,248			5,864,758			5,730,487
Cost of Video		1,832,081			1,627,853			5,238,003			4,777,795
Cost of Data		484,493			341,112			1,128,776			866,718
Cost of Other Nonregulated Services		528,660			575,995			1,638,260			1,566,774
Depreciation and Amortization		2,438,620			2,221,458			7,145,149			6,656,115
Selling, General and Administrative		1,762,107			1,583,172			5,364,455			5,056,095
Total Operating Expenses		8,930,424			8,200,838			26,379,401			24,653,984
OPERATING INCOME		1,142,051			1,728,053			3,549,262			4,284,325
OTHER (EXPENSE) INCOME
Interest Expense		(234,302)			(256,114)			(704,206)			(1,138,010)
Interest Income		15,526			26,197			119,526			122,390
Interest During Construction		8,597			3,656			15,779			9,026
CoBank Patronage Dividends		-			-			435,319			521,796
Other Investment Income		51,333			52,437			174,636			119,671
Total Other Income (Expense)		(158,846)			(173,824)			41,054			(365,127)
INCOME BEFORE INCOME TAXES		983,205			1,554,229			3,590,316			3,919,198
INCOME TAXES		412,944			652,778			1,507,929			1,646,065
NET INCOME	$	570,261		$	901,451		$	2,082,387		$	2,273,133
BASIC AND DILUTED  NET INCOME PER SHARE	$	0.11		$	0.18		$	0.41		$	0.44
DIVIDENDS PER SHARE	$	0.0850		$	0.0850		$	0.2550		$	0.2525
WEIGHTED AVERAGE SHARES OUTSTANDING		5,101,334			5,118,134			5,096,090			5,111,816

 

The accompanying notes are an integral part of these consolidated financial statements

 

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Table of Contents

 

 

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New Ulm Telecom’s and Sleepy Eye Telephone Company’s (SETC) settlements from the pools are based on their actual costs to provide service, while the settlements for NU Telecom subsidiaries – Western Telephone Company, Peoples Telephone Company and Hutchinson Telephone Company (HTC) are based on nationwide average schedules. Access revenues for New Ulm Telecom and SETC include an estimate of a cost study each year that is trued-up subsequent to the end of any given year. Our management believes the estimates included in our preliminary cost study are reasonable. We cannot predict the future impact that industry or regulatory changes will have on interstate access revenues.

 

Intrastate access rates are filed with state regulatory commissions in Minnesota and Iowa.

 

We derive revenues from the sale, installation and servicing of communication systems. In accordance with GAAP, these deliverables are accounted for separately. We recognize revenue from customer contracts for sales and installations using the completed-contract method, which recognizes income when the contract is substantially complete. We recognize rental revenues over the rental period.

 

Cost of Services (excluding depreciation and amortization)

Cost of services includes all costs related to delivery of communication services and products. These operating costs include all costs of performing services and providing related products including engineering, network monitoring and transport cost.

 

Selling, General and Administrative Expenses

Selling, general and administrative expenses include direct and indirect selling expenses, customer service, billing and collections, advertising and all other general and administrative costs associated with the operations of the business.

 

Depreciation and Amortization Expense

We use the group life method (mass asset accounting) to depreciate the assets of our telephone companies. Telephone plant acquired in a given year is grouped into similar categories and depreciated over the remaining estimated useful life of the group. When an asset is retired, both the asset and the accumulated depreciation associated with that asset are removed from the books. Due to rapid changes in technology, selecting the estimated economic life of telecommunications plant and equipment requires a significant amount of judgment. We periodically review data on expected utilization of new equipment, asset retirement activity and net salvage values to determine adjustments to our depreciation rates. Depreciation expense was $5,291,724 and $4,802,690 for the nine months ended September 30, 2014 and 2013. We amortize our definite-lived intangible assets over their estimated useful lives. Identifiable intangible assets that are subject to amortization are evaluated for impairment.

 

Income Taxes

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 our deferred taxes arise from differences (i) in the basis of property, plant and equipment due to the use of accelerated depreciation methods for tax purposes, as well as (ii) in partnership investments and intangible assets due to the difference between book and tax basis. Our effective income tax rate is normally higher than the United States tax rate due to state income taxes and permanent differences. 

 

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We account for income taxes in accordance with GAAP. As required by GAAP, we recognize 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.

 

As of September 30, 2014 and 2013 we had $259,739 and $143,866 of unrecognized tax benefits net of a federal tax benefit of $88,311 and $48,914, which if recognized would affect the effective tax rate. Currently, a petition related to Hector Communications Corporation’s (HCC) 2006 Minnesota tax return has been filed in Minnesota Tax Court. It is unknown when this matter will be resolved. 

 

We are primarily subject to United States, Minnesota, Nebraska and Iowa income taxes. Tax years subsequent to 2010 remain open to examination by federal and state tax authorities. Our policy is to recognize interest and penalties related to income tax matters as income tax expense. As of September 30, 2014 and December 31, 2013 we had $68,286 of accrued interest that related to income tax matters.

 

Recent Accounting Developments

 

In May 2014, the Financial Accounting Standards Board (FASB) issued ASU 2014-09, “Revenue from Contracts with Customers” and created a new topic in the FASB Accounting Standards Codification, Topic 606. The new standard provides a single comprehensive revenue recognition framework for all entities and supersedes nearly all existing United States GAAP revenue recognition guidance, including industry-specific guidance. The core principle of the revenue model is that an entity should recognize revenue in a manner that depicts the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The standard is designed to create greater comparability for financial statement users across industries and also requires enhanced disclosures. The amendments are effective for annual reporting periods beginning after December 15, 2016, including interim periods within the reporting period. Early application is not permitted. We are currently evaluating the impact this guidance may have on our consolidated financial statements and related disclosures.

 

In the first quarter of 2013, the FASB issued ASU 2013-02 to improve the disclosure of reclassifications out of accumulated other comprehensive income. The Update requires an entity to provide information about the amounts reclassified out of accumulated other comprehensive income by component. Also, an entity is required to present significant amounts reclassified out of accumulated other comprehensive income by the respective line items of net income (only if the amount reclassified is required under GAAP to be reclassified to net income in its entirety in the same reporting period) either on the face of the statement where net income is presented or in the notes. The adoption of this guidance did not have a material impact on our disclosures or consolidated financial statements.

 

We have reviewed all other significant newly issued accounting pronouncements and determined they are either not applicable to our business or that no material effect is expected on our financial position and results of operations.

 

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Note 2 – Fair Value Measurements

 

We have adopted the rules prescribed under GAAP for our financial assets and liabilities. GAAP includes a fair value hierarchy that is intended to increase consistency and comparability in fair value measurements and related disclosures. The fair value hierarchy is based on inputs to valuation techniques used to measure fair value that are either observable or unobservable. Observable inputs reflect assumptions market participants would use in pricing an asset or liability based on market data obtained from independent sources, while unobservable inputs reflect a reporting entity’s pricing based upon its own market assumptions. The fair value hierarchy consists of the following three levels:

 

Level 1:		Inputs are quoted prices in active markets for identical assets or liabilities.
Level 2:		Inputs are quoted prices for similar assets or liabilities in an active market, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable, and market-corroborated inputs that are derived principally from or corroborated by observable market data.
Level 3:		Inputs are derived from valuation techniques in which one or more significant inputs or value drivers are unobservable.

 

We previously have used financial derivative instruments to manage our overall cash flow exposure to fluctuations in interest rates. We accounted for derivative instruments in accordance with GAAP that requires derivative instruments to be recorded on the balance sheet at fair value. Changes in fair value of derivative instruments must be recognized in earnings unless specific hedge accounting criteria are met, in which case, the gains and losses are included in other comprehensive income rather than in earnings.

 

We previously had entered into interest rate swaps with our lender, CoBank, ACB (CoBank), to manage our cash flow exposure to fluctuations in interest rates. These instruments were designated as cash flow hedges and were effective at mitigating the risk of fluctuations on interest rates in the market place. Any gains or losses related to changes in the fair value of these derivatives were accounted for as a component of accumulated other comprehensive income (loss) for as long as the hedge remains effective.

 

The fair value of our interest rate swap agreements is discussed in Note 5 – “Interest Rate Swaps”. The fair value of our swap agreements were determined based on Level 2 inputs.

 

Other Financial Instruments

 

Other Investments - It is difficult to estimate a fair value for equity investments in companies carried on the equity or cost basis due to a lack of quoted market prices. We conducted an evaluation of our investments in all of our companies in connection with the preparation of our audited financial statements at December 31, 2013. We believe the carrying value of our investments is not impaired.

 

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Note 3 – Goodwill and Intangibles

 

We account for goodwill and other intangible assets under GAAP. Under GAAP, goodwill and intangible assets with indefinite useful lives are not amortized, but are instead tested for impairment (i) on at least an annual basis and (ii) when changes in circumstances indicate that the fair value of goodwill may be below its carrying value. Our goodwill totaled $39,805,349 at September 30, 2014 and December 31, 2013.    

 

As required by GAAP, we do not amortize goodwill and other intangible assets with indefinite lives, but test for impairment on an annual basis or earlier if an event occurs or circumstances change that would reduce the fair value of a reporting unit below its carrying amount. These circumstances include, but are not limited to (i) a significant adverse change in the business climate, (ii) unanticipated competition or (iii) an adverse action or assessment by a regulator. Determining impairment involves estimating the fair value of a reporting unit using a combination of (i) the income or discounted cash flows approach and (ii) the market approach that utilizes comparable companies’ data. If the carrying amount of a reporting unit exceeds its fair value, the amount of the impairment loss must be measured. The impairment loss is calculated by comparing the implied fair value of the reporting unit’s goodwill to its carrying amount. In calculating the implied fair value of the reporting unit’s goodwill, the fair value of the reporting unit is allocated to all of the assets and liabilities of the reporting unit. The excess of the fair value of a reporting unit over the amount assigned to its other assets and liabilities is the implied value of goodwill. We recognize impairment loss when the carrying amount of goodwill exceeds its implied fair value.

 

In 2013 and 2012, we engaged an independent valuation firm to complete our annual impairment testing for goodwill. For 2013 and 2012, the testing results indicated no impairment charge to goodwill as the determined fair value was sufficient to pass the first step of the impairment test.   

 

Our intangible assets subject to amortization consist of acquired customer relationships, regulatory rights, trade name and a non-competition agreement. We amortize intangible assets with finite lives over their respective estimated useful lives. Identifiable intangible assets that are subject to amortization are evaluated for impairment. In addition, we periodically reassess the carrying value, useful lives and classifications of our identifiable intangible assets. The components of our identified intangible assets are as follows:

 

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Amortization expense related to the definite-lived intangible assets was $1,853,425 for both the nine months ended September 30, 2014 and 2013.  

 

Amortization expense for the remaining three months of 2014 and the five years subsequent to 2014 is estimated to be:

 

• (October 1 – December 31) - $617,808
• 2015 - $2,471,233
• 2016 - $2,469,256
• 2017 - $2,469,083
• 2018 - $2,355,083
• 2019 - $2,355,083

 

Note 4 – Secured Credit Facility

 

We have a credit facility with CoBank. Under the credit facility, we entered into separate Master Loan Agreements (MLAs) and a series of supplements to the respective MLAs.

 

On September 5, 2014, NU Telecom entered into an agreement with CoBank to amend the second supplement of its MLA. CoBank agreed to increase the size of its MLA Second Supplement from $10 million to $12 million. The loan is due on December 14, 2014 and is secured by the Company’s assets. The increase in this loan allowed the Company to accommodate additional working capital needs relating to its network expansion.

 

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NU Telecom and its respective subsidiaries also have entered into security agreements under which substantially all of the assets of NU Telecom and its respective subsidiaries have been pledged to CoBank as collateral. In addition, NU Telecom and its respective subsidiaries have guaranteed all obligations under the credit facility.

 

Our loan agreements include restrictions on our ability to pay cash dividends to our stockholders. However, we are allowed to pay dividends (a) (i) in an amount up to $2,050,000 in any year and (ii) in any amount if our “Total Leverage Ratio”, that is, the ratio of our “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 we are not in default or potential default under our loan agreements. As of September 30, 2014, per our loan agreements, we do not have any restrictions on our ability to pay cash dividends to our stockholders.  

 

Our credit facility requires us to comply with specified financial ratios and tests. These financial ratios and tests include total leverage ratio, debt service coverage ratio, equity to total assets ratio and maximum annual expenditures tests.

 

Per our MLAs with CoBank our current outstanding debt has a balloon maturity date on December 31, 2014. At December 31, 2013, all of our outstanding debt became current. Due to the balloon maturity, we notified CoBank that we would be in violation of our debt service coverage ratio in our loan covenants and also notified them that it is our intent to refinance the debt prior to December 31, 2014. Due to these circumstances, CoBank provided a waiver letter of the debt service coverage ratio in our loan covenants effective December 31, 2013. With this waiver letter, we are in compliance with all the stipulated financial ratios in our loan agreements as of September 30, 2014. 

 

As described in Note 5  – “Interest Rate Swaps”, we previously had entered into interest rate swaps that effectively fixed  our interest rates. As of June 30, 2013 the remaining swap matured and we currently have no interest rate swaps in effect. The remaining debt of $45.0 million ($3.2 million available under the revolving credit  facilities and $41.8 million currently outstanding) remains subject to variable interest rates at an effective weighted average interest rate of 2.08%, as of September 30, 2014. 

 

Note 5 – Interest Rate Swaps

 

We assess 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.

 

We generally use variable-rate debt to finance our operations, capital expenditures and acquisitions. These variable-rate debt obligations expose us to variability in interest payments due to changes in interest rates. The terms of our credit facilities with CoBank required that we enter into interest rate agreements designed to protect us against fluctuations in interest rates, in an aggregate principal amount and for a duration determined under the credit facility.

 

To meet this objective, we previously had entered into Interest Rate Swap Agreements with CoBank. Under these Interest Rate Swap Agreements and subsequent swaps that each covered  a specified notional dollar amount, we had  changed the variable-rate cash flow exposure on the debt obligations to fixed cash flows. Under the terms of those interest rate swaps, we paid a fixed contractual interest rate and (i) made an additional payment if the LIBOR variable rate payment was below a contractual rate or (ii) receive a payment if the LIBOR variable rate payment was above the contractual rate.

 

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As previously stated, our last remaining swap matured as of June 30, 2013 and we currently have no interest rate swaps in effect.

 

Each month, we made interest payments to CoBank under its loan agreements based on the current applicable LIBOR Rate,  plus the contractual LIBOR margin then in effect with respect to each applicable loan, without reflecting any interest rate swaps. At the end of each calendar quarter, CoBank adjusted our aggregate interest payments based upon the difference, if any, between the amounts paid by us during the quarter and the current effective interest rate. Net interest payments are reported in our consolidated income statement as interest expense.

 

Pursuant to these interest rate swap agreements, we previously entered into interest rate swaps covering (i) $39.0 million of our aggregate indebtedness to CoBank effective March 19, 2008 and (ii) an additional $6.0 million of our aggregate indebtedness to CoBank effective June 23, 2008. These swaps effectively locked  in the interest rate on (i) $6.0 million of variable-rate debt through March 2011, (ii) $33.0 million of variable-rate debt through March 2013, (iii) $3.0 million of variable-rate debt through June 2011 and (iv) $3.0 million of variable-rate debt through June 2013.

 

On March 31, 2013, $33,000,000 of our swaps matured on Loan RX0583-T1 ($11,250,000) and Loan RX0584-T1 ($21,750,000). No gain or loss was recognized on these swaps as they had reached their full maturities.

 

On June 30, 2013, $3,000,000 of our swaps matured on Loan RX0583-T2. No gain or loss was recognized on this swap as it had reached its full maturity.

 

These interest rate swaps qualified as cash flow hedges for accounting purposes under GAAP. We reflected the effect of these hedging transactions in the financial statements. The unrealized gains were reported in other comprehensive income. If we had terminated our interest rate swap agreements, the cumulative change in fair value at the date of termination would have been reclassified from accumulated other comprehensive income, which is classified in stockholders’ equity, into earnings on the consolidated statements of income.

 

The fair value of the Company’s interest rate swap agreements were determined based on valuations received from CoBank and were based on the present value of expected future cash flows using discount rates appropriate with the terms of the swap agreements. The fair value indicates an estimated amount we would be required to pay if the contracts were canceled or transferred to other parties.

 

Note 6 – Other Investments  

 

We are a co-investor with other rural telephone companies in several partnerships and limited liability companies. These joint ventures make it possible to offer services to customers, including digital video services and fiber optic transport services that we would have difficulty offering on our own. These joint ventures also make it possible to invest in new technologies with a lower level of financial risk. We recognize income and losses from these investments on the equity method of accounting. For a listing of our investments, see Note 9 – “Segment Information”.

 

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Note 7 – Guarantees

 

On September 30, 2011, FiberComm, LC refinanced two existing loans with American State Bank into a ten-year loan, maturing on September 30, 2021. As of September 30, 2014, we have recorded a liability of $265,723 in connection with the guarantee on this loan. This guarantee may be exercised if FiberComm, LC does not make its required payments on this note.

 

Note 8 – Deferred Compensation

 

As of September 30, 2014 and December 31, 2013, we have recorded other deferred compensation relating to executive compensation payable to certain former executives of past acquisitions.   

 

Note 9 – Segment Information  

 

We operate in the Telecom Segment and have no other significant business segments. The Telecom Segment consists of voice, data and video communication services delivered to the customer over our local communications network. No single customer accounted for a material portion of our consolidated revenues.

 

The Telecom Segment operates the following incumbent local exchange carriers (ILECs) and competitive local exchange carriers (CLECs) and has investment ownership interests as follows:

 

Telecom Segment

 

● ILECs:
	▪	NU Telecom, the parent company;
	▪	Hutchinson Telephone Company, a wholly-owned subsidiary of NU Telecom;
	▪	Peoples Telephone Company, a wholly-owned subsidiary of NU Telecom;
	▪	Sleepy Eye Telephone Company, a wholly-owned subsidiary of NU Telecom; and
	▪	Western Telephone Company, a wholly-owned subsidiary of NU Telecom;
● CLECs:
	▪	NU Telecom, located in Redwood Falls, Minnesota; and
	▪	Hutchinson Telecommunications, Inc., a wholly-owned subsidiary of HTC, located in Litchfield, Minnesota;
● Our investments and interests in the following entities include certain management responsibilities:
	▪	FiberComm, LC – 18.27% subsidiary equity ownership interest. FiberComm, LC is located in Sioux City, Iowa;
	▪	Broadband Visions, LLC – 24.30% subsidiary equity ownership interest. Broadband Visions, LLC provides video headend and Internet services; and
	▪	Independent Emergency Services, LLC – 14.29% subsidiary equity ownership interest. Independent Emergency Services, LLC is a provider of E-911 services to the State of Minnesota as well as a number of counties located in Minnesota.

 

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On April 15, 2014 NU Telecom received a notice of dispute from an IXC regarding traffic exchanged between the two companies and specifically the classification of IntraMTA wireless traffic related to access charges. This dispute is an industry-wide dispute affecting numerous telecom companies. NU Telecom is working with other telecom companies towards a resolution of the dispute at both the federal and state levels. We cannot currently predict the outcome of this dispute or its impact to our company.  

 

The Company is also a defendant in legal proceedings arising in the normal course of its operations. While the outcome of these matters cannot be predicted with certainty, management presently believes the disposition of these proceedings will not have a material impact on the financial position of the Company.

 

We did not experience any changes to material contractual obligations in the first nine months of 2014. Refer to the Company’s Annual Report on Form 10-K for the year ended December 31, 2013 for the discussion relating to commitments and contingencies.

 

Note 11 – Subsequent Events

 

We have evaluated and disclosed subsequent events through the filing date of this Quarterly Report on Form 10-Q.

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Forward Looking Statements

 

The Private Securities Litigation Reform Act of 1995 contains certain safe harbor provisions regarding forward-looking statements. This Quarterly Report on Form 10-Q may include forward-looking statements. These statements may include, without limitation, statements with respect to anticipated future operating and financial performance, growth opportunities and growth rates, acquisition and divestiture opportunities, business strategies, business and competitive outlook, and other similar forecasts and statements of expectation. Words such as “expects”, “anticipates”, “intends”, “plans”, “believes”, “seeks”, “estimates”, “targets”, “projects”, “will”, “may”, “continues”, and “should”, and variations of these words and similar expressions, are intended to identify these forward-looking statements. These forward-looking statements are subject to risks and uncertainties that could cause our actual results to differ materially from such statements.

 

Because of these risks, uncertainties and assumptions and the fact that any forward-looking statements made by us and our management are based on estimates, projections, beliefs and assumptions of management, they are not guarantees of future performance and you should not place undue reliance on them. In addition, forward-looking statements speak only as of the date they are made, which is the filing date of this Form 10-Q. With the exception of the requirements set forth in the federal securities laws or the rules and regulations of the SEC, we do not undertake any obligation to update or review any forward-looking information, whether as a result of new information, future events or otherwise.

 

Table of Contents

 

Critical Accounting Policies and Estimates

 

Management’s discussion and analysis of financial condition and results of operations stated in this Form 10-Q, are based upon NU Telecom’s consolidated unaudited financial statements that have been prepared in accordance with GAAP and, where applicable, conform to the accounting principles as prescribed by federal and state telephone utility regulatory authorities. We presently give accounting recognition to the actions of regulators where appropriate. The preparation of our financial statements requires our management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, and the related disclosure of contingent assets and liabilities. Our senior management has discussed the development and selection of accounting estimates and the related Management Discussion and Analysis disclosure with our Audit Committee. For a summary of our significant accounting policies, see Note 1 – “Summary of Significant Accounting Policies” to the Consolidated Financial Statements contained in our Annual Report on Form 10-K for the year ended December 31, 2013, which is incorporated herein by reference.

• During 2014 and 2013, NU Telecom continued to integrate the operations of SETC, which NU Telecom acquired in a spin-off agreement with HCC. NU Telecom originally acquired a one-third interest in HCC on November 3, 2006. HCC was equally owned by NU Telecom, Blue Earth Valley Communications, Inc. and Arvig Enterprises, Inc. Under the spin-off agreement, NU Telecom received all of the stock of SETC and other assets and investments of HCC and incurred $3.3 million of additional debt to finance the spin-off.

• In the third quarter of 2014, NU Telecom completed construction of an expansion in our fiber optic cable network and began providing Little Crow Telemedia Network (Little Crow) and the Minnesota River Valley Education District (MRVED), which are a consortium of school districts in central and southern Minnesota, with high capacity video/audio and data switching services and fiber optic cable transport of information between its members. This agreement allowed us to expand our state-of-the-art; fiber-rich communications network outside of our traditional service territories and will allow us access to new markets that we have not originally served. This contract term is for ten years. In addition, NU Telecom began providing high capacity fiber and data services to Pioneerland Library System, which is a consortium of public libraries located along the same fiber route as Little Crow and MRVED. This contract term is for three years.   

 

Trends

 

Included below is a synopsis of trends management believes will continue to affect our business in 2014. 

 

Voice and switched access revenues are expected to continue to be adversely impacted by future declines in access lines due to competition in the telecommunications industry from cable television providers (CATV), Voice over Internet Protocol (VoIP) providers, wireless, other competitors and emerging technologies. As we experience access line losses, our switched access revenue will continue to decline consistent with industry-wide trends. A combination of changing minutes of use, carriers optimizing their network costs and lower demand for dedicated lines may affect our future voice and switched access revenues. Voice and switched access revenues may also be significantly affected by potential changes in rate regulation at the state and federal levels. We continue to monitor regulatory changes as we believe that rate regulation will continue to be scrutinized and may be subject to change. Access line decreases totaled 1,638 or 5.61% for the twelve months ended September 30, 2014 due to the reasons mentioned above.  

 

The expansion of our state-of-the-art; fiber-rich communications network, growth in broadband customer sales along with continued migration to higher connectivity speeds and the sales of Internet value-added services such as on-line data backup, and hosted and managed service solutions are expected to continue to offset a portion of the revenue declines from the access line trends discussed above.

 

To be competitive, we continue to emphasize the bundling of our products and services. Our customers have the option to bundle local phone, high-speed Internet, long distance and video services. These bundles provide our customers with one convenient location to obtain all of their communications and entertainment options, a convenient billing solution and bundle discounts. We believe that product bundles positively impact our customer retention, and the associated discounts provide our customers the best value for their communications and entertainment options. We have a state-of-the-art, fiber-rich broadband network, which, along with the bundling of our voice, Internet and video services allows us to meet customer demands for products and services. We continue to focus on the research and deployment of advanced technological products that include broadband services, private line, VoIP, digital video, IP Television and hosted and managed services.

 

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We continue to evaluate our operating structure to identify opportunities for increased operational efficiencies and effectiveness. This involves evaluating opportunities for task automation, network efficiency and the balancing of our workforce based on the current needs of our customers.

 

Financial results for the Telecom Segment are included below:

 

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Local Service – We receive recurring revenue for basic local services that enable customers to make and receive telephone calls within a defined local calling area for a flat monthly fee. In addition to subscribing to basic local telephone services, our customers may choose from a variety of custom calling features such as call waiting, call forwarding, caller identification and voicemail. Local service revenue was $1,598,021, which is $77,217 or 4.61% lower in the three months ended September 30, 2014 compared to the three months ended September 30, 2013 and was $4,873,361, which is $149,025 or 2.97% lower in the nine months ended September 30, 2014 compared to the nine months ended September 30, 2013. These decreases were primarily due to the decline in access lines. The number of access lines we serve as an ILEC and CLEC have been decreasing, which is consistent with a general industry trend, as customers are increasingly utilizing other technologies, such as wireless phones and IP services, as well as customers eliminating second phone lines when they move their Internet service from a dial-up platform to a broadband platform. To help offset declines in local service revenue, we implemented an overall strategy that continues to focus on selling a competitive bundle of services. Our focus on marketing competitive service bundles to our customers creates value for the customer and aids in the retention of our voice lines. 

 

Network Access – We provide access services to other telecommunications carriers for the use of our facilities to terminate or originate traffic on our network. Additionally, we bill subscriber line charges (SLCs) to substantially all of our customers for access to the public switched network. These monthly SLCs are regulated and approved by the FCC. In addition, network access revenue is derived from several federally administered pooling arrangements designed to provide network support and distribute funding to the ILECs. Network access revenue was $2,782,650, which is $423,625 or 13.21% lower in the three months ended September 30, 2014 compared to the three months ended September 30, 2013 and was $8,876,997, which is $321,099 or 3.49% lower in the nine months ended September 30, 2014 compared to the nine months ended September 30, 2013. These decreases were primarily due to lower minutes of use on our network.   

 

In recent years, IXCs and others have become more aggressive in disputing both interstate carrier access charges and the applicability of access charges to their network traffic. We believe that long distance and other communication providers will continue to challenge the applicability of access charges either before the FCC or directly with the local exchange carriers. We cannot predict the likelihood of future claims and cannot estimate the impact.

 

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Video – We receive monthly recurring revenue from our subscribers for providing commercial TV programming in competition with local CATV, satellite dish TV and off-air TV service providers. We serve seventeen communities with our IPTV/digital TV services and four communities with our CATV services. Video revenue was $2,138,824, which is $273,521 or 14.66% higher in the three months ended September 30, 2014 compared to the three months ended September 30, 2013 and was $6,155,510, which is $744,686 or 13.76% higher in the nine months ended September 30, 2014 compared to the nine months ended September 30, 2013. These increases were primarily due to rate increases introduced into several of our markets over the course of 2014 and 2013. Also contributing to the increase in video revenue was an increase in demand for our HD and DVR services.

 

Data – We provide high speed Internet to business and residential customers. Our revenue is earned based on the offering of various flat rate packages based on the level of service, data speeds and features. We also provide e-mail and managed services, such as web hosting and design, on-line file back up and on-line file storage. Data revenue was $2,372,304, which is $465,407 or 24.41% higher in the three months ended September 30, 2014 compared to the three months ended September 30, 2013 and was $6,294,160, which is $677,744 or 12.07% higher in the nine months ended September 30, 2014 compared to the nine months ended September 30, 2013. These increases were primarily due to the addition of Little Crow/MRVED and Pioneerland on our newly expanded fiber optic cable network, an increase in data customers and increased managed services revenues. We expect continued growth in this area will be driven by expansion of service areas, our aggressively packaging service bundles and marketing managed service solutions to businesses.

 

Long Distance – Our customers are billed for toll or long-distance services on either a per call or flat-rate basis. This also includes the offering of directory assistance, operator service and long distance private lines. Long distance revenue was $191,524, which is $14,914 or 7.22% lower in the three months ended September 30, 2014 compared to the three months ended September 30, 2013 and was $605,882, which is $20,955 or 3.34% lower in the nine months ended September 30, 2014 compared to the nine months ended September 30, 2013. These decreases were primarily due to the decline in the number of customers subscribing to our long distance service.  

 

Other Revenue – We generate revenue from directory publishing, sales and service of customer premise equipment (CPE), bill processing and other customer services. Our directory publishing revenue for Yellow Page advertising in our telephone directories recurs monthly. We also provide retail sales and service of cellular phones and accessories through Telespire, a national wireless provider. We resell these wireless services as TechTrends Wireless, our branded product. We receive both recurring revenue for our wireless services, as well as revenue collected for the sales of wireless phones and accessories. Other revenue was $989,152, which is $79,588 or 7.45% lower in the three months ended September 30, 2014 compared to the three months ended September 30, 2013. This decrease was primarily due to a decrease in the sales and installation of CPE, partially offset by an increase in the sales of cellular phone and activation revenues. Other revenue was $3,122,753, which is $59,003 or 1.93% higher in the nine months ended September 30, 2014 compared to the nine months ended September 30, 2013. This increase was primarily due to an increase in the sales of cellular phone and activation revenues, and an increase in the sales and installation of CPE.    

 

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Table of Contents

 

 

 

Table of Contents

Other income for the nine months ended September 30, 2014 and 2013 included a patronage credit earned with CoBank as a result of our debt agreements with them. The patronage credit allocated and received in 2014 was $435,319, compared to $521,796 allocated and received in 2013. CoBank determines and pays the patronage credit annually, generally in the first quarter of the calendar year, based on its results from the prior year. We record these patronage credits as income when they are received.

 

Other investment income was $51,333, which is $1,104 or 2.11% lower in the three months ended September 30, 2014 compared to the three months ended September 30, 2013 and was $174,636, which is $54,965 or 45.93% higher in the nine months ended September 30, 2014 compared to the nine months ended September 30, 2013. Other investment income is primarily from our equity ownership in several partnerships and limited liability companies.

 

Income Taxes

 

Income tax expense was $412,944, which is $239,834 or 36.74% lower in the three months ended September 30, 2014 compared to the three months ended September 30, 2013 and was $1,507,929, which is $138,136 or 8.39% lower in the nine months ended September 30, 2014 compared to the nine months ended September 30, 2013. The effective income tax rates for the nine months ending September 30, 2014 and 2013 were approximately 42.0% for both periods. The effective income tax rate differs from the federal statutory income tax rate primarily due to state income taxes and other permanent differences.

 

Liquidity and Capital Resources

 

Capital Structure

 

NU Telecom’s total capital structure (long-term and short-term debt obligations, plus stockholders’ equity) was $99,609,576 at September 30, 2014, reflecting 58.0% equity and 42.0% debt. This compares to a capital structure of $97,661,439 at December 31, 2013, reflecting 58.3% equity and 41.7% debt. In the telecommunications industry, debt financing is most often based on operating cash flows. Specifically, our current use of our credit facilities is in a ratio of approximately 2.99 times debt to EBITDA (earnings before interest, taxes, depreciation and amortization) as defined in our credit agreements, well within acceptable limits for our agreements and our industry. Our management believes adequate operating cash flows and other internal and external resources, such as our cash on hand and revolving credit facility, are available to finance ongoing operating requirements, including capital expenditures, business development, debt service and temporary financing of trade accounts receivable and dividends.

 

Liquidity Outlook

 

Our short-term and long-term liquidity needs arise primarily from (i) capital expenditures; (ii) working capital requirements needed to support the growth of our business; (iii) debt service; (iv) dividend payments on our stock and (v) potential acquisitions.

 

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Our primary sources of liquidity for the nine months ended September 30, 2014 were proceeds from cash generated from operations and cash reserves held at the beginning of the period. At September 30, 2014 we had a working capital deficit of $38,713,869. Per our MLAs with CoBank, our current outstanding debt has a balloon maturity date on December 31, 2014. At December 31, 2013, all of our outstanding debt became current. Due to the balloon maturity, we notified CoBank that we would be in violation of our debt service coverage ratio in our loan covenants and also notified them that it is our intention to refinance the debt prior to December 31, 2014. Due to these circumstances, CoBank provided a waiver letter of the debt service coverage ratio in our loan covenants effective December 31, 2013. With this waiver letter, we are in compliance with all the stipulated financial ratios in our loan agreements as of September 30, 2014.

 

On September 5, 2014, NU Telecom entered into an agreement with CoBank to amend the second supplement of its MLA. CoBank agreed to increase the size of its MLA Second Supplement from $10 million to $12 million. The loan is due on December 14, 2014 and is secured by the Company’s assets. The increase in this loan allowed the Company to accommodate additional working capital needs relating to its network expansion. In addition, at September 30, 2014 we also had approximately $3.2 million available under this revolving credit facility to fund any short-term working capital needs.

  

Cash Flows

 

We expect our liquidity needs to include capital expenditures, payment of interest and principal on our indebtedness, income taxes and dividends. We use our cash inflow to manage the temporary increases in cash demand and utilize our revolving credit facility to manage more significant fluctuations in liquidity caused by growth initiatives.

 

While it is often difficult to predict the impact of general economic conditions on our business, we believe that we will be able to meet our current and long-term cash requirements primarily through our operating cash flows, and anticipate that we will be able to plan for and match future liquidity needs with future internal and available external resources.

 

We periodically seek to add growth initiatives by expanding our network or our markets through organic or internal investments or through strategic acquisitions. We feel that we can adjust the timing or the number of our initiatives according to any limitations which may be imposed by our capital structure or sources of financing. At this time, we do not anticipate our capital structure will limit our growth initiatives over the next twelve months.

 

The following table summarizes our cash flow:

 

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Cash Flows from Operating Activities

 

Cash generated by operations in the first nine months of 2014 was $7,869,993, compared to cash generated by operations of $7,377,133 in 2013. The increase in cash from operating activities in 2014 was primarily due to a decrease in inventories and accounts receivable, partially offset by a decrease in other accrued liabilities and accrued income taxes.

 

Cash generated by operations continues to be our primary source of funding for existing operations, capital expenditures, debt service and dividend payments to stockholders. Cash at September 30, 2014 was $700,923, compared to $964,404 at December 31, 2013.

 

Cash Flows Used in Investing Activities

 

We operate in a capital intensive business. We continue to upgrade our local networks for changes in technology to provide advanced services to our customers.

 

Cash used in investing activities was $7,915,224 in the first nine months of 2014 compared to $3,907,632 in the first nine months of 2013. Capital expenditures relating to on-going operations were $7,867,723 in the first nine months 2014 compared to $3,929,302 in the first nine months of 2013. We expect total plant additions to be approximately $9.0 million in 2014. Our investing expenditures are financed with cash flows from our current operations and advances on our line of credit. We believe that our current operations will provide adequate cash flows to fund our plant additions for the remainder of this year; however, funding from our revolving credit facility is available if the timing of our cash flows from operations does not match our cash flow requirements. At September 30, 2014, we had approximately $3.2 million available under our existing credit facility to fund capital expenditures and other operating needs.

 

Cash Flows Used in Financing Activities

 

Cash used in financing activities for the nine months ended September 30, 2014 was $218,250 and included long-term debt repayments of $3,253,500, draws on our revolving credit facility of $4,334,090 and the distribution of $1,298,840 of dividends to stockholders. Cash used in financing activities for the nine months ended September 30, 2013 was $4,483,846 and included long-term debt repayments of $3,028,500, payments on our revolving credit facility of $165,393 and the distribution of $1,289,953 of dividends to stockholders.

 

Working Capital

 

We had a working capital deficit (i.e. current assets minus current liabilities) of $38,713,869 as of September 30, 2014, with current assets of approximately $7.3 million and current liabilities of approximately $46.0 million, compared to a working capital deficit of $38,447,515 as of December 31, 2013. The ratio of current assets to current liabilities was 0.16 and 0.14 as of September 30, 2014 and December 31, 2013. Per our MLAs with CoBank, our current outstanding debt has a balloon maturity date on December 31, 2014. At December 31, 2013, all of our outstanding debt became current. Due to the balloon maturity, we notified CoBank that we would be in violation of our debt service coverage ratio in our loan covenants and also notified them that it is our intent to refinance the debt prior to December 31, 2014. Due to these circumstances, CoBank provided a waiver letter of the debt service coverage ratio in our loan covenants effective December 31, 2013. With this waiver letter, we are in compliance with all the stipulated financial ratios in our loan agreements as of September 30, 2014. In addition, if it becomes necessary, we will have sufficient availability under our revolving credit facility to fund any fluctuations in working capital and other cash needs. 

 

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