Nuvera Communications, Inc. - Annual Report: 2017 (Form 10-K)

 

UNITED STATES

 SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

 

FORM 10-K

 

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

 

For the fiscal year ending December 31, 2017

 

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

 

For the transition period from______to______

                                                                                                                                                                                                                       

Commission File Number: 0-3024

 

NEW ULM TELECOM, INC.

(Exact name of registrant as specified in its charter)

 

Minnesota	41-0440990
(State or other jurisdiction of	(I.R.S. Employer
incorporation or organization)	Identification No.)

 

27 North Minnesota Street

New Ulm, Minnesota 56073

(Address of principal executive offices)

 

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

 

Securities registered pursuant to Section 12 (g) of the Act: 

 

Title of each class		Name of each exchange on which registered
Common Stock - $1.66 par value		OTCQB Marketplace

                             

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes  o   No  x

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.  Yes  o No  x

       

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes  x  No  o

 

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

 

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Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  Yes  x  No  o

 

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

 

o  Large accelerated filer  o  Accelerated filer  o  Non-accelerated filer  x  Smaller reporting company    oEmerging growth company     

 

If emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o      

 

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

 

The aggregate market value of the registrant’s common stock held by non-affiliates computed by reference to the price at which the common stock was sold, as of the last business day of the registrant’s most recently completed second fiscal quarter was $46,795,286. This calculation is based upon the closing price of $11.90 of the stock on June 30, 2017, as quoted on the OTCQB Marketplace. Without asserting that any director or executive officer of the registrant, or person owning 5% or more of the registrant’s common stock, is an affiliate, the shares of which they are the beneficial owners have been deemed to be owned by affiliates solely for this calculation.

 

As of March 15, 2018, the registrant had 5,160,065 shares of common stock outstanding.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the registrant’s Proxy Statement for the 2018 Annual Meeting of Stockholders to be held on May 24, 2018 are incorporated herein by reference in Part III of this Annual Report on Form 10-K to the extent stated herein. Such proxy statement will be filed with the Securities and Exchange Commission within 120 days of the registrant’s fiscal year ended December 31, 2017.

 

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NOTE ABOUT FORWARD LOOKING STATEMENTS

 

The Securities and Exchange Commission (“SEC”) encourages companies to disclose forward-looking information so that investors can better understand a company’s future prospects and make informed investment decisions. Certain statements in this Annual Report on Form 10-K, including those relating to the impact on future revenue sources, pending and future regulatory orders, continued expansion of the telecommunications network and expected changes in the sources of our revenue and cost structure resulting from our entrance into new communications markets, are forward-looking statements and are made pursuant to the safe harbor provisions of the Securities Litigation Reform Act of 1995. These forward-looking statements reflect, among other things, our current expectations, plans, strategies and anticipated financial results. There are a number of risks, uncertainties and conditions that may cause our actual results to differ materially from those expressed or implied by these forward-looking statements. Many of these circumstances are beyond our ability to control or predict. Moreover, forward-looking statements necessarily involve assumptions on our part. These forward-looking statements generally are identified by the words “believe”, “expect”, “anticipate”, “estimate”, “project”, “intend”, “plan”, “should”, “may”, “will”, “would”, “will be”, “will continue” or similar expressions. Such forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause actual results, performance or achievements of New Ulm Telecom, Inc. (“NU Telecom,” the “Company,” “we” or “our” or “us”) to be different from those expressed or implied in the forward-looking statements. All forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by the cautionary statements that appear throughout this report. Furthermore, forward-looking statements speak only as of the date they are made. Except as required under federal securities laws or the rules and regulations of the SEC, we disclaim any intention or obligation to update or revise publicly any forward-looking statements. Undue reliance should not be placed on forward-looking statements. 

 

Website Access to SEC Reports

 

Our website at www.nutelecom.net provides information about our products and services, along with general information about NU Telecom and its management and financial results. Copies of our most recent Annual Report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934, can be obtained, free of charge, as soon as reasonably practical after these reports are electronically filed or furnished to the SEC. To obtain this information, visit our website noted above and select “About Us – Investors” to view NU Telecom SEC filings,” or call (844) 354-4111. The SEC also maintains a website at www.sec.gov that contains reports, proxy and information statements, and other information regarding public companies, including NU Telecom. Any reports filed with the SEC may also be obtained from the SEC’s Reference Room at 100F Street, NE, Washington, DC 20549.

 

Code of Business Conduct and Ethics

 

Our Board of Directors has adopted a Code of Business Conduct and Ethics that is applicable to all directors, the chief executive officer, chief financial officer and to all other employees of NU Telecom. All employees of NU Telecom have undergone training on this Code of Business Conduct and Ethics. The information required by Item 406 of Regulation S-K is contained under “Code of Business Conduct” in the 2018 Proxy Statement and is incorporated by reference. Our Board of Directors has also adopted written charters for its committees that comply with the NASDAQ Global Select Market. Copies of the committee charters are available on our website above or by contacting us at (844) 354-4111.  

 

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PART I

 

Item 1.   Business

 

Company Overview and History

 

NU Telecom is a diversified communications company headquartered in New Ulm, Minnesota with more than 112 years of experience in the local telephone exchange and telecommunications business. We operate in one principal business segment: the Telecom Segment.

 

Our principal line of business is the operation of five local telephone companies or incumbent local exchange carriers (ILEC) and the operation of two competitive local exchange carriers (CLEC) telephone companies. Our original business was founded in 1905 and consisted of the operation of a single ILEC (New Ulm Rural Telephone Company). In 1984, we changed our name to New Ulm Telecom, Inc. In 1986, we acquired our second ILEC, Western Telephone Company (WTC). In 1993, we acquired our third ILEC, Peoples Telephone Company (PTC). In 2008, we acquired our fourth ILEC, Hutchinson Telephone Company (HTC). In 2012, we acquired our fifth ILEC, Sleepy Eye Telephone Company (SETC). Our businesses consist of connecting customers to our state-of-the-art, fiber-rich communications network, providing managed services, switched service and dedicated private lines, connecting customers to long distance service providers and providing many other services associated with our businesses. Our businesses also provide Internet protocol television (IPTV), cable television services (CATV), Internet access services, including high-speed broadband access, and long distance service. We also install and maintain communications systems to the areas in and around our service territories in southern Minnesota and northern Iowa. In 2002, we formed a CLEC in the city of Redwood Falls, Minnesota and acquired our second CLEC in 2008, with the acquisition of HTC. This CLEC operates in and around the city of Litchfield, Minnesota. In 2010, we acquired the cable TV system in the city of Glencoe and operate Glencoe under the Litchfield CLEC. Our CLECs offer the same services as our ILECs. In 2000, we changed our marketing name to NU-Telecom and currently operate under that name in our markets.

 

Our operations are currently conducted through the following subsidiaries:

 

Telecom Segment

 

●	ILECs:
	▪	New Ulm Telecom, Inc., 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;
	▪	Western Telephone Company, a wholly-owned subsidiary of NU Telecom;
●	CLECs:
	▪	NU Telecom, located in Redwood Falls, Minnesota;
	▪	Hutchinson Telecommunications, Inc., a wholly-owned subsidiary of HTC, located in Litchfield and Glencoe, Minnesota;
●	Our investments and interests in the following entities include some management responsibilities:
	▪	FiberComm, LC – 20.00% subsidiary equity ownership interest. FiberComm, LC is located in Sioux City, Iowa;
	▪	Broadband Visions, LLC (BBV) – 24.30% subsidiary equity ownership interest. BBV provides video headend and Internet services;
	▪	Independent Emergency Services, LLC (IES) – 14.29% subsidiary equity ownership interest. IES is a provider of E-911 services to the State of Minnesota as well as a number of counties located in Minnesota; and
	▪	SM Broadband, LLC (SMB) – 12.50% subsidiary equity ownership interest. SMB provides network connectivity for regional businesses.

 

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We report the business operations of our five ILECs and two CLECs and their associated services as a single segment that we refer to as the Telecom Segment. 

 

The Telecom Segment operates five ILECs: New Ulm Telecom, Inc. (New Ulm), HTC, PTC, SETC and WTC and two CLECs located in the cities of Redwood Falls, Litchfield and Glencoe, Minnesota. New Ulm, HTC, SETC and WTC are independent telephone companies that are regulated by the Minnesota Public Utilities Commission at the state level, while PTC is an independent telephone company that is regulated by the Iowa Utilities Board at the state level. Our two CLECs are currently not under the same level of regulatory oversight as our ILECs. As of December 31, 2017 we served 21,954 access lines in the Minnesota communities of Bellechester, Courtland, Evan, Goodhue, Hanska, Hutchinson, Klossner, Litchfield, Mazeppa, New Ulm, Redwood Falls, Sanborn, Searles, Sleepy Eye, Springfield and White Rock, as well as the adjacent rural areas of Blue Earth, Brown, Goodhue, McLeod, Meeker, Nicollet, Redwood and Wabasha counties in south central Minnesota. We also serve the community of Aurelia, Iowa as well as the adjacent rural areas surrounding Aurelia. The Telecom Segment also operates multiple IPTV and CATV systems in Minnesota (including the cities of Cologne, Courtland, Glencoe, Goodhue, Hanska, Hutchinson, Litchfield, Mayer, New Germany, New Ulm, Plato, Redwood Falls, Sanborn, Sleepy Eye and Springfield) and one IPTV system in Aurelia, Iowa. These systems serve approximately 10,346 customers.

 

The Telecom Segment derives its principal revenues from (i) local service charges to its residential and business subscribers, (ii) access charges to Interexchange Carriers (IXCs) for providing the carriers access to our local phone networks and (iii) the provisioning of video and data services. We also receive revenue from long distance carriers for providing the billing and collection of long distance toll calls to our subscribers.

 

Neither our ILECs nor CLECs are dependent upon any single customer or small group of customers. No single customer accounted for 10% or more of our consolidated revenues in any of the last two years.

We receive the majority of our revenues through the following revenue sources:

 

Data and Transport Services – We provide a variety of business communication services to small, medium and large business customers, including many services over our advanced fiber network. The services we offer include scalable high speed broadband Internet access and voice over Internet protocol (VoIP) phone services, which range from basic service plans to virtual hosted systems. Our hosted VoIP package utilizes our soft switching technology and enables our customers to have the flexibility of employing new telephone advances and features without investing in a new telephone system. This package bundles local service, calling features, IP business telephones and unified messaging, which integrates multiple technologies into a single system and allows the customer to receive and listed to voice messages through e-mail. 

 

In addition to Internet and VoIP services, we also offer a variety of commercial data connectivity services in select markets including private line and Ethernet services to provide high bandwidth across point-to-point and multiple site networks.

 

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Broadband Services – Broadband services include revenue from residential customers for subscriptions to our VoIP, data and video products. We offer high speed internet access depending on the nature of the network facilities that are available, the level of service selected and the location. Our VoIP digital phone service is also available as an alternative to the traditional telephone line. We offer multiple voice services plans with customizable calling features and voicemail. Depending on geographical market availability, our video services range from limited basic service to advanced digital TV, which includes several plans each with hundreds of local, national music channels including premium and pay-per-view channels as well as video-on-demand service. Certain customers may also subscribe to our advanced video services, which consist of high-definition (HD) TV, digital video recorders (DVR) and or home DVR. Our Whole Home DVR allows customers the ability to watch recorded shows on any TV in the house, record multiple shows at one time and utilize an intuitive on-screen guide and user interface. Video subscribers also have access to our TV Everywhere service which allows subscriber access to full episodes of available shows, movies and live screens using a computer or mobile device.  

 

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. 

 

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 customers for access to the public switched network. These monthly SLCs are regulated and approved by the Federal Communications Commission (FCC). In addition, network access revenue is derived from several federally administered pooling arrangements designed to provide support and distribute funding to the ILECs.   

 

Video – We provide a variety of enhanced video services on a monthly recurring basis to our customers. We also 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 TV services and five communities with our CATV services.

 

Data – We provide high speed Internet to business and residential customers. Our revenue is earned based on the offering of various flat rate packages based on the level of service, data speeds and features. We also provide e-mail and managed services, such as web hosting and design, on-line file back up and on-line file storage.  

 

Alternative Connect America Cost Model (A-Cam)/Federal Universal Service Fund (FUSF) – Prior to 2017, we received FUSF funding from the Federal Communications Commission (FCC). FUSF funding was established to overcome geographical differences in costs of providing voice service and to enable all citizens to communicate over networks regardless of geographical location and/or personal income. In our Form 10-Q for the quarter ended September 30, 2016, NU Telecom disclosed that we had elected the A-CAM for our Minnesota and Iowa operations, replacing our former legacy support. NU Telecom will receive A-CAM support for a period of ten years in exchange for meeting defined broadband build-out requirements.  See pages 12-14 for a discussion regarding A-CAM and FUSF.

 

Other – Our customers are billed for toll and 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. We also generate revenue from directory publishing, sales and service of customer premise equipment (CPE), bill processing and other customer services. Our directory publishing revenue 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 sale of wireless phones and accessories. 

 

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Strategy

 

Our vision is to position ourselves as a “one-stop” communications solutions provider. We believe our customers place a value on the fact that we are a local company whose goal is to meet our customers’ total communications needs. The success of this vision depends on the following strategies:

 

·      We market services to our residential customers either individually or as a bundled package. We offer a competitive, multi-service bundle of voice, high-speed Internet and IPTV. Data connections continue to increase as a result of consumer trends towards increased Internet usage and our enhanced product and service offerings.

 

·      Our consumer broadband speed allows us to continue to meet the needs of our customers and the demand for higher speed resulting from the growing trend of over-the-top content viewing. The availability of faster speeds also complements our wireless home networking (Wi-Fi) that supports our TV everywhere service and allows our subscribers to watch their favorite programs at home or away on a computer, smartphone or tablet.

 

·      We tailor our services to commercial customers by developing solutions to fit their specific needs. We provide services to a wide range of commercial customers from sole proprietors and other small businesses to multi-location corporations. Our business suite of services includes local and long-distance calling plans, hosted voice services using network servers, the added capacity for multiple phone lines, scalable broadband Internet, online back up and business directory listings.

 

·      We believe that we have several advantages over our competition, including a state-of-the-art, fiber-rich communications network, competitive pricing and costs, outstanding service quality and a strong reputation, a high level of commitment to the communities we serve and a direct billing relationship with a vast majority of the customers we serve in our service territories. We manage the potential decline in Telecom network access and local service revenues by offering value-added services such as higher Internet speeds, HD IPTV, DVR services, managed services, customized communications solutions content, along with outstanding customer service as a competitive differentiator.

 

·      We have and will continue to upgrade our networks and enhance our products and services to take advantage of the latest technology including advanced high-bandwidth capabilities and services, expansion of our network for wholesale and retail customers, Fiber-to-the-Tower services for wireless carriers and last mile fiber builds to residential and business customers. We intend to continue to introduce new services that draw upon our core competencies and we believe are attractive to our target customers. In considering new services, we look for market opportunities that we believe present growth opportunities.

 

·      We continue to seek ways to improve our internal processes and gain operational efficiencies. While focusing resources on revenue growth and market share gains, we continually challenge our management team and employees at all levels to seek efficiencies and enhance our customers’ experience. We continue to invest in our networks and train our employees to achieve customer service excellence.

 

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·      Our current customer base provides a recurring revenue stream generating stable cash flow. Our focus remains on growing our services and supporting product lines so as to generate sufficient cash flow to fund our current operations, service our debt, fund our capital expenditure needs, pay dividends and expand our business. We have allocated resources to maintain and upgrade our network while focusing on optimizing returns by completing strategic capital outlays that will make our network more efficient and cost effective while providing the products and services that our customers desire in the markets we serve.

 

·      We intend to continue to pursue a disciplined process of evaluating acquisitions of businesses as well as organic growth opportunities of market expansion and/or products which are complementary to our business portfolio.  

 

Competition

 

We compete in a rapidly evolving and highly competitive industry, and expect competition will continue to intensify as consolidations and mergers occur within the industry. Regulatory developments and technological advances over the past several years have increased opportunities for alternative communications service providers, which in turn have increased competitive pressures on our business. These alternative providers often face fewer regulations and have lower cost structures than we do. In addition, several of our competitors have consolidated with other communication providers and as a result are generally larger, have more financial and business resources and have greater geographical reach to provide services. Our competitive advantages include: our strong commitment and presence in the communities we serve, knowledge of these markets, our experienced local service and support team, and our ability to offer more flexible communications solutions than our larger competitors.

 

The long-range effect of competition on the delivery of communications services and equipment will depend on technological advances, regulatory actions at both the federal and the state levels, court decisions, and possible additional future federal and state legislation. Past federal and state legislation have tended to expand competition in the telecommunications industry. 

 

Alternatives to our service include customers leasing private line switched voice and data services in or adjacent to our service territories that permit the bypassing of our communications facilities. In addition, microwave transmission services, wireless communications, fiber-optic/coaxial cable deployment, VoIP, satellite and other services also permit the bypassing of our local exchange network. These alternatives to local exchange service represent a potential threat to our long-term ability to provide local exchange services at economical rates.

 

In order to meet the competition present in our industry, our businesses have deployed new technology to enable our local exchange networks to capture operating efficiencies and to provide additional new services to our new and existing customer base. These new technologies include the latest release of digital switching technology for all of our switches and the installation of a Common Channel Signaling System No. 7 (SS7) out-of-band system for all of our access lines. Our businesses have also connected fiber rings (redundant route designs that allow traffic to be re-routed in the event of network problems) that protect our local networks and enable them to provide a reliable level of service to our customers. The value of our local network is also enhanced by the ability of our operating companies to offer access to high-speed Internet with broadband access to our access lines. Broadband technology allows customer access to high-speed Internet and traditional voice connectivity over the same connection. In addition, our businesses have further enhanced our networks to allow the offering of video services over the same facilities that provide our customers with voice and Internet access. This technology is available to approximately 89% of our access lines.

 

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We compete as a CLEC in the cities of Redwood Falls, Litchfield and Glencoe, Minnesota. CenturyLink is the existing ILEC in these markets. Competition also exists in the other communities and areas served by our businesses for traditional telephone service from wireless communications providers and we also expect competition to increase from service providers offering VoIP. We experience competition in the Minnesota communities of Glencoe, Hutchinson, Litchfield, New Ulm, Redwood Falls, Sleepy Eye and Springfield in the provisioning of video services. Comcast is the existing incumbent provider of video services in the New Ulm market. Mediacom is the existing incumbent provider of video services in the Hutchinson, Litchfield, Redwood Falls, Sleepy Eye and Springfield markets. Several other communications providers compete with us in our markets in providing Internet services. Our businesses have responded to these competitive pressures by creating active programs to market our products, bundle our services and enhance our infrastructure to create higher customer value.  

 

We are experiencing competition for some of our other services from IXCs, such as customer billing services, dedicated private lines and network switching. The provisioning of these services is contractual in nature and is primarily directed by the IXCs. Other services, such as directory advertising, operator services and cellular communications are open to competition, based primarily on service and customer experience.

 

Materials and Supplies

 

The materials and supplies that are necessary for the operation of our businesses are available from a variety of sources. We are not dependent on any particular supplier or group of affiliated suppliers for our equipment needs.

 

Regulation

 

The following summary provides a high-level overview, but may not include all present and proposed federal, state and local legislation and regulations affecting the telecommunications industry. Some legislation and other regulations are currently the subject of judicial proceedings, legislative hearings and administrative proposals that could change the manner in which this industry operates. At this time, we cannot predict the outcome of any of these developments or their potential impact on us. Regulation can change rapidly in the telecommunications industry and these changes could have an adverse effect on us in the future.

 

Overview

 

Our consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP), rules and regulations of the SEC and, where applicable, conform to the accounting principles as prescribed by federal and state telephone utility regulatory authorities.

 

The services we offer are subject to varying levels of regulatory oversight. Federal and state regulatory agencies share responsibility for enforcing statutes and rules relative to the provision of communications services. Our interstate telecommunications services are subject to regulation by the FCC. Intrastate services are governed by the relevant state regulatory commission. The Telecommunications Act of 1996 (TA96) and the rules enacted under it also gave oversight of interconnection arrangements and access to network elements to the state commissions. Our TV services are governed by FCC rules and municipal franchise agreements. There are also varying levels of regulatory oversight depending on the nature of the services offered or if the services are offered by an ILEC or CLEC.

 

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Our CLEC businesses provide services with less regulatory oversight than our ILEC companies. A company must file for CLEC or interexchange authority to operate with the appropriate public utility commission in each state it serves. Our CLECs provide a variety of services to both residential and business customers in multiple jurisdictions.

 

Federal Regulatory Framework

 

All carriers must comply with the Federal Communications Act of 1934 (FCA34) as amended that requires, among other things, that our interstate services be provided at just and reasonable rates and on non-discriminatory terms and conditions. The TA96 amended the FCA34 and has had a dramatic effect on the competitive environment in the telecommunications industry. In addition to these laws, we are also subject to rules promulgated by the FCC and could be affected by any regulatory decisions or orders they issue.

 

The TA96 and Local Competition

 

The primary goal of the TA96 and the FCC’s rules promulgated under it was to open local telecommunications markets to competition while enhancing universal service. To some extent, Congress pre-empted the local authority of states to oversee local telecommunications services.

 

The TA96 imposes a number of requirements on all local telecommunications providers including:

 

·         To interconnect directly or indirectly with other carriers; 

 

·         To allow others to resell services;

 

·         To provide for number portability to allow end-users to retain their telephone number when changing providers;

 

·         To ensure dialing parity;

 

·         To ensure that competitor customers have non-discriminatory access to telephone numbers, operator services, directory assistance and directory listing services; and

 

·         To allow competitors access to telephone poles, ducts, conduits and rights-of-way, and to establish reciprocal compensation arrangements for the transport and termination of telecommunications traffic.

 

Access Charges

 

Access charges refer to the compensation received by local exchange carriers (LECs) for the use of their networks by an IXC. We provide two types of access services: special access and switched access. Special access is provided through dedicated circuits that connect other carriers to our network and is structured on a flat monthly fee basis. Switched access rates that are billed to other carriers are based on a per-minute of use fee basis. The FCC regulates prices that our businesses charge for interstate access charges. There has been a trend toward lowering the rates charged to carriers accessing local networks and the application of a SLC as a flat rate on end-user bills. Regulation, competition, carriers optimizing their network costs and lower demand for dedicated lines have resulted in lower access rates and overall lower minutes of use on our network, which has affected our network access revenues.  

 

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Interstate access rates are established by the nationwide pooling of companies known as the National Exchange Carriers Association (NECA). The 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 each 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 IXCs. We believe this trend will continue. 

 

Each of our ILECs determined interstate access charges under rate of return regulation, whereby they earned a fixed return over and above operating costs. The specific process of setting interstate access rates was governed by FCC rules, which applies only to service providers with fewer than 50,000 lines. Three of our ILECs (HTC, PTC and WTC) utilized an average schedule process and the concept of pooling with other ILECs in NECA to arrive at rates and fair compensation. Our other two ILECs (New Ulm and SETC) arrived at their interstate rates through a study of their own individual interstate costs. Minnesota and Iowa utility commissions regulated the intrastate access rates for all five of our ILECs in their respective states.

 

Wireline Interstate

 

Our ILEC companies participated in the NECA common line pool where end-user common line funds collected were pooled. A portion of our ILEC revenue was based on settlements distributed from this pool. Our ILEC companies also participated in the NECA traffic-sensitive pool. These pool settlements were adjusted periodically.

 

Interstate access rates for CLECs were established according to an order issued by the FCC in 2001. Under that order, the switched access rates charged by a competitive carrier can be no higher than the rates charged by the ILEC with whom the CLEC competes, unless the CLEC qualifies for the Rural Exemption.

 

Intercarrier Compensation and (FUSF) Reform 

 

The FCC released the National Broadband Plan in April 2010 recommending significant changes to the access charge policy and processes. This was followed on November 18, 2011, by FCC Order 11-161 (the Transformation Order), with comprehensive rules reforming all forms of intercarrier compensation and implementing a new support mechanism for the deployment of broadband. Generally, the intercarrier compensation reform sets forth a path towards a “bill & keep” regime which eliminates compensation for termination of traffic received from another carrier. The timeline for this transition had numerous steps depending on the type of traffic exchanged and the regulated status of the affected LEC.    

 

These rules have been clarified in several orders on Reconsideration and have had an impact on our companies by reducing our terminating intercarrier compensation, including intrastate and interstate access charges.  

 

The FCC Transformation Order also confirmed the applicability of access charges on VoIP traffic and eliminated reciprocal compensation charges for termination of local wireless traffic. Despite these changes IXCs and others are still quite aggressive in disputing carrier access charges and/or the applicability of access charges to their traffic.

 

Due to the combination of rate reforms instituted by the FCC, competitive substitution by wireless and other carriers and decreased use of the switched network, the aggregate amount of interstate network access charges paid by long distance carriers to access providers such as our company, has decreased and we project that this decline will continue. For the year ended December 31, 2017, Telecom network access revenue represented 17.7% of our operating revenue, down from 25.9% for the year ended December 31, 2016. This excludes any funding received from the A-CAM for broadband funding (see page 14 for more information).

 

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Universal Service

 

The FUSF was originally established to overcome geographic differences in costs of providing voice service and to enable all citizens to communicate over networks regardless of geographical location and/or personal income. The FCC established universal service policies at the national level under terms contained in the Telecommunications Act of 1934. The TA96 requires explicit FUSF mechanisms and enlarged the scope of universal service to include four distinct programs:

 

·       High-Cost program that supports local carriers operating in high-cost regions of the country to ensure reasonably based telephone rates;    

 

·       Lifeline (low-income) Subscribers program that includes the Link Up and Lifeline programs that provide support for service initiation and monthly fees and have eligibility based on subscriber income;

 

·       Rural Health Care Providers program that supports telecommunication services used by rural health care providers and provides them with toll free access to an Internet service provider; and

 

·       Schools and Libraries program, also called the E-Rate program that provides support funding to schools and libraries for telecommunications services, Internet access and internal connections.

 

In its Transformation Order released November 18, 2011, the FCC adopted rules which dramatically reform the universal service program and intercarrier compensation regime. These rules eliminated the legacy Local Switching support, but also provide for a new Connect America Fund (CAF) support for rate of return carriers to make up some of their access revenue reductions and provide direct support to PriceCap carriers for broadband build outs. The new rules have caused rates for end users to increase as intercarrier compensation is reduced and the legacy mandate for ubiquitous voice service shifts toward broadband availability as a key outcome of the program. 

 

FUSF high-cost payments are distributed by NECA and are only available to carriers that have been designated as an eligible telecommunications carrier (ETC) by a state commission. Each of our ILECs has been designated as an ETC. CLECs are also eligible to be designated as ETCs if they meet the requirements of the program and meet a public interest standard as determined by the appropriate state regulatory agency. Our CLECs are currently not receiving FUSF support. All ETCs must certify annually to the Universal Service Administrative Company or their appropriate state regulatory commission that the funds they receive from the FUSF are being used in the manner intended. The states must then certify to the FCC which carriers have met this standard. The Transformation Order expands the information that must be reported to the State Commissions to include information on broadband availability, plans for expansion to unserved and underserved areas, in addition to information about voice services. To some extent, these levels of scrutiny make the receipt of a consistent level of FUSF payments each year more difficult to predict.   

 

For the year ended December 31, 2017, we received an aggregate of $1,434,439 from FUSF, consisting of $1,474,388 of CAF support and consisting of $3,136 for a combination of high cost loop support and safety net additive.  In addition, we were assessed $43,085 in trueups to prior year disbursements from the Federal common line support funding mechanism. Our net FUSF in 2017 comprised 3.1% of our total revenue for the year. For the year ended December 31, 2016, we received an aggregate of $3,634,555 from FUSF, consisting of $40,244 for a combination of high cost loop support and safety net additive, $1,925,483 of Federal common line support and $1,668,828 of CAF support. Our net FUSF in 2016 comprised 8.6% of our total revenue for the year. We receive no State universal service funding as the states in which we operate have not established state universal service funding mechanisms. 

 

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Effective January 1, 2017 we no longer receive funding from the FUSF based on the pooling and redistribution of revenues based on a company’s actual or average costs as described above, but has instead, elected to receive funding based on the A-CAM as described below.

 

A-CAM

 

The FUSF was established as part of the TA96 and provides subsidies to telecommunications providers as means of increasing the availability and affordability of advanced telecommunications services. In 2011, significant reform was introduced, including the creation of the CAF, to help modernize the FUSF and promote support of these telecom services in the nation’s high-cost areas. In 2016, the FCC announced additional reform to further transition the CAF from supporting the provision of voice services to the provision of broadband services. On March 30, 2016, the FCC issued a Report and Order (2016 Order) that adopts the following changes to the FUSF for rate-of-return carriers:

 

·         Establishes a voluntary cost model; 

 

·         Creates specific broadband deployment obligations; 

 

·         Provides a mechanism for support of broadband-only deployment; 

 

·         Gradually reduces the authorized rate-of-return from 11.25 percent to 9.75 percent;

 

·         Eliminates support in those local areas served by unsubsidized competitors;

 

·         Establishes “glide-path” transition periods for all the new changes; and

 

·         Maintains the $2 billion budget established by the 2011 Transformation Order.

   

While the 2011 FUSF Transformation Order established CAF Phase I and CAF Phase II as high-cost support mechanisms for the price-cap carriers (i.e., the larger, national LECs such as Verizon and AT&T), it was not as specific about how subsidies would change for the rate-of-return carriers (i.e., the smaller LECs, including all rural LECs). In contrast, the 2016 Order focuses on the rate-of-return carriers, announces specific changes to existing funding mechanisms as well as a new funding mechanism, and provides rural telecommunications providers with greater certainty about future support.

 

One of the major changes introduced by the 2016 Order is the creation of the A-CAM, a new CAF support mechanism for rate-of-return carriers. Utilization of the A-CAM is voluntary; and rate-of-return carriers may instead choose to continue relying on the legacy support mechanism known as interstate common line support (ICLS), but now modified and renamed CAF Broadband Loop Support (CAF-BLS). Each carrier must decide which support mechanism to elect, and must choose one or the other, per state.

 

In our Form 10-Q for the quarter ended September 30, 2016, NU Telecom disclosed that we had elected the A-CAM for our Minnesota and Iowa operations, replacing our former ICLS. NU Telecom will receive A-CAM support for a period of ten years in exchange for meeting defined broadband build-out requirements. At the time of NU Telecom’s election, the FCC had not yet determined the final award numbers.

 

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Consistent with the stated disclosure in our Form 10-Q, NU Telecom notified the FCC that we would continue to elect the A-CAM program. Under the report that accompanied the FCC December 20, 2016 Public Notice, NU-Telecom would annually receive (i) $391,896 for our Iowa operations and (ii) $6,118,567 for our Minnesota operations. The Company will use the annual $6.5 million that we receive through the A-CAM program to meet our defined broadband build-out obligations. The A-CAM payments will replace the Company’s former ICLS payments. In 2016 NU Telecom received $1,965,727 under the former ICLS program.

 

Privacy and Data Security Regulation

 

The FCA34 generally restricts the nonconsensual collection and disclosure to third parties of telecommunication company customers’ personally identifiable information by telecommunication companies, except for rendering service, conducting legitimate business activities related to the service, and responding to legal requests. We are also subject to various state and federal regulations that provide protections for customer proprietary network information (CPNI) related to our voice services. The FCC expects broadband Internet access service providers such as us to take reasonable, good faith steps to comply with existing statutory requirements to protect broadband CPNI and plans to propose new privacy and data security rules for broadband Internet service providers. The FCC has recently imposed substantial civil penalties and remediation obligations on several companies for alleged privacy and data security violations.

 

The Federal Trade Commission exercises authority over privacy protections, generally, using its existing authority over unfair and deceptive acts or practices to apply greater restrictions on the collection and use of personally identifiable and other information relating to customers. It also has undertaken numerous enforcement actions against parties that do not provide sufficient security protections against the loss of unauthorized disclosure of this type of information. We also are subject to stringent data security and data retention requirements on website operators and online services. Other privacy-oriented laws have been extended by courts to online video providers and are increasingly being used in privacy lawsuits, including class actions, against providers of video materials online.

 

We are also subject to state and federal laws and regulations regarding data security that primarily apply to sensitive personal information that could be used to commit identity theft. Most states have security breach notification laws that generally require a business to give notice to consumers and government agencies when certain information has been disclosed, due to a security breach, and the FCC has adopted security breach rules for voice services. Several states have also enacted general data security requirements to safeguard consumer information, including the proper disposal of consumer information.

 

The National Institute of Standards and Technology, in cooperation with other federal agencies and owners and operators of United States critical infrastructure, have developed a voluntary framework that provides a prioritized, flexible, repeatable, performance-based and cost-effective approach to cybersecurity risk. It is compendiums of existing cross-sector cyber-defense processes, practices and protocols that can help companies identify, assess and manage their cyber risks and vulnerabilities, and several governmental agencies have encouraged compliance with this framework. Additionally, in December 2015, Congress enacted the Cybersecurity Act of 2015, which is intended to encourage and facilitate the sharing of security threat and defensive measure information with government agencies and other companies, in order to strengthen the country’s overall cybersecurity protections. Finally, there are pending legislative proposals that could impose new requirements on owners and operators of critical infrastructure and the FCC is considering expanding its cybersecurity guidelines or adopting new cybersecurity requirements.    

 

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Network Architecture and Technology

 

We have made significant investments in our technologically advanced telecommunications networks and continue to enhance and expand our network by deploying technologies to provide additional capacity to our customers. As a result, we are able to deliver high-quality, reliable data, video and voice services in the markets we serve. Our wide-ranging network and extensive use of fiber provide an easy reach into existing and new areas. By bringing the fiber network closer to the customer premises, we can increase our service offerings, quality and bandwidth services. Our existing network enables us to efficiently respond and adapt to changes in technology and is capable of supporting the rising customer demand for bandwidth in order to support the growing amount of wireless data devices in our customer’s homes and businesses.

 

Our networks are supported by advanced switches, with a fiber network connecting our exchanges. We continue to enhance our copper network to increase bandwidth in order to provide additional products and services to our marketable homes. In addition to our copper plant enhancements, we have deployed fiber-optic cable extensively throughout our network, resulting in a 100% fiber backbone network that supports all of the inter-office and host-remote links. In addition, this fiber infrastructure provides the connectivity required to provide video service, Internet and long-distance services to residential and commercial customers. Our fiber network utilizes fiber-to-the-home and fiber-to-the-node networks to offer bundled residential and commercial services.

 

We operate fiber networks which we own for fiber network access. At December 31, 2017, our fiber-optic network consisted of approximately 1,401 route miles, including 824 transport route miles and 577 local route miles.

 

Through our extensive fiber network, we are also able to support the increased demand on wireless carriers for data bandwidth. In all the markets we serve, we have launched initiatives to support fiber backhaul services to cell sites.

 

Environmental Regulation

 

We are subject to federal, state and local laws and regulations governing the use, storage, disposal of, and exposure to, hazardous materials, the release of pollutants into the environment and the remediation of contamination. We could be subject to environmental laws that impose liability for the entire cost of cleanup at a contaminated site, regardless of fault or the lawfulness of the activity that resulted in contamination. We believe that our operations are in compliance with all applicable environmental laws and regulations.

 

Employees

 

As of March 1, 2018 we had 134 full-time equivalent employees dedicated to NU Telecom operations. In addition, as of March 1, 2018 we had an additional 12 full-time equivalent employees that are employed by NU Telecom but are dedicated to IES. IES is a minority equity subsidiary of NU Telecom and NU Telecom acts as the managing entity for IES.

 

Intellectual Property

 

We have trademarks, trade names and licenses that we believe are necessary for the operation of our business as we currently conduct it. We do not consider our trademarks, trade names or licenses to be material to the operation of our business.

 

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Executive Officers of the Registrant

 

The names and ages of all our executive officers and the positions held by them as of March 1, 2018, are as follows:

 

Name and Age		Position with the Company		Age
Bill D. Otis		President and Chief Executive Officer – NU Telecom		60
Barbara A.J. Bornhoft		Vice-President, Chief Operating Officer and Corporate Secretary – NU Telecom		61
Curtis O. Kawlewski		Chief Financial Officer and Treasurer – NU Telecom		51
Craig S. Anderson		Chief Business Development Officer – NU Telecom		49

 

Our executive officers are appointed annually and serve at the discretion of our Board of Directors. Mr. Otis, President and Chief Executive Officer; Ms. Bornhoft, Vice-President, Chief Operating Officer and Corporate Secretary; and Mr. Kawlewski, Chief Financial Officer and Treasurer have written employment contracts. There are no familial relationships between any director and executive officers.

                                                                                                                                

Mr. Otis has been President and Chief Executive Officer since 1985. Prior to that time, he was the Office Manager/Controller from 1979 to 1985. Mr. Otis serves as Chairman of the Board for SMB, IES and BBV, all equity subsidiaries of ours. In addition, Mr. Otis sits on the Board of Governors of FiberComm, LC, also an equity subsidiary of ours.

 

Ms. Bornhoft has been Vice President, Chief Operating Officer and Corporate Secretary since 1998. Ms. Bornhoft has been employed with us since 1990. Ms. Bornhoft serves as a board member for BBV, in addition to serving as President for both IES and BBV, all equity subsidiaries of ours.

 

Mr. Kawlewski has been Chief Financial Officer and Treasurer since 2009. Mr. Kawlewski also serves as the Treasurer for IES and BBV, all equity subsidiaries of ours.

 

Mr. Anderson has been the Chief Business Development Officer since 2017.

 

Item 1A.   Risk Factors.

 

Not required for a smaller reporting company.

 

Item 1B.  Unresolved Staff Comments

 

Not required for a smaller reporting company.

 

Item 2.   Properties

 

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Our business is primarily focused on the provision of communication services and our properties are used primarily for administrative support and to house and safeguard our operating equipment. On December 31, 2017, our gross property, plant and equipment totaled $155,825,178 (net balance of $41,949,833).

 

Our corporate headquarters are located at 27 North Minnesota Street, New Ulm, Minnesota. We also own office facilities and related equipment for administrative personnel, central office buildings and operations in Minnesota and Iowa.

 

In addition to land and structures, our property consists of equipment necessary for the provision of communication services including central office equipment, CPE and connections, pole lines, towers, remote terminals, aerial and underground cable and wire facilities and associated outside plant for use in providing our services, telephone switches, fiber-optic networks and communications network equipment, vehicles, furniture and fixtures, computers and other equipment. Our extensive fiber-optic network is primarily owned by us, but we also have indefeasible rights to use and long-term leasing commitments to complement our owned network. We also own various communications equipment that we lease to subscribers.

 

In addition to plant and equipment we wholly-own, we utilize poles, towers, cable and conduit systems jointly-owned with other entities and lease space on facilities to other entities. These arrangements are in accordance with written agreements customary in the industry. We also have appropriate easements, rights of way and other arrangements for the accommodation of our pole lines, underground conduits, aerial and underground cables and wires. 

 

We believe our properties are suitable and adequate to provide modern and effective communications services within our service areas, including local dial-tone, long distance service, broadband, TV and dedicated and switched long-haul transport. We also believe our properties and equipment are adequately insured. See Note 4 – “Long-Term Debt” to the Consolidated Financial Statements of this Annual Report on Form 10-K for descriptions of the mortgages and collateral relating to the above referenced properties. See Note 1 – “Summary Of Significant Accounting Policies” and Note 2 – “Property, Plant and Equipment” to the Consolidated Financial Statements of this Annual Report on Form 10-K for a description of our depreciation policies and information relating to the above referenced properties and equipment and their respective depreciation.

 

Item 3.   Legal Proceedings

 

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

 

Item 4.   Mine Safety Disclosures

 

Not Applicable.

 

PART II

 

Item 5.   Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

 

Our common stock is quoted on the OTCQB Marketplace under the symbol "NULM." As of March 1, 2018 there were 1,335 registered stockholders and approximately 617 beneficial owners of NU Telecom stock. The following table sets forth the end-of-day high and low prices for our common stock quoted on the OTCQB Marketplace during 2017 and 2016. The OTCQB Marketplace quotations reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not necessarily reflect actual transactions.

 

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The Company’s Articles of Incorporation restrict any one individual or entity from beneficially owning more than seven percent of the outstanding capital stock of the corporation. Specific details of this restriction are contained in Article III of the Company’s Articles of Incorporation.  

 

Dividends and Restrictions

 

We declared a quarterly dividend of $0.10 per share for the second, third and fourth quarters of 2017 and $0.095 per share for the first quarter of 2017, which totaled $516,007 per quarter for the third and fourth quarters, $515,636 for the second quarter and $488,242 for the first quarter. We declared a quarterly dividend of $0.09 per share for the second, third and fourth quarters of 2016 and $0.0875 per share for the first quarter of 2016, which totaled $462,544 per quarter for the second, third and fourth quarters and $447,724 for the first quarter. A quarterly cash dividend of $0.10 per share will be paid on March 15, 2018 to stockholders of record at the close of business on March 5, 2018.

 

We expect to continue to pay quarterly dividends during 2018, 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, ACB (CoBank) credit facility that contain restrictions on our distributions to stockholders and investment in, or loans, to others. See below and Note 4 – “Long-Term Debt” to the Consolidated Financial Statements of this Annual Report on Form 10-K for additional information.

 

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 $2,100,000 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. On March 31, 2016 our Total Leverage Ratio fell below 2.50, thus eliminating any restrictions on our ability to pay cash dividends to our stockholders. Our current Total Leverage Ratio at December 31, 2017 is 1.47.  

 

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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Item 6.   Selected Financial Data

 

Not required for a smaller reporting company.

 

Item 7.   Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

The following discussion should be read in conjunction with our historical financial statements and the related notes contained elsewhere in this report.

 

Overview

 

NU Telecom has a state-of-the-art; fiber-rich communications network and offers a diverse array of communications products and services. Our 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, 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

 

Highlights:

 

·       Effective January 1, 2017 the Company no longer receives funding from the FUSF based on the pooling and redistribution of revenues based on a company’s actual or average costs, but has instead, elected to receive funding based on the A-CAM. See page 14 for a discussion regarding the A-CAM.

 

·       On December 1, 2015 the Minnesota State Department of Employment and Economic Development (DEED) announced NU Telecom as one of the companies that will receive state grants for broadband development. The State announced a total of $11 million in grants through the Border-to-Border Broadband Development Grant Program. The winners came out of a pool of 44 grant applicants requesting more than $29 million. NU Telecom was to receive $115,934 of the $244,125, or 47.5%, of the total project costs to build fiber connections to 24 homes and businesses in an area northeast of Goodhue. NU Telecom completed the project in late 2016. At December 31, 2017 the Company has received $115,934 from this grant.

 

·       On January 12, 2017 the DEED announced NU Telecom as one of the companies that will receive state grants for broadband development. NU Telecom received three of the forty-two grants announced by Lieutenant Governor Tina Smith. A total of $34 million was awarded by DEED with the aim of providing reliable, affordable high-speed internet to more than 16,000 households, more than 2,000 businesses and more than 70 community institutions throughout the state. NU Telecom will receive $850,486 of the $1,889,968, or 45%, of the total project costs to build fiber connections to homes and businesses in the rural areas of Hanska and Mazeppa and in and around Bellechester. Construction on one of the projects began in the spring of 2017 and the construction on the other two projects began in the summer of 2017. Grant funds will be received by NU Telecom as work progresses and costs are provided to DEED. At December 31, 2017 we had received $51,223.98 from this grant.     

 

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·       On November 24, 2017 the DEED announced NU Telecom as one of the companies that will receive state grants for broadband development. NU Telecom received two of the thirty-nine grants announced by Lieutenant Governor Tina Smith. A total of $26.4 million was awarded by DEED with the aim of providing reliable, affordable high-speed internet to nearly 10,000 households, more than 2,000 businesses and more than 60 community institutions throughout the state. NU Telecom will receive $736,598 of the $1,727,998, or 42.6%, of the total project costs to build fiber connections to homes and businesses in the rural areas of Hanska and White Rock. Construction on the projects is expected to begin in the spring of 2018. Grant funds will be received by NU Telecom as work progresses and costs are provided to DEED.    

 

·       Net income in 2017 totaled $9,954,236, which was a $7,099,749, or 248.7% increase compared to 2016. This increase was primarily due to a reduction in our corporate taxes due to the revaluation of our deferred tax assets and liabilities, which was a result of the 2017 Tax Cuts and Jobs Act tax reform legislation. In addition, the net income also increased due to an increase in operating revenues, partially offset by an increase in operating expenses, all of which are described below.

 

·       Consolidated revenue for 2017 totaled $46,889,181, which was a $4,570,035 or 10.8% increase compared to 2016. This increase was primarily due to an increase in our A-CAM funding support based on the Company’s election to receive funding under A-CAM (see page 14), and increased video and data revenues. These increases were partially offset by a decrease in local service, network access and other non-regulated revenues, all of which are described below.  

 

Business Trends

 

Included below is a synopsis of business trends management believes will continue to affect our business in 2018.

 

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 CATV providers, 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. Access line decreases totaled 1,602 or 6.8% in 2017 compared to 2016 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.

 

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To be competitive, we continue to emphasize the bundling of our products and services. Our customers have the option to bundle local phone, high-speed Internet, long distance and video services. These bundles provide our customers with one convenient location to obtain all of their communications and entertainment options, a convenient billing solution and bundle 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, wireless services, private line, VoIP, digital video, IPTV and hosted and managed services.

 

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

 

Financial results for the Telecom Segment for the years ended December 31, 2017 and 2016 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 $5,819,471, which is $44,252 or 0.8% lower in 2017 than in 2016. This decrease was primarily due to the decline in access lines partially offset by rate increases implemented in several of our markets in 2016 and 2017.

 

The number of access lines we serve as a company 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.

 

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 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 ILECs. Network access revenue was $6,846,324, which is $468,884 or 6.4% lower in 2017 than in 2016. This decrease was 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 LECs. 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 services and five communities with our CATV services. Video revenue was $9,730,361, which is $349,219 or 3.7% higher in 2017 than in 2016. This increase was primarily due to a combination of rate increases introduced into several of our markets over the course of the last several years. Also contributing to the increase in video revenues was an increased demand for our HD and DVR services.

 

Data – We provide high speed Internet to business and residential customers. Our revenue is earned based on the offering of various flat rate packages based on the level of service, data speeds and features. We also provide e-mail and managed services, such as web hosting and design, on-line file back up and on-line file storage. Data revenue was $12,152,732, which is $546,999 or 4.7% higher in 2017 than in 2016. This increase was primarily due to an increase in data customers and increased managed services revenue. 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.

 

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A-CAM/FUSF – Prior to 2017, the Company received support from the FUSF based on the pooling and redistribution of revenues based on a company’s actual or average costs. See pages 12-14 for a discussion regarding FUSF.

 

Effective January 1, 2017, the Company no longer receives support from the FUSF, but has instead, elected to receive support based on the A-CAM. See page 14 for a discussion regarding the A-CAM. A-CAM/FUSF support totaled $7,944,902, which is $4,310,347 or 118.6% higher in 2017 than in 2016.

 

Other Revenue – Our customers are billed for toll and 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. We also generate revenue from directory publishing, sales and service of CPE, bill processing and other customer services. Our directory publishing revenue 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 $4,395,391, which is $123,394 or 2.7% lower in 2017 than in 2016. This decrease was primarily due to a decrease in the sales and installation of CPE.

 

Cost of Services (Excluding Depreciation and Amortization)

 

Cost of services (excluding depreciation and amortization) was $20,591,004, which is $498,480 or 2.5% higher in 2017 than in 2016. This increase was primarily due to higher programming costs 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 $7,185,340, which is $131,545 or 1.9% higher in 2017 than in 2016. This increase was primarily due to higher costs associated with professional and consulting services.  

 

Depreciation and Amortization

 

Depreciation and amortization was $9,652,754, which is $111,180 or 1.1% lower in 2017 than in 2016. This decrease was primarily due to portions of our legacy telephone network becoming fully depreciated. This decrease was partially offset by increased depreciation associated with increases in our broadband property, plant and equipment, reflecting our continual investment in technology and infrastructure in order to meet our customers’ demands for products and services.     

 

Operating Income

 

Operating income was $9,460,082, which is $4,051,189 or 74.9% higher in 2017 than in 2016. This increase was primarily due to an increase in revenues, partially offset by increase in expenses, all of which are described above.

 

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See Consolidated Statements of Income on Page 38 (for discussion below)

 

Other Income (Expense) and Interest Expense   

 

Other income in 2017 and 2016 included a patronage credit earned with CoBank as a result of our debt agreements with them. The patronage credit allocated and received in 2017 was $337,137, compared to $386,843 allocated and received in 2016. 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.

 

Interest and dividend income increased $6,054 in 2017 compared to 2016. This increase was primarily due to an increase in interest income earned on our increased cash balances.

 

Interest expense decreased $233,286 in 2017 compared to 2016. This decrease was primarily due to lower outstanding debt balances.   

 

Other investment income decreased $28,006 in 2017 compared to 2016. Other investment income is primarily from our equity ownerships in several partnerships and limited liability companies.                       

 

Income Taxes

 

Income tax expense decreased by $2,836,455 in 2017 compared to 2016 as we recorded an income tax benefit of $803,315 in 2017 and an income tax expense of $2,033,140 in 2016. The decrease in income taxes was primarily due to a reduction in our corporate taxes due to the revaluation of our deferred tax assets and liabilities, which was a result of the 2017 Tax Cuts and Jobs Act tax reform legislation. The effective income tax rate was (8.78%) and 41.60% for 2017 and 2016. The difference between the effective tax rate and the federal statutory tax rate are reconciled in Note 6 – “Income Taxes” to the Consolidated Financial Statements of this Annual Report on Form 10-K.

 

Inflation 

 

It is the opinion of our management that the effects of inflation on operating revenue and expenses over the past two years have been immaterial. Our management anticipates that this trend will continue in the near future.

 

Off Balance Sheet Arrangements

 

The Company has no significant Off Balance Sheet Arrangements (as defined in Item 303 (a)(4) of Regulation S-K).

 

Non-GAAP Measures

 

In addition to the results reported with GAAP, we also use certain non-GAAP measures such as EBITDA and adjusted EBITDA to evaluate operating performance and to facilitate the comparison of our historical results and trends. These financial measures are not a measure of financial performance under GAAP and should not be considered in isolation or as a substitute for net income as a measure of performance and net cash provided by operating activities as a measure of liquidity. They are not, on their own, necessarily indicative of cash available to fund cash needs as determined in accordance with GAAP. The calculation of these non-GAAP measures may not be comparable to similarly titled measures used by other companies. Reconciliations of these non-GAAP measures to the most directly comparable financial measures presented in accordance with GAAP are provided below.

 

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EBITDA is defined as net earnings before interest expense, income taxes, and depreciation and amortization. Adjusted EBITDA is comprised of EBITDA, adjusted for certain items as permitted or required under our credit facility as described in the reconciliations below. These measures are a common measure of operating performance in the telecommunications industry and are useful, with other data, as a means to evaluate our ability to fund our estimated uses of cash.

 

The following table is a reconciliation of net income to adjusted EBITDA for the years ended December 31, 2017 and 2016.

 

 

Liquidity and Capital Resources

 

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Capital Structure

 

NU Telecom’s total capital structure (long-term and short-term debt obligations, net of unamortized loan fees, plus stockholders’ equity) was $95,787,020 at December 31, 2017, reflecting 71.5% equity and 28.5% debt. This compares to a capital structure of $91,872,382 at December 31, 2016, reflecting 65.6% equity and 34.4% 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 1.47 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.

 

 

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 year ended December 31, 2017 were proceeds from cash generated from operations and cash reserves held at the beginning of the period. At December 31, 2017 we had a working capital deficit of $1,811,710. In addition, at December 31, 2017, we also had approximately $9.0 million available under our revolving credit facility to fund any short-term working capital needs. The working capital deficit as of December 31, 2017 was primarily the result of the utilization of operating cash flows to fund operations and purchase capital equipment in lieu of using our revolving credit facility.       

 

We have not conducted a public equity offering. We operate with original equity capital, retained earnings and additions to indebtedness in the form of senior debt and bank lines of credit.

 

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 for us 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 either expanding our network or our markets through organic or internal investments or through strategic acquisitions. We feel 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.

 

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The following table summarizes our cash flow:

 

 

Cash Flows from Operating Activities

 

Cash generated by operations for the year ended December 31, 2017 was $13,939,556, compared to cash generated by operations of $12,186,427 in 2016. The increase in cash flows from operating activities in 2017 was primarily due to increased net income, partially offset by decreased deferred income taxes.     

 

Cash generated by operations continues to be our primary source of funding for existing operations, capital expenditures, debt service and dividend payments to stockholders. Cash at December 31, 2017 was $1,842,092, compared to $616,114 at December 31, 2016.  

 

Cash Flows Used in Investing Activities

 

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

 

Cash flows used in investing activities were $6,342,908 for the year ended December 31, 2017, compared to $5,861,514 used in investing activities in 2016. Capital expenditures relating to on-going operations were $6,267,066 in 2017 and $5,725,287 in 2016. 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 upcoming 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 December 31, 2017, we had approximately $9.0 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 year ended December 31, 2017 was $6,370,670. This included long-term debt repayments of $2,700,000, net payments on our revolving credit facility of $1,634,778 and the distribution of $2,035,892 of dividends to stockholders. Cash used in financing activities for the year ended December 31, 2016 was $6,260,623. This included long-term debt repayments of $2,025,000, net payments on our revolving credit facility of $2,400,267 and the distribution of $1,835,356 of dividends to stockholders.

 

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Working Capital

 

We had a working capital deficit (i.e. current assets minus current liabilities) of $1,811,710 as of December 31, 2017, with current assets of approximately $6.7 million and current liabilities of approximately $8.5 million, compared to a working capital deficit of $2,827,419 as of December 31, 2016. The ratio of current assets to current liabilities was 0.79 and 0.66 as of December 31, 2017 and 2016. The working capital deficit as of December 31, 2017 was primarily the result of the utilization of operating cash flows to fund operations and purchase capital equipment in lieu of using our revolving credit facility. 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.    

 

Long-Term Debt and Revolving Credit Facilities

 

Our long-term debt obligations as of December 31, 2017, were $24,200,000 (excluding long-term loan origination fees),  net of current debt maturities of $3,375,000 (excluding short-term loan origination fees). Our long-term debt obligations as of December 31, 2016, were $28,534,778 (excluding long-term loan origination fees), net of current debt maturities of $3,375,000 (excluding short-term loan origination fees).

   

    MLA RX0583

 

●          RX0583-T2A - $9,000,000 revolving note with interest payable monthly. Final maturity date of the note is December 31, 2021. We currently have drawn $0 on this revolving note as of December 31, 2017.

 

●          RX0583-T3A - $35,000,000 term note with interest payable monthly. Final maturity date of the note is December 31, 2021. Twenty-eight quarterly principal payments of $675,000 are due commencing March 31, 2015 through December 31, 2021. A final balloon payment of $16,100,000 is due at maturity of the note on December 31, 2021.

 

RX0583-T2A and RX0583-T3A initially bear interest at a “LIBOR Margin” rate equal to 3.25 percent over the applicable LIBOR rate. The LIBOR Margin decreases as our “Leverage Ratio” decreases.

 

Within 180 days after the closing date of December 31, 2014, NU Telecom needed to enter into interest rate protection agreements in form and substance reasonably satisfactory to CoBank so as to fix or limit interest rates payable by NU Telecom at all times to at least 40% of the outstanding principal balance of Loan RX0583-T3A for an initial average weighted life of at least three years.

 

As described in Note 5 – “Interest Rate Swaps” to the Consolidated Financial Statements of this Annual Report on Form 10-K,  we have entered into an interest rate swap agreement that effectively fixed our interest rates and covers $14.0 million at a weighted average rate of 3.72%, as of December 31, 2017. The remaining debt of $22.6 million ($9.0 million available under the revolving credit facilities and $13.6 million currently outstanding) remains subject to variable interest rates at an effective weighted average interest rate of 4.07%, as of December 31, 2017.

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.

 

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Our credit facility requires us to comply with specified financial ratios and tests. These financial ratios include total leverage ratio, debt service coverage ratio, equity to total assets ratio and fixed coverage ratio. At December 31, 2017, we were in compliance with all financial ratios in the loan agreements.

 

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 $2,100,000 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. On March 31, 2016 our Total Leverage Ratio fell below 2.50, thus eliminating any restrictions on our ability to pay cash dividends to our stockholders. Our current Total Leverage Ratio at December 31, 2017 is 1.47. 

 

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. Also, our credit facility contains restrictions that, among other things, limits or restricts our ability to enter into guarantees and contingent liabilities, incur additional debt, issue stock, transact asset sales, transfers or dispositions, and engage in mergers and acquisitions, without CoBank approval.

 

See Note 4 – “Long-Term Debt” to the Consolidated Financial Statements of this Annual Report on Form 10-K for information pertaining to our long-term debt and current effective interest rates.  

 

Guarantees

 

We have guaranteed the obligations of our New Ulm subsidiary joint venture investment in FiberComm, LC. See Note 11 – “Guarantees” to the Consolidated Financial Statements of this Annual Report on Form 10-K.

 

Critical Accounting Policies and Estimates

 

Management’s discussion and analysis of financial condition and results of operations stated in this 2017 Annual Report on Form 10-K are based upon NU Telecom’s consolidated financial statements that have been prepared in accordance with GAAP and, where applicable, conform to the accounting principles as prescribed by federal and state telephone utility regulatory authorities. We presently give accounting recognition to the actions of regulators where appropriate. The preparation of our financial statements requires our management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, and the related disclosure of contingent assets and liabilities. Our senior management has discussed the development and selection of accounting estimates and the related Management Discussion and Analysis disclosure with our Audit Committee. For a summary of our significant accounting policies, see Note 1 – “Summary of Significant Accounting Policies” to the Consolidated Financial Statements of this Annual Report on Form 10-K. There were no significant changes to these accounting policies during the year ended December 31, 2017.

 

Revenue Recognition

 

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

 

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

 

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

 

Interstate access rates are established by a nationwide pooling of companies known as NECA. The 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’s and SETC’s settlements from the pools were based on their actual costs to provide service, while the settlements for NU Telecom subsidiaries – WTC, PTC and HTC were based on nationwide average schedules. Access revenues for New Ulm 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 were 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.

 

Effective January 1, 2017 we no longer receive funding from the FUSF based on the pooling and redistribution of revenues based on a company’s actual or average costs as described above, but have instead, elected to receive funding based on the A-CAM as described below.

 

The FUSF was established as part of the TA96 and provides subsidies to telecommunications providers as means of increasing the availability and affordability of advanced telecommunications services. In 2011, significant reform was introduced, including the creation of the CAF, to help modernize the FUSF and promote support of these telecom services in the nation’s high cost areas. In 2016, the FCC announced additional reform to further transition the CAF from supporting the provision of voice services to the provision of broadband services. On March 30, 2016, the FCC issued the 2016 Order that adopts the following changes to the FUSF for rate-of-return carriers:

 

·         Establishes a voluntary cost model;

 

·         Creates specific broadband deployment obligations; 

 

·         Provides a mechanism for support of broadband-only deployment; 

 

·         Gradually reduces the authorized rate-of-return from 11.25 percent to 9.75 percent;

 

·         Eliminates support in those local areas served by unsubsidized competitors;

 

·         Establishes “glide-path” transition periods for all the new changes; and

 

·         Maintains the $2 billion budget established by the 2011 Transformation Order.

 

While the 2011 FUSF Transformation Order established CAF Phase I and CAF Phase II as high cost support mechanisms for the price cap carriers (i.e., the larger, national LECs such as Verizon and AT&T), it was not as specific about how subsidies would change for the rate-of-return carriers (i.e., the smaller LECs, including all rural LECs). In contrast, the 2016 Order focuses on the rate-of-return carriers, announces specific changes to existing funding mechanisms as well as a new funding mechanism, and provides rural telecommunications providers with greater certainty about future support.

 

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One of the major changes introduced by the 2016 Order is the creation of the A-CAM, a new CAF support mechanism for rate-of-return carriers. Utilization of the A-CAM is voluntary; and rate-of-return carriers may instead choose to continue relying on the legacy support mechanism known as ICLS, but now modified and renamed CAF-BLS. Each carrier must decide which support mechanism to elect, and must choose one or the other, per state.

 

In our Form 10-Q for the quarter ended September 30, 2016, NU Telecom disclosed that we had elected the A-CAM for our Minnesota and Iowa operations, replacing our former ICLS. NU Telecom will receive A-CAM support for a period of ten years in exchange for meeting defined broadband build-out requirements. At the time of NU Telecom’s election, the FCC had not yet determined the final award numbers.

 

Consistent with the stated disclosure in our Form 10-Q, NU Telecom notified the FCC that we would continue to elect the A-CAM program. Under the report that accompanied the FCC December 20, 2016 Public Notice, NU Telecom would annually receive (i) $391,896 for our Iowa operations and (ii) $6,118,567 for our Minnesota operations. The Company will use the annual $6.5 million that we receive through the A-CAM program to meet our defined broadband build-out obligations. The A-CAM payments will replace the Company’s former ICLS payments. In 2016, NU Telecom received $1,965,727 under the former ICLS program.

 

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.

 

Allowance for Doubtful Accounts

 

We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. In making the determination of the appropriate allowance for doubtful accounts, we consider specific accounts, historical write-offs, changes in customer relationships, credit worthiness and concentrations of credit risk. Specific accounts receivable are written off once a determination is made that the account is uncollectible. Additional allowances may be required if the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments. Our allowance for doubtful accounts was $83,000 and $43,200 as of December 31, 2017 and 2016.  

 

Financial Derivative Instruments and 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:

 

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         Level 1:   Inputs are quoted prices in active markets for identical assets or liabilities.

 

         Level 2:  Inputs are quoted prices for similar assets or liabilities in an active market, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable and market–corroborated inputs that are derived principally from or corroborated by observable market data.

 

         Level 3:   Inputs are derived from valuation techniques where one or more significant inputs or value drivers are unobservable.

 

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

 

We have entered into an interest rate swap agreement (IRSA) with our lender CoBank to manage our cash flow exposure to fluctuations in interest rates. This instrument is designated as a 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 IRSA is discussed in Note 5 – “Interest Rate Swaps” to the Consolidated Financial Statements of this Annual Report on Form 10-K. The fair value of our swap agreement was determined based on Level 2 inputs.

 

Valuation of Goodwill

 

We have goodwill on our books related to prior acquisitions of telephone properties. As discussed more fully in Note 3 – “Goodwill and Intangibles” to the Consolidated Financial Statements of this Annual Report on Form 10-K, and in accordance with GAAP, goodwill is reviewed for impairment annually or more frequently if an event occurs or circumstances change that would reduce the fair value below its carrying value. We perform our annual fair value evaluation in the fourth quarter of each year.    

 

The impairment test for goodwill involves a two-step process: step one consists of a comparison of the fair value of a reporting unit with its carrying amount, including the goodwill allocated to each reporting unit. If the carrying amount is in excess of the fair value, step two requires the comparison of the implied fair value of the reporting unit goodwill with the carrying amount of the reporting unit goodwill. Any excess of the carrying value of the reporting unit goodwill over the implied fair value of the reporting unit goodwill will be recorded as an impairment loss.

 

In 2017 and 2016, we engaged an independent valuation firm to complete an annual impairment test for existing goodwill acquired. For 2017 and 2016, the testing resulted in no impairment to goodwill as the determined fair value was sufficient to pass the first step of the impairment test. Our independent valuation firm used a combination of Income (Discounted Cash Flow Method or DCF Method) and Market Approaches to estimate the fair value of the goodwill on our books related to prior acquisitions of telephone properties. The assumptions used in the estimates of fair value were based on projections provided by our management and a rate of return based on market information observed in debt and traded equity securities. Their Market Approaches considered market multiples observed in companies comparable to ours, traded on public exchange or over-the-counter, or transacted in a merger or acquisition transaction. 

 

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Assumptions used in our 2017 DCF model include the following:

 

·       A 9.00% weighted average cost of capital based on an industry weighted average cost of capital; and

 

·       A 2.00% terminal revenue growth rate.

 

The most significant amount of goodwill recorded on our books was due to the acquisition of HTC and the addition of goodwill obtained through the HCC spin-off. The carrying value of the goodwill was $39,805,349 as of December 31, 2017 and 2016.

 

In 2017, we tested the HTC goodwill. Based on the DCF models, and income and market-based approaches that were used, we determined the estimated enterprise fair value of our reporting unit exceeded the carrying amount of that reporting unit by approximately $20.3 million, which indicated that we had no impairment as of December 31, 2017. In addition, in 2017, we tested the SETC goodwill. Based on the DCF models, and income and market-based approaches we used, we determined the estimated enterprise fair value of our reporting unit exceeded the carrying amount of that reporting unit by approximately $17.6 million, which indicated that we had no impairment as of December 31, 2017. The market-based approaches used in our evaluations are subject to change as a result of changing economic and competitive conditions. Future negative changes relating to our financial operations could result in a potential impairment of goodwill.  

 

Income Taxes

 

The provision for income taxes consists of an amount for taxes currently payable and a provision for tax consequences deferred to future periods. Deferred income taxes are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities, and their respective tax basis. Significant components of our deferred taxes arise from differences (i) in the basis of property, plant and equipment due to the use of accelerated depreciation methods for tax purposes, as well as (ii) in partnership investments and intangible assets due to the difference between book and tax basis. Our effective income tax rate is normally higher than the United States tax rate due to state income taxes and permanent differences.

 

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. The Company has identified no significant income tax uncertainties as of December 31, 2017 and 2016.

 

In accordance with GAAP, we record net unrecognized tax benefits that, if recognized, would affect the income tax provision when recorded. See Note 6 – “Income Taxes” to the Consolidated Financial Statements of this Annual Report Form 10-K.

 

As of December 31, 2017 and 2016 we had $0 of unrecognized tax benefits, which if recognized would affect the effective tax rate.  

 

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We are primarily subject to United States, Minnesota, Nebraska and Iowa income taxes. Tax years subsequent to 2013 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 December 31, 2017 and 2016 we had no interest or penalties accrued that related to income tax matters.

 

Property, Plant and Equipment

 

We record impairment losses on long-lived assets used in operations when events and circumstances indicate the assets might be impaired and the undiscounted cash flows estimated to be generated by those assets are less than the carrying amounts of those assets. In assessing the recoverability of long-lived assets, we compare the carrying value to the undiscounted future cash flows the assets are expected to generate. If the total of the undiscounted future cash flows is less than the carrying amount of the assets, we would write down those assets based on the excess of the carrying amount over the fair value of the assets. Fair value is generally determined by calculating the discounted future cash flows expected from those assets. Changes in these estimates could have a material adverse effect on the assessment of long-lived assets, thereby requiring a write-down of the assets. Write-downs of long-lived assets are recorded as impairment charges and are a component of operating expenses. We have reviewed our long-lived assets and concluded that no impairment charge on these long-lived assets is necessary.

 

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. We have not made any significant changes to the lives of assets in the two-year period ended December 31, 2017.

 

Equity Method Investment

 

We are an investor in several partnerships and limited liability corporations. Our percentages of ownership in these joint ventures range from 12.50% to 24.30%. We use the equity method of accounting for these investments, which reflects original cost and the recognition of our share of the net income or losses from the respective operations.  

 

Incentive Compensation

 

We engaged an outside consultant in 2005 to advise us in our development of an Employee Incentive Plan for employees other than executive officers and a Management Incentive Plan for our executive officers.  Both plans were implemented in 2006. Both of these plans were cash-based incentive plans. Payments on each plan are based on an achievement of objectives of measurable corporate performance using financial targets. The financial targets are based on an achievement of specified operating revenues and operating income before interest, taxes, depreciation and amortization (OIBITDA).  

 

We accrue an estimated liability each year for these potential payouts and reverse that accrual if the incentive payout targets are not met and paid out. Incentive payouts, if earned, are typically paid in late March or early April of the year following the target year and after the filing of our Annual Report on Form 10-K.  

 

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On February 24, 2017, our Board of Directors adopted the New Ulm Telecom, Inc. 2017 Omnibus Stock Plan (2017 Plan) effective May 25, 2017. The shareholders of the Company approved the plan at the May 25, 2017 Annual Meeting of Shareholders. The purpose of the 2017 Plan was to enable NU Telecom and its subsidiaries to attract and retain talented and experienced people, closely link employee compensation with performance realized by shareholders, and reward long-term results with long-term compensation. The plan enables us to grant stock incentive awards to current and new employees, including officers, and to Board members and service providers. The 2017 Plan permits stock incentive awards in the form of options (incentive and non-qualified), stock appreciation rights, restricted stock, restricted stock units, performance stock, performance units, and other awards in stock or cash. The 2017 Plan permits the issuance of up to 625,000 shares of our Common Stock in any of the above stock awards.

 

On July 25, 2017, our Board of Directors granted 6,077 shares of restricted stock units in the Common Stock of the Company to its executive officers. We recognize share-based compensation expense for these restricted stock units over the vesting period of the restricted stock units, which was determined by our Board of Directors. The 2017 restricted stock units will vest on December 31, 2019, at which point, the executives will be able to receive Common Stock in the Company for the restricted stock units.

Recent Accounting Developments

 

See Note 1 – “Summary of Significant Accounting Policies” to the Consolidated Financial Statements of this Annual Report on Form 10-K, for a discussion of recent accounting developments.

 

Item 7A.    Quantitative and Qualitative Disclosures about Market Risk

 

Not required for a smaller reporting company.

 

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Item 8.   Financial Statements and Supplementary Data

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

To the Board of Directors and Stockholders of

New Ulm Telecom, Inc.

 

Opinion on the Financial Statements

 

We have audited the accompanying consolidated balance sheets of New Ulm Telecom, Inc. (a Minnesota corporation) and subsidiaries (the Company) as of December 31, 2017 and 2016, and the related consolidated statements of income, comprehensive income, stockholders’ equity and cash flows for the years then ended, and the related notes (collectively referred to as the financial statements). In our opinion, the consolidated financial statements, present fairly, in all material respects, the consolidated financial position of the Company as of December 31, 2017 and 2016, and the consolidated results of their operations and their cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America.

 

Basis for Opinion

 

These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

 

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.

 

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Our audits included performing procedures to assess the risk of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation pf the financial statements. We believe that our audits provide a reasonable basis for our opinion.

 

/s/ Olsen Thielen & Co., Ltd.

 

We have served as the Company’s auditor since 2008.

 

Roseville, Minnesota

March 15, 2018

 

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NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Description of Business

 

NU Telecom is a diversified communications company headquartered in New Ulm, Minnesota with more than 110 years of experience in the local telephone exchange and telecommunications business. Our principal line of business is the operation of five local telephone companies and the operation of two CLEC telephone companies. Our businesses consist of connecting customers to our state-of-the-art, fiber-rich communications network, providing managed services, switched service and dedicated private lines, connecting customers to long distance service providers and providing many other services associated with our company. Our businesses also provide IPTV, CATV, Internet access services, including high-speed broadband access, and long distance service. We also install and maintain communications systems to the areas in and around our service territories in southern Minnesota and northern Iowa. 

 

Basis of Presentation and Principles of Consolidation

 

Our accounting policies conform with GAAP and, where applicable, to the accounting principles as prescribed by federal and state telephone utility regulatory authorities. We presently give accounting recognition to the actions of regulators where appropriate in preparing general purpose financial statements for most public utilities. In general, the type of regulation covered by this statement permits rates (prices) for some services to be set at levels intended to recover the estimated costs of providing regulated services or products, including the cost of capital (interest costs and a provision for earnings on stockholders’ investments).

 

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

 

Classification of Costs and Expenses

 

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 transportation costs.

 

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.

 

Use of Estimates

 

The preparation of our consolidated financial statements in conformity with GAAP requires our management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses, and disclosure of contingent assets and liabilities. The estimates and assumption used in the accompanying consolidated financial statements are based on our management’s evaluation of the relevant facts and circumstances as of the date of the financial statements. Actual results may differ from those estimates and assumptions.

 

Revenue Recognition

 

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

 

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

 

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

 

Interstate access rates were established by a nationwide pooling of companies known as NECA. The FCC established NECA in 1983 to develop and administer interstate access service rates, terms and conditions. Revenues were 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’s and SETC’s settlements from the pools were based on their actual costs to provide service, while the settlements for NU Telecom subsidiaries – WTC, PTC and HTC were based on nationwide average schedules. Access revenues for New Ulm and SETC included an estimate of a cost study each year that was trued-up subsequent to the end of any given year. Our management believes the estimates included in our preliminary cost study were 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.

 

A-CAM

 

The FUSF was established as part of the TA96 and provides subsidies to telecommunications providers as means of increasing the availability and affordability of advanced telecommunications services. In 2011, significant reform was introduced, including the creation of the CAF, to help modernize the FUSF and promote support of these telecom services in the nation’s high-cost areas. In 2016, the FCC announced additional reform to further transition the CAF from supporting the provision of voice services to the provision of broadband services. On March 30, 2016, the FCC issued the  2016 Order that adopts the following changes to the FUSF for rate-of-return carriers:

 

·         Establishes a voluntary cost model;  

 

·         Creates specific broadband deployment obligations; 

 

·         Provides a mechanism for support of broadband-only deployment; 

 

·         Gradually reduces the authorized rate-of-return from 11.25 percent to 9.75 percent;

 

·         Eliminates support in those local areas served by unsubsidized competitors;

 

·         Establishes “glide-path” transition periods for all the new changes; and

 

·         Maintains the $2 billion budget established by the 2011 Transformation Order.

 

While the 2011 FUSF Transformation Order established CAF Phase I and CAF Phase II as high-cost support mechanisms for the price-cap carriers (i.e., the larger, national LECs such as Verizon and AT&T), it was not as specific about how subsidies would change for the rate-of-return carriers (i.e., the smaller LECs, including all rural LECs). In contrast, the 2016 Order focuses on the rate-of-return carriers, announces specific changes to existing funding mechanisms as well as a new funding mechanism, and provides rural telecommunications providers with greater certainty about future support.

 

One of the major changes introduced by the 2016 Order is the creation of the A-CAM, a new CAF support mechanism for rate-of-return carriers. Utilization of the A-CAM is voluntary; and rate-of-return carriers may instead choose to continue relying on the legacy support mechanism known as ICLS, but now modified and renamed CAF-BLS. Each carrier must decide which support mechanism to elect, and must choose one or the other, per state.

 

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In our Form 10-Q for the quarter ended September 30, 2016, NU Telecom disclosed that we had elected the A-CAM for our Minnesota and Iowa operations, replacing our former ICLS. NU Telecom will receive A-CAM support for a period of ten years in exchange for meeting defined broadband build-out requirements. At the time of NU Telecom’s election, the FCC had not yet determined the final award numbers. 

 

Consistent with the stated disclosure in our Form 10-Q, NU Telecom notified the FCC that we would continue to elect the A-CAM program. Under the report that accompanied the FCC December 20, 2016 Public Notice, NU-Telecom would annually receive (i) $391,896 for our Iowa operations and (ii) $6,118,567 for our Minnesota operations. The Company will use the annual $6.5 million that we receive through the A-CAM program to meet our defined broadband build-out obligations. The A-CAM payments will replace the Company’s former ICLS payments. In 2016 NU Telecom received $1,965,727 under the former ICLS program.

 

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.

 

Receivables

 

As of December 31, 2017 and 2016, our consolidated receivables totaled $1,944,501 and $2,232,571, net of the allowance for doubtful accounts. We believe our receivables as of December 31, 2017 and 2016 are recorded at their fair value. As there may be exposure or risk with receivables, we routinely monitor our receivables and adjust the allowance for doubtful accounts when events occur that may potentially affect the collection of our receivables.  

 

Allowance for Doubtful Accounts

 

We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. In making the determination of the appropriate allowance for doubtful accounts, we consider specific accounts, historical write-offs, changes in customer relationships, credit worthiness and concentrations of credit risk. Specific accounts receivable are written off once a determination is made that the account is uncollectible. Additional allowances may be required if the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments. 

 

The activity in our allowance for doubtful accounts includes the following:

 

 

Inventories

 

Inventory includes parts, materials and supplies stored in our warehouses to support basic levels of service and maintenance as well as scheduled capital projects and equipment awaiting configuration for customers. Inventory also includes (i) parts and equipment shipped directly from vendors to customer locations while in transit and (ii) parts and equipment returned from customers that are being returned to vendors for credit. Our inventory value as of December 31, 2017 and 2016 was $2,075,199 and $1,860,157.

 

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We value inventory using the lower of cost or market method. Similar to our allowance for doubtful accounts, we make estimates related to the valuation of inventory. As of December 31, 2017 and 2016, we had no inventory reserve. We adjust our inventory carrying value for estimated obsolescence or unmarketable inventory to the estimated market value based upon assumptions about future demand and market conditions. As market and other conditions change, we may establish additional inventory reserves at a time when the facts that give rise to a lower value are warranted. We use the first-in, first-out method of inventory costing for our non-retail inventory. We use the average cost method of inventory costing for our retail inventory.

 

Fair Value Measurements

 

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

 

         Level 1:   Inputs are quoted prices in active markets for identical assets or liabilities.

 

         Level 2:   Inputs are quoted prices for similar assets or liabilities in an active market, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable and market–corroborated inputs that are derived principally from or corroborated by observable market data.

 

         Level 3:   Inputs are derived from valuation techniques where one or more significant inputs or value drivers are unobservable.

 

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

 

We have entered into an IRSA with our lender CoBank to manage our cash flow exposure to fluctuations in interest rates. This instrument is designated as a 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 IRSA is discussed in Note 5 – “Interest Rate Swaps” to the Consolidated Financial Statements of this Annual Report on Form 10-K. The fair value of our swap agreement was determined based on Level 2 inputs.

 

Property, Plant and Equipment

 

We record impairment losses on long-lived assets used in operations when events and circumstances indicate the assets might be impaired and the undiscounted cash flows estimated to be generated by those assets are less than the carrying amounts of those assets. In assessing the recoverability of long-lived assets, we compare the carrying value to the undiscounted future cash flows the assets are expected to generate. If the total of the undiscounted future cash flows is less than the carrying amount of the assets, we would write down those assets based on the excess of the carrying amount over the fair value of the assets. Fair value is generally determined by calculating the discounted future cash flows expected from those assets. Changes in these estimates could have a material adverse effect on the assessment of long-lived assets, thereby requiring a write-down of the assets. Write-downs of long-lived assets are recorded as impairment charges and are a component of operating expenses. We have reviewed our long-lived assets and concluded that no impairment charge on our long-lived assets is necessary.

 

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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. We have not made any significant changes to the lives of these assets in the two year period ended December 31, 2017.

 

Goodwill and Intangible Assets

 

We amortize our definite-lived intangible assets over their estimated useful lives. Customer relationships are amortized over fourteen to fifteen years, regulatory rights are amortized over fifteen years and trade names are amortized over three to five years. Intangible assets with finite lives are amortized over their respective estimated useful lives. In accordance with GAAP, goodwill and intangible assets with indefinite useful lives are not amortized, but tested for impairment at least annually. See Note 3 – “Goodwill and Intangibles” to the Consolidated Financial Statements of this Annual Report on Form 10-K for a more detailed discussion of the intangible assets and goodwill. Our goodwill balance was $39,805,349 as of December 31, 2017 and 2016. In the fourth quarter of 2017 and 2016 we completed our annual impairment tests for existing acquired goodwill. This testing resulted in no impairment charges to goodwill at December 31, 2017 and 2016. 

 

Investments and Other Assets

 

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 use the equity method of accounting for these investments that reflects original cost and recognition of our share of the net income or losses from the respective operations. See Note 14 – “Segment Information” to the Consolidated Financial Statements of this Annual Report on Form 10-K for a listing of our investments.  

Long-term investments in other companies that are not intended for resale or are not readily marketable are valued at the lower of cost or net realizable value.

 

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, 2017. 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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Advertising Expense

 

Advertising is expensed as incurred. Advertising expense charged to operations was $255,150 and $251,939 in 2017 and 2016. 

 

Interest During Construction

 

We include an average cost of debt for the construction of plant in our communications plant accounts.

 

Income Taxes

 

We account for income taxes in accordance with GAAP, which requires an asset and liability approach to financial accounting and reporting for income taxes. Accordingly, deferred tax assets and liabilities arise from the difference between the tax basis of an asset or liability and its reported amount in the financial statements and operating and tax credit carryforwards. Deferred tax assets and liabilities are determined using enacted tax rates expected to apply to taxable income in the periods in which those temporary differences are expected to be recovered or settled. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. We recognize interest and penalties related to income tax matters as income tax expense. Income tax expense or benefit is the tax payable or refundable, respectively, for the period plus or minus the change in deferred tax assets and liabilities during the period.

 

GAAP requires us to recognize the financial statement benefit of a tax position 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. See Note 6 – “Income Taxes” to the Consolidated Financial Statements of this Annual Report on Form 10-K for additional information regarding income taxes.

 

Collection of Taxes from Customers

 

Sales, excise and other taxes are imposed on most of our sales to nonexempt customers. We collect these taxes from our customers and remit the entire amounts to governmental authorities. Our accounting policies dictate that we exclude these taxes collected and remitted from our revenues and expenses.

 

Credit Risk

 

Financial instruments that potentially subject us to concentrations of credit risk consist primarily of cash investments and receivables. We deposit some of our cash investments in high credit quality financial institutions accounts which, at times, may exceed federally insured limits. We have not experienced any losses in these accounts and do not believe we are exposed to any significant credit risk. Concentrations of credit risk with respect to trade receivables are limited due to our large number of customers.

 

Earnings And Dividends Per Share

 

Basic earnings per share (EPS) are computed by dividing net income by the weighted average number of shares of common stock outstanding during the year. Our basic and diluted EPS are based on our weighted average number of shares outstanding of 5,153,579 and 5,133,548 for the periods ended December 31, 2017 and 2016.  

 

Dividends per share have been declared quarterly by the NU Telecom Board of Directors.

 

Recent Accounting Developments

 

In May 2017, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update No. 2017-09 (ASU 2017-09), “Scope of Modification Accounting).” ASU 2017-09 clarifies the modification accounting guidance for stock compensation included in Topic 718, “Compensation – Stock Compensation.” ASU 2017-09 provides guidance about which changes to the terms or conditions of a share-based payment award must be accounted for as a modification under Topic 718. The new guidance is effective prospectively for annual and interim periods beginning after December 15, 2017, with early adoption permitted. We plan to adopt this update effective January 1, 2018 and will apply this guidance to applicable transactions after adoption date.

 

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In January 2017, the FASB issued ASU 2017-04, “Intangibles – Goodwill and other (Topic 350).” ASU 2017-04 simplifies the accounting for goodwill impairment and removes Step 2 of the goodwill impairment test. Goodwill impairment will now be the amount by which a reporting unit’s carrying value exceeds its fair value limited to the total amount of goodwill allocated to that reporting unit. Entities will continue to have the option to perform a qualitative assessment to determine if a quantitative impairment test is necessary. The same one-step impairment test will be applied to goodwill at all reporting units, even those with zero or negative carrying amounts. The amendments in this update should be applied on a prospective basis. ASU 2017-04 is effective for the Company beginning January 1, 2021. Early adoption is permitted. Management is evaluating the impact the adoption of ASU 2017-04 will have on the Company’s financial statements (if any).

 

In June 2016, the FASB issued ASU 2016-13, “Financial Instruments – Credit Losses: Measurement of Credit Losses on Financial Instruments.” ASU 2016-13 requires entities to use a new forward-looking, expected loss model to estimate credit losses. It also requires additional disclosures relating to the credit quality of trade and other receivables, including information relating to management’s estimate of credit allowances. NU Telecom is required to adopt ASU 2016-13 on January 1, 2020. Early adoption as of January 1, 2019 is permitted. We are evaluating the effects that adoption of ASU 2016-13 will have on our financial position, results of operations and disclosures.

 

In February 2016, the FASB issued ASU 2016-02, “Leases,” which requires the recognition of lease assets and lease liabilities by lessees for those leases classified as operating leases under previous GAAP. This change will result in an increase to recorded assets and liabilities on lessees’ financial statements, as well as changes in the categorization of rental costs, from rent expense to interest and depreciation expense. Other effects may occur depending on the types of leases and the specific terms of them utilized by particular lessees. The ASU is effective for the Company on January 1, 2019, and early application is permitted. Modified retrospective application is required. The Company is evaluating the effect that ASU 2016-02 will have on its consolidated financial statements and related disclosures.  

 

In May 2014, the FASB issued ASU 2014-09, “Revenue from Contracts with Customers (Topic 606) (Accounting Standards Codification (ASC) 606),” and has since amended the standard with ASU 2015-14, “Revenue from Contracts with Customers: Deferral of the Effective Date,” ASU 2016-08, “Revenue from Contracts with Customers: Principal versus Agent Considerations (Reporting Revenue Gross versus Net),” ASU 2016-10, “Revenue from Contracts with Customers: Identifying Performance Obligations and Licensing,” ASU 2016-12, “Revenue from Contracts with Customers: Narrow-Scope Improvements and Practical Expedients,” and ASU 2016-20, “Technical Corrections and Improvements to Topic 606, Revenue from Contracts with Customers.” These standards replace existing revenue recognition rules with a single comprehensive model to use in accounting for revenue arising from contracts with customers. These standards require an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. As amended, the new standard is effective for the Company on January 1, 2018, using either a retrospective basis or a modified retrospective basis with early adoption permitted.

 

We adopted ASU 2014-09 as of January 1, 2018 using the modified retrospective method for open contracts. Under this transition method, the accounting change is applied to the current period with a cumulative effect adjustment recorded to opening retained earnings. Previously reported results will not be restated under this transition method. The adoption of this new standard will result in additional disclosures around the nature and timing of the Company’s performance obligations, deferred revenue contract liabilities, deferred contract cost assets, as well as significant judgements and practical expedients used by the Company in applying the new five-step revenue model. The Company has implemented new processes and internal controls to enable the prepartation of financial information upon adoption.

 

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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.

 

NOTE 2 – PROPERTY, PLANT AND EQUIPMENT

 

Property, plant and equipment as of December 31, 2017 and 2016, include the following:

 

 

 

Depreciation is computed using the straight-line method based on the estimated service or remaining useful lives of the various classes of depreciable assets. Depreciation expense was $7,183,671 and $7,294,678 in 2017 and 2016. The composite depreciation rates on communications plant and equipment for the two years ended December 31, 2017 and 2016 were 4.7% and 4.9%. Other property and video plant is depreciated over estimated useful lives of three to twenty-five years.

 

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 December 31, 2017 and 2016.

 

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 DCF 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 2017 and 2016, we engaged an independent valuation firm to complete our annual impairment testing for existing goodwill. For 2017 and 2016, 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 assets was $2,469,083 for 2017 and $2,469,256 for 2016. Amortization expense for the next five years is estimated to be:

 

 

NOTE 4 - LONG-TERM DEBT

 

We have a credit facility with CoBank. Under the credit facility, we entered into a master loan agreement (MLA) and a series of supplements to the respective MLA.

 

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. The 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.

 

Secured Credit Facility:

 

MLA RX0583

 

●           RX0583-T2A - $9,000,000 revolving note with interest payable monthly. Final maturity date of the note is December 31, 2021. We currently have drawn $0 on this revolving note as of December 31, 2017.

 

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●           RX0583-T3A - $35,000,000 term note with interest payable monthly. Final maturity date of the note is December 31, 2021. Twenty-eight quarterly principal payments of $675,000 are due commencing March 31, 2015 through December 31, 2021. A final balloon payment of $16,100,000 is due at maturity of the note on December 31, 2021.

 

RX0583-T2A and RX0583-T3A initially bear interest at a “LIBOR Margin” rate equal to 3.25 percent over the applicable LIBOR rate. The LIBOR Margin decreases as our “Leverage Ratio” decreases.

 

Within 180 days after the closing date of December 31, 2014, NU Telecom needed to enter into interest rate protection agreements in form and substance reasonably satisfactory to CoBank so as to fix or limit interest rates payable by NU Telecom at all times to at least 40% of the outstanding principal balance of Loan RX0583-T3A for an initial average weighted life of at least three years.

 

As described in Note 5 – “Interest Rate Swaps” to the Consolidated Financial Statements of this Annual Report on Form 10-K, we have entered into an IRSA that effectively fixed our interest rates and cover $14.0 million at a weighted average rate of 3.72%, as of December 31, 2017. The remaining debt of $22.6 million ($9.0 million available under the revolving credit facilities and $13.6 million currently outstanding) remains subject to variable interest rates at an effective weighted average interest rate of 4.07%, as of December 31, 2017.

 

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 $2,100,000 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. On March 31, 2016 our Total Leverage Ratio fell below 2.50, thus eliminating any restrictions on our ability to pay cash dividends to our stockholders. Our current Total Leverage Ratio at December 31, 2017 is 1.47.

 

Our credit facility requires us to comply with specified financial ratios. These financial ratios include total leverage ratio, debt service coverage ratio, equity to total assets ratio and fixed coverage ratio. At December 31, 2017 we were in compliance with all the stipulated financial ratios in our loan agreements.

 

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. Also, our credit facility contains restrictions that, among other things, limits or restricts our ability to enter into guarantees and contingent liabilities, incur additional debt, issue stock, transact asset sales, transfers or dispositions, and engage in mergers and acquisitions, without CoBank approval.

 

Long-term debt is as follows:

 

 

 

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Required principal payments are as follows:

 

 

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 required that we enter into interest rate agreements designed to protect us against fluctuations in interest rates, in an aggregate principal amount and for a duration determined under the credit facility.

 

To meet this objective, on June 18, 2015 we entered into an IRSA with CoBank covering $14.0 million of our aggregate indebtedness to CoBank. This swap effectively locked in the interest rate on $14.0 million of variable-rate debt through June 2018. Under this IRSA, we have changed the variable-rate cash flow exposure on the debt obligations to fixed cash flows. Under the terms of the IRSA, we pay a fixed contractual interest rate and (i) made 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.

 

Each month, we make interest payments to CoBank under its loan agreements based on the current applicable LIBOR Rate plus the contractual LIBOR margin then in effect with respect to the loan, without reflecting our IRSA. 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 December 31, 2017 we had the following IRSA in effect.

 

 

(1)   As described in Note 4 – “Long-Term Debt” to the 2017 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 IRSA 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/loss is reported in other comprehensive income. If we terminate our IRSA, 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 IRSA 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 IRSA. The fair value indicates an estimated amount we would be required to pay if the contracts were canceled or transferred to other parties. At December 31, 2017, the fair value of the swap was $28,178, which has been recorded net of deferred tax of $8,043 for the $20,135 in accumulated other comprehensive income. At December 31, 2016, the fair value liability of the swap was $22,812, which has been recorded net of deferred tax benefit of $9,232, for the $13,580 in accumulated other comprehensive loss.

 

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NOTE 6 - INCOME TAXES

 

Income taxes recorded in our consolidated statements of income consists of the following:

 

 

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 December 31, 2017 we had no unrecognized tax benefits.

 

We are primarily subject to United States, Minnesota, Nebraska and Iowa income taxes. Tax years subsequent to 2013 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 December 31, 2017 and 2016, we had no interest or penalty accrued that related to income tax matters.

 

The differences between the statutory federal tax rate and the effective tax rate were as follows:

 

 

Deferred income taxes and unrecognized tax benefits reflected in our consolidated balance sheets are summarized as follows:

 

 

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On December 22, 2017, the President of the United States signed into law, the Tax Cuts and Jobs Act tax reform legislation. This legislation makes significant changes in United States tax law including a reduction in the corporate tax rates, changes to net operating loss carryforwards and carrybacks and a repeal of the corporate alternative minimum tax. The legislation reduced the United States corporate tax rate from the current rate of 35% to 21%. As a result of the enacted law, the Company was required to revalue deferred tax assets and liabilities at the 21% rate. This revaluation resulted in a benefit of $4,549,332 to income tax expense in continuing operations and a corresponding reduction in the deferred tax liability. The other provisions of the Tax Cuts and Jobs Act did not have a material impact on the 2017 consolidated financial statements.

 

NOTE 7 - RETIREMENT PLAN

 

We have a 401(k) employee savings plan in effect for employees who meet age and service requirements. Our contributions to our 401(k) employee savings plan were $505,292 and $511,751 in 2017 and 2016.

 

NOTE 8 – 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 year ended December 31, 2017.

 

Our capital budget for 2018 is approximately $8.5 million and will be financed through internally generated funds.

 

NOTE 9 - NONCASH INVESTING ACTIVITIES

 

Noncash investing activities included $453,506 and $455,166 during the years ended December 31, 2017 and 2016. These activities related to plant and equipment additions placed in service and are recorded in our accounts payable at year-end.

 

NOTE 10 – 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 14 – “Segment Information” to the Consolidated Financial Statements of this Annual Report on Form 10-K.

 

NOTE 11 - GUARANTEES

 

NU Telecom has guaranteed a ten-year loan owed by Fibercomm, LC maturing on September 30, 2021. As of December 31, 2017, we have recorded a liability of $158,043 in connection with the guarantee on this loan. This guarantee may be exercised if FiberComm, LC does not make its required payments on this note.

 

NOTE 12 – DEFERRED COMPENSATION

 

As of December 31, 2017 and 2016, we have recorded other deferred compensation relating to executive compensation payable to certain former executives of past acquisitions.

 

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NOTE 13 – RESTRICTED STOCK UNITS

 

On February 24, 2017, our Board of Directors adopted the New Ulm Telecom, Inc. 2017 Omnibus Stock Plan (2017 Plan) effective May 25, 2017. The shareholders of the Company approved the plan at the May 25, 2017 Annual Meeting of Shareholders. The purpose of the 2017 Plan was to enable NU Telecom and its subsidiaries to attract and retain talented and experienced people, closely link employee compensation with performance realized by shareholders, and reward long-term results with long-term compensation. The plan enables us to grant stock incentive awards to current and new employees, including officers, and to Board members and service providers. The 2017 Plan permits stock incentive awards in the form of options (incentive and non-qualified), stock appreciation rights, restricted stock, restricted stock units, performance stock, performance units, and other awards in stock or cash. The 2017 Plan permits the issuance of up to 625,000 shares of our Common Stock in any of the above stock awards.

 

On July 25, 2017, our Board of Directors granted 6,077 shares of restricted stock units in the Common Stock of the Company to its executive officers. We recognize share-based compensation expense for these restricted stock units over the vesting period of the restricted stock units, which was determined by our Board of Directors. The 2017 restricted stock units will vest on December 31, 2019, at which point, the executives will be able to receive Common Stock in the Company for the restricted stock units.

 

NOTE 14 – 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 in any of the last two years.

 

The Telecom Segment operates the following ILECs and CLECs and has investment ownership interests as follows:

 

Telecom Segment

 

●	ILECs:
	▪	New Ulm Telecom, Inc., 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;
	▪	Western Telephone Company, a wholly-owned subsidiary of NU Telecom;
●	CLECs:
	▪	NU Telecom, located in Redwood Falls, Minnesota;
	▪	Hutchinson Telecommunications, Inc., a wholly-owned subsidiary of HTC, located in Litchfield and Glencoe, Minnesota;
●	Our investments and interests in the following entities include some management responsibilities:
	▪	FiberComm, LC – 20.00% subsidiary equity ownership interest. FiberComm, LC is located in Sioux City, Iowa;
	▪	Broadband Visions, LLC – 24.30% subsidiary equity ownership interest. BBV provides video headend and Internet services;
	▪	Independent Emergency Services, LLC – 14.29% subsidiary equity ownership interest. IES is a provider of E-911 services to the State of Minnesota as well as a number of counties located in Minnesota; and
	▪	SM Broadband, LLC – 12.50% subsidiary equity ownership interest. SMB provides network connectivity for regional businesses.

 

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Note 15 – Transactions with equity method investments

 

We receive and provide services to various partnerships and limited liability companies where we are an investor. Services received include digital video, special access and communications circuits. Services provided include Board of Director meeting attendance, labor, Internet help desk services and management services. Cost of services we receive from affiliated parties may not be the same as the costs of such services had they been obtained from different parties.

 

Total revenues from transactions with affiliates were $1,145,557 and $1,105,201 for 2017 and 2016. Total expenses from transactions with affiliates were $482,916 and $505,572 for 2017 and 2016.

 

NOTE 16 – BROADBAND GRANTS

 

In December 2015, the Company was awarded a $244,125 broadband grant from the Minnesota Department of Employment and Economic Development.  The grant provided up to 47.5% of the cost of building fiber connections to homes and businesses for improved high-speed internet in unserved or underserved communities and businesses in the Company’s service area.  The Company will provide the remaining 52.5% matching funds.  At December 31, 2017, the Company had received the full grant amount.

 

In January 2017, the Company was awarded $1,889,968 in broadband grants from the Minnesota Department of Employment and Economic Development.  The grants provided up to 45% of the cost of building fiber connections to homes and businesses for improved high-speed internet in unserved or underserved communities and businesses in the Company’s service area.  The Company will provide the remaining 55% matching funds.  At December 31, 2017, the Company has received $51,224.  These projects will be completed in 2018.

 

In November 2017, the Company was awarded $1,727,998 in broadband grants from the Minnesota Department of Employment and Economic Development.  The grants provided up to 42.6%  of the cost of building fiber connections to homes and businesses for improved high-speed internet in unserved or underserved communities and businesses in the Company’s service area.  The Company will provide the remaining 57.4% matching funds.  Construction and expenditures for these projects will begin in 2018.

 

NOTE 17 -- SUBSEQUENT EVENTS

 

NU Telecom’s Board of Directors has declared a regular quarterly dividend on our common stock of $.10 per share, payable on March 15, 2018 to stockholders of record at the close of business on March 5, 2018.

 

On February 23, 2018, NU Telecom announced that it had entered into a Stock Purchase Agreement dated February 22, 2018 to purchase Scott-Rice Telephone Company (Scott-Rice) from Allstream Business U.S., LLC, an affiliate of Zayo Group Holdings, Inc. (Zayo) for approximately $42 million in cash. NU Telecom intends to finance the acquisition from existing capital resources and proceeds from a credit facility with its principal lender CoBank.

 

Scott-Rice provides phone, video and internet services with over 18,000 connections, serving the communities of Prior Lake, Savage, Elko and New Market, Minnesota.

 

The transaction is subject to customary closing conditions and regulatory approvals, but is not subject to New Ulm shareholder approval. The transaction has been unanimously approved by the Boards of Directors of New Ulm and Zayo. New Ulm expects the transaction to close during the second quarter of 2018.

 

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

 

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Item 9.   Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

 

None.

Item 9A.    Controls and Procedures

 

Evaluation of Disclosure Controls and Procedures

 

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

 

Management’s Report on Internal Control over Financial Reporting

 

Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f) and 15d-15(f). Internal control over financial reporting refers to the process designed by, or under the supervision of, our Chief Executive Officer and Chief Financial Officer, and effected by our Board of Directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with GAAP, and includes those policies and procedures that:

 

(1)   Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of our assets;  

 

(2)   Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with GAAP, and that our receipts and expenditures are being made only in accordance with authorization of our management and directors; and

 

(3)   Provide reasonable assurance regarding prevention or timely detection or unauthorized acquisition, use, or disposition of our assets that could have a material effect on the financial statements.

 

Because of its inherent limitations, internal control over financial reporting cannot provide absolute assurance of preventing and detecting misstatements on a timely basis. It is possible to design into the process safeguards to reduce, though not eliminate, the risk that misstatements are not prevented or detected on a timely basis. Management is responsible for establishing and maintaining adequate internal control over financial reporting for the Company.

 

Our management conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework set forth in the report entitled Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework). Based on this assessment, management has concluded that, as of December 31, 2017, our internal control over financial reporting was effective.

 

This annual report does not include an attestation report of Olsen Thielen & Co., Ltd., our independent registered public accounting firm, regarding internal control over financial reporting. Our management’s report was not subject to attestation by our independent registered public accounting firm pursuant to Section 989G of the Dodd-Frank Wall Street Reform and Consumer Protection Act, which exempts smaller reporting companies from the independent registered public accounting firm attestation requirement.

 

Changes in Internal Control over Financial Reporting

 

There have been no changes in the Company’s internal control over financial reporting that occurred during the fiscal year ended December 31, 2017 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

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Item 9B. Other Information

 

None.

 

PART III

 

Information Incorporated by Reference

 

In response to Part III, Items 10, 11, 12, 13 and 14, portions of the Company’s definitive proxy statement for its Annual Meeting to be held on May 24, 2018 are incorporated by reference into this Form 10-K. The Proxy Statement will be filed pursuant to Regulation 14A within 120 days of December 31, 2017, the last day of the Company fiscal year.

 

Item 10.           Directors, Executive Officers and Corporate Governance

 

The information required by Item 401 of Regulation S-K relating to directors and nominees of the Company is contained under “Proposal 1 – Election of Directors” in the 2018 Proxy Statement and is incorporated by reference. Information required under Item 401 about executive officers is included in Part I, Item 1 of this Annual Report on Form 10-K under “Executive Officers of the Registrant.” The information required by Item 405 of Regulation S-K is contained under “Section 16(a) Beneficial Ownership Reporting Compliance” in the 2018 Proxy Statement and is incorporated by reference.

 

We have adopted a code of conduct that applies to all officers, directors and employees of the company. This code of conduct is available on our Website at www.nutelecom.net and in print upon written request to New Ulm Telecom, Inc., 27 North Minnesota Street, New Ulm, Minnesota 56073, Attention: Chief Financial Officer. Any amendment to, or waiver from, a provision of our code of conduct will be posted to the above-referenced Website.

 

The information required by Item 407(d)(4) and (d)(5), under “Audit Committee,” is contained under “The Board of Directors and Committees – Audit Committee” in the 2018 Proxy Statement and is incorporated by reference. There is no disclosure required under Item 407(c)(3) regarding material changes in shareholder director nominating procedures.

 

Item 11.           Executive Compensation

 

The information required by Item 402 of Regulation S-K is contained under “Executive Compensation” in the 2018 Proxy Statement and is incorporated by reference.

 

The information required by Regulation S-K Item 407(e)(4), “Compensation Committee Interlocks and Insider Participation,” and Item 407(e)(5), “Compensation Committee Report,” is not required because the Company is a smaller reporting company.

 

Item 12.           Security Ownership of Beneficial Owners and Management, and Related Stockholder Matters

 

The information required by Item 201(d) of Regulation S-K, “Securities Authorized for Issuance under Equity Compensation Plans” is contained under “Non-Employee Director Compensation” in the 2018 Proxy Statement and is incorporated by reference.

 

The information required by Item 403 of Regulation S-K relating to security ownership of certain beneficial owners and management is contained under “Security Ownership of Certain Beneficial Owners and Management" in our 2018 Proxy Statement and is incorporated by reference.

 

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Item 13.           Certain Relationships and Related Transactions, and Director Independence

 

There are no matters that require disclosure with respect to certain transactions with related persons as set forth in Item 404 of Regulation S-K.

 

The information required by Item 404(b) and Item 407(a) of Regulation S-K is contained under “Certain Relationship and Related Transactions” and “Corporate Governance,” respectively in the 2018 Proxy Statement and is incorporated by reference.

 

Item 14.           Principal Accountant Fees and Services

 

The information relating to principal accounting fees and services required by Item 9(e) of Regulation 14A is set forth under “Proposal 2- Ratification of Independent Registered Public Accounting Firm” – “Fees Billed and Paid to Independent Registered Public Accounting Firm, – “Audit Fees,” – “Audit-Related Fees,” – “Tax Fees,” – “All Other Fees,” and – “Audit Committee Pre-Approval Policy for Services of Independent Registered Public Accounting Firm,” in the Proxy Statement and incorporated by reference.

 

Item 15.           Exhibits and Financial Statement Schedules

 

(a) 1.	Consolidated Financial Statements
	Included in Part II, Item 8, of this report:
		Pages
	Report of Independent Registered Public Accounting Firm	37
	Consolidated Statements of Income for the Years Ended December 31, 2017 and 2016	39
	Consolidated Statements of Comprehensive Income for the Years  Ended December 31, 2017 and 2016	40
	Consolidated Balance Sheets as of December 31, 2017 and 2016	41-42
	Consolidated Statements of Cash Flows for the Years Ended December 31, 2017 and 2016	43
	Consolidated Statements of Stockholders’ Equity for the Years Ended Ended December 31, 2017 and 2016	44
	Notes to Consolidated Financial Statements	45-59
(a) 2.	Consolidated Financial Statement Schedules:
	Other schedules are omitted because they are not required or are not applicable, or the required
	information is shown in the financial statements or notes thereto.
(a) 3.	Exhibits Required
	See “Index to Exhibits”	64

 

Item 16.            Form 10-K Summary

 

Not Applicable.

 

 

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SIGNATURES

 

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

Dated: March 15, 2018	NEW ULM TELECOM, INC.
	(Registrant)
	By	/s/ Bill D. Otis
		Bill D. Otis, Chief Executive Officer
		(Principal Executive Officer)
	By	/s/ Curtis O. Kawlewski
		Curtis O. Kawlewski, Chief Financial Officer
		(Principal Financial Officer)

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the following persons on behalf of the registrant and in the capacities and on the dates indicated have signed this report.