NEW ULM TELECOM INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations

(Edgar Glimpses Via Acquire Media NewsEdge) Forward Looking Statements The Private Securities Litigation Reform Act of 1995 contains certain safe harbor provisions regarding forward-looking statements. This Quarterly Report on Form 10-Q may include forward-looking statements. These statements may include, without limitation, statements with respect to anticipated future operating and financial performance, growth opportunities and growth rates, acquisition and divestiture opportunities, business strategies, business and competitive outlook, and other similar forecasts and statements of expectation. Words such as "expects," "anticipates," "intends," "plans," "believes," "seeks," "estimates," "targets," "projects," "will," "may," "continues," and "should," and variations of these words and similar expressions, are intended to identify these forward-looking statements. These forward-looking statements are subject to risks and uncertainties that could cause our actual results to differ materially from such statements. Factors that might cause differences include, but are not limited to, those contained in Item 1A of Part II, "Risk Factors," and Item 1A, "Risk Factors" of our Annual Report on Form 10-K for the year ended December 31, 2011, which is incorporated herein by reference.

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

Critical Accounting Policies Preparing consolidated financial statements in conformity with GAAP requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, and disclosure of contingent assets and liabilities. The estimates and assumptions 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. Our senior management has discussed the development and selection of accounting estimates and the related Management Discussion and Analysis disclosure with our Audit Committee. A description of the accounting policies that we consider particularly important for the portrayal of our results of operations and financial position, and which may require a higher level of judgment by our management, is contained under the caption, "Critical Accounting Policies and Estimates," in the Management's Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the year ended December 31, 2011.

18 -------------------------------------------------------------------------------- Table of Contents Results of Operations Overview NU Telecom offers a diverse array of communications products and services. Our ILEC businesses provide local telephone service and network access to other telecommunications carriers for calls originated or terminated on our network.

In addition, we provide long distance service, dial-up and broadband Internet access, and video services. In 2010, we acquired the assets of the cable television (CATV) system located in and around Glencoe, Minnesota, continuing the expansion of our service area. We also sell and service other communications products.

Our operations consist primarily of providing services to customers for a monthly charge. Because many of these services are recurring in nature, backlog orders and seasonality are not significant factors. Our working capital requirements include financing the construction of our networks, which consists of switches and cable, data, Internet protocol (IP) and digital TV. We also need 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; and to provide for the carrying value of trade accounts receivable, some of which may take several months to collect in the normal course of business.

Trends 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, Voice over Internet Protocol (VoIP) providers, wireless, other competitors and emerging technologies. As we experience access line losses, our switched access revenue will continue to decline consistent with industry-wide trends. A combination of changing minutes of use, carriers optimizing their network costs and lower demand for dedicated lines may affect our future voice and switched access revenues. Voice and switched access revenues may also be significantly affected by potential changes in rate regulation at the state and federal levels. We continue to monitor regulatory changes as we believe that rate regulation will continue to be scrutinized and may be subject to change. Access line losses totaled 1,081 or 4.0% for the twelve months ended September 30, 2012.

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 are expected to continue to offset some of the revenue declines from the unfavorable access line trends discussed above.

To combat competitive pressures, we continue to emphasize the bundling of our products and services. Our customers can 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 needs, 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 needs. We have built a state-of-the-art broadband network, which, along with the bundling of our voice, Internet and video services allows us to meet customer demands for products and services. We continue to focus on the research and deployment of advanced technological products that include broadband services, private line, VoIP, digital video, Internet Protocol Television (IPTV) and managed services.

19-------------------------------------------------------------------------------- Table of Contents We continue to evaluate our operating structure to identify opportunities for increased operational efficiencies and effectiveness. Among other things, this involves evaluating opportunities for task automation, network efficiency and the balancing of our workforce based on the current needs of our customers.

Financial results for the Telecom Segment are included below: Telecom Segment Three Months Ended September 30, Nine Months Ended September 30, 2012 2011 2012 2011 Operating Revenues Local Service $ 1,448,759 $ 1,489,581 $ 4,364,582 $ 4,459,707 Network Access 2,563,335 3,035,447 8,123,960 9,104,649 Video 1,494,017 1,449,038 4,420,306 4,221,963 Data 1,386,433 1,318,277 4,128,579 3,898,769 Long Distance 155,715 163,809 461,078 485,016 Other 979,088 974,577 2,859,877 2,908,214 Total Operating Revenues 8,027,347 8,430,729 24,358,382 25,078,318 Cost of Services, Excluding Depreciation and Amortization 3,408,379 3,223,754 10,574,102 9,873,655 Selling, General and Administrative 1,339,482 1,711,415 4,573,112 4,920,838 Depreciation and Amortization Expenses 2,055,708 2,013,785 6,092,798 6,841,531 Total Operating Expenses 6,803,569 6,948,954 21,240,012 21,636,024 Operating Income $ 1,223,778 $ 1,481,775 $ 3,118,370 $ 3,442,294 Net Income $ 543,125 $ 706,328 $ 1,650,086 $ 1,685,513 Capital Expenditures $ 1,658,374 $ 1,263,261 $ 5,125,745 $ 4,127,719 September 30, Key metrics 2012 2011 Access Lines 25,717 26,798 Video Customers 10,034 10,324 Broadband Customers 10,623 10,162 Dial Up Internet Customers 443 711 Long Distance Customers 13,192 13,431 Certain historical numbers have been changed to conform to the current year's presentation.

Revenue Local Service - We receive recurring revenue for basic local services that enable end-user customers to make and receive telephone calls within a defined local calling area for a flat monthly fee. In addition to subscribing to basic local telephone services, our customers may choose from a variety of custom calling features such as call waiting, call forwarding, caller identification and voicemail. Local service revenue was $1,448,759, which is $40,822 or 2.7% lower in the three months ended September 30, 2012 compared to the three months ended September 30, 2011 and was $4,364,582, which is $95,125 or 2.1% lower in the nine months ended September 30, 2012 compared to the nine months ended September 30, 2011. The decreases were primarily due to the loss of 1,081 or 4.0% of our customer base at September 30, 2012 compared to September 30, 2011.

The decreases were partially offset by increases in local private line and other optional services. Our access lines are decreasing as customers are increasingly utilizing other technologies, such as wireless phones and IP services, as well as customers eliminating second phone lines when they move their Internet service from a dial-up platform to a broadband platform. The number of access lines we serve as an ILEC and CLEC have been decreasing, which is consistent with a general industry trend. 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 helps create value for the customer and aids in the retention of our voice lines.

20-------------------------------------------------------------------------------- Table of Contents Network Access - We provide access services to other telecommunications carriers for the use of our facilities to terminate or originate long distance calls on our network. Additionally, we bill subscriber line charges (SLCs) to substantially all of our end-user customers for access to the public switched network. These monthly SLCs are regulated and approved by the FCC. In addition, network access revenue is derived from several federally administered pooling arrangements designed to provide network support and distribute funding to the ILECs. Network access revenue was $2,563,335, which is $472,112 or 15.6% lower in the three months ended September 30, 2012 compared to the three months ended September 30, 2011 and was $8,123,960, which is $980,689 or 10.8% lower in the nine months ended September 30, 2012 compared to the nine months ended September 30, 2011. The decreases in network access revenues were primarily due to lower minutes of use and the implementation of the FCC Intercarrier Compensation and Universal Service Fund reform order in regards to state access pricing levels that took effect on July 3, 2012.

Video - We receive monthly recurring revenue from our end-user subscribers for providing commercial TV programming in competition with local CATV, satellite dish TV and off-air TV service providers. We serve eleven communities with our digital TV services and five communities with our CATV services. Video revenue was $1,494,017, which is $44,979 or 3.1% higher in the three months ended September 30, 2012 compared to the three months ended September 30, 2011 and was $4,420,306, which is $198,343 or 4.7% higher in the nine months ended September 30, 2012 compared to the nine months ended September 30, 2011. A combination of rate increases introduced into several of our markets over the course of 2011 and 2012; and the launching of IPTV services in New Ulm, Courtland, Redwood Falls, Springfield, Sanborn, Hutchinson and Litchfield, Minnesota and Aurelia, Iowa resulted in the increased revenues. This new enhanced service offering provides our customers with desired features and options, such as digital video recording. We also recognize increased revenues from these additional features and options.

Data - We provide Internet services, including dial-up and high speed Internet to business and residential customers. Our revenue is received in various flat rate packages based on the level of service, data speeds and features. We also provide e-mail and managed services, such as web hosting and design, on-line file back up and on-line file storage. Data revenue was $1,386,433, which is $68,156 or 5.2% higher in the three months ended September 30, 2012 compared to the three months ended September 30, 2011 and was $4,128,579, which is $229,810 or 5.9% higher in the nine months ended September 30, 2012 compared to the nine months ended September 30, 2011. These increases were primarily due to a 461 or 4.5% increase in our broadband customers. We expect future growth in this area will be driven by customer migration from dial-up Internet to broadband products, such as our broadband services, expansion of service areas and our aggressively packaging and selling service bundles.

21-------------------------------------------------------------------------------- Table of Contents Long Distance - Our end-user customers are billed for toll or long-distance services on either a per call or flat-rate basis. This also includes the offering of directory assistance, operator service and long distance private lines. Long distance revenue was $155,715, which is $8,094 or 4.9% lower in the three months ended September 30, 2012 compared to the three months ended September 30, 2011 and was $461,078, which is $23,938 or 4.9% lower in the nine months ended September 30, 2012 compared to the nine months ended September 30, 2011. These decreases were primarily the result of a 239 or 1.8% decrease in our long distance customer base at September 30, 2012 compared to September 30, 2011. Our long distance customer base continues to decline as our customers utilize other technologies such as wireless and IP services to satisfy their long distance communication needs.

Other Revenue - We generate revenue from directory publishing, sales and service of customer premise equipment (CPE), bill processing and add/move/change services. Our directory publishing revenue from end-user subscribers for Yellow Page advertising in our telephone directories recurs monthly. We also provide the 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 the wireless product, as well as revenue collected for the sale of wireless phones and accessories. Other revenue was $979,088, which is $4,511 or 0.5% higher in the three months ended September 30, 2012 compared to the three months ended September 30, 2011. This increase was primarily due to increases in the sales of cellular phone and activation revenues, partially offset by a decrease in the sales of CPE revenues. Other revenue was $2,859,877, which is $48,337 or 1.7% lower in the nine months ended September 30, 2012 compared to the nine months ended September 30, 2011. This decrease was primarily due to a decrease in the sales of CPE and a decrease in leased CPE revenues. These decreases were partially offset by increases in the sales of cellular phones and activation revenues.

Cost of Services (excluding Depreciation and Amortization) Cost of services (excluding depreciation and amortization) was $3,408,379, which is $184,625 or 5.7% higher in the three months ended September 30, 2012 compared to the three months ended September 30, 2011 and was $10,574,102, which is $700,447 or 7.1% higher in the nine months ended September 30, 2012 compared to the nine months ended September 30, 2011. The increases were primarily due to higher programming cost from video content providers and higher costs associated with increased maintenance and support agreements on our equipment and software, partially offset by lower employee benefit costs.

Selling, General and Administrative Expenses Selling, general and administrative expenses were $1,339,482, which is $371,933 or 21.7% lower in the three months ended September 30, 2012 compared to the three months ended September 30, 2011 and were $4,573,112, which is $347,726 or 7.1% lower in the nine months ended September 30, 2012 compared to the nine months ended September 30, 2011. The decreases were primarily due to lower employee benefit costs, partially offset by increased expenses associated with complying with new SEC financial reporting requirements.

22-------------------------------------------------------------------------------- Table of Contents Depreciation and Amortization Depreciation and amortization was $2,055,708, which is $41,923 or 2.1% higher in the three months ended September 30, 2012 compared to the three months ended September 30, 2011. This increase is primarily due to an increase in our plant and broadband network. Depreciation and amortization was $6,092,798, which is $748,733 or 10.9% lower in the nine months ended September 30, 2012 compared to the nine months ended September 30, 2011. This decrease was primarily due to portions of our legacy telephone network becoming fully depreciated during 2011 as we migrate to a new broadband network.

Operating Income Operating income was $1,223,778, which is $257,997 or 17.4% lower in the three months ended September 30, 2012 compared to the three months ended September 30, 2011. This decrease was primarily due to a decrease in revenues combined with an increase in cost of services and depreciation and amortization, partially offset by a decrease in selling, general and administrative expenses, all of which are described above. Operating income was $3,118,370, which is $323,924 or 9.4% lower in the nine months ended September 30, 2012 compared to the nine months ended September 30, 2011. This decrease was primarily due to a decrease in revenues combined with increases in cost of services, partially offset by a decrease in selling, general and administrative expenses, and depreciation and amortization, all of which are described above.

See Consolidated Statements of Income on Page 3 (for discussion below) Other Income and Interest Expense Interest expense was $556,562, which is $11,993 or 2.1% lower in the three months ended September 30, 2012 compared to the three months ended September 30, 2011 and was $1,665,981, which is $183,338 or 9.9% lower in the nine months ended September 30, 2012 compared to the nine months ended September 30, 2011.

The decreases were primarily due to lower outstanding debt balances and the maturing of several of our swap agreements with CoBank, ACB during 2011. The variable rate we now pay on the portion of debt that had been previously swapped is lower than the fixed rate we had been paying.

Interest income was $808, which is $2,685 or 76.9% lower in the three months ended September 30, 2012 compared to the three months ended September 30, 2011 and was $81,276, which is $5,561 or 6.4% lower in the nine months ended September 30, 2012 compared to the nine months ended September 30, 2011. As a result of servicing our debt, excess cash available to purchase investments was lower, and combined with lower interest rates offered by banks and other investment institutions, our interest income has declined.

Our equity portion of HCC's net income was $218,372, which is $618 or 0.3% higher in the three months ended September 30, 2012 compared to the three months ended September 30, 2011 and was $711,073, which is $231,813 or 48.4% higher in the nine months ended September 30, 2012 compared to the nine months ended September 30, 2011. HCC's total net income was $655,118, which was $1,856 higher in the three months ended September 30, 2012 compared to the three months ended September 30, 2011 and was $2,133,220, which was $695,440 higher in the nine months ended September 30, 2012 compared to the nine months ended September 30, 2011. These increases were primarily the result of lower interest expense paid by Hector for their outstanding debt.

23-------------------------------------------------------------------------------- Table of Contents Other income for the nine months ended September 30, 2012 and 2011, included a patronage credit earned with CoBank, ACB as a result of our debt agreements with them. The patronage credit allocated and received in 2012 amounted to $449,878, compared to $485,812 allocated and received in 2011. CoBank, ACB determines and pays the patronage credit annually, generally in the first quarter of the calendar year, based on its results from the prior year. We record these patronage credits as income when they are received.

Other investment income was $43,422, which is $30,004 or 40.9% lower in the three months ended September 30, 2012 compared to the three months ended September 30, 2011 and was $132,364, which is $39,846 or 23.1% lower in the nine months ended September 30, 2012 compared to the nine months ended September 30, 2011. Other investment income includes our equity ownerships in several partnerships and limited liability companies.

Income Taxes Income tax expense was $392,910, which is $118,569 or 23.2% lower in the three months ended September 30, 2012 compared to the three months ended September 30, 2011 and was $1,193,816, which is $23,200 or 2.0% higher in the nine months ended September 30, 2012 compared to the nine months ended September 30, 2011.

The effective income tax rates for the nine months ending September 30, 2012 and 2011 were approximately 42.0% and 41.0%. The increase in the effective tax rate for the nine months ended September 30, 2012 compared to the nine months ended September 30, 2011 was primarily due to the recognition of approximately $29,000 in net tax benefits in the nine months ended September 30, 2011. This amount was originally reserved for the 2006 tax year, which was no longer open for examination by federal and state tax authorities. The effective income tax rate differs from the federal statutory income tax rate primarily due to state income taxes and other permanent differences.

Hector Communications Corporation Investment In accordance with GAAP, we currently report our one-third ownership of HCC on the equity method. Under this method, we report our pro-rata share of net income or net loss each period from HCC's operations. For the three months ended September 30, 2012 and 2011, we reported net income of $218,372 and $217,754.

For the nine months ended September 30, 2012 and 2011, we reported net income of $711,073 and $479,260. All reported net income amounts reflect our one-third ownership. As set forth in Note 11 - "Hector Communications Corporation," in the first nine months of 2012 and 2011, HCC had revenues of approximately $20.1 million and $20.3 million that are not reflected in our financial statements.

The pro forma information for our investment in HCC is shown in the following table using the proportionate consolidation method. We are providing this pro forma information to show the effect that our HCC investment has on our net income and would have on our operating income before interest, taxes, depreciation and amortization (OIBITDA) if we included these earnings in our operating income.

24 -------------------------------------------------------------------------------- Table of Contents Three Months Ended September 30, Nine Months Ended September 30, 2012 2011 2012 2011 Proportionate Method: Operating Revenues $ 2,244,841 $ 2,336,579 $ 6,698,243 $ 6,771,290 Operating Expenses, Excluding Depreciation and Amortization 1,108,417 1,069,237 3,255,065 3,182,257 Depreciation and Amortization 745,930 728,257 2,216,747 2,205,560 Total Operating Expenses 1,854,347 1,797,494 5,471,812 5,387,817 Operating Income 390,494 539,085 1,226,431 1,383,473 Net Income $ 218,372 $ 217,754 $ 711,073 $ 479,260 If we included our proportionate share of HCC's OIBITDA in the OIBITDA of NU Telecom, our combined OIBITDA would have increased from $3,279,486 and $3,495,560 for NU Telecom alone, to $4,415,910 and $4,762,902 for the three months ended September 30, 2012 and 2011, and would have increased from $9,211,168 and $10,283,825 for NU Telecom alone, to $12,654,346 and $13,872,858 for the nine months ended September 30, 2012 and 2011.

Three Months Ended September 30, Nine Months Ended September 30, 2012 2011 2012 2011 NU Telecom Operating Income $ 1,223,778 $ 1,481,775 $ 3,118,370 $ 3,442,294 NU Telecom Depreciation and Amortization 2,055,708 2,013,785 6,092,798 6,841,531 NU Telecom OIBITDA $ 3,279,486 $ 3,495,560 $ 9,211,168 $ 10,283,825 HCC Proportionate Operating Income $ 390,494 $ 539,085 $ 1,226,431 $ 1,383,473 HCC Proportionate Depreciation and Amort 745,930 728,257 2,216,747 2,205,560 HCC Proportionate OIBITDA $ 1,136,424 $ 1,267,342 $ 3,443,178 $ 3,589,033 Combined OIBITDA $ 4,415,910 $ 4,762,902 $ 12,654,346 $ 13,872,858 Adjusted OIBITDA is a common measure of operating performance in the telecommunications industry. The presentation of OIBITDA is not a measure of financial performance under GAAP and should not be considered in isolation or as a substitute for consolidated net income (loss) as a measure of performance and may not be comparable to similarly titled measures used by other companies.

Liquidity and Capital Resources Capital Structure NU Telecom's total capital structure (long-term and short-term debt obligations, plus stockholders' equity) was $96,319,786 at September 30, 2012, reflecting 56.6% equity and 43.4% debt. This compares to a capital structure of $97,191,975 at December 31, 2011, reflecting 55.2% equity and 44.8% 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 3.44 times debt to EBITDA (earnings before interest, taxes, depreciation and amortization) as defined in our credit agreements, well within acceptable limits for our agreements and our industry. Our management believes adequate operating cash flows and other internal and external resources, such as our cash on hand and revolving credit facility, are available to finance ongoing operating requirements, including capital expenditures, business development, debt service and temporary financing of trade accounts receivable.

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

Our primary sources of liquidity for the nine months ended September 30, 2012 were proceeds from cash generated from operations and cash reserves held at the beginning of the period. In addition, we currently have approximately $5.2 million available under our revolving credit facility to fund any short-term working capital needs.

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

While it is often difficult 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. We were in full compliance with our debt covenants as of September 30, 2012, and anticipate that we will be able to plan for and match future liquidity needs with future internal and available resources.

While we periodically seek to add growth initiatives by either expanding our network or our markets through organic/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.

The following table summarizes our cash flow: Nine Months Ended September 30, 2012 2011 Change % Net cash provided by (used in): Operating activities $ 7,539,726 $ 6,763,035 $ 776,691 11.48 % Investing activities (5,167,129 ) (4,165,437 ) (1,001,692 ) -24.05 % Financing activities (3,003,899 ) (3,943,332 ) 939,433 23.82 % Increase (Decrease) in cash and cash equivalents $ (631,302 ) $ (1,345,734 ) $ 714,432 53.09 % 26 -------------------------------------------------------------------------------- Table of Contents Cash Flows from Operating Activities The increase in cash flows provided by operations for the nine months ended September 30, 2012 compared to the nine months ended September 30, 2011 was primarily due to a decrease in receivables due to the collection of a large amount of outstanding receivables, an increase in accounts payable and the other liabilities, partially offset by the increase in income taxes receivable and inventories, and a decrease in other accrued liabilities.

Cash generated by operations continues to be our primary source of funding for existing operations, capital expenditures, debt service and dividend payments to stockholders. Cash and cash equivalents at September 30, 2012 were $590,415, compared to $1,221,717 at December 31, 2011.

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 higher in the first nine months of 2012 compared to the first nine months of 2011 primarily due to higher capital expenditures in 2012 related to current operations. Capital expenditures relating to on-going operations were $5,125,745 for the nine months ended September 30, 2012, compared to $4,127,719 for the nine months ended September 30, 2011. We expect total plant additions to be approximately $6,500,000 in 2012. Our investing expenditures have been financed with cash flows from our current operations and advances on our line of credit. We believe that our current operations will provide adequate cash flows to fund our plant additions for the remainder of this year; however, funding from our revolving credit facility is available if the timing of our cash flows from operations does not match our cash flow requirements. We currently have approximately $5.2 million available under our existing credit facility to fund capital expenditures and other operating needs.

Cash Flows Used in Financing Activities Cash used in financing activities for the nine months ended September 30, 2012 included long-term debt repayments of $2,589,383 and the distribution of $1,268,895 of dividends to stockholders, offset by a $854,379 increase in debt due the use of our revolving credit facility.

Working Capital We had working capital deficit (i.e. current assets minus current liabilities) of $1,033,301 as of September 30, 2012, with current assets of approximately $6.9 million and current liabilities of approximately $7.9 million, compared to a working capital deficit of $232,247 as of December 31, 2011. The ratio of current assets to current liabilities was 0.87 and 0.97 as of September 30, 2012 and December 31, 2011. The decrease in the working capital was primarily due to a portion of our long-term swaps becoming short-term in 2012, an increase in checks written in excess of cash balances and decreases in cash and cash equivalents and receivables, partially offset by an increase in inventories.

27-------------------------------------------------------------------------------- Table of Contents Dividends and Restrictions We declared a quarterly dividend of $.0825 per share for the first, second and third quarters of 2012, which totaled $422,025 for the first quarter and $423,435 per quarter for the second and third quarters. We declared a quarterly dividend of $.08 per share for the first quarter of 2011, which totaled $409,235 and a quarterly dividend of $.0825 per share for the second and third quarters of 2011, which totaled $422,025 per quarter. Our Board of Directors reviews quarterly dividend declarations based on 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.

Our loan agreements include restrictions on our ability to pay cash dividends to our stockholders. However, we are allowed to pay dividends (a) (i) in an amount up to $2,050,000 in any year and (ii) in any amount if our "Total Leverage Ratio," that is, the ratio of our "Indebtedness" to "EBITDA" (in each case as defined in the loan documents) is equal to or less than 3:50 to 1:00, and (b) in either case, if we were not in default or potential default under the loan agreements. If we fail to comply with these covenants, our ability to pay dividends would be limited. As of September 30, 2012, our Total Leverage Ratio fell below the 3:50 to 1:00 ratio, thus eliminating any restrictions on our ability to pay cash dividends to our stockholders. At September 30, 2012, we were in compliance with all the stipulated financial ratios in our loan agreements.

Obligations and Commitments We have a credit facility with CoBank, ACB. Information about our contractual obligations, including obligations under the credit facility, and along with the cash principal payments due each period on our unsecured note payable and long-term debt is set forth in the following table. For additional information about our contractual obligations as of September 30, 2012 see Note 4 - "Secured Credit Facility".

October 1 - December 31 Description Total 2012 2013-2014 2015-2016 Thereafter Deferred Compensation $ 950,929 $ 17,441 $ 133,137 $ 124,766 $ 675,585 Long-term Debt 41,773,050 1,109,500 40,663,550 0 0 Interest on Long-term Debt (A) 2,414,130 539,188 1,874,942 0 0 Loan Guarantees 310,642 7,013 59,285 64,830 179,514 Operating Lease 93,030 6,645 53,160 33,225 0 Purchase Obligations (B) 0 0 0 0 0Total Contractual Cash Obligations $ 45,541,781 $ 1,679,787 $ 42,784,074 $ 222,821 $ 855,099 A. Interest on long-term debt is estimated using rates in effect as of September 30, 2012. We use interest rate swap agreements to manage our cash flow exposure to interest rate movements on a portion of our variable rate debt obligations (see Note 5 - "Interest Rate Swaps").

B. There were no purchase obligations outstanding as of September 30, 2012.

28 -------------------------------------------------------------------------------- Table of Contents Long-Term Debt See Note 4 - "Secured Credit Facility" for information pertaining to our long-term debt.

Federal Regulation and Legislation Intercarrier Compensation and Universal Service Fund (USF) Reform On November 18, 2011 the FCC released an order (the Order) which established a framework for reform of the intercarrier compensation system and the federal USF. The Order included two major provisions: • the elimination of terminating switched access rates and other per-minute terminating charges between service providers by 2018, through annual reductions in rates; and • the provision of USF support for voice and broadband services.

In reforming the USF, the Order established a short-term (Phase 1) and a longer-term (Phase 2) framework for a new fund, the Connect America Fund (CAF).

Under Phase 1 of the CAF, the Order provides for continued legacy USF funding frozen at 2011 levels as well as the opportunity for incremental broadband funding to a number of unserved locations equal to the amount of incremental support accepted divided by $775.

For Phase 2 of CAF, the FCC is working to establish rules for CAF funding based on a forward-looking cost model to further extend broadband to high-cost areas.

If the FCC does not complete Phase 2 of CAF by the end of 2012, our USF funding will continue to be frozen at 2011 levels until completion of Phase 2 of CAF, but we will be required to use one-third of the frozen legacy support to operate and build broadband networks beginning in 2013. In 2014, this condition will increase from one-third to two-thirds, and in 2015 will increase to 100 percent.

Based on current expenditures, we do not foresee any concerns complying with these additional funding conditions for all periods. The FCC is currently conducting the CAF Phase 2 rule-making proceeding, and we do not expect this proceeding to be complete by the end of 2012.

As part of the Order's reform of intercarrier compensation, the FCC established two recovery mechanisms that mitigate the revenue reductions resulting from the reductions and ultimate elimination of terminating access rates. First, the FCC established a monthly charge that may be assessed to our retail consumers (Access Recovery Charge or ARC) subject to certain rate caps. Second, revenue reductions not recovered from the assessment of the ARC are eligible for recovery through additional universal service support through an access recovery mechanism.

On April 25, 2012 the FCC decided that on July 1, 2014 originating access charges for intrastate long distance traffic exchanged between an IP network and the traditional telecommunications network will be subject to no higher than interstate originating access rates. We continue to assess the impacts of the FCC's intercarrier compensation reform on our business activities.

Additional implications of the Order will likely result in future additional rule making and require significant interpretation, management judgment and collaboration with other telecommunications carriers. We believe the steps we have taken to diversify our revenue streams and focus on growth opportunities will help us navigate through this transition without significant adverse effects.

29-------------------------------------------------------------------------------- Table of Contents Recent Accounting Developments See Note 1 - "Basis of Presentation and Consolidation" for a discussion of recent accounting developments.

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