| • FORM 10-Q FOR THE QUARTER ENDED MARCH 31, 2012 • CERTIFICATION OF CEO PURSUANT TO SECTION 302 • CERTIFICATION OF CFO PURSUANT TO SECTION 302 • CERTIFICATION OF CEO PURSUANT TO SECTION 906 • CERTIFICATION OF CFO PURSUANT TO SECTION 906 • XBRL INSTANCE FILE • XBRL SCHEMA FILE • XBRL CALCULATION FILE • XBRL DEFINITION FILE • XBRL LABEL FILE • XBRL PRESENTATION FILE | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
(Mark One)
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 Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definition of “large accelerated filer, accelerated filer, and smaller reporting 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 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 total number of shares of the Registrant’s common stock outstanding as of May 14, 2012: 5,115,435. 1 2 PART I – FINANCIAL INFORMATION NEW ULM TELECOM, INC.
Certain historical numbers have been changed to conform to the current year’s presentation The accompanying notes are an integral part of these consolidated financial statements. 3 NEW ULM TELECOM, INC. AND SUBSIDIARIES
4 NEW ULM TELECOM, INC. ASSETS
The accompanying notes are an integral part of these consolidated financial statements. 5 NEW ULM TELECOM, INC. LIABILITIES AND STOCKHOLDERS’ EQUITY
The accompanying notes are an integral part of these consolidated financial statements. 6 NEW ULM TELECOM, INC.
The accompanying notes are an integral part of these consolidated financial statements. 7 NEW ULM TELECOM, INC. YEAR ENDED DECEMBER 31, 2011, AND
The accompanying notes are an integral part of these consolidated financial statements. 8 NEW ULM TELECOM, INC. Note 1 – Basis of Presentation and Consolidation The accompanying unaudited condensed consolidated financial statements of New Ulm Telecom, Inc. and its subsidiaries (NU Telecom) have been prepared in accordance with accounting principles generally accepted in the United States (GAAP) for interim financial information and with the rules and regulations of the Securities and Exchange Commission (SEC). Certain information and disclosures normally included in annual financial statements prepared in accordance with GAAP have been omitted or condensed pursuant to such rules and regulations. In the opinion of management, the unaudited condensed consolidated financial statements reflect all adjustments (consisting only of normal and recurring accruals) considered necessary for the fair presentation of the financial statements and present fairly the results of operations, financial position and cash flows for the interim periods presented as required by Regulation S-X, Rule 10-01. These unaudited interim condensed consolidated financial statements should be read in conjunction with our audited consolidated financial statements and notes thereto contained in our Annual Report on Form 10-K for the year ended December 31, 2011. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, expenses and related disclosures at the date of the financial statements and during the reporting period. Actual results could differ from these estimates. The results of operations for the interim periods presented are not necessarily indicative of the results that may be expected for the fiscal year as a whole or any other interim period. 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. Revenue Recognition 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 interexchange carriers 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. 9 Interstate access rates are established by a nationwide pooling of companies known as the National Exchange Carriers Association (NECA). The Federal Communications Commission (FCC) established NECA in 1983 to develop and administer interstate access service rates, terms and conditions. Revenues are pooled and redistributed on the basis of a company’s actual or average costs. New Ulm Telecom’s settlements from the pools are based on its actual costs to provide service, while the settlements for NU Telecom subsidiaries – Western Telephone Company, Peoples Telephone Company and Hutchinson Telephone Company (HTC) are based on nationwide average schedules. Access revenues for New Ulm Telecom include an estimate of a cost study each year that is trued-up subsequent to the end of any given year. Our management believes the estimates included in our preliminary cost study are reasonable. We cannot predict the future impact that industry or regulatory changes will have on interstate access revenues. Intrastate access rates are filed with state regulatory commissions in Minnesota and Iowa. We derive revenues from 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. Cost of Services (excluding depreciation and amortization) Selling, General and Administrative Expenses Depreciation and Amortization Expense Income Taxes 10 We account for income taxes in accordance with GAAP. As required by GAAP, we recognize the financial statement benefit of tax positions only after determining that the relevant tax authority would more-likely-than-not sustain the position following an audit. For tax positions meeting the more-likely-than-not threshold, the amount recognized in the financial statements is the largest benefit that has a greater than 50 percent likelihood of being realized upon ultimate settlement with the relevant tax authority. In accordance with GAAP, we had no net unrecognized tax benefits at March 31, 2012 that, if recognized, would affect the income tax provision when recorded. We are primarily subject to United States, Minnesota and Iowa income taxes. Tax years subsequent to 2007 remain open to examination by federal and state tax authorities. Our policy is to recognize interest and penalties related to income tax matters as income tax expense. As of March 31, 2012 and December 31, 2011 we had no interest or penalties accrued that were related to income tax matters. Recent Accounting Developments In September 2011, the Financial Accounting Standards Board (FASB) issued new guidance regarding the qualitative testing of goodwill. The intent of this guidance was to simplify how entities, both public and nonpublic, test goodwill for impairment. The new guidance permits an entity to first assess qualitative factors to determine whether it is more-likely-than-not that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test. The more-likely-than-not threshold is defined as having a likelihood of more than 50 percent. This qualitative assessment can be bypassed in any period in the event the entity wants to proceed directly to performing the first step of the legacy two-step goodwill impairment test. This new guidance was effective for annual and interim goodwill impairment testing performed for fiscal years beginning after December 15, 2011. Our adoption of this guidance has not had a material impact on our financial statements. In June 2011, FASB issued new guidance regarding the presentation of comprehensive income. The guidance requires the presentation of comprehensive income, the components of net income and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. The guidance also requires presentation of adjustments for items that are reclassified from other comprehensive income to net income in the statement where the components of net income and the components of other comprehensive income are presented. The guidance is effective on a retrospective basis for financial statements issued for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2011. Our adoption of this guidance has not had a material impact on our financial statements. In May 2011, the FASB issued new guidance related to fair value measurement. The purpose of this guidance is to achieve commonality between United States GAAP and International Financial Reporting Standards pertaining to fair value measurements and disclosure requirements. It changes certain fair value measurement principles and enhances the disclosure requirements, particularly for Level 3 fair value measurements. The amendment became effective for annual periods beginning after December 15, 2011. Our adoption of this guidance will not have a material impact on our disclosures. 11 We 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 – Fair Value Measurements We have adopted the rules prescribed under GAAP for our financial assets and liabilities. GAAP includes a fair value hierarchy that is intended to increase consistency and comparability in fair value measurements and related disclosures. The fair value hierarchy is based on inputs to valuation techniques used to measure fair value that are either observable or unobservable. Observable inputs reflect assumptions market participants would use in pricing an asset or liability based on market data obtained from independent sources, while unobservable inputs reflect a reporting entity’s pricing based upon its own market assumptions. The fair value hierarchy consists of the following three levels:
We 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 5 – “Interest Rate Swaps”. Our swap agreements’ fair values were determined based on Level 2 inputs. Other Financial Instruments Other Investments - It is difficult to estimate a fair value for equity investments in companies carried on the equity or cost basis due to a lack of quoted market prices. We conducted an evaluation of our investments in all of our companies in connection with the preparation of our audited financial statements at December 31, 2011. We believe the carrying value of our investments is not impaired. 12 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 for which the current carrying amounts approximate fair market value. Note 3 – Goodwill and Intangible Assets 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 $29,707,100 at March 31, 2012 and December 31, 2011. As required by GAAP, we do not amortize goodwill and other intangible assets with indefinite lives, but test for impairment on an annual basis or earlier if an event occurs or circumstances change that would reduce the fair value of a reporting unit below its carrying amount. These circumstances include, but are not limited to (i) a significant adverse change in the business climate, (ii) unanticipated competition or (iii) an adverse action or assessment by a regulator. Determining impairment involves estimating the fair value of a reporting unit using a combination of (i) the income or discounted cash flows approach and (ii) the market approach that utilizes comparable companies’ data. If the carrying amount of a reporting unit exceeds its fair value, then 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 2011, 2010 and 2009, we engaged an independent valuation firm to complete our annual impairment testing for goodwill. For 2011, 2010 and 2009, the testing resulted in no impairment charge to goodwill as the determined fair value was sufficient to pass the first step of the impairment test. Our intangible assets subject to amortization consist of acquired customer relationships, regulatory rights and a noncompetition agreement. As of December 31, 2009, our management determined that our trade name intangible was no longer an indefinite-lived intangible asset due to the rebranding of HTC’s products and services. Our management anticipates that this rebranding process would take approximately three years to complete. We anticipate an additional charge to amortization expense of $266,667 per year, over the three years which began in 2010, due to this rebranding process. 13 We amortize intangible assets with finite lives over their respective estimated useful lives. Identifiable intangible assets that are subject to amortization are evaluated for impairment. In addition, we periodically reassess the carrying value, useful lives and classifications of our identifiable intangible assets. The components of our identified intangible assets are as follows:
Amortization expense related to the definite-lived intangible assets was $519,188 for both the three months ended March 31, 2012 and 2011. Amortization expense for the remaining nine months of 2012 and the five years subsequent to 2012 is estimated to be:
Note 4 – Secured Credit Facility We have a credit facility with CoBank, ACB. Under the credit facility, we entered into separate Master Loan Agreements (MLAs) and a series of supplements to those respective MLAs. NU Telecom and its respective subsidiaries also have entered into security agreements under which substantially all of the assets of NU Telecom and its respective subsidiaries have been pledged to CoBank, ACB as collateral. In addition, NU Telecom and its respective subsidiaries have guaranteed all obligations under the credit facility. The loan agreements include restrictions on the ability to pay cash dividends to its 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 NU Telecom’s “Total Leverage Ratio,” that is, the ratio of its “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 NU Telecom is not in default or potential default under the loan agreements. As of December 31, 2010, 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. 14 As of March 31, 2012, we were in compliance with the financial ratios in the loan agreements. As described in Note 5 – “Interest Rate Swaps,” we have entered into interest rate swaps that effectively fix our interest rates and cover $36.0 million at a weighted average rate of 5.52%, as of March 31, 2012. The additional $12.7 million of outstanding debt ($6.5 million available under the credit facilities and $6.2 million currently outstanding) remains subject to variable interest rates at an effective weighted average interest rate of 2.30%, as of March 31, 2012. 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 facilities with CoBank, ACB require that we enter into interest rate agreements designed to protect us against fluctuations in interest rates, in an aggregate principal amount and for a duration determined under the credit facility. To meet this objective, we entered into Interest Rate Swap Agreements with CoBank, ACB. Under these Interest Rate Swap Agreements and subsequent swaps that each covers a specified notional dollar amount, we have changed the variable-rate cash flow exposure on the debt obligations to fixed cash flows. Under the terms of these interest rate swaps, we pay a fixed contractual interest rate and (i) make an additional payment if the LIBOR variable rate payment is below a contractual rate or (ii) receive a payment if the LIBOR variable rate payment is above the contractual rate. Each month, we make interest payments to CoBank, ACB under its loan agreements based on the current applicable LIBOR Rate, plus the contractual LIBOR margin then in effect with respect to each applicable loan, without reflecting any interest rate swaps. At the end of each calendar quarter, CoBank, ACB adjusts our aggregate interest payments based upon the difference, if any, between the amounts paid by us during the quarter and the current effective interest rate set forth in the table below. All net interest payments made by us are reported in our consolidated income statement as interest expense. Pursuant to these interest rate swap agreements, we entered into interest rate swaps covering (i) $39.0 million of our aggregate indebtedness to CoBank, ACB effective March 19, 2008 and (ii) an additional $6.0 million of our aggregate indebtedness to CoBank, ACB effective June 23, 2008. These swaps effectively locked in the interest rate on (i) $6.0 million of variable-rate debt through March 2011, (ii) $33.0 million of variable-rate debt through March 2013, (iii) $3.0 million of variable-rate debt through June 2011 and (iv) $3.0 million of variable-rate debt through June 2013. 15 On January 1, 2011, we entered into a cash management agreement with CoBank, ACB. This agreement reduces our borrowing expense in the form of lower interest expense by ensuring there are no idle funds in our bank accounts as those excess funds are used to reduce our debt. When we have excess cash in our bank accounts, our surplus cash is automatically applied to our outstanding loan balances in our revolver debt facilities and when we have a cash deficit position in our bank accounts, CoBank, ACB advances funds on our revolver debt facilities to fund the deficit position. Over time, our interest expense is reduced as we are in a cash surplus position more often than a deficit position. On March 31, 2011, $5,000,000 of our swaps matured on Loan RX0583-T1 ($1,000,000) and Loan RX0584-T1 ($4,000,000). No gain or loss was recognized on these swaps as they had reached their full maturities. On June 30, 2011, an additional $3,000,000 of our swaps matured on Loan RX0583-T2. No gain or loss was recognized on this swap as it had reached its full maturity. As of March 31, 2012 we had the following interest rate swaps in effect.
(1) As described in Note 4 – “Secured Credit Facility,” each note initially bears interest at a LIBOR rate determined by the maturity of the note, plus a “LIBOR Margin” rate equal to either 2.00% or 2.25% 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. These interest rate swaps qualify as cash flow hedges for accounting purposes under GAAP. We have reflected the effect of these hedging transactions in the financial statements. The unrealized gains were reported in other comprehensive income (loss). If we were to terminate our interest rate swap agreements, the cumulative change in fair value at the date of termination would be reclassified from accumulated other comprehensive income (loss), which is classified in stockholders’ equity, into earnings on the consolidated statements of income. The fair value of the Company’s interest rate swap agreements is determined based on valuations received from CoBank, ACB and are based on the present value of expected future cash flows using discount rates appropriate with the terms of the swap agreements. The fair value indicates an estimated amount we would have to pay if the contracts were canceled or transferred to other parties. Note 6 – Other Investments We are a co-investor with other rural telephone companies in several partnerships and limited liability companies. These joint ventures make it possible to offer services to customers, including digital video services and fiber optic transport services that we would have difficulty offering on our own. These joint ventures also make it possible to invest in new technologies with a lower level of financial risk. We recognize income and losses from these investments on the equity method of accounting. For a listing of our investments, see Note 9 – “Segment Information”. 16 Note 7 – Guarantees On September 30, 2011, Fibercomm, LC refinanced two existing loans with American State Bank with a new ten-year loan, maturing on September 30, 2021. As of March 31, 2012, we have recorded a liability of $324,473 in connection with the guarantee on this new loan. This guarantee may be exercised if FiberComm, LC does not make its required payments on this note. Note 8 – Deferred Compensation As part of the acquisition of HTC, we have recorded other deferred compensation relating to the estimated present value of executive compensation payable to certain former executives of HTC. Note 9 – Segment Information We operate in the Telecom Segment and have no other significant business segments. The Telecom Segment consists of voice, data and video communication services delivered to the customer over our local communications network. No single customer accounted for a material portion of our consolidated revenues. The Telecom Segment operates the following incumbent local exchange carriers (ILECs) and competitive local exchange carriers (CLECs) and has investment ownership interests as follows: Telecom Segment
Note 10 – Commitments and Contingencies We are involved in certain contractual disputes in the ordinary course of business. We do not believe the ultimate resolution of any of these existing matters will have a material adverse effect on our financial position, results of operations or cash flows. We did not experience any changes to material contractual obligations in the first three months of 2012. Refer to the Company’s Annual Report on Form 10-K for the year ended December 31, 2011 for the discussion relating to commitments and contingencies. 17 Note 11 – Hector Communications Corporation On November 3, 2006 we acquired a one-third interest in HCC. HCC is owned equally by NU Telecom, Blue Earth Valley Communications, Inc. and Arvig Enterprises, Inc. Each of the owners provides management and other operational services to HCC and its subsidiaries. Our President and Chief Executive Officer, Mr. Bill D. Otis, has been named Chairman of the Board of Directors and President of HCC. Ms. Barbara A.J. Bornhoft, our Vice-President and Chief Operating Officer, also serves on the Board of Directors of HCC. The following table summarizes financial information of HCC for the periods ended March 31, 2012 and 2011:
Note 12 – Subsequent Events We have evaluated and disclosed subsequent events through the filing date of this Quarterly Report on Form 10-Q. Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 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 or review any forward-looking information, whether as a result of new information, future events or otherwise. 18 Critical Accounting Policies Preparing consolidated financial statements in conformity with GAAP requires 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 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. 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 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, 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 1,777 or 6.3% for the twelve months ended March 31, 2012. 19 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, 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. 20 Financial results for the Telecom Segment are included below:
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. We also receive reciprocal compensation revenue based on interconnection agreements with wireless carriers using our network to terminate calls for their wireless subscribers. Local service revenue was $1,472,008, which is $19,064 or 1.3% lower in the three months ended March 31, 2012 compared to the three months ended March 31, 2011. This decrease was primarily due to the loss of 1,777 or 6.3% of our customer base at March 31, 2012 compared to March 31, 2011. This decrease was offset by increases in local private line 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. 21 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 $2,770,012, which is $368,022 or 11.7% lower in the three months ended March 31, 2012 compared to the three months ended March 31, 2011. The decrease in network access revenues was primarily due to lower minutes of use. 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 $1,438,854, which is $69,658 or 5.1% higher in the three months ended March 31, 2012 compared to the three months ended March 31, 2011. A combination of a 56 or 0.6% increase in our customer base at March 31, 2012 compared to March 31, 2011; rate increases introduced into several of our markets over the course of 2011 and the beginning of 2012; and the launching of IPTV services in New Ulm, Courtland, Redwood Falls, 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. 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 $1,358,828, which is $80,894 or 6.3% higher in the three months ended March 31, 2012 compared to the three months ended March 31, 2011. Despite a 344 or 39.0% decrease in our dial-up Internet customers between March 31, 2012 and March 31, 2011, data revenues increased over the same timeframe primarily due to an 892 or 9.2% increase in our broadband customers. 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 $155,542, which is $3,067 or 2.0% higher in the three months ended March 31, 2012 compared to the three months ended March 31, 2011. Despite a decrease of 474 or 3.4% of our customer base at March 31, 2012 compared to March 31, 2011, long distance revenues have remained static. 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. 22 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 $970,284, which is $20,737 or 2.1% lower in the three months ended March 31, 2012 compared to the three months ended March 31, 2011. This decrease was primarily due to a decrease in the sales of CPE. This decrease was partially offset by increases in the sales of cellular phones, activation revenues, and increased revenue for management services. Cost of Services (excluding Depreciation and Amortization) Cost of services (excluding depreciation and amortization) was $3,621,026, which is $290,505 or 8.7% higher in the three months ended March 31, 2012 compared to the three months ended March 31, 2011. This increase was primarily due to higher programming cost from content providers and higher costs associated with increased maintenance and support agreements on our equipment and software. Selling, General and Administrative Expenses Selling, general and administrative expenses were $1,632,972, which is $5,117 or 0.3% higher in the three months ended March 31, 2012 compared to the three months ended March 31, 2011. This increase was primarily due to increased employee benefit costs and increased expenses associated with complying with new SEC financial reporting requirements. Depreciation and Amortization Depreciation and amortization was $2,017,419, which is $376,496 or 15.7% lower in the three months ended March 31, 2012 compared to the three months ended March 31, 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 $894,111, which is $173,330 or 16.2% lower in the three months ended March 31, 2012 compared to the three months ended March 31, 2011. This decrease was primarily due to a decrease in revenues combined with increases in cost of services and selling, general and administrative expenses, partially offset by a decrease in depreciation and amortization, all of which are described above. 23 Consolidated Results Other Income and Interest Expense Interest expense was $556,282, which is $113,083 or 16.9% lower in the three months ended March 31, 2012 compared to the three months ended March 31, 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. 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 $70,047, which is $2,728 or 3.7% lower in the three months ended March 31, 2012 compared to the three months ended March 31, 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 $243,486, which is $130,471 or 115.4% higher in the three months ended March 31, 2012 compared to the three months ended March 31, 2011. HCC’s total net income was $730,459, which was $391,415 higher in the three months ended March 31, 2012 compared to the three months ended March 31, 2011. This increase was primarily the result of lower interest expense. Other income for the three months ended March 31, 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 $42,532, which is $7,395 or 14.8% lower in the three months ended March 31, 2012 compared to the three months ended March 31, 2011. Other investment income includes our equity ownerships in several partnerships and limited liability companies. Income Taxes Income tax expense was $481,786, which is $21,127 or 4.6% higher in the three months ended March 31, 2012 compared to the three months ended March 31, 2011. The effective income tax rates for the three months ending March 31, 2012 and 2011 were approximately 42.0% and 40.5%. The increase in the effective tax rate for the three months ended March 31, 2012 compared to the three months ended March 31, 2011 was primarily due to the recognition of approximately $29,000 in net tax benefits in the three months ended March 31, 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. 24 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 March 31, 2012 and 2011, we reported net income of $243,486 and $113,015. All reported net income amounts reflect our one-third ownership. As set forth in Note 11 – “Hector Communications Corporation,” in the first three months of 2012 and 2011, HCC had revenues of approximately $6.6 million and $6.5 million for the three months ended March 31, 2012 and 2011 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.
If we included our proportionate share of HCC’s OIBITDA in the OIBITDA of NU Telecom, our combined OIBITDA would have increased from $2,911,530 and $3,461,356 for NU Telecom alone, to $4,071,444 and $4,616,335 for the three months ended March 31, 2012 and 2011.
25 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 $96,207,599 at March 31, 2012, reflecting 56.1% equity and 43.9% 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 3.33 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. 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 three months ended March 31, 2012 were proceeds from cash generated from operations and cash reserves held at the beginning of the period. In addition, we currently have approximately $6.5 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 March 31, 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 nine months. 26 The following table summarizes our cash flow:
Cash Flows from Operating Activities The increase in cash flows provided by operations for the three months ended March 31, 2012 compared to the three months ended March 31, 2011 was primarily due to the collection of a large amount of outstanding accounts receivable. 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 March 31, 2012 were $1,330,038, 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 lower in the first three months of 2012 compared to the first three months of 2011 primarily due to lower capital expenditures in 2012 related to current operations. Capital expenditures relating to on-going operations were $1,106,784 for the three months ended March 31, 2012, compared to $1,502,638 for the three months ended March 31, 2011. We expect total plant additions to be approximately $5,500,000 in 2012. Our investing expenditures have been financed with cash flows from our current operations. 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 $6.5 million available under our existing credit facility to fund capital expenditures and other operating needs. Cash Flows Used in Financing Activities Cash used in financing activities for the three months ended March 31, 2012 included long-term debt repayments of $1,311,173 and the distribution of $422,025 of dividends to stockholders 27 Working Capital We had a working capital deficit (i.e. current assets minus current liabilities) of $1,757,659 as of March 31, 2012, with current assets of approximately $6.0 million and current liabilities of approximately $7.8 million, compared to a working capital deficit of $232,247 as of December 31, 2011. The ratio of current assets to current liabilities was 0.77 and 0.97 as of March 31, 2012 and December 31, 2011. The increase in the working capital deficit was primarily due to a significant portion of our long-term swaps becoming short-term in 2012. In addition, as described in Note 5 – “Interest Rate Swaps,” we have a cash management agreement with CoBank, ACB. Through this agreement, all available cash is used to reduce our outstanding loan balances in our revolver debt facilities. Therefore, we have increased funds available under our revolving credit facility to fund any fluctuations in working capital and other cash needs. Dividends and Restrictions We declared a quarterly dividend of $.0825 per share for the first quarter of 2012, which totaled $422,025 and a quarterly dividend of $.08 per share for the first quarter of 2011, which totaled $409,235. 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 relating to our ability to pay cash dividends to our stockholders. 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 December 31, 2010, 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 March 31, 2012, we were in compliance with all the stipulated financial ratios in our loan agreements. 28 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 March 31, 2012 see Note 4 – “Secured Credit Facility”.
Long-Term Debt See Note 4 – “Secured Credit Facility” for information pertaining to our long-term debt. Regulation In 2009, the United Stated Congress directed the FCC to develop a National Broadband Plan (NBP) to ensure every American has “access to broadband capability.” In March, 2010, the FCC released the NBP, which describes the FCC’s goals in enhancing broadband availability and the methods for achieving those goals over the next decade. The NBP contemplates significant changes to overall telecommunications policy in relation to underlying network support and associated equipment which enables broadband deployment, and approved broadband speeds which meet the FCC definition of broadband, depending on whether service is considered urban or rural. The NBP also made recommendations for transitioning the Universal Service Fund (USF) from supporting voice networks to broadband networks over time. On February 8, 2011, the FCC issued a Notice of Proposed Rulemaking (NPR) seeking comment on proposals to revamp the USF and provide support for broadband deployment and for reforming the existing intercarrier compensation regime. Intercarrier compensation is compensation carriers pay to each other to originate, transport and terminate traffic among telecommunications networks. Pursuant to the NBP and subsequent NPRs, on November 18, 2011, the FCC released a Report and Order and Further NPR adopting reforms of its universal service and intercarrier compensation mechanisms, and proposing further rules to advance reform. The Reform Order substantially revises the current USF high cost program and intercarrier compensation regime. The current USF program, which supports voice services, is to be phased out over time and replaced with the Connect America Fund (CAF), a new Mobility Fund, and a Remote Area Fund, which will collectively support broadband-capable networks. The timeline for this transition has numerous steps, depending on the type of traffic exchanged and the regulated status of the affected local exchange carrier. At this time, we cannot predict the timing or potential outcome of these changes. 29 The FCC’s Reform Order, and any subsequent orders it adopts to reform universal service and intercarrier compensation, are subject to judicial review. It is expected that one or more parties will appeal the FCC’s Reform Order. To date, at least one appeal has been filed. At this time, we cannot predict the timing or potential outcome of any such appeals or whether such appeals would result in a material adverse effect on our business, financial condition or results of operations. At this time, we cannot predict the net effect of the FCC’s changes to the USF high cost support program in the Reform Order or whether reductions in network support will be offset with additional network support from the CAF or the Mobility Fund. Accordingly, we cannot predict whether such changes will have a material adverse effect on our business, financial condition or results of operations. Recent Accounting Developments See Note 1 – “Basis of Presentation and Consolidation” to the Consolidated Financial Statements of this Quarterly Report on Form 10-Q for a discussion of recent accounting developments. Item 3. Quantitative and Qualitative Disclosures about Market Risk We do not have operations subject to risks of foreign currency fluctuations. We do, however, use derivative financial instruments that qualify as cash-flow hedges to manage our exposure to interest rate fluctuations on a portion of our variable-interest rate debt. Our objectives for holding derivatives are to minimize interest rate risks using the most effective methods to eliminate or reduce the impact of these exposures. Variable rate debt instruments are subject to interest rate risk. On March 19, 2008, we executed interest-rate swap agreements, effectively locking in the interest rate on $6.0 million of our variable-rate debt through March 2011, and $33.0 million of our variable-rate debt through March 2013. On June 23, 2008, we executed interest-rate swap agreements, effectively locking in the interest rate on $3.0 million of our variable-rate debt through June 2011, and $3.0 million of variable-rate debt through June 2013. A summary of these agreements is contained in Note 5 – “Interest Rate Swaps”. We report the cumulative gain or loss on current derivative instruments as a component of accumulated other comprehensive income (loss) in stockholders’ equity. If the protection agreement is concluded prior to reaching full maturity, the cumulative gain or loss is recognized in earnings. At the conclusion of the full term maturity of the protection agreement, no gain or loss is recognized. For any portion of our debt not covered with interest rate swap agreements, our earnings are affected by changes in interest rates as a portion of our long-term debt has variable interest rates based on LIBOR. If interest rates for the portion of our long-term debt based on variable rates had averaged 10% more for the three months ended March 31, 2012, our interest expense would have increased approximately $4,000. 30 Item 4. Controls and Procedures As of the end of the period covered by this Quarterly Report on Form 10-Q (the Evaluation Date), we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, regarding the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) promulgated under the Securities and Exchange Act of 1934, as amended). Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded, as of the end of the period covered by this Quarterly Report, that our disclosure controls and procedures ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act are recorded, processed, summarized and reported within the time periods specified in applicable rules and forms and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, in a manner that allows timely decisions regarding required disclosure. There have been no changes in our internal control over financial reporting during our most recently completed fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. From time to time we are involved in legal proceedings arising in the ordinary course of our business. There is no litigation pending that could have a material adverse effect on our results of operations and financial condition. There have not been any material changes to the risk factors previously disclosed in Item 1A, “Risk Factors,” of our Annual Report on Form 10-K for the fiscal year ended December 31, 2011. Item 2. Unregistered Sales of Equity Securities and Use of Proceeds. None. Item 3. Defaults Upon Senior Securities. None. Item 4. Mine Safety Disclosures None. None. 31
32 Pursuant to the requirements 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.
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