NEW ULM TELECOM INC - 10-K - Management's Discussion and Analysis of Financial Condition and Results of Operations
(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion should be read in conjunction with our historical
financial statements and the related notes contained elsewhere in this report.
NU Telecom offers a diverse array of communications products and services. Our
ILEC and CLEC businesses provide local telephone service and network access to
other telecommunications carriers for calls originated or terminated on our
network. In addition, we provide long distance service, dial-up and broadband
Internet access, and video services. On December 31, 2012 NU Telecom completed a
spin-off agreement with HCC, continuing the expansion of our service area into
the Minnesota communities and surrounding areas of Bellechester, Goodhue,
Hanska, Mazzepa, Sleepy Eye and White Rock. In 2010, we acquired the assets of
the CATV system located in and around Glencoe, Minnesota. 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, 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.
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Highlights in 2012:
• On December 31, 2012 NU Telecom completed a spin-off agreement with HCC.
NU Telecom had originally acquired a one-third interest in HCC on
November 3, 2006. HCC was equally owned by NU Telecom, Blue Earth Valley
Communications, Inc. and Arvig Enterprises, Inc. Under the spin-off
agreement, NU Telecom received all of the stock of SETC and other assets
and investments of HCC and incurred $3.3 million of additional debt to
finance the spin-off. Additional information pertaining to this
acquisition is available in Note 3 - "Acquisitions and Dispositions" to
the Consolidated Financial Statements of this Annual Report on Form
• Net income in 2012, totaled $3,174,914, which was a 56.6% increase
compared to 2011. The HCC spin-off was structured as a tax-free
reorganization under Section 355 of the Internal Revenue Code. NU
Telecom had $1,778,309 of deferred book taxes associated with the HCC
equity subsidiary that was reversed in 2012 due to the HCC spin-off.
This reversal eliminated our income tax expense for 2012 and allowed us
to record an income tax benefit of $365,477 for 2012.
• Consolidated revenue for 2012 totaled $32,482,988, which was a $788,463
decrease compared to 2011. Network access revenue declined $1,071,332 or
9.0% in 2012 compared to 2011 largely due to lower minutes of use and
the implementation of the FCC Intercarrier Compensation and the USF
reform order in regards to state access pricing levels that took effect
on July 3, 2012. This decrease was partially offset by increases in
video and data revenue of $311,378 or 5.5% and $320,037 or 6.1%.
• The HCC spin-off added approximately 4,700 access lines, 1,100 video
customers, 2,900 broadband customers, 100 dial-up internet customers and
2,400 long distance customers to our customer base as of December 31,
Included below is synopsis of trends management believes will continue to affect
our business in 2013.
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. 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 increases totaled 3,659 or 13.8% in 2012 compared to 2011 due to the
addition of SETC.
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.
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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, 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.
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.
In November, 2011 the FCC released proposed rulemaking which comprehensively
reforms and begins a new era in universal service and intercarrier compensation.
This reform order impacts numerous support mechanisms and network access revenue
streams that we have received in the past. While these rules may be altered
based on ongoing petitions for reconsideration and are being challenged through
appeals, we are evaluating them. We cannot predict the entire impact these
regulatory changes will have on our revenue and costs, but do believe it will
increase the historical decline in revenue and profitability of our company.
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Financial results for the Telecom Segment for the years ended December 31, 2012
and 2011 are included below:
2012 2011 Increase (Decrease)
Local Service $ 5,782,218 $ 6,000,257 $ (218,039 ) -3.63 %
Network Access 10,781,356 11,852,688 $ (1,071,332 ) -9.04 %
Video 5,969,610 5,658,232 $ 311,378 5.50 %
Data 5,568,000 5,247,963 $ 320,037 6.10 %
Long Distance 607,902 649,404 $ (41,502 ) -6.39 %
Other 3,773,902 3,862,907 $ (89,005 ) -2.30 %
Total Operating Revenues 32,482,988 33,271,451 $ (788,463 ) -2.37 %
Cost of Services, Excluding
Depreciation and Amortization 14,310,030 13,456,756 $ 853,274 6.34 %
Selling, General and
Administrative 6,269,618 6,400,900 $ (131,282 ) -2.05 %
Depreciation and Amortization
Expenses 8,219,749 9,010,393 $ (790,644 ) -8.77 %
Total Operating Expenses 28,799,397 28,868,049 $ (68,652 ) -0.24 %
Operating Income $ 3,683,591 $ 4,403,402 $ (719,811 ) -16.35 %
Net Income $ 3,174,914 $ 2,027,523 $ 1,147,391 56.59 %
Capital Expenditures $ 7,014,135 $ 4,824,204 $ 2,189,931 45.39 %
Access Lines 30,252 26,593 3,659 13.76 %
Video Customers 11,204 10,309 895 8.68 %
Broadband Customers 13,652 10,465 3,187 30.45 %
Dial Up Internet Customers 476 638 (162 ) -25.39 %
Long Distance Customers 15,372 13,530 1,842 13.61 %
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 $5,782,218, which is $218,039 or 3.6%
lower in 2012 than in 2011. Local service revenue was lower in 2012 compared to
2011 primarily due to a decrease in access lines of 1,055 or 4.0%, prior to the
addition of access lines associated with the spin-off of SETC on December 31,
2012. The decrease in revenues was 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.
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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.
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 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 ILECs. Network access revenue
was $10,781,356, which is $1,071,332 or 9.0% lower in 2012 than in 2011
primarily due to lower minutes of use and the implementation of the FCC
Intercarrier Compensation and the USF reform order in regards to state access
pricing levels that took effect on July 3, 2012.
Video- We provide a variety of enhanced data network services on a monthly
recurring basis to our end-user customers. This includes the broadband access
portion of traditional Telecom broadband service. We also 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 seventeen communities with our digital TV services
and five communities with our CATV services. Video revenue was $5,969,610, which
is $311,378 or 5.5% higher in 2012 than in 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 Courtland, Hutchinson, Litchfield, New Ulm,
Redwood Falls, Sanborn and Springfield, 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 $5,568,000, which is
$320,037 or 6.1% higher in 2012 than in 2011. This increase was primarily due to
an increase in broadband customers of 269 or 2.6%, partially offset by a loss of
243 dial-up customers or 38.1%, prior to the addition of data customers
associated with the spin-off of SETC on December 31, 2012. Broadband customers
have a higher profit margin than dial-up Internet 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.
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 $607,902, which is $41,502 or 6.4% lower in
2012 than in 2011. Long distance revenue was lower in 2012 compared to 2011
primarily due to a decrease in long distance lines of 552 or 4.1%, prior to the
addition of long distance lines associated with the spin-off of SETC on December
31, 2012, as customers continue to use other technologies such as wireless and
IP services to satisfy their long distance communication needs.
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Other Revenue - We generate revenue from directory publishing, sales and service
of 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
$3,773,902, which is $89,005 or 2.3% lower in 2012 than in 2011. This decrease
was primarily due to a decrease in the sales of CPE revenues, partially offset
by an increase in the sales of cellular phone and activation revenues.
Cost of Services (Excluding Depreciation and Amortization)
Cost of services (excluding depreciation and amortization) was $14,310,030,
which is $853,274 or 6.3% higher in 2012 than in 2011. This increase was
primarily due to higher programming cost from video content providers and higher
costs associated with increased maintenance and support agreements on our
equipment and software, partially offset by lower employee benefit costs.
Selling, General and Administrative Expenses
Selling, general and administrative expenses were $6,269,618, which is $131,282
or 2.1% lower in 2012 than in 2011. This decrease was primarily due to lower
employee benefit costs, partially offset by increased expenses associated with
complying with new SEC financial reporting requirements.
Depreciation and Amortization
Depreciation and amortization was $8,219,749, which is $790,644 or 8.8% lower in
2012 than in 2011. This decrease was primarily due to portions of our legacy
telephone network becoming fully depreciated during 2012 and 2011 as we migrate
to a new broadband network.
Operating income was $3,683,591, which is $719,811 or 16.3% lower in 2012 than
in 2011. This decrease was primarily due to a decrease in revenue combined with
an increase in cost of services, partially offset by a decrease in depreciation
and amortization, and selling, general and administrative expenses, all of which
are described above.
Other Income and Interest Expense
HCC investment income increased $80,741 in 2012 compared to 2011. The increase
reflects our equity portion of HCC net income prior to the spin-off of HCC on
December 31, 2012. HCC net income increased in 2012 and 2011 primarily due to
decreased interest expense associated with reduction of debt combined with lower
interest rates on outstanding debt.
Other income in 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
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Interest income decreased $5,249 in 2012 compared to 2011. As a result of
servicing our debt, excess cash available to purchase investments was lower.
Interest expense decreased $188,995 in 2012 compared to 2011. This decrease was
primarily due to lower outstanding debt balances and the maturing of several of
our swap agreements with CoBank, ACB during 2011 as the variable rate we now pay
on that debt portion is lower than the fixed rate we were previously paying, and
the implementation of a cash management program with CoBank, ACB at the
beginning of 2011.
Other investment income decreased $95,785 in 2012 compared to 2011. Other
investment income includes our equity ownerships in several partnerships and
limited liability corporations. We recorded $158,582 of income from equity
investments in 2012 and $228,168 of income in 2011
Income tax expense decreased by $1,869,394 as we recorded an income tax benefit
of $365,477 in 2012 and income tax expense of $1,503,917 in 2011. The effective
income tax rate was (13.0%) and 42.6% for 2012 and 2011. The effective income
tax rate in 2012 was lower than 2011 primarily due to changes in deferred taxes
as a result of the HCC spin-off, partially offset by the recognition of
approximately $29,000 in net tax benefits in 2011. This amount was originally
for the 2006 tax year, which was no longer open for examination by federal and
state tax authorities. The difference between the effective tax rate and the
federal statutory tax rate are reconciled in Note 7 - "Income Taxes" to the
Consolidated Financial Statements of this Annual Report on Form 10-K.
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).
Liquidity and Capital Resources
NU Telecom's total capital structure (long-term and short-term debt obligations,
plus stockholders' equity) was $102,338,011 at December 31, 2012, reflecting
54.5% equity and 45.5% 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 3.15 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.
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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 year ended December 31, 2012 were
proceeds from cash generated from operations and cash reserves held at the
beginning of the period. At December 31, 2012 we had a working capital deficit
of $4,947. However, at December 31, 2012 we also had approximately $3.8 million
available under our revolving credit facility to fund any short-term working
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.
We expect our liquidity needs to originate from 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 December 31, 2012, and
anticipate that we will be able to plan for and match future liquidity needs
with future internal and available external 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:
For Year Ended December 31
2012 2011 Increase (Decrease)
Net cash provided by (used in):
Operating activities $ 10,450,013 $ 8,654,333 $ 1,795,680 20.75 %
Investing activities (7,020,595 ) (4,866,204 ) (2,154,391 ) 44.27 %
Financing activities (1,901,285 ) (4,961,115 ) 3,059,830 -61.68 %
Increase (decrease) in cash $ 1,528,133 $ (1,172,986 ) $ 2,701,119 -230.28 %
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Cash Flows from Operating Activities
Cash generated by operations for the year ended December 31, 2012 was
$10,450,013, compared to cash generated by operations of $8,654,333 in 2011. The
increase in cash flows from operating activities in 2012 was primarily due to an
increase in net income, the timing of changes in receivables, partially offset
by the change in deferred income tax.
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, 2012 was $2,749,850, 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
Cash flows used in investing activities were $7,020,595 for the year ended
December 31, 2012, compared to $4,866,204 used in investing activities in 2011.
Capital expenditures relating to on-going operations were $7,014,135 in 2012 and
$4,824,204 in 2011. 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 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. We currently have approximately $3.8 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, 2012 was
$1,901,285. This included long-term debt repayments of $3,698,883 and the
distribution of $1,692,329 of dividends to stockholders, offset by a $1,191,713
increase in debt due to the new loan associated with the HCC spin-off and a
$2,298,214 increase in debt due to the use of our revolving credit facility.
Cash used in financing activities for the year ended December 31, 2011 was
$4,961,115. This included long-term debt repayments of $3,208,976, a $76,829
reduction in our revolving credit facility and the distribution of $1,675,310 of
dividends to stockholders.
We had a working capital deficit (i.e. current assets minus current liabilities)
of $4,947 as of December 31, 2012, with current assets of approximately $8.6
million and current liabilities of approximately $8.6 million, compared to a
working capital deficit of $232,247 as of December 31, 2011. The ratio of
current assets to current liabilities was 1.00 and 0.97 as of December 31, 2012
and 2011. 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.
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Long-Term Debt and Revolving Credit Facilities
Our long-term debt obligations as of December 31, 2012, were $42,494,385,
excluding current debt maturities of $4,113,000. Long-term debt obligations as
of December 31, 2011, were $39,809,171, excluding current debt maturities of
We have a credit facility with CoBank, ACB. Under the credit facility, we
entered into separate Master Loan Agreements (MLAs) and a series of supplements
to the respective MLAs. Under the terms of the two MLAs and the supplements, we
initially borrowed $59,700,000 and borrowed an additional $4,500,000 on December
19, 2012 and entered into promissory notes on the following terms:
RX0583-T1 - $15,000,000 term note with interest payable monthly. Twelve
quarterly principal payments of $125,000 are due commencing March 31,
2008 through December 31, 2010. Sixteen quarterly principal payments of
$250,000 are due commencing March 31, 2011 through December 31, 2014. A
final balloon payment of $9,500,000 is due at maturity of the note on
December 31, 2014.
RX0583-T2 - $10,000,000 revolving note with interest payable monthly.
Final maturity date of the note is December 31, 2014. We currently have
drawn $8,221,385 on this revolving note as of December 31, 2012.
RX0583-T3 - $4,500,000 term note with interest payable monthly. Final
maturity date of the note is December 31, 2014. Seven quarterly
principal payments of $225,000 are due commencing June 30, 2013 through
December 31, 2014. A final balloon payment of $2,925,000 is due at
maturity of the note on December 31, 2014.
RX0583-T1 and RX0583-T2 initially bear interest at a "LIBOR Margin" rate
equal to 2.50 percent over the applicable LIBOR rate. RX0583-T3 initially
bears interest at a "LIBOR Margin" rate equal to 3.00 percent over the
applicable LIBOR rate. The LIBOR Margin decreases as our "Leverage Ratio"
RX0584-T1 - $29,700,000 term note with interest payable monthly. Twenty
quarterly principal payments of $609,500 are due commencing March 31,
2010 through December 31, 2014. A final balloon payment of $17,510,000
is due at maturity of the note on December 31, 2014.
RX0584-T2 - $2,000,000 revolving note with interest payable monthly.
Final maturity of the note is December 31, 2014. We currently have not
drawn any funds on this revolving note as of December 31, 2012.
RX0584-T3 - $3,000,000 term note with interest payable monthly. Final
maturity of the note was April 3, 2008. This note has been fully paid.
Each note above initially bears interest at a "LIBOR Margin" rate equal to
2.75 percent over the applicable LIBOR rate. The LIBOR Margin decreases as
our "Leverage Ratio" decreases.
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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, ACB as collateral. In
addition, NU Telecom and its respective subsidiaries have guaranteed all the
obligations under the credit facility.
Our credit facility requires us to comply with specified financial ratios and
tests. These financial ratios and tests include total leverage ratio, debt
service coverage ratio, equity to total assets ratio and maximum annual capital
expenditures tests. At December 31, 2012 and 2011, 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 $2,050,000 in any year and (ii) in any amount if our "Total Leverage
Ratio," that is, the ratio of our "Indebtedness" to "EBITDA" (in each case as
defined in the loan documents) is equal to or less than 3.50 to 1.00, and (b) in
either case if we are not in default or potential default under our loan
agreements. As of 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.
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, ACB approval.
See Note 5 - "Long-Term Debt" to the Consolidated Financial Statements of this
Annual Report on Form 10-K for information pertaining to our long-term debt.
We have guaranteed the obligations of our New Ulm subsidiary joint venture
investment in FiberComm, LC. See Note 12 - "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 2012 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, 2012.
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We recognize revenue when (i) persuasive evidence of an arrangement exists, (ii)
delivery of the product has occurred or a service has been provided, (iii) the
price is fixed or determinable and (iv) collectability is reasonably assured.
Revenues are earned from our customers primarily through the connection to our
local network, digital and commercial television programming, and Internet
services (both dial-up and high-speed broadband). Revenues for these services
are billed based on set rates for monthly service or based on the amount of time
the customer is utilizing our facilities. The revenue for these services is
recognized when the service is rendered.
Revenues earned from IXCs accessing our network are based on the utilization of
our network by these carriers as measured by minutes of use on 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. New Ulm's and
SETC's settlements from the pools are based on its actual costs to provide
service, while the settlements for NU Telecom subsidiaries - WTC, PTC and HTC
are 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 are reasonable. We cannot predict the future impact that
industry or regulatory changes will have on interstate access revenues.
Intrastate access rates are filed with state regulatory commissions in Minnesota
We derive revenues from system sales and services through 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 $175,705 and
$300,000 as of December 31, 2012 and 2011.
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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
Level 1: Inputs are quoted prices in active markets for identical assets or
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 use financial derivative instruments to manage our overall cash flow exposure
to fluctuations in interest rates. We account 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 interest rate swaps with our lender CoBank, ACB to manage
our cash flow exposure to fluctuations in interest rates. These instruments were
designated as cash flow hedges and were effective at mitigating the risk of
fluctuations on interest rates in the market place. Any gains or losses related
to changes in the fair value of these derivatives are accounted for as a
component of accumulated other comprehensive income (loss) for as long as the
hedge remains effective.
The fair value of our interest rate swap agreements is discussed in Note 6 -
"Interest Rate Swaps" to the Consolidated Financial Statements of this Annual
Report on Form 10-K. The fair value of our swap agreements were 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 4 - "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.
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In 2012 and 2011, we engaged an independent valuation firm to complete an annual
impairment test for existing goodwill acquired. For 2012 and 2011, 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.
Assumptions used in our 2012 DCF model include the following:
• A 10.00% weighted average cost of capital based on an industry weighted
average cost of capital; and
• A 1.50% terminal 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 that goodwill was $39,975,906 as of December 31,
2012 and $29,707,100 as of December 31, 2011. The increase of $10,268,806 in
goodwill in 2012 compared to 2011 is due to the addition of goodwill obtained
through the HCC spin-off on December 31, 2012.
In 2012, we tested the HTC 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 $5.9 million, which indicated that we had no impairment as of
December 31, 2012. 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.
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
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.
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In accordance with GAAP, we record net unrecognized tax benefits that, if
recognized, would affect the income tax provision when recorded. See Note 7 -
"Income Taxes" to the Consolidated Financial Statements of this Annual Report
We are primarily subject to United States, Minnesota and Iowa income taxes. Tax
years subsequent to 2008 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.
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, 2012.
Equity Method Investment
We are an investor in several partnerships and limited liability corporations.
Our percentages of ownership in these joint ventures range from 14.29% to
24.39%. 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.
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 are cash-based incentive plans.
Payments on each plan are based on an achievement of objectives of measurable
corporate performance, with financial and customer related targets. The
financial targets are based on an achievement of specified operating revenues
and net income, based on our budget, while the customer service targets are
based on several factors, including (i) "uptime" (the amount of time that our
phone, cable and Internet services are available to customers) and restoration
time (our ability to restore service when an interruption occurs), (ii) customer
retention and (iii) customer service (derived from customer service data).
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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
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.
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