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

PART I – FINANCIAL INFORMATION

Item 1. Financial Statements

Table of Contents

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. 

10

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.

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

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.

Table of Contents

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:

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.

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.  

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:

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

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 6  – “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. 

Table of Contents

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.

17

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.

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 provided  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 served  on the Board of Directors of HCC.

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

Table of Contents

Table of Contents

Executive Summary

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.

22

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:

Table of Contents

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.

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.  

Table of Contents

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.

26

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.

27

Table of Contents

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:

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.

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.

30

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

Item 4. Controls and Procedures

PART II. OTHER INFORMATION

Item 1. Legal Proceedings.

Item 1A. Risk Factors.

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

Item 3. Defaults Upon Senior Securities.

Item 4. Mine Safety Disclosures

Item 5. Other Information.

Item 6. Exhibits.

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

33