Nuvera Communications, Inc. - Quarter Report: 2015 June (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 June 30, 2015

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)

27 North Minnesota Street

New Ulm, Minnesota  56073

(Address of principal executive offices)

Registrant’s telephone number, including area code: (507) 354-4111

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 S  No  £

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 S No  £                 

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

£Large accelerated filer  £Accelerated filer  £Non-accelerated filer  SSmaller reporting company

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes £  NoS

The total number of shares of the Registrant’s common stock outstanding as of August 14, 2015: 5,116,826.

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 PART I – FINANCIAL INFORMATION

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PART I – FINANCIAL INFORMATION

Item 1.Financial Statements

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

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

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

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

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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

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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.

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 $3,665,444 and $3,470,913 for the six months ended June 30, 2015 and 2014. We amortize our definite-lived intangible assets over their estimated useful lives. Identifiable intangible assets that are subject to amortization are evaluated for impairment.

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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. 

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 June 30, 2015 and 2014 we had $0 and $259,739 of unrecognized tax benefits net of a federal tax benefit of $0 and $88,311, which if recognized would affect the effective tax rate. A petition related to Hector Communications Corporation’s (HCC) 2006 Minnesota tax return was previously filed in Minnesota Tax Court. This matter was resolved in April 2015. 

We are primarily subject to United States, Minnesota, Nebraska and Iowa income taxes. Tax years subsequent to 2010 remain open to examination by federal and state tax authorities. Our policy is to recognize interest and penalties related to income tax matters as income tax expense. As of June 30, 2015 and December 31, 2014 we had $0 and $89,910 of accrued interest that related to income tax matters.

Recent Accounting Developments

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

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

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Note 2 – Fair Value Measurements

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

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 have entered into an interest rate swap with our lender, CoBank, ACB (CoBank), to manage our cash flow exposure to fluctuations in interest rates. This instrument is designated as cash flow hedge and is 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 this derivative is 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 agreement is discussed in Note 5 – “Interest Rate Swaps”. The fair value of our swap agreement was 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, 2014. 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 rates of borrowing 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.

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Note 3 – Goodwill and Intangibles

We account for goodwill and other intangible assets under GAAP. Under GAAP, goodwill and intangible assets with indefinite useful lives are not amortized, but are instead tested for impairment (i) on at least an annual basis and (ii) when changes in circumstances indicate that the fair value of goodwill may be below its carrying value. Our goodwill totaled $39,805,349 at June 30, 2015 and December 31, 2014.    

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 2014 and 2013, we engaged an independent valuation firm to complete our annual impairment testing for existing goodwill. For 2014 and 2013, 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 and trade names. 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 $1,235,617 and $1,235,616 for the six months ended June 30, 2015 and 2014.  

Amortization expense for the remaining six months of 2015 and the five years subsequent to 2015 is estimated to be:

Note 4 – Secured Credit Facility

We have a credit facility with CoBank. Under the credit facility, we entered into 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 the assets of NU Telecom and its respective subsidiaries have been pledged to CoBank as collateral. In addition, NU Telecom and its respective subsidiaries have guaranteed all the obligations under the credit facility. These mortgage notes are required to be paid in quarterly installments covering principal and interest, beginning in the year of issue and maturing on December 31, 2021.  

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On December 31, 2014, NU Telecom entered into an Amended and Restated MLA with CoBank. The new MLA refinances and replaces the existing credit facility between CoBank and NU Telecom and the subsidiaries of NU Telecom. NU Telecom’s subsidiary HTC was a borrower under the prior credit facility, but NU Telecom is now the sole borrower under the new MLA. There are two loans under the new MLA, which include a $35 million term loan and a $9 million revolver loan. Also, under the new MLA, NU Telecom has the ability to either increase the amount of the commitment under the revolver loan by up to $6 million in a single increase, or add an incremental term loan up to $6 million.

Our new 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 $2,100,000 in any year if our “Total Leverage Ratio,” that is, the ratio of our “Indebtedness” to “EBITDA” (earnings before interest, taxes, depreciation and amortization) – as defined in the loan documents, is greater than 2.50 to 1.00, and (ii) in any amount if our Total Leverage Ratio is less than 2.50 to 1.00, and (b) in either case, if we are not in default or potential default under the loan agreements. 

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, fixed coverage ratio and maximum annual capital expenditures tests.  

As described in Note 5– “Interest Rate Swaps”,we have entered into interest rate swaps that effectively fix our interest rates and cover $14.0 million at a weighted average rate of 4.47%, as of June 30, 2015. The remaining debt of $28.7 million ($3.6 million available under the revolving credit facilities and $25.1 million currently outstanding) remains subject to variable interest rates at an effective weighted average interest rate of 3.44%, as of June 30, 2015.

Note 5 – Interest Rate Swaps

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

We generally use variable-rate debt to finance our operations, capital expenditures and acquisitions. These variable-rate debt obligations expose us to variability in interest payments due to changes in interest rates. The terms of our credit facility with CoBank 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, on June 18, 2015 we entered into an Interest Rate Swap Agreement with CoBank covering (i) $14.0 million of our aggregate indebtedness to CoBank effective June 18, 2015. This swap effectively locks in the interest rate on $14.0 million of variable-rate debt through June 2018. Under this Interest Rate Swap Agreement, we have changed the variable-rate cash flow exposure on the debt obligations to fixed cash flows. Under the terms of this interest rate swap, we pay a fixed contractual interest rate and (i) make an additional payment if the LIBOR variable rate payment is below a contractual rate or (ii) receive a payment if the LIBOR variable rate payment is above the contractual rate.

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

As of June 30, 2015 we had the following interest rate swap in effect.

(1)     As described in Note 4 – “Long-Term Debt” to the 2014 Consolidated Financial Statements on Form 10-K, the note above initially bears interest at a LIBOR rate determined by the maturity of the note, plus a “LIBOR Margin” rate equal to 3.25% according to the individual secured credit facility. The LIBOR Margin decreases as the borrower’s “Leverage Ratio” decreases. The “Current Effective Interest Rate” in the table reflects the rate we pay giving effect to the swaps.

Our interest rate swap under our credit facilities qualifies as a cash flow hedge for accounting purposes under GAAP. We reflect the effect of this hedging transaction in the financial statements. The unrealized gain is reported in other comprehensive income. If we terminate our interest rate swap agreement, the cumulative change in fair value at the date of termination would be 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 agreement was determined based on valuations received from CoBank and are based on the present value of expected future cash flows using discount rates appropriate with the terms of the swap agreement. The fair value indicates an estimated amount we would be required to pay if the contracts were canceled or transferred to other parties. At June 30, 2015, the fair value liability of the swap was $51,807, which has been recorded net of deferred tax benefit of $20,966, for the $30,841 in accumulated other comprehensive loss.

Note 6 – Other Investments  

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

Note 7 – Guarantees

On September 30, 2011, FiberComm, LC refinanced two existing loans with American State Bank into a ten-year loan, maturing on September 30, 2021. As of June 30, 2015, we have recorded a liability of $283,170 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.

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Note 8 – Deferred Compensation

As of June 30, 2015 and December 31, 2014, we have recorded other deferred compensation relating to executive compensation payable to certain former executives of past acquisitions.  

Note 9 – Segment Information  

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

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

Telecom Segment

Note 10– Commitments and Contingencies

Over the course of 2014, NU Telecom received notice of disputes from several IXCs, and has subsequently been named in litigation regarding traffic exchanged between our companies and specifically the classification of IntraMTA wireless traffic related to access charges. This litigation is an industry-wide dispute affecting numerous telecom companies. NU Telecom is working with other telecom companies towards a resolution of the litigation at both the federal and state levels. We cannot currently predict the outcome of this litigation or its impact to our company. Refer to the Company’s Annual Report on Form 10-K for the year ended December 31, 2014 for the discussion relating to commitments and contingencies.

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Note 11 – Subsequent Events

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

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

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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 connections to our networks. In addition, we provide long distance service, broadband Internet access, video services, and managed and hosted solutions services.

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.

Executive Summary

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

·       On December 31, 2014, NU Telecom entered into an Amended and Restated MLA with CoBank. The new MLA refinances and replaces the existing credit facility between CoBank and NU Telecom and the subsidiaries of NU Telecom. NU Telecom’s subsidiary HTC was a borrower under the prior credit facility, but NU Telecom is now the sole borrower under the new MLA. There are two loans under the new MLA, which include a $35 million term loan and a $9 million revolver loan. The term loan requires payments of $675,000 per quarter, beginning March 2015, with the final installment due December 31, 2021. NU Telecom may borrow from time to time under the revolver loan, which also matures on December 31, 2021. Also, under the new MLA, NU Telecom has the ability to either increase the amount of the commitment under the revolver loan by up to $6 million in a single increase, or add an incremental term loan up to $6 million. See Note 4 – “Secured Credit Facility” for additional information.

·      On June 18, 2015 NU Telecom entered into an Interest Rate Swap Agreement with CoBank covering (i) $14.0 million of our aggregate indebtedness to CoBank effective June 18, 2015. This swap effectively locks in the interest rate on $14.0 million of variable-rate debt through June 2018. Under this Interest Rate Swap Agreement, we have changed the variable-rate cash flow exposure on the debt obligations to fixed cash flows. Under the terms of this interest rate swap, we pay a fixed contractual interest rate and (i) make an additional payment if the LIBOR variable rate payment is below a contractual rate or (ii) receive a payment if the LIBOR variable rate payment is above the contractual rate.

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·    Net income for the second quarter of 2015 totaled $533,774, which was a $40,492 or 7.05% decrease compared to the second quarter of 2014. This decrease was primarily due to an increase in interest expense resulting from our new Amended and Restated MLA with CoBank, which is described above.

·    Consolidated revenue for the second quarter of 2015 totaled $10,246,185, which was a $369,198 or 3.74% increase compared to the second quarter of 2014. This increase was primarily due to increases in data and video revenues. Data revenues increased primarily due to the addition of Little Crow/MRVED on our newly expanded fiber optic cable network, an increase in data customers and increased managed service revenues. Video revenues 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 the last couple of years.   

Business Trends

Included below is a synopsis of business trends management believes will continue to affect our business in 2015. 

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 1,409 or 5.04% for the twelve months ended June 30, 2015 due to the reasons mentioned above. 

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

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

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

Financial results for the Telecom Segment are included below:

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Revenue

Local Service– We receive recurring revenue for basic local services that enable customers to make and receive telephone calls within a defined local calling area for a flat monthly fee. In addition to subscribing to basic local telephone services, our customers may choose from a variety of custom calling features such as call waiting, call forwarding, caller identification and voicemail. Local service revenue was $1,608,323, which is $30,668 or 1.87% lower in the three months ended June 30, 2015 compared to the three months ended June 30, 2014 and was $3,222,117, which is $53,223 or 1.62% lower in the six months ended June 30, 2015 compared to the six months ended June 30, 2014. These decreases were primarily due to the decline in access lines. The number of access lines we serve as an ILEC and CLEC have been decreasing, which is consistent with a general industry trend, as customers are increasingly utilizing other technologies, such as wireless phones and IP services. 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. 

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Network Access– We provide access services to other telecommunications carriers for the use of our facilities to terminate or originate traffic on our network. Additionally, we bill subscriber line charges (SLCs) to substantially all of our customers for access to the public switched network. These monthly SLCs are regulated and approved by the FCC. In addition, network access revenue is derived from several federally administered pooling arrangements designed to provide network support and distribute funding to the ILECs. Network access revenue was $2,766,608, which is $118,625 or 4.11% lower in the three months ended June 30, 2015 compared to the three months ended June 30, 2014 and was $5,838,462, which is $255,885 or 4.20% lower in the six months ended June 30, 2015 compared to the six months ended June 30, 2014. These decreases were primarily due to lower minutes of use on our network.  

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

Video– We receive monthly recurring revenue from our subscribers for providing commercial TV programming in competition with local CATV, satellite dish TV and off-air TV service providers. We serve seventeen communities with our IPTV/digital TV services and four communities with our CATV services. Video revenue was $2,278,656, which is $190,942 or 9.15% higher in the three months ended June 30, 2015 compared to the three months ended June 30, 2014 and was $4,472,572, which is $455,886 or 11.35% higher in the six months ended June 30, 2015 compared to the six months ended June 30, 2014. These increases were primarily due to increased demand for our HD and DVR services. Also contributing to the increases in video revenue were a combination of rate increases introduced into several of our markets over the course of the last several years.   

Data– We provide high speed Internet to business and residential customers. Our revenue is earned based on the offering of various flat rate packages based on the level of service, data speeds and features. We also provide e-mail and managed services, such as web hosting and design, on-line file back up and on-line file storage. Data revenue was $2,492,275, which is $508,548 or 25.64% higher in the three months ended June 30, 2015 compared to the three months ended June 30, 2014 and was $4,928,521, which is $1,006,665 or 25.67% higher in the six months ended June 30, 2015 compared to the six months ended June 30, 2014. These increases were primarily due to the addition of Little Crow/MRVED on our newly expanded fiber optic cable network, an increase in data customers and increased managed services revenues. We expect continued growth in this area will be driven by expansion of service areas, our aggressively packaging service bundles and marketing managed service solutions to businesses.

Long Distance– Our customers are billed for toll or long-distance services on either a per call or flat-rate basis. This also includes the offering of directory assistance, operator service and long distance private lines. Long distance revenue was $187,034, which is $22,126 or 10.58% lower in the three months ended June 30, 2015 compared to the three months ended June 30, 2014 and was $374,782, which is $39,576 or 9.55% lower in the six months ended June 30, 2015 compared to the six months ended June 30, 2014. These decreases were primarily due to the decline in the number of customers subscribing to our long distance service.

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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 $913,289, which is $158,873 or 14.82% lower in the three months ended June 30, 2015 compared to the three months ended June 30, 2014 and was $1,897,348, which is $236,253 or 11.07% lower in the six months ended June 30, 2015 compared to the six months ended June 30, 2014. These decreases were primarily due to decreases in the sales of CPE, partially offset by increases in the sales of cellular phone and activation revenues.     

Cost of Services (excluding Depreciation and Amortization)

Cost of services (excluding depreciation and amortization) was $4,897,934, which is $293,866 or 6.38% higher in the three months ended June 30, 2015 compared to the three months ended June 30, 2014 and was $9,870,584, which is $730,484 or 7.99% higher in the six months ended June 30, 2015 compared to the six months ended June 30, 2014. These increases were primarily due to higher programming costs from video content providers, increased costs associated with providing service and support for Little Crow/MRVED, 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 $1,807,693, which is $38,853 or 2.20% higher in the three months ended June 30, 2015 compared to the three months ended June 30, 2014 and was $3,748,258, which is $145,910 or 4.05% higher in the six months ended June 30, 2015 compared to the six months ended June 30, 2014. These increases were primarily due to higher costs associated with professional and consulting services.

Depreciation and Amortization

Depreciation and amortization was $2,470,980, which is $96,232 or 4.05% higher in the three months ended June 30, 2015 compared to the three months ended June 30, 2014 and was $4,901,061, which is $194,532 or 4.13% higher in the six months ended June 30, 2015 compared to the six months ended June 30, 2014. These increases were primarily due to depreciation recognized on the expansion of our new fiber optic cable network in 2014.    

Operating Income

Operating income was $1,069,578, which is $59,753 or 5.29% lower in the three months ended June 30, 2015 compared to the three months ended June 30, 2014 and was $2,213,899, which is $193,312 or 8.03% lower in the six months ended June 30, 2015 compared to the six months ended June 30, 2014. These decreases were primarily due to an increase in operating expenses, partially offset by an increase in revenues, 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 $370,778, which is $135,981 or 57.91% higher in the three months ended June 30, 2015 compared to the three months ended June 30, 2014 and was $730,119, which is $260,215 or 55.38% higher in the six months ended June 30, 2015 compared to the six months ended June 30, 2014. These increases were primarily due to the increased interest rates charged on the Amended and Restated MLA with CoBank entered into on December 31, 2014.     

Interest income was $35,709, which is $17,831 or 99.74% higher in the three months ended June 30, 2015 compared to the three months ended June 30, 2014. This increase was primarily due to an increase in dividend income earned on our investments in the second quarter of 2015.  Interest income was $90,861, which is $13,139 or 12.63% lower in the six months ended June 30, 2015 compared to the six months ended June 30, 2014. This decrease was primarily due to a decrease in dividend income earned on our investments over the first six months of 2015.  

Other income for the six months ended June 30, 2015 and 2014 included a patronage credit earned with CoBank as a result of our debt agreements with them. The patronage credit allocated and received in 2015 was $409,132, compared to $435,519 allocated and received in 2014. CoBank determines and pays the patronage credit annually, generally in the first quarter of the calendar year, based on its results from the prior year. We record these patronage credits as income when they are received.

Other investment income was $86,619, which is $12,938 or 17.56% higher in the three months ended June 30, 2015 compared to the three months ended June 30, 2014 and was $135,152, which is $11,849 or 9.61% higher in the six months ended June 30, 2015 compared to the six months ended June 30, 2014. Other investment income is primarily from our equity ownership in several partnerships and limited liability companies.

Income Taxes

Income tax expense was $290,779, which is $125,065 or 30.07% lower in the three months ended June 30, 2015 compared to the three months ended June 30, 2014 and was $759,838, which is $335,147 or 30.61% lower in the six months ended June 30, 2015 compared to the six months ended June 30, 2014. The decrease in income taxes was primarily due to the recognition of unrealized tax benefits associated with the HCC Minnesota tax issue, which was resolved in April 2015. The effective income tax rates for the six months ending June 30, 2015 and 2014 were approximately 35.73% and 42.0% respectively. 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 $97,689,462 at June 30, 2015, reflecting 60.0% equity and 40.0% debt. This compares to a capital structure of $97,694,469 at December 31, 2014, reflecting 59.4% equity and 40.6% 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 2.78 times debt to EBITDA as defined in the loan documents, which is 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, 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 six months ended June 30, 2015 were proceeds from cash generated from operations and cash reserves held at the beginning of the period. At June 30, 2015 we had a working capital surplus of $468,162. In addition, at June 30, 2015, we also had approximately $3.6 million available under our revolving credit facility to fund any short-term working capital needs. 

On December 31, 2014, NU Telecom entered into an Amended and Restated MLA with CoBank. The new MLA refinances and replaces the existing credit facility between CoBank and NU Telecom and the subsidiaries of NU Telecom. NU Telecom’s subsidiary HTC was a borrower under the prior credit facility, but NU Telecom is now the sole borrower under the new MLA. There are two loans under the new MLA, which include a $35 million term loan and a $9 million revolver loan. The term loan requires payments of $675,000 per quarter, beginning March 2015, with the final installment due December 31, 2021. NU Telecom may borrow from time to time under the revolver loan, which also matures on December 31, 2021. Also, under the new MLA, NU Telecom has the ability to either increase the amount of the commitment under the revolver loan by up to $6 million in a single increase, or add an incremental term loan up to $6 million.

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. 

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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 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 six months of 2015 was $4,213,881, compared to cash generated by operations of $4,666,951 in 2014. The decrease in cash from operating activities in 2015 was primarily due to a decrease in accounts payable and deferred income tax, partially offset by a decrease in accounts receivable and an increase in other accrued liabilities.

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 June 30, 2015 was $444,297 compared to $945,087 at December 31, 2014.

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 $3,240,685 in the first six months of 2015 compared to $3,692,582 in the first six months of 2014. Capital expenditures relating to on-going operations were $3,081,835 in the first six months 2015 compared to $3,645,080 in the first six months of 2014. We expect total plant additions to be approximately $6.6 million in 2015. 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. As of June 30, 2015, we had approximately $3.6 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 six months ended June 30, 2015 was $1,473,986 and included long-term debt repayments of $1,350,000, payment of loan origination costs of $22,826, draws on our revolving credit facility of $766,070 and the distribution of $867,230 of dividends to our stockholders. Cash used in financing activities for the six months ended June 30, 2014 was $1,133,937 and included long-term debt repayments of $2,169,000, draws on our revolving credit facility of $1,900,287 and the distribution of $865,224 of dividends to stockholders.

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Working Capital

We had a working capital surplus (i.e. current assets minus current liabilities) of $468,162 as of June 30, 2015, with current assets of approximately $6.7 million and current liabilities of approximately $6.3 million, compared to a working capital deficit of $1,252,359 as of December 31, 2014. The ratio of current assets to current liabilities was 1.07 and 0.85 as of June 30, 2015 and December 31, 2014. The working capital surplus at June 30, 2015 was primarily the result of a reduction in spending for capital expenditures in 2015 compared to 2014.

At June 30, 2015 and December 31, 2014 we are in compliance with all stipulated financial ratios in our loan agreements.

Dividends and Restrictions

We declared a quarterly dividend of $.0850 per share for both the first and second quarters of 2015, which totaled $433,615 per quarter for both the first and second quarters. We declared a quarterly dividend of $.0850 per share for both the first and second quarters of 2014, which totaled $432,612 for both the first and second quarters.  

We expect to continue to pay quarterly dividends during 2015, 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. 

There are security and loan agreements underlying our current CoBank credit facility that contain restrictions on our distributions to stockholders and investment in, or loans, to others. See below and Note 4 – “Secured Credit Facility” for additional information.

On December 31, 2014, we entered into an Amended and Restated MLA with CoBank. The MLA refinances and replaces the existing credit facility between CoBank and NU Telecom and the subsidiaries of NU Telecom. NU Telecom’s subsidiary HTC was a borrower under the prior credit facility, but NU Telecom is now the sole borrower under the new MLA.

Our new 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 $2,100,000 in any year if our “Total Leverage Ratio,” that is, the ratio of our “Indebtedness” to “EBITDA” – as defined in the loan documents, is greater than 2.50 to 1.00, and (ii) in any amount if our Total Leverage Ratio is less than 2.50 to 1.00, and (b) in either case, if we are not in default or potential default under the loan agreements.

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 4 – “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

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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.

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Item 6. Exhibits.

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SIGNATURES