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

FORM 10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

_________________

 

FORM 10-Q

 

(Mark One)

 

x     QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

         For the quarterly period ended March 31, 2014

 

OR

 

¨      TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

         For the transition period from     to     .

 

Commission File Number  0-3024

 

NEW ULM TELECOM, INC.

(Exact name of Registrant as specified in its charter)

 

             Minnesota

 

41-0440990

(State or other jurisdiction of

 

(I.R.S. Employer

incorporation or organization)

 

Identification No.)

 

27 North Minnesota Street

New Ulm, Minnesota  56073

(Address of principal executive offices and 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 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  o

 

Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files).  Yes x  No  o        

 

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definition of “large accelerated filer, accelerated filer, and smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one): 

 

o Large accelerated filer  o Accelerated filer  o Non-accelerated filer  x 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

 

The total number of shares of the Registrant’s common stock outstanding as of May 15, 2014: 5,089,534.

 

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table of contents

 

 

 

 

 

PART I – FINANCIAL INFORMATION 

 

 

 

 

Item 1

Financial Statements

3-8

 

 

 

 

Consolidated Statements of Income (unaudited) for the Three Months Ended March 31, 2014 and 2013

3

 

 

 

 

Consolidated Statements of Comprehensive Income (unaudited) for the Three Months Ended March 31, 2014 and 2013

4

 

 

 

 

Consolidated Balance Sheets (unaudited) as of March 31, 2014 and December 31, 2013

5-6

 

 

 

 

Consolidated Statements of Cash Flows (unaudited) for the Three Months Ended March 31, 2014 and 2013

7

 

 

 

 

Consolidated Statements of Stockholders’ Equity (unaudited) for the Year Ended December 31, 2013 and for the Three Months ended March 31, 2014

8

 

 

 

 

Condensed Notes to Consolidated Financial Statements (unaudited)

9-20

 

 

 

Item 2

Management’s Discussion and Analysis of Financial Condition and Results of Operations

20-31

 

 

Item 3

Quantitative and Qualitative Disclosures About Market Risk

31

 

 

 

Item 4

Controls and Procedures  

31

 

 

 

 

PART II – OTHER INFORMATION

 

 

 

 

Item 1

Legal Proceedings  

32

 

 

 

Item 1A

Risk Factors

32

 

 

 

Item 2

Unregistered Sales of Equity Securities and Use of Proceeds

32

 

 

 

Item 3

Defaults Upon Senior Securities

32

 

 

 

Item 4

Mine Safety Disclosures

32

 

 

 

Item 5

Other Information

32

 

 

 

Item 6

Exhibits Listing

32

 

 

 

 

Signatures

34

 

 

 

 

Exhibits

 

 

 

 

 

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Table of Contents

PART I – FINANCIAL INFORMATION

 

Item 1. Financial Statements

  

NEW ULM TELECOM, INC.

CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

           
 

Three Months Ended

 

March 31,

 

2014

 

2013

OPERATING REVENUES:

         

Local Service

$

1,636,349

 

$

1,685,713

Network Access

 

3,209,114

   

2,971,600

Video

 

1,928,972

   

1,731,457

Data

 

1,938,129

   

1,803,080

Long Distance

 

205,198

   

215,440

Other Non-Regulated

 

1,061,439

   

1,005,155

Total Operating Revenues

 

9,979,201

 

 

9,412,445

           

OPERATING EXPENSES:

         

Plant Operations (Excluding Depreciation

         

and Amortization)

 

1,964,577

   

1,881,383

Cost of Video

 

1,713,184

   

1,596,651

Cost of Data

 

323,538

   

249,275

Cost of Other Nonregulated Services

 

534,733

   

488,203

Depreciation and Amortization

 

2,331,781

   

2,210,500

Selling, General and Administrative

 

1,833,508

   

1,799,326

Total Operating Expenses

 

8,701,321

 

 

8,225,338

           

OPERATING INCOME

 

1,277,880

 

 

1,187,107

           

OTHER (EXPENSE) INCOME

         

Interest Expense

 

(235,107)

   

(571,150)

Interest Income

 

86,122

   

70,727

Interest During Construction

 

3,165

   

2,888

CoBank Patronage Dividends

 

435,319

   

521,796

Other Investment Income

 

49,622

   

40,625

Total Other Income (Expense)

 

339,121

 

 

64,886

           

INCOME BEFORE INCOME TAXES

 

1,617,001

   

1,251,993

           

INCOME TAXES

 

679,141

 

 

524,804

           

NET INCOME

$

937,860

 

$

727,189

           

BASIC AND DILUTED

         

NET INCOME PER SHARE

$

0.18

 

$

0.14

           

DIVIDENDS PER SHARE

$

0.0850

 

$

0.0825

           

WEIGHTED AVERAGE SHARES OUTSTANDING

 

5,089,534

 

 

5,103,918

           

 

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

 

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NEW ULM TELECOM, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited)

 

 

 

 

 

 

 

Three Months Ended

 

March 31,

 

2014

 

2013

 

 

 

 

 

 

Net Income

$

937,860

 

$

727,189

 

 

 

 

 

 

Other Comprehensive Income (Loss):

 

 

 

 

 

Unrealized Gain on Interest Rate Swaps

 

-

 

 

271,950

Income Tax Expense Related to Unrealized Gain on Interest Rate Swaps

 

-

 

 

(110,058)

Other Comprehensive Income

 

-

 

 

161,892

 

 

 

 

 

 

Comprehensive Income

$

937,860

 

$

889,081

 

 

 

 

 

 

 

 

 

 

 

 

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

 

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NEW ULM TELECOM, INC.

CONSOLIDATED BALANCE SHEETS

(Unaudited)

           

ASSETS

           
 

March 31,

2014

 

December 31,

2013

   

CURRENT ASSETS:

         

Cash and Cash Equivalents

$

623,574

 

$

964,404

Receivables, Net of Allowance for

         

Doubtful Accounts of $160,000 and $120,000

 

1,848,248

   

1,458,627

Income Taxes Receivable

 

60,901

   

-

Materials, Supplies, and Inventories

 

2,562,617

   

2,535,046

Deferred Income Taxes

 

760,072

   

761,076

Prepaid Expenses

 

787,988

 

 

778,035

Total Current Assets

 

6,643,400

 

 

6,497,188

           

INVESTMENTS & OTHER ASSETS:

         

Goodwill

 

39,805,349

   

39,805,349

Intangibles

 

25,520,152

   

26,137,960

Other Investments

 

6,923,088

   

6,731,959

Other Assets

 

125,873

 

 

148,477

Total Investments and Other Assets

 

72,374,462

 

 

72,823,745

           

PROPERTY, PLANT & EQUIPMENT:

         

Telecommunications Plant

 

109,058,513

   

108,677,838

Other Property & Equipment

 

12,402,276

   

11,512,589

Video Plant

 

9,292,903

 

 

9,444,324

Total Property, Plant and Equipment

 

130,753,692

   

129,634,751

Less Accumulated Depreciation

 

87,348,536

 

 

86,075,424

Net Property, Plant & Equipment

 

43,405,156

 

 

43,559,327

           

TOTAL ASSETS

$

122,423,018

 

$

122,880,260

           

 

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

 

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NEW ULM TELECOM, INC.

CONSOLIDATED BALANCE SHEETS (continued)

(Unaudited)

           

LIABILITIES AND STOCKHOLDERS' EQUITY

           
 

March 31,

2014

 

December 31,

2013

   

CURRENT LIABILITIES:

         

Current Portion of Long-Term Debt

$

40,862,267

 

$

40,707,730

Accounts Payable

 

1,260,227

   

1,792,608

Accrued Income Taxes

 

-

   

114,017

Other Accrued Taxes

 

250,563

   

190,954

Deferred Compensation

 

62,404

   

65,523

Accrued Compensation

 

257,804

   

605,861

Other Accrued Liabilities

 

1,328,059

   

1,468,010

Total Current Liabilities

 

44,021,324

 

 

44,944,703

           

LONG-TERM DEBT, Less Current Portion

 

-

 

 

-

           

NONCURRENT LIABILITIES:

         

Loan Guarantees

 

267,158

   

274,649

Deferred Income Taxes

 

19,417,246

   

19,418,249

Unrecognized Tax Benefit

 

259,739

   

259,739

Other Accrued Liabilities

 

93,164

   

107,765

Deferred Compensation

 

905,430

 

 

921,446

Total Noncurrent Liabilities

 

20,942,737

 

 

20,981,848

           

COMMITMENTS AND CONTINGENCIES:

 

-

   

-

           

STOCKHOLDERS' EQUITY:

         

Preferred Stock - $1.66 Par Value, 10,000,000 Shares Authorized, None Issued

 

-

   

-

Common Stock - $1.66 Par Value, 90,000,000 Shares Authorized, 5,089,534 Shares Issued and Outstanding

 

8,482,556

   

8,482,556

Retained Earnings

 

48,976,401

   

48,471,153

Total Stockholders' Equity

 

57,458,957

 

 

56,953,709

           

TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY

$

122,423,018

 

$

122,880,260

 

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

 

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NEW ULM TELECOM, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

           
 

Three Months Ended

 

March 31,

2014

 

March 31,

2013

   

CASH FLOWS FROM OPERATING ACTIVITIES:

         

Net Income

$

937,860

 

$

727,189

Adjustments to Reconcile Net Income to Net Cash

         

Provided by Operating Activities:

         

Depreciation and Amortization

 

2,341,465

   

2,220,184

Undistributed Earnings of Other Equity Investments

 

(46,291)

   

(40,025)

Noncash Patronage Refund

 

(108,830)

   

(130,449)

Distributions from Equity Investments

 

-

   

14,616

Stock Issued in Lieu of Cash Payment

 

16,800

   

21,000

Changes in Assets and Liabilities:

         

Receivables

 

(376,701)

   

31,830

Income Taxes Receivable

 

(60,901)

   

201,270

Inventories

 

(27,571)

   

(266,035)

Prepaid Expenses

 

(26,753)

   

(70,992)

Accounts Payable

 

(751,622)

   

(119,253)

Accrued Income Taxes

 

(114,017)

   

162,644

Other Accrued Taxes

 

59,609

   

58,941

Other Accrued Liabilities

 

(502,609)

   

41,131

Deferred Compensation

 

(19,135)

   

(20,197)

Net Cash Provided by Operating Activities

 

1,321,304

 

 

2,831,854

           

CASH FLOWS FROM INVESTING ACTIVITIES:

         

Additions to Property, Plant, and Equipment, Net

 

(1,340,560)

   

(1,122,358)

Other, Net

 

(43,499)

   

(81,636)

Net Cash Used in Investing Activities

 

(1,384,059)

 

 

(1,203,994)

           

CASH FLOWS FROM FINANCING ACTIVITIES:

         

Principal Payments of Long-Term Debt

 

(1,084,500)

   

(609,500)

Changes in Revolving Credit Facility

 

1,239,037

   

(2,313,868)

Dividends Paid

 

(432,612)

   

(421,075)

Net Cash Used in Financing Activities

 

(278,075)

 

 

(3,344,443)

           

NET DECREASE IN CASH

 

(340,830)

   

(1,716,583)

           

CASH at Beginning of Period

 

964,404

 

 

2,749,850

           

CASH at End of Period

$

623,574

 

$

1,033,267

           
           

Supplemental cash flow information:

         

Cash paid for interest

$

221,882

 

$

553,637

Net cash paid for income taxes

$

855,500

 

$

160,000

           
 
The accompanying notes are an integral part of these consolidated financial statements.
 
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NEW ULM TELECOM, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

(Unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

YEAR ENDED DECEMBER 31, 2013, AND

THREE MONTHS ENDED MARCH 31, 2014

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accumulated

Other

Comprehensive

Income (Loss)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Common Stock

Shares

 

 

 

 

 

Retained

Earnings

 

Total

Equity

 

 

Amount

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

BALANCE on December 31, 2012

5,103,918

 

$

8,506,530

 

$

(179,313)

 

$

47,403,409

 

$

55,730,626

Director's Stock Plan

14,216

 

 

23,693

 

 

 

 

 

68,707

 

 

92,400

Retirement of Stock from BCS Holdings

(28,600)

 

 

(47,667)

 

 

 

 

 

(132,513)

 

 

(180,180)

Net Income

 

 

 

 

 

 

 

 

 

2,854,115

 

 

2,854,115

Dividends

 

 

 

 

 

 

 

 

 

(1,722,565)

 

 

(1,722,565)

Other Comprehensive Income

 

 

 

 

 

 

179,313

 

 

 

 

 

179,313

 

 

 

 

 

 

 

 

 

 

 

 

 

 

BALANCE on December 31, 2013

5,089,534

 

 

8,482,556

 

 

-

 

 

48,471,153

 

 

56,953,709

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net Income

 

 

 

 

 

 

 

 

 

937,860

 

 

937,860

Dividends

 

 

 

 

 

 

 

 

 

(432,612)

 

 

(432,612)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

BALANCE on March 31, 2014

5,089,534

 

$

8,482,556

 

$

-

 

$

48,976,401

 

$

57,458,957

 

 

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

 

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NEW ULM TELECOM, INC.

CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2014 (Unaudited)

 

Note 1 – Basis of Presentation and Consolidation

 

The accompanying unaudited condensed consolidated financial statements of New Ulm Telecom, Inc. and its subsidiaries (NU Telecom) have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP) for interim financial information and with the rules and regulations of the Securities and Exchange Commission (SEC). Certain information and disclosures normally included in annual financial statements prepared in accordance with GAAP have been omitted or condensed pursuant to such rules and regulations. In the opinion of management, the unaudited condensed consolidated financial statements reflect all adjustments (consisting only of normal and recurring accruals) considered necessary for the fair presentation of the financial statements and present fairly the results of operations, financial position and cash flows for the interim periods presented as required by Regulation S-X, Rule 10-01. These unaudited interim condensed consolidated financial statements should be read in conjunction with our audited consolidated financial statements and notes thereto contained in our Annual Report on Form 10-K for the year ended December 31, 2013.

 

The preparation of our financial statements in conformity with GAAP requires our management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosures at the date of the financial statements and during the reporting period. Actual results may differ from these estimates. The results of operations for the interim periods presented are not necessarily indicative of the results that may be expected for the fiscal year as a whole or any other interim period.

 

Our consolidated financial statements report the financial condition and results of operations for NU Telecom and its subsidiaries in one business segment: the Telecom Segment. Inter-company transactions have been eliminated from the consolidated financial statements.

 

Revenue Recognition

We recognize revenue when (i) persuasive evidence of an arrangement exists, (ii) delivery of the product has occurred or a service has been provided, (iii) the price is fixed or determinable and (iv) collectability is reasonably assured.

 

Revenues are earned from our customers primarily through the connection to our local network, digital and commercial television programming, and Internet services (both dial-up and high-speed broadband). Revenues for these services are billed based on set rates for monthly service or based on the amount of time the customer is utilizing our facilities. The revenue for these services is recognized when the service is rendered.

 

Revenues earned from interexchange carriers (IXC) accessing our network are based on the utilization of our network by these carriers as measured by minutes of use on the network or special access to the network by the individual carriers. Revenues are billed at tariffed access rates for both interstate and intrastate calls. Revenues for these services are recognized based on the period the access is provided.

 

 

Interstate access rates are established by a nationwide pooling of companies known as the National Exchange Carriers Association (NECA). The Federal Communications Commission (FCC) established NECA in 1983 to develop and administer interstate access service rates, terms and conditions. Revenues are pooled and redistributed on the basis of a company's actual or average costs. There has been a change in the composition of interstate access charges in recent years, shifting more of the charges to the end user and reducing the amount of access charges paid by the IXC’s. We believe this trend will continue.

 

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.

 

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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 $1,713,973 and $1,592,692 for the three months ended March 31, 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 bases. 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 March 31, 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 2009 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 March 31, 2014 and December 31, 2013 we had $68,286 of accrued interest that related to income tax matters.

 

Recent Accounting Developments

 

In the first quarter of 2013, the Financial Accounting Standards Board 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 reviewed all 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.

 

Note 2 – Acquisitions and Dispositions

 

Hector Communications Corporation Spin-Off Agreement

 

On December 31, 2012 NU Telecom completed a spin-off agreement with HCC. NU Telecom had 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 and incurred $3.3 million of additional debt to finance the spin-off.

 

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The final allocation of the spin-off value of HCC is shown below:

 

Current Assets

$

439,664

Property, Plant, and Equipment

 

9,847,787

Investments

 

2,412,938

Customer Relationship Intangible

 

9,900,000

Trade Name Intangible

 

570,000

Excess Costs Over Net Assets Acquired (Goodwill)

 

10,098,249

Current Liabilities

 

(300,621)

Deferred Liabilities

 

(7,675,522)

     

Total Purchase Price

 

25,292,495

Less Cash Acquired

 

(18,150)

     

Cash Paid for Acquisition

$

25,274,345

     

 

This spin-off was accounted for using the acquisition method of accounting for business combinations, and accordingly, the acquired assets were recorded at estimated fair values as of the date of acquisition. Based on our final spin-off price allocation, the excess of the purchase price and acquisition costs over the fair value of the net identifiable tangible assets acquired was $20,568,249, which is not deductible for income tax purposes.The Company recorded an intangible asset related to the acquired company’s customer relationships of $9,900,000 and trade name intangible of $570,000. The estimated useful life of the customer relationship intangible is 14 years and trade name intangible is 5 years.

 

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Note 3 – 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 on 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 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 had entered into interest rate swaps with our lender, CoBank, ACB, 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 6 – “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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Debt – We estimate the fair value of our long-term debt based on the discounted future cash flows we expect to pay using current borrowing rates for similar types of debt. Fair value of the debt approximates carrying value.

 

Other Financial Instruments - Our financial instruments also include cash equivalents, trade accounts receivable and accounts payable where the current carrying amounts approximate fair market value.

 

Note 4 – 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 March 31, 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 existing 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.  

 

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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:

 

 
 

 

 

 

March 31, 2014

 

December 31, 2013

 

 

 

Gross

Carrying

Amount

 

 

 

 

Gross

Carrying

Amount

 

 

 

 

Useful

 

 

Accumulated

Amortization

 

 

Accumulated

Amortization

 

Lives

 

 

 

 

Definite-Lived Intangible Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

Customers Relationships

14-15 yrs

 

$

29,278,445

 

$

9,519,140

 

$

29,278,445

 

$

8,996,498

Regulatory Rights

15 yrs

 

 

4,000,000

 

 

1,666,653

 

 

4,000,000

 

 

1,599,987

Non-Competition Agreement

5 yrs

 

 

800,000

 

 

800,000

 

 

800,000

 

 

800,000

Trade Name

3-5 yrs

 

 

1,370,000

 

 

942,500

 

 

1,370,000

 

 

914,000

Indefinitely-Lived Intangible Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

Video Franchise

 

 

 

3,000,000

 

 

-

 

 

3,000,000

 

 

-

Total

 

 

$

38,448,445

 

$

12,928,293

 

$

38,448,445

 

$

12,310,485

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net Identified Intangible Assets

 

 

 

 

 

$

25,520,152

 

 

 

 

$

26,137,960

 

Amortization expense related to the definite-lived intangible assets was $617,808 for both the three months ended March 31, 2014 and 2013. 

 

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

 

  • (April 1 – December 31) - $1,853,425
  • 2015 - $2,471,233
  • 2016 - $2,469,256
  • 2017 - $2,469,083
  • 2018 - $2,355,083
  • 2019 - $2,355,083

 

Note 5 – Secured Credit Facility

 

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

 

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, ACB 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 March 31, 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, ACB, 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, ACB 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 March 31, 2014. 

 

As described in Note – “Interest Rate Swaps”,  we had entered into interest rate swaps that effectively fixed  our interest rates. As of June 30, 2013 our last remaining swap matured and we currently have no interest rate swaps in effect. The remaining debt of $45.2 million ($4.3 million available under the revolving credit  facilities and $40.9 million currently outstanding) remains subject to variable interest rates at an effective weighted average interest rate of 2.10%, as of March 31, 2014

 

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Note 6 – 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, ACB require 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 had entered into Interest Rate Swap Agreements with CoBank, ACB. 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.

 

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, ACB under its loan agreements based on the current applicable LIBOR Rate plus the contractual LIBOR margin in effect with respect to each applicable loan, without reflecting any interest rate swaps. At the end of each calendar quarter, CoBank, ACB adjusted  our aggregate interest payments based on 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 entered into interest rate swaps covering (i) $39.0 million of our aggregate indebtedness to CoBank, ACB effective March 19, 2008 and (ii) an additional $6.0 million of our aggregate indebtedness to CoBank, ACB 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.

 

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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, ACB 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 indicated an estimated amount we would have been required to pay if the contracts were canceled or transferred to other parties.

 

Note 7 – 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 10 – “Segment Information”.

 

Note 8 – Guarantees

 

On September 30, 2011, FiberComm, LC refinanced two existing loans with American State Bank into a new ten-year loan, maturing on September 30, 2021. As of March 31, 2014, we have recorded a liability of $267,158 in connection with the guarantee on this new loan. This guarantee may be exercised if FiberComm, LC does not make its required payments on this note.

 

Note 9 – Deferred Compensation

 

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

 

Note 10 – 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.

 

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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.

 

Note 11  – Commitments and Contingencies

 

We are involved in certain contractual disputes in the ordinary course of business. We do not believe the ultimate resolution of any of these existing matters will have a material adverse effect on our financial position, results of operations or cash flows. We did not experience any changes to material contractual obligations in the first three 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 12 – Hector Communications Corporation

 

On November 3, 2006 we acquired a one-third interest in HCC. HCC was equally owned by NU Telecom, Blue Earth Valley Communications, Inc. and Arvig Enterprises, Inc. Each of the owners provide management and other operational services to HCC and its subsidiaries.

 

On December 31, 2012 NU Telecom completed a spin-off agreement with HCC. NU Telecom originally acquired a one-third interest in HCC on November 3, 2006. Under the spin-off agreement, NU Telecom received all of the stock of SETC and other assets and investments and incurred $3.3 million of additional debt.

 

Our President and Chief Executive Officer, Mr. Bill D. Otis, was elected Chairman of the Board of Directors and President of HCC. Ms. Barbara A.J. Bornhoft, our Vice-President and Chief Operating Officer, also serve on the Board of Directors of HCC.

 

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Note 13 – Subsequent Events

 

On April 29, 2014, NU Telecom’s Board of Directors declared a regular quarterly dividend on our common stock of $0.085 per share, payable on June 13, 2014 to stockholders of record at the close of business on May 9, 2014.

 

On April 15, 2014 NU Telecom received a notice of dispute from a wireless telephone carrier regarding traffic exchanged between the two companies and specifically the classification of IntraMTA wireless traffic related to access charges. NU Telecom is currently working 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.  

 

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.

 

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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 on 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.

 

Results of Operations

 
Overview

 

NU Telecom has a state-of-the-art; fiber-rich communications network and offers a diverse array of communications products and services. Our ILEC and CLEC businesses provide local telephone service and network access to other telecommunications carriers for calls originated or terminated on our network. In addition, we provide long distance service, dial-up and broadband Internet access, video services and managed and hosted solutions services. On December 31, 2012 NU Telecom completed a spin-off agreement with HCC, continuing the expansion of our service area into the Minnesota communities and surrounding areas of Bellechester, Goodhue, Hanska, Mazzepa, Sleepy Eye and White Rock. As a one-stop shopping experience for our customers, we sell and service other communications products.

 

Our operations consist primarily of providing services to customers for a monthly charge. Because many of these services are recurring in nature, backlog orders and seasonality are not significant factors. Our working capital requirements include financing the construction of our networks, which consists of switches and cable, data, Internet protocol (IP) and digital TV. We also require capital to maintain our networks and infrastructure; fund the payroll costs of our highly skilled labor force; maintain inventory to service capital projects, our network and our telephone equipment customers; pay dividends and provide for the carrying value of trade accounts receivable, some of which may take several months to collect in the normal course of business.

 

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Executive Summary

 

     ·  

In 2013 and early 2014, 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. Additional information pertaining to this acquisition is available in Note 2 – “Acquisitions and Dispositions.”

 
     ·

Net income for the first quarter of 2014 totaled $937,860 which was a $210,671 or 28.97% increase compared to the first quarter of 2013. This increase was primarily due to an increase in revenues described below and a decrease in interest expense due to the maturing of several of our swap agreements with CoBank, ACB during 2013 as the variable rate we currently pay on that debt portion is lower than the fixed rate we were previously paying.

 
     ·

Consolidated revenue for the first quarter of 2014 totaled $9,979,201, which was a $566,756 or 6.02% increase compared to the first quarter of 2013. This increase was primarily due to increases in network access, video and data revenues. Network access revenues increased primarily due to increased sales of special access circuits. Video revenue increased primarily due to increased demand for our high definition (HD) and digital video recorder (DVR) services. Also contributing to the increase in video revenue was a combination of rate increases introduced into several of our markets over the course of 2014 and 2013. Data revenues increased primarily due to increased sales of our broadband services.

 

Business 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 1,428 or 4.78% for the twelve months ended March 31, 2014 due to the reasons mentioned above.  

 

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.

 

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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 pricing discounts. We believe 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 including broadband services, private line, VoIP, digital video, Internet Protocol Television and hosted and managed services.

 

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:

 

 

Telecom Segment

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended March 31,

 

2014

 

2013

 

Increase (Decrease)

Operating Revenues

 

 

 

 

 

 

 

 

 

 

Local Service

$

1,636,349

 

$

1,685,713

 

$

(49,364)

 

-2.93%

Network Access

 

3,209,114

 

 

2,971,600

 

 

237,514

 

7.99%

Video

 

1,928,972

 

 

1,731,457

 

 

197,515

 

11.41%

Data

 

1,938,129

 

 

1,803,080

 

 

135,049

 

7.49%

Long Distance

 

205,198

 

 

215,440

 

 

(10,242)

 

-4.75%

Other

 

1,061,439

 

 

1,005,155

 

 

56,284

 

5.60%

Total Operating Revenues

 

9,979,201

 

 

9,412,445

 

 

566,756

 

6.02%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of Services, Excluding Depreciation and Amortization

 

4,536,032

 

 

4,215,512

 

 

320,520

 

7.60%

Selling, General and Administrative

 

1,833,508

 

 

1,799,326

 

 

34,182

 

1.90%

Depreciation and Amortization Expenses

 

2,331,781

 

 

2,210,500

 

 

121,281

 

5.49%

Total Operating Expenses

 

8,701,321

 

 

8,225,338

 

 

475,983

 

5.79%

 

 

 

 

 

 

 

 

 

 

 

Operating Income

$

1,277,880

 

$

1,187,107

 

$

90,773

 

7.65%

 

 

 

 

 

 

 

 

 

 

 

Net Income

$

937,860

 

$

727,189

 

$

210,671

 

28.97%

 

 

 

 

 

 

 

 

 

 

 

Capital Expenditures

$

1,340,560

 

$

1,122,358

 

$

218,202

 

19.44%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Key metrics

 

 

 

 

 

 

 

 

 

 

Access Lines

 

28,432

 

 

29,860

 

 

(1,428)

 

-4.78%

Video Customers

 

10,894

 

 

11,098

 

 

(204)

 

-1.84%

Broadband Customers

 

14,196

 

 

13,774

 

 

422

 

3.06%

Dial Up Internet Customers

 

226

 

 

423

 

 

(197)

 

-46.57%

Long Distance Customers

 

14,876

 

 

15,215

 

 

(339)

 

-2.23%

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Revenue

 

Local Service – We receive recurring revenue for basic local services that enable end-user 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 $1,636,349, which is $49,364 or 2.93% lower in the three months ended March 31, 2014 compared to the three months ended March 31, 2013. This decrease was 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 long distance calls on our network. Additionally, we bill subscriber line charges (SLCs) to substantially all of our end-user 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 $3,209,114, which is $237,514 or 7.99% higher in the three months ended March 31, 2014 compared to the three months ended March 31, 2013. This increase was primarily due to increased sales of special access circuits, offset by lower minutes of use.

 

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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.

 

On April 15, 2014 NU Telecom received a notice of dispute from a wireless telephone carrier regarding traffic exchanged between the two companies and specifically the classification of IntraMTA wireless traffic related to access charges. NU Telecom is currently working 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.  

 

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 Internet Protocol TV/digital TV services and four communities with our CATV services. Video revenue was $1,928,972, which is $197,515 or 11.41% higher in the three months ended March 31, 2014 compared to the three months ended March 31, 2013. This increase was primarily due to increased demand for our HD and DVR services. Also contributing to the increase in video revenue was a combination of rate increases introduced into several of our markets over the course of 2014 and 2013.   

 

Data – We provide Internet services, including dial-up and 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 $1,938,129, which is $135,049 or 7.49% higher in the three months ended March 31, 2014 compared to the three months ended March 31, 2013. This increase is primarily due to an increase in data customers and increased managed services revenues. We expect continued growth in this area will be driven by expansion of our 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 $205,198, which is $10,242 or 4.75% lower in the three months ended March 31, 2014 compared to the three months ended March 31, 2013. This decrease was 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 $1,061,439, which is $56,284 or 5.60% higher in the three months ended March 31, 2014 compared to the three months ended March 31, 2013. This increase was primarily due to increases in the sales of cellular phone and activation revenues, and an increase in the sales of CPE.  

 

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Cost of Services (excluding Depreciation and Amortization)

 

Cost of services (excluding depreciation and amortization) was $4,536,032, which is $320,520 or 7.60% higher in the three months ended March 31, 2014 compared to the three months ended March 31, 2013. The increase was primarily due to higher programming cost from video content providers and higher costs associated with increased maintenance and support agreements on our equipment and software.

 

Selling, General and Administrative Expenses

 

Selling, general and administrative expenses were $1,833,508, which is $34,182 or 1.90% higher in the three months ended March 31, 2014 compared to the three months ended March 31, 2013. The increase was primarily due to higher costs associated with professional and consulting services.

 

Depreciation and Amortization

 

Depreciation and amortization was $2,331,781, which is $121,281 or 5.49% higher in the three months ended March 31, 2014 compared to the three months ended March 31, 2013. This increase was due to higher depreciation associated with the increase in our assets, which reflects our continual investment in technology and infrastructure in order to meet our customers’ demands for products and services.

 

Operating Income

 

Operating income was $1,277,880, which is $90,773 or 7.65% higher in the three months ended March 31, 2014 compared to the three months ended March 31, 2013. This increase was primarily due to an increase in revenues, partially offset by an increase in expenses, all of which are described above.

 

 

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See Consolidated Statements of Income on Page 3 (for discussion below)

 

Other Income and Interest Expense 

 

Interest expense was $235,107, which is $336,043 or 58.84% lower in the three months ended March 31, 2014 compared to the three months ended March 31, 2013. This decrease was primarily due to lower outstanding debt balances and the maturing of several of our swap agreements with CoBank, ACB during 2013 as the variable rate we now pay on that portion of our debt is lower than the fixed rate we were previously paying.

 

Interest income was $86,122, which is $15,395 or 21.77% higher in the three months ended March 31, 2014 compared to the three months ended March 31, 2013. This increase is primarily due to an increase in dividend income earned on our investments for the period ended March 31, 2014 as compared to the period ended March 31, 2013.

 

Other income for the three months ended March 31, 2014 and 2013, included a patronage credit earned with CoBank, ACB 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, ACB 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 $49,622, which is $8,997 or 22.15% higher in the three months ended March 31, 2014 compared to the three months ended March 31, 2013. Other investment income is primarily from our equity ownership in several partnerships and limited liability companies.

 

Income Taxes

 

Income tax expense was $679,141, which is $154,337 or 29.41% higher in the three months ended March 31, 2014 compared to the three months ended March 31, 2013.The effective income tax rates for the three months ending March 31, 2014 and 2013 were approximately 42.0% and 41.9%. 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 $98,321,224 at March 31, 2014, reflecting 58.4% equity and 41.6% 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 2.83 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.

 

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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.

 

Our primary sources of liquidity for the three months ended March 31, 2014 were proceeds from cash generated from operations and cash reserves held at the beginning of the period. At March 31, 2014 we had a working capital deficit of $37,377,924. Per our MLAs with CoBank, ACB, 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, ACB 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 March 31, 2014. At March 31, 2013, we were in compliance with all the stipulated financial ratios in our loan agreements.

 

In addition, at March 31, 2014 we also had approximately $4.3 million available under our 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 believe 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:

 

 

 

Three Months Ended March 31,

 

2014

 

2013

Net cash provided by (used in):

 

 

 

 

 

Operating activities

 

 1,321,304

 

$

 2,831,854

Investing activities

 

(1,384,059)

 

 

(1,203,994)

Financing activities

 

(278,075)

 

 

(3,344,443)

Increase (Decrease) in cash

 

 (340,830)

 

 

 (1,716,583)

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Cash Flows from Operating Activities

 

Cash generated by operations in the first three months of 2014 was $1,321,304, compared to cash generated by operations of $2,831,854 in the first three months of 2013. The decrease in cash from operating activities in 2014 was primarily due to a decrease in accounts payable and other accrued liabilities, and an increase in receivables and inventories.

 

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 March 31, 2014 was $623,574, 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 $1,384,059 during the first three months of 2014 compared to $1,203,994 for the first three months of 2013. Capital expenditures relating to on-going operations were $1,340,560 for the three months ended March 31, 2014, compared to $1,122,358 for the three months ended March 31, 2013. We expect total plant additions to be approximately $6.3 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 March 31, 2014, we had approximately $4.3 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 three months ended March 31, 2014 was $278,075 and included long-term debt repayments of $1,084,500, advances on our revolving credit facility of $1,239,037 and the distribution of $432,612 of dividends to our stockholders. Cash used in financing activities for the three months ended March 31, 2013 was $3,344,443 and included long-term debt repayments of $609,500, payments on our revolving credit facility of $2,313,868 and the distribution of $421,075 of dividends to our stockholders.

 

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Working Capital

 

We had a working capital deficit (i.e. current assets minus current liabilities) of $37,377,924 as of March 31, 2014, with current assets of approximately $6.6 million and current liabilities of approximately $44.0 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 0.15 and 0.14 as of March 31, 2014 and December 31, 2013. Per our MLAs with CoBank, ACB, 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, ACB 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 March 31, 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. 

 

Dividends and Restrictions

 

We declared a quarterly dividend of $.0850 per share for the first quarter of 2014 and $0.825 per share for the first quarter of 2013, which totaled $432,612 for the first quarter of 2014 and $421,075 for the first quarter of 2013.

 

We expect to continue to pay quarterly dividends during 2014, but only if and to the extent declared by our Board of Directors on a quarterly basis and subject to various restrictions on our ability to do so (described below). Dividends on our common stock are not cumulative. 

 

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 were not in default or potential default under the loan agreements. As of March 31, 2014, per our loan agreements, we do not have any restrictions on our ability to pay cash dividends to our stockholders. 

 

Our Board of Directors reviews quarterly dividend declarations based on our anticipated earnings, capital requirements and our operating and financial conditions. The cash requirements of our current dividend payment practices are in addition to our other expected cash needs. Should our Board of Directors determine a dividend will be declared, we expect we will have sufficient availability from our current cash flows from operations to fund our existing cash needs and the payment of our dividends. In addition, we expect we will have sufficient availability under our revolving credit facility to fund dividend payments in addition to any fluctuations in working capital and other cash needs.

 

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Long-Term Debt

 

See Note 5 – “Secured Credit Facility” for information pertaining to our long-term debt.

 

Recent Accounting Developments 

 

See Note 1 – “Basis of Presentation and Consolidation” for a discussion of recent accounting developments.

 

Item 3. Quantitative and Qualitative Disclosures about Market Risk

 

Not required for a smaller reporting company.

 

Item 4. Controls and Procedures

 

Our principal executive officer and principal financial officer evaluated the effectiveness of our disclosure controls and procedures, as defined in Exchange Act Rule 13a-15(e) or Rule 15d-15(e), as of the end of the period subject to this Report. Based on this evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures were effective.

 

Management’s Report on Internal Control over Financial Reporting

 

As of the end of the period covered by this Quarterly Report on Form 10-Q (the Evaluation Date), we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, regarding the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) promulgated under the Securities and Exchange Act of 1934, as amended). Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded, as of the end of the period covered by this Quarterly Report, that our disclosure controls and procedures ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act are recorded, processed, summarized and reported within the time periods specified in applicable rules and forms and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, in a manner that allows timely decisions regarding required disclosure.

 

Changes in Internal Control over Financial Reporting

 

There has been no change in the Company’s internal control over financial reporting that occurred during the Company’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting. 

 

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PART II. OTHER INFORMATION

 

Item 1. Legal Proceedings.

 

Other than routine litigation incidental to our business, there are no pending material legal proceedings to which we are a party or to which any of our property is subject. 

 

Item 1A. Risk Factors.

 

Not required for a smaller reporting company.

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

 

None.

 

Item 3. Defaults Upon Senior Securities.

 

None.

 

Item 4. Mine Safety Disclosures

 

Not Applicable.

 

Item 5. Other Information.

 

None.

 

Item 6. Exhibits.

             

Exhibit

Number           Description 

 

31.1                 Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

31.2                 Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

 

32.1                 Certification of Chief Executive Officer pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

32.2                 Certification of Chief Financial Officer pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

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101.INS          XBRL Instance Document

 

101.SCH         XBRL Taxonomy Extension Schema Document

 

101.CAL         XBRL Taxonomy Extension Calculation Linkbase Document

 

101.DEF         XBRL Taxonomy Extension Definition Linkbase Document

 

101.LAB         XBRL Taxonomy Extension Label Linkbase Document

 

101.PRE          XBRL Taxonomy Extension Presentation Linkbase Document

 

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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.

 

 

 

 

 

NEW ULM TELECOM, INC.

 

 

 

 

 

 

 

 

 

 

Dated: May 15, 2014

By

/s/ Bill D. Otis

 

 

 

 

Bill D. Otis, President and Chief Executive Officer

 

 

 

 

 

 

 

 

 

 

Dated: May 15, 2014

 

 

By

/s/ Curtis O. Kawlewski

 

 

 

 

Curtis O. Kawlewski, Chief Financial Officer

 

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