Item 1. Business
History
We were formed as a Delaware limited liability company in 1998 for the purpose of operating and acquiring rural local exchange carriers (“RLECs”). Since 1999, we have acquired eleven RLEC businesses, four of which serve contiguous territories in north central Alabama; three of which serve territories adjacent to either Portland or Bangor, Maine; and one each serving a portion of western Massachusetts, central Missouri, western Vermont and southern West Virginia. In addition to traditional telephone services, we provide a variety of unregulated telecommunications services in all of our RLEC territories, including internet data lines and long distance services. We have also acquired three facilities-based competitive local exchange carriers (“CLECs”), which offer services primarily to business and enterprise customers in Maine, New Hampshire and Massachusetts, and have historically operated under the trade name OTT Communications. The Company completed an initial public offering in December 2004, at which time it converted from a Delaware limited liability company into a Delaware corporation and changed its name to Otelco Inc. In 2018, we transitioned to using the brand name Otelco in all locations where we provide service.
Our RLEC companies trace their history to the introduction of telecommunication services in the areas they serve over 100 years ago. We are able to leverage our long-standing relationship with our local service customers by offering them a broad suite of telecommunications and information services, such as long distance, internet/broadband data access and, in some areas, video and security, thereby increasing customer loyalty and revenue per customer. Each RLEC qualifies as a rural telephone company under the Federal Communications Act of 1934 (the “Communications Act”). We are currently exempt from certain costly interconnection requirements imposed on larger incumbent local telephone companies by the Communications Act. Although this exemption helps us maintain a strong competitive position, we have direct competition in the majority of our RLEC markets, primarily where a cable provider also serves the same market. In addition, the leading wireless carriers have deployed their networks to serve our markets.
In Maine, Massachusetts and New Hampshire, our facilities-based CLEC serves primarily business and enterprise customers, utilizing both owned and leased fiber as its backbone network. After two decades of operations, the CLEC serves over 2,400 business and enterprise customers.
Acquisitions have represented a significant part of our growth. From 1999 to 2003, we acquired four contiguous RLECs in north central Alabama. In 2004, we acquired an RLEC in central Missouri. In 2006, we acquired an RLEC adjacent to Bangor, Maine, and a CLEC serving the state of Maine. In 2008, we acquired RLECs adjacent to Portland, Maine, in western Massachusetts and southern West Virginia, as well as two CLECs serving customers in Maine and New Hampshire. In 2011, we acquired an RLEC in western Vermont. In 2014, we acquired the assets of Reliable Networks of Maine, LLC, a Portland, Maine-based provider of cloud hosting and managed services for companies who rely on mission-critical software applications. The acquisition expanded our CLEC service offerings to include multi-tenancy hosting of vendor-agnostic email, database, web and industry vertical software applications, as well as related professional engineering services (collectively, “managed services”).
Our internet address is http://www.Otelco.com. The information contained on our website is not part of, and is not incorporated in, this report or any other report we file with or furnish to the Securities and Exchange Commission (the “SEC”).
The following table reflects the percentage of total revenues derived from each of our service offerings for the year ended December 31, 2019:
Revenue Mix
Local Services
We are the sole provider of wireline voice telephone services in three of the eleven RLEC territories we serve. In seven territories, the incumbent cable provider also offers local services in portions of these territories. In Missouri, a local electric co-operative also offers local services in a portion of our territory. Local services enable customers to originate and receive telephone calls. The amount that we can charge a customer for certain basic voice services in Alabama, Maine, Massachusetts, Missouri, Vermont and West Virginia is regulated by the Alabama Public Service Commission (the “APSC”), the Maine Public Utilities Commission (the “MPUC”), the Massachusetts Department of Telecommunications and Cable (the “MDTC”), the Missouri Public Service Commission (the “MPSC”), the Vermont Public Utilities Commission (the “VPUC”) and the West Virginia Public Service Commission (the “WVPSC”), respectively. We also have authority to provide service in New Hampshire from the New Hampshire Public Utilities Commission (the “NHPUC”). The regulatory involvement in pricing varies by state and by type of service. In recent years, state commissions have relaxed price regulation of most of our services.
Revenue derived from local services includes monthly recurring charges for voice lines providing local dial tone and calling features, including caller identification, call waiting, call forwarding and voicemail. We also receive revenue for providing long distance services to our customers and directory advertising. We provide local services on a retail basis to residential and business customers. With the high level of acceptance of local service bundles, a significant percentage of our customers receive a broad range of bundled services for a single, fixed monthly price.
We offer long distance telephone services to our RLEC local telephone customers. We provide long distance services on our own facilities or through services purchased from various network service providers. The majority of our RLEC voice customers also utilize our long distance services. Our long distance business is an integral part of the bundles of services we provide to our RLEC customers.
In Maine, Massachusetts and New Hampshire, our CLEC provides communications services tailored to business and enterprise customers, including specialized data and voice network configurations, to support their unique business requirements. Our fiber network allows us to offer our customers affordable and reliable voice and data solutions to support their business requirements and applications.
Network Access
Network access revenue relates primarily to services provided by us to long distance carriers in connection with their use of our facilities to originate and terminate interstate and intrastate long distance, or toll, telephone calls. As toll calls are generally billed to the customer originating the call, network access charges are applied in order to compensate each telecommunications company providing services relating to the call. Network access charges apply to both interstate and intrastate calls. Until December 31, 2016, all eleven of our RLECs received Interstate Common Line Support (“ICLS”) and revenue from the Universal Service Fund (the “USF”), and three of our RLECs also received Universal Service Fund High Cost Loop (“USF HCL”) revenue. This revenue is included in our reported network access revenue. Beginning January 1, 2017,
ICLS and USF HCL funding was replaced by Alternative Connect America Model (“A-CAM”) funding for ten of our RLECs. Our Vermont RLEC, which did not qualify for A-CAM because it had already deployed fiber to parts of its network, continued to receive USF HCL, and a revised form of ICLS called Connect America Fund Broadband Loop Support (“CAF BLS”), through December 31, 2018.
In December 2018, the FCC issued an order which revised the A-CAM program (“A-CAM II Order”). A-CAM II changed the broadband buildout requirements from speeds of 10/1 to 25/3 Mbps, provided additional funding for the higher speeds and extended the time for completing the buildout by two years. Accordingly, existing Otelco A-CAM participants became eligible for additional funding and extended their buildout period by two years. In addition, our Vermont RLEC qualified for participation in A-CAM II and elected to give up its CAF BLS support in exchange for A-CAM II funding. The A-CAM II support was effective on January 1, 2019.
Intrastate Access Charges. We generate intrastate access revenue when a long distance call, involving a long distance carrier, is originated and terminated within the same state. The interexchange carrier pays us an intrastate access payment for either terminating or originating the call. We record the details of the call through our carrier access billing system. Our access charges for our intrastate access services were historically set by state regulatory commissions. The Federal Communications Commission (the “FCC”) issued its intercarrier compensation order in October 2011 (the “FCC ICC Order”). The FCC ICC Order preempted the state commissions’ authority to set terminating intrastate access service rates. The FCC required companies with terminating access rates higher than interstate rates to reduce their terminating intrastate access rates to a rate equal to interstate access service rates by July 1, 2013, and to move to a “bill and keep” arrangement by July 1, 2020, which will eliminate terminating access charges between carriers. The FCC ICC Order also created the Connect America Fund (the “CAF”) to offset the RLECs’ resulting loss in intrastate terminating access revenues, but limited the yearly amount recovered to 95% of the previous year’s revenue requirement. There is no recovery mechanism for the lost revenue in our CLEC.
Interstate Access Charges. We generate interstate access revenue when a long distance call originates from an area in a state served by one of our local exchange carriers and terminates outside of that state, or vice versa. We bill interstate access charges in a manner similar to intrastate access charges. Our RLEC interstate access charges are regulated by the FCC through our participation in tariffs filed by John Staurulakis Inc. The FCC regulates the prices local exchange carriers charge for access services in two ways: price caps and rate-of-return. All of our RLECs are rate-of-return carriers for purposes of interstate network access regulation. Interstate access revenue for rate-of-return carriers for non-FCC ICC Order elements is based on an FCC regulated rate-of-return on investment and recovery of operating expenses and taxes, in each case solely to the extent related to interstate access. From 1990 through June 2016, the rate-of-return had been authorized up to 11.25%. In March 2016, the FCC reduced the authorized rate-of-return to 9.75% (effective July 1, 2021), using a transitional approach to reduce the impact of an immediate reduction. On July 1, 2016, the rate-of-return transition began with the authorized rate reduced to 11.0%, with further 25 basis points reductions each July 1 thereafter until the authorized rate reaches 9.75% on July 1, 2021. The FCC requires terminating interstate access rates to move to a “bill and keep” arrangement by July 1, 2020, which will eliminate access charges between carriers. Initial reductions in interstate access rates began July 1, 2012, with additional reductions on July 1 of each year through July 1, 2020. The CAF provides recovery of terminating interstate access revenues. This recovery is limited to 95% of the previous year’s revenue requirement and excludes CLECs.
Transition Service Fund Revenue. Our four Alabama RLECs recover a portion of their costs through the Transition Service Fund (the “TSF”), which is administered by the APSC. All interexchange carriers originating calls in Alabama contribute to the TSF on a monthly basis, with the amount of each carrier’s contribution calculated based upon its relative originating minutes of use compared to the aggregate originating minutes of use for all telecommunication carriers participating in the TSF. The TSF reduces the vulnerability of our Alabama RLECs to a loss of access and interconnection revenue. TSF payments are received monthly. Negotiations to eliminate TSF payments in Alabama were completed in August 2015. TSF payments will be phased out over a five-year period that began in June 2016 and will end in June 2021. The reduction in the TSF was 5% in each of 2016 and 2017 and 10% in 2018 and will be 15% in each of 2019 and 2020.
Maine Universal Service Fund. One of our three Maine RLECs recovers a portion of its costs through the Maine Universal Service Fund (the MUSF”), which is administered by the MPUC. All local and interexchange carriers in Maine contribute to the MUSF on a monthly basis, with the amount of each carrier’s contribution calculated based upon a percentage of retail intrastate revenues. The MUSF was created to support RLEC universal service goals in response to legislative mandates to reduce intrastate access rates, expand local calling areas and cap local service rates.
Internet
We provide a variety of internet data services to our customers, including bulk broadband data to support large corporate enterprise users and digital high-speed data lines in varying capacity speeds for business and residential use. Digital high-speed data services are provided via fiber to the premise; fiber to the node; digital subscriber line (“DSL”); cable modems; and wireless broadband, depending upon the location in which the service is offered, and via dedicated fiber connectivity to larger business customers. With the expansion of our RLEC fiber network, the upgrade of our cable network to DODSIS 3.1 and the standardization on VDSL throughout our network, approximately 75% of the RLEC territory will be able to have from 50 mps to gigabit capability by the end of 2020. We charge our internet customers a flat rate for unlimited usage and a premium for higher speed internet services. We are able to provide digital internet data lines to virtually all of our RLEC customers and all of our CLEC customers. Under A-CAM, we have specific requirements to expand the availability of higher broadband speeds to our customers and expect to invest in our network to meet or exceed those requirements in the timeframes required by the FCC.
Transport Services
Our CLEC receives monthly recurring revenues for the rental of fiber to transport data and other telecommunication services in Maine and New Hampshire from businesses and telecommunication carriers over our fiber network. Large business, education and government customers in our RLEC are also served from our fiber-based network.
Video and Security
We provide cable television services, including high definition, digital video recording capability and pay- per-view programming, over networks with 750 MHz of transmission capacity or by Internet Protocol television (“IPTV”) in our Alabama service area. We offer digital signals, high-definition program content and digital video recording capability through both our traditional cable plant and IPTV. In 2020, our cable network will be upgraded to DOCSIS 3.1, enabling customers to have up to gigabit speed internet services. Our cable television packages offer up to 200 channels. We are a licensed installer of security equipment in Alabama. We offer wireless security systems in Alabama and Missouri and monthly monitoring of security systems through a third-party monitoring company.
Managed Services
We provide private/hybrid cloud hosting services, as well as consulting and professional IT engineering services, for mission-critical software applications used by small and mid-sized North American companies. Revenues are generated from monthly recurring hosting fees, commonly referred to as Infrastructure as a Service (“IaaS”), monthly maintenance fees, à la carte professional engineering services and pay-as-you-use Software as a Service (“SaaS”). Services are domiciled in two diverse Company-owned data centers.
Network Assets
Our telephone networks include carrier-grade advanced switching capabilities provided by both traditional digital and software-based switches; fiber rings and routers; and network software supporting specialized business applications, all of which meet industry standards for service integrity, redundancy, reliability and flexibility. Our networks enable us to provide traditional and Internet Protocol (“IP”), wireline telephone services and other calling features; long distance services; digital internet services through DSL, cable modems and dedicated circuits; and specialized customer specific applications.
Sales, Marketing and Customer Service
In Maine, Massachusetts, New Hampshire, Vermont and West Virginia, our RLECs and CLEC historically provided services under the brand names “OTT Communications” and “Reliable Networks.” However, beginning in 2018, all services were rebranded under the brand name “Otelco.” Our CLEC competes with the incumbent carriers throughout each state, as well as with other competitive communications providers, utilizing both an employee and agent sales force. Service configurations are tailored to meet specific customer requirements, utilizing customer designed voice and data telecommunications configurations. Increased service monitoring for business customers is provided through a state of the art network operations center and serves as a differentiator for our offers. We offer an IP-based Hosted Private Branch Exchange service (“HPBX”) that provides industry-leading capability for our customers, as well as cloud hosting and professional engineering services.
Our RLEC marketing approach emphasizes locally managed, customer-oriented sales, marketing and service. We believe that we are able to differentiate ourselves from any competition by providing a superior level of service in our territories. Each of our RLECs has a long history in the communities it serves, which has helped to enhance our reputation among local residents by fostering familiarity with our products and level of service. Our customer service representatives are local residents and often have a direct connection to their communities, which we believe further improves customer satisfaction. We also build upon our strong reputation by participating in local activities, such as local fundraising and charitable events for schools and community organizations and, in Alabama, by airing local interest programs on our local access community cable channels.
Part of our strategy is to increase customer loyalty and strengthen our brand name by deploying new technologies, adding fiber to our distribution network, and offering comprehensive bundling of services, including digital high-speed internet access, cable television, unlimited long distance and a full array of calling features. In addition, our ability to provide our customers with a single, unified bill for all of our RLEC and CLEC services is a competitive advantage and helps to enhance customer loyalty.
Competition
Local Services
We believe that many of the competitive threats to wireline telephone companies are not as significant in portions of our RLEC service areas as in more urban areas. The demographic characteristics of rural telecommunications markets generally require significant capital investment to offer competitive wireline telephone services with low potential revenues. However, our RLECs face wireline telephone competition in the majority of our markets from a cable company or electric co-operative offering telephone and data services. New market entrants, such as providers of satellite broadband, and indirect competition, such as providers of voice over IP (“VoIP”), have also gained greater acceptance over time.
We currently qualify for the federal rural exemption from certain interconnection obligations that support industry competition, including obligations to provide services for resale at discounted wholesale prices and to offer unbundled network elements. If the exemption were terminated by a state commission, then our RLECs could face additional competition.
In all of our markets, we face competition from wireless carriers. We have experienced a decrease in voice lines as a result of customers switching their residential wireline telephone service to a wireless service. A portion of the wireless technology threat to our business is reduced, due in part to the topography of some of our telephone territories, which can result in inconsistent wireless coverage in some areas. Nevertheless, as wireless carriers continue the deployment of newer technologies in our territories, we expect to experience increased competition from these carriers.
The long distance market remains competitive in all of our RLEC territories. We compete with wireless carriers and other service providers. However, we believe that our service bundling that includes long distance, our long-standing local presence in our territories and our ability to provide a single, unified bill for all of our services are competitive advantages. The majority of our customers have selected us for their long distance services as part of their overall package of services.
In Maine, Massachusetts and New Hampshire, we operate as a facilities-based CLEC in areas primarily served by Consolidated Communications (formerly FairPoint Communications) or Verizon. There are other competitors who serve these markets today as both facilities-based and resale carriers. Our focus has been on the small-to-medium size business customer with multiple locations and enterprise telecommunications requirements, where we offer a combination of knowledge, experience, competitive pricing and IP-based products to meet their specialized needs.
Internet
Competition in the provision of RLEC data lines and internet services currently comes from alternative digital high-speed internet service providers. Competitors vary on a market-to-market basis and include cable providers Charter Communications, Inc., under the Spectrum brand name (“Spectrum”), Comcast Corporation (“Comcast”) and Co-Mo Electric Cooperative, Inc. in Missouri, we provide wireless high-speed data lines to over 2,000 subscribers outside of our rural telephone services territory. Our CLEC customers are provided a variety of data service options based on their individual requirements.
Transport Services
Other local telephone companies, long distance carriers, cable providers, utilities, governments and industry associations deploy and sell fiber capacity to users. Existing and newly deployed capacity could affect market pricing. Multi-year contracts generally protect existing relationships and provide revenue stability. The cost of and time required for deploying new fiber can be a deterrent to adding capacity. We have expanded our fiber networks in Maine and Alabama to reach additional locations and serve incremental customers.
Video and Security
We offer cable television services in our Alabama territory. Cable services are delivered through traditional cable technology and IPTV. Spectrum provides cable service, passing about 30% of our RLEC Alabama telephone subscribers and approximately 60% of our RLEC Maine telephone subscribers. In Massachusetts, Comcast provides cable service, passing more than 90% of our telephone subscribers. In West Virginia, Shentel provides cable service, passing more than 98% of our telephone subscribers. In addition, we compete against digital broadcast satellite providers including DISH Network and AT&T’s DirecTV in our Alabama territory. Our broadband subscribers also have access to “Over The Top” entertainment services offered by numerous providers, such as Netflix and Hulu, including local broadcast channels in Vermont.
Managed Services
The managed services and cloud hosting market has numerous competitors from very large multi-dimensional companies such as Amazon, Microsoft, Google and IBM, to divisions of large telecommunications firms, to small operations serving specific local markets or industries. Our managed services offerings are focused on small and mid-sized companies who have mission-critical software applications that also need operational and design support for their applications.
Information Technology and Support Systems
We have an integrated software system that functions as both an operational support and a customer care/billing system. The system includes automated provisioning and service activation, mechanized line records and trouble reporting. These services are provided through the use of licensed third-party software, which has been tailored for our use by the vendor. The system will include detailed network and premise maps for all RLEC territories by the end of 2020.
We have implemented all currently established safeguards to Customer Proprietary Network Information as established by the FCC for telecommunications providers, and we are compliant with the “red flag” provisions of the Fair and Accurate Credit Transactions Act.
Environment
We are subject to various federal, state and local laws relating to the protection of the environment. We believe that we are in compliance in all material respects with all such laws. The environmental compliance
costs incurred by us to date have not been material, and we currently have no reason to believe that such costs will become material in the foreseeable future.
Employees
As of December 31, 2019, we employed 201 employees, 200 of which were full-time employees. None of our employees are members of, or are represented by, any labor union or other collective bargaining unit. We consider our relations with our employees to be good.
Item 1A.
Item 1A. Risk Factors
In evaluating our business, every investor should carefully consider the following risk factors. Our business, financial condition, results of operations and cash flows could be materially and adversely affected by any of the following risks. Our business operations could also be affected by additional risk factors that apply generally to companies, as well as other risks that are not presently known to us or that we currently consider to be immaterial.
The Telecommunications Industry Experiences Continuous Competition.
The market for telecommunication services is highly competitive. Currently, we have competition in eight of our markets from cable providers and an electric co-operative. Certain competitors benefit from brand recognition, financial, personnel and marketing resources and access to capital that are significantly greater than ours, which may also be affected by further industry consolidation. In addition, our relative size and the distance between our regional businesses makes it more difficult for us to achieve scale economies and efficiencies than certain of our competitors, which puts us at a competitive disadvantage and may lead to customer attrition. We cannot predict the number of new competitors that will emerge, especially as a result of existing or new federal and state regulatory or legislative actions. Increased competition from existing and new entities could have an adverse effect on our business, revenue and cash flow.
In all of our markets, we face competition from wireless carriers. As wireless carriers continue to build out and enhance their voice and data networks and add products and services targeted to the fixed wireless market, we may experience increased competition, which could have an adverse effect on our business, revenue and cash flow.
The current and potential competitors in our RLEC territories include cable television companies; electric utilities; CLECs and other providers of telecommunications and data services, including internet and VoIP service providers; wireless carriers; satellite television companies; alternate access providers; and neighboring incumbent local exchange carriers.
In Maine, New Hampshire and Massachusetts, our CLEC operations may encounter changes in the competitive landscape that would affect its continued ability to grow and/or retain customers, sustain current pricing plans and control the cost of access to incumbent carrier customers. Our CLEC leases a portion of its facilities, reducing its ability to adjust to price competition. A portion of these “last mile” facilities leased from the incumbent carrier can no longer be ordered for new customers and may become more expensive in February 2023, which would negatively impact our cost of service.
We provide our long distance services within our territories, primarily through bundling long distance with other local services and providing a single bill for these services. Carriers offering VoIP services continue to develop attractive new offerings. There can be no assurance that our local services revenue, including long distance services, will not decrease in the future due to competition and/or the introduction of new services by current and new competitors.
Changes in the Regulation of the Telecommunications Industry Could Adversely Affect Our Business, Revenue or Cash Flow.
We operate in an industry that is regulated at the federal, state and local level. The majority of our revenue has historically been supported by and/or subject to some level of regulation. Certain federal and state regulations and local franchise requirements have been, are currently, and may in the future be, the subject of judicial proceedings, legislative hearings and administrative proposals. Such proceedings may relate to, among
other things, federal and state universal service funds, the rates we may charge for our local, network access and other services, the manner in which we offer and bundle our services, the terms and conditions of interconnection, unbundled network elements and resale rates, and could change the manner in which telecommunications companies operate. The FCC ICC Order began significantly reducing access revenue received by us in July 2012. Subsequently, we accepted the FCC’s A-CAM offer for all of our eleven RLECs, which replaced USF HCL revenue for ten of those RLECs effective as of January 1, 2017, and one RLEC during 2019, requiring additional network capital expenditures. A-CAM support will decline over a twelve year period. In addition, there can be no assurances that recent FCC actions will not be changed in the future. Any such changes could adversely affect our business, revenue and cash flow.
If We Fail to Meet Our Broadband Deployment Obligations Under A-CAM, We May Lose All or Part of Our A-CAM Support.
On March 23, 2016, the FCC released an order, which adopted changes to the Universal Service programs, directed to preserve and advance voice and broadband service in areas served by rate-of-return carriers. The order provided qualifying rate-of-return carriers the option of receiving model-based support through A-CAM in lieu of legacy rate-of-return support through CAF BLS, formerly ICLS, and USF HCL. Ten of our RLECs qualified for A-CAM and elected to accept A-CAM support beginning in 2017. Our other RLEC became eligible for A-CAM in 2019 and elected to receive support beginning in January 2019. These elections are expected to provide A-CAM support through 2028. However, the A-CAM election includes specific broadband deployment obligations, including the number of locations to be capable of specific broadband speeds within certain eligible Census Blocks in our service areas. If we fail to meet these broadband deployment obligations, we may lose all or part of our A-CAM support, which would adversely affect our business, revenue and cash flow.
If We Continue to Lose Voice and Data Lines, Our Business and Results of Operations Will Likely Be Adversely Affected.
Our business generates revenue by delivering voice and data services. We have experienced net voice and data line loss in our markets due to wireless substitution, increased competition from organizations using different delivery technologies and the inability to offer increased data speeds for our customers driven by the nature of the Company’s primarily copper-based network. Without increased investment in fiber and other delivery technologies, we expect to continue to experience net voice and data line loss in our markets, which could impact our ability to fund continued investment in our network.
We Are Subject to Restrictive Debt Covenants That Limit Our Business Flexibility By Imposing Operating and Financial Restrictions on Our Operations.
Our credit facility contains certain covenants that, among other things, restrict our ability to take specific actions, which may limit our ability to invest in new services or respond to competitive forces, including, without limitation, restrictions on our ability to:
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incur certain liens;
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incur additional indebtedness;
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wind up, liquidate, merge, or consolidate with any other person or transfer or dispose of certain properties or assets;
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change the nature of our business;
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make certain types of restricted payments, including dividends on our common stock, investments and acquisitions;
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enter into specified transactions with affiliates; and
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enter into sale and leaseback transactions.
Future debt obligations may impose similar or other restrictive covenants.
Our credit facility also requires quarterly fixed principal payments and annual variable excess cash flow payments, which may limit cash available for our operations. In addition, our financial covenants may require the use of operating cash to pay outstanding debt and limit our ability to invest in our operations.
The interest rates of our term loans are set at a margin over an adjusted LIBOR rate.
LIBOR, the London interbank offered rate, is the basic rate of interest used in lending between banks on the London interbank market and is widely used as a reference for setting the interest rate on loans globally. Interest rates applicable to our term loans (including any incremental term loans incurred under the accordion feature) and the revolving loans (other than the swing line loans) under our credit facility are set at a margin over an adjusted LIBOR rate (which is defined as the higher of  (1) LIBOR multiplied by the statutory reserve rate and (2) 0.0% per annum) or a base rate (which is defined as the highest of  (a) the prime rate, (b) the federal funds effective rate plus 0.50% per annum, (c) the adjusted LIBOR rate for an interest period of one month plus 1.00% per annum, and (d) 0.0% per annum), at our option. Interest rates applicable to the swing line loans under our credit facility are set at a margin over the above-mentioned base rate.
On July 27, 2017, the United Kingdom’s Financial Conduct Authority, which regulates LIBOR, announced that it intends to phase out LIBOR by the end of 2021. It is unclear if at that time LIBOR will cease to exist or if new methods of calculating LIBOR will be established such that it continues to exist after 2021. The Alternative Reference Rates Committee, a steering committee comprised of large U.S. financial institutions convened by the U.S. Federal Reserve, has recommended the Secured Overnight Financing Rate (“SOFR”) as a more robust reference rate alternative to U.S. dollar LIBOR. SOFR is calculated based on short-term repurchase agreements, backed by Treasury securities. SOFR is observed and backward looking, which stands in contrast with LIBOR under the current methodology, which is an estimated forward-looking rate and relies, to some degree, on the expert judgment of submitting panel members. Given that SOFR is a secured rate backed by government securities, it will be a rate that does not take into account bank credit risk (as is the case with LIBOR). SOFR is therefore likely to be lower than LIBOR and is less likely to correlate with the funding costs of financial institutions. Whether or not SOFR attains market traction as a LIBOR replacement tool remains in question. As such, the future of LIBOR at this time is uncertain. In preparation for the potential phase out of LIBOR, we may need to renegotiate our financial obligations and derivative instruments that utilize LIBOR. However, these efforts may not be successful in mitigating the legal and financial risk from changing the reference rate in our legacy agreements. Furthermore, the discontinuation of LIBOR may adversely impact our ability to manage and hedge exposures to fluctuations in interest rates using derivative instruments.
We May Not Be Able to Integrate New Technologies and Provide New Services in a Cost-Efficient Manner.
The telecommunications industry is subject to rapid and significant changes in technology, frequent new service introductions, changes in pricing and evolving industry standards. Technological developments may reduce the competitiveness of our networks and require additional capital expenditures or the procurement of additional products that could be expensive and time consuming to install and integrate into our network. Our financial condition or the terms and conditions included in our credit facility may limit our ability to make additional capital expenditures or procure additional products. In addition, a substantive investment by a competitor in a new technology could challenge our position in the marketplace, as the services offered by our competitor arising out of new technology may reduce the attractiveness of our services. If we fail to adapt successfully to technological advances or fail to obtain access to new technologies, we could lose customers and be limited in our ability to attract new customers and/or sell new services to our existing customers. In addition, delivery of new services in a cost-efficient manner depends upon many factors, and we may not generate the revenue anticipated from such services.
Disruptions in Our Networks and Infrastructure May Cause Us to Lose Customers and Incur Additional Expenses.
To be successful, we will need to continue to provide our customers with reliable and timely service over our networks. We face the following risks to our networks and infrastructure:
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our territories could have significant weather events which physically damage network infrastructure, potentially disrupting our ability to provide service and potentially encouraging our customers to find alternative service providers;
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our rural geography creates the risk of security breaches, break-ins and sabotage;
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much of our equipment has long service lives, which could increase the frequency of malfunction and outage;
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our equipment, access and network interface suppliers could experience outages, delivery limitations or labor issues which could impact our ability to provide services to our customers;
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power surges and outages, computer viruses or hacking and software or hardware defects that are beyond our control; and
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unusual spikes in demand or capacity limitations in our or our suppliers’ networks.
Disruptions may cause interruptions in service or reduced capacity for customers, either of which could cause us to lose customers and/or incur expenses, and thereby adversely affect our business, revenue and cash flow. In addition, the APSC, MPUC, MDTC, MPSC, NHPUC, VPUC and/or WVPSC could require us to issue credits on customer bills for such service interruptions, further impacting revenue and cash flow.
Our Operating Activities Are Subject to Risks Caused by Misappropriation, Misuse, Leakage, Falsification and Accidental Release or Loss of Information Maintained in Our Information Technology Systems.
We operate critical infrastructure and our operating activities are subject to risks caused by misappropriation, misuse, leakage, falsification and accidental release or loss of information maintained in our information technology systems, including customer, personnel and vendor data. These risks could result from cyber-attacks, which may be committed by our employees or external factors operating in any geography, including jurisdictions where law enforcement measures to address such attacks are unavailable or ineffective, or by other means. Cyber-attacks against companies have increased in frequency, sophistication, scope and potential harm in recent years. Any preventive actions we have taken or may take to reduce the risks of cyber-attacks may be insufficient to repel or mitigate the effects of a cyber-attack in the future, and our resources available to take preventive actions in the future may be limited. We could be exposed to significant costs if any of the above risks were to materialize, and any of the events described above could impair our operations, damage the reputation and credibility of us and our business and have a negative impact on our revenues. Costs related to these risks could include incentives offered to existing customers to retain their business, increased expenditures on cyber security measures and the use of alternate resources, lost revenues from business interruption and litigation, which may be protracted in nature. We could also be required to expend significant capital and other resources to remedy any such security breach.
Our Business is Geographically Concentrated and Dependent on Regional Economic Conditions.
Our business is conducted primarily in north central Alabama, Maine, New Hampshire, western Massachusetts, central Missouri, western Vermont and southern West Virginia and, accordingly, our business is dependent upon the general economic conditions of these regions. There can be no assurance that future economic conditions in these regions will not impact demand for our services or cause residents or businesses to relocate to other regions, which may adversely impact our business, revenue and cash flow. There can also be no assurance that these regions will respond to market and economic changes in a similar nature to urban markets or other regional areas.
Our Success Depends on a Small Number of Key Personnel.
Our success depends on the personal efforts of a small group of skilled employees and senior management. The rural nature of much of our service area provides for a smaller pool of skilled telephone employees and increases the challenge of hiring employees. The loss of key personnel could have a material adverse effect on our financial performance.
Our Performance Is Subject to a Number of Economic and Non-Economic Factors That Are Beyond Our Control, Which We May Not Be Able to Predict Accurately.
There are factors that may be beyond our control that could affect our operations and business. Such factors include adverse changes in the conditions in the specific markets for our services, the conditions in the
broader market for telecommunication services, natural disasters and health emergencies, including earthquakes, fires, power outages, typhoons, floods, pandemics or epidemics such as the coronavirus and manmade events such as civil unrest, labor disruption, international trade disputes, international conflicts, terrorism, wars and critical infrastructure attacks and the conditions in the domestic and global economies, generally. Any of these events, among others, could materially and adversely affect our financial condition and operating results. For example, the coronavirus may impact the global economy or negatively affect various aspects of our business, including our workforce and demand for our services, which could impact our ability to deliver services to our customers and make it more difficult to meet our expectations and obligations.
Although our performance is affected by the general condition of the economy, not all of our services are affected equally. Voice revenue is generally linked to relatively consistent variables such as population changes, housing starts and general economic activity levels in the areas served. Data and cable television revenue is generally related to more variable factors, such as changing levels of discretionary spending on entertainment and the adoption of e-commerce and other online activities by our current or prospective customers. It is not possible for management to accurately predict all of these factors and the impact of such factors on our performance.
Changes in the competitive, technological and regulatory environments may also impact our ability to increase revenue and/or earnings from the provision of local wireline services. We may therefore have to place increased emphasis on developing and realizing revenue through the provision of new and enhanced services with higher growth potential. In such a case, there is a risk that these revenue sources, as well as our cost savings efforts through further efficiency gains, will not grow or develop at a fast enough pace to offset declines in local residential services. It is also possible that, as we invest in new technologies and services, demand for those new services may not develop. There can be no assurance that we will be able to successfully expand our service offerings through the development of new services, and our efforts to do so may have a material adverse effect on our financial performance.
Failure to Receive Approved Levels of FCC Support Funding Would Adversely Affect Our Business, Revenue and Cash Flow.
Beginning January 1, 2017, A-CAM replaced USF HCL for two of our three RLECS that had previously received USF HCL support payments, and the third RLEC continued to receive USF HCL and CAF BLS support payments through December 2018. On January 1, 2019 it qualified for, and began receiving, A-CAM II funding. The A-CAM and A-CAM II support requires us to make additional capital investments to build out our network to support the delivery of higher broadband speeds. If our participating RLECs do not receive the approved level of A-CAM or A-CAM II support from the FCC for any reason, our business, revenue and cash flow would be negatively affected.
The outcome of any future FCC proceedings and other regulatory or legislative changes could affect the amount of support that we receive, and could have an adverse effect on our business, revenue and cash flow. If a wireless or other telecommunication carrier receives ETC status in our service areas or even outside of our service areas, the amount of support we receive from the USF HCL could decline under current rules, and under some proposed USF HCL rule changes, could be significantly reduced.
USAC serves as the administrative agent to collect data and distribute funds for USF and in 2006, it began conducting High Cost Beneficiary audits, designed to ensure compliance with FCC rules and program requirements and to assist in program compliance. USAC randomly selects RLECs to be audited each year and several of our RLECs have been selected for one of these audits each year. In December 2016, four of our RLECs were selected for a payment quality assurance audit, which has since been completed with no material findings. USAC has issued a no further action determination letter for three of these audits and the fourth audit revealed an overpayment due to us, which we refunded to USAC in July 2017. If USAC determines in any future audit that any of our data submissions were incorrect, we could be required to return funds to USAC for the period under review, which would negatively affect our business revenue and cash flow.
If we fail to maintain proper and effective internal control over financial reporting, our ability to produce accurate and timely financial statements could be impaired, which could harm our operating results, investors’ views of us and, as a result, the value of our common stock.
Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, our management is required to report upon the effectiveness of our internal control over financial reporting. However, for so long as we remain a
“non-accelerated filer” for SEC reporting purposes, we intend to take advantage of certain exemptions from various SEC reporting requirements, including, but not limited to, not being required to comply with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act of 2002, which section would otherwise require us to annually obtain an audited opinion from our independent registered public accounting firm regarding the effectiveness of our internal control over financial reporting. If material weaknesses or deficiencies in our internal controls exist and go undetected or unremediated, our financial statements could contain material misstatements that, when discovered in the future, could harm our operating results, investors’ views of us and, as a result, the value of our common stock.
Item 1B.
Item 1B. Unresolved Staff Comments
None.
Item 2.
Item 2. Properties
Our properties consist primarily of land and buildings; central office, internet and cable equipment; computer software; telephone lines; and related equipment. Our telephone lines include aerial and underground cable, conduit, poles and wires. Our central office equipment includes digital and software-based switches, internet and other servers and related peripheral equipment. We own substantially all our real property in Alabama, Missouri, Vermont and West Virginia, including our corporate office. We primarily lease real property in Maine, Massachusetts and New Hampshire, including our primary office locations in Bangor, New Gloucester and Portland, Maine. As of December 31, 2019, our property and equipment consisted of the following (in thousands):
Item 3.
Item 3. Legal Proceedings
From time to time, we may be involved in various claims, legal actions and regulatory proceedings incidental to and in the ordinary course of business, including administrative hearings of the APSC, MPUC, MDTC, MPSC, NHPUC, VPUC and WVPSC relating primarily to rate making and customer service requirements. In addition, we may be involved in similar proceedings with interconnection carriers and the FCC. Currently, none of our legal proceedings are expected to have a material effect on our business.
Item 4.
Item 4. Mine Safety Disclosures
Not applicable.
Item X. Information About Our Executive Officers
The following table sets forth the names and positions of our executive officers, and their ages.
Name
Age
Position
Richard A. Clark
Chief Executive Officer, President and Director
Curtis L. Garner, Jr.
Chief Financial Officer and Secretary
Jerry C. Boles
Senior Vice President and Controller
Trina M. Bragdon
General Counsel, Assistant Secretary and Vice President - Human Resources and Regulatory
Richard A. Clark joined Otelco as our Chief Operating Officer in October 2018,was appointed as our President in May 2019 and as our Chief Executive Officer effective January 1, 2020, and was also appointed as a Director effective January 1, 2020. Prior to joining Otelco, Mr. Clark served as Executive Vice President and Chief Financial Officer at FirstLight Fiber (a fiber network service provider) from December 2016 until September 2018. From October 2013 until December 2016, he served as Executive Vice President and Chief Financial Officer of Oxford Networks until Oxford was acquired by FirstLight Fiber. Mr. Clark served as Senior Vice President and Chief Financial Officer of WAI Global (a global manufacturer and distributor of automotive aftermarket parts) from February 2011 through September 2013 and as Executive Vice President and Chief Financial Officer of Parts Depot, Inc. (a distributor of auto parts) from November 2005 through February 2011. He served in executive positions from 1995 through 2005 at various companies in financial and operating positions. Mr. Clark began his career at PriceWaterhouseCoopers from 1986 through 1995.
Curtis L. Garner, Jr. has served as our Chief Financial Officer and Secretary since February 2004. Prior to becoming our Chief Financial Officer, he provided consulting services to a number of businesses and not-for-profit organizations from October 2002. He served PTEK Holdings, Inc. (now known as Premiere Global) from November 1997 through September 2002 (including one year as a consultant), first as President of one of its divisions, and later as Chief Administrative Officer for another division. Prior thereto, he spent 26 years at AT&T Corp., retiring in 1997 as the Chief Financial Officer of the Southern and Southwestern Regions of AT&T Corp.’s consumer long distance business.
Jerry C. Boles became our Senior Vice President and Controller in July 2010. He joined Otelco in January 1999 as Vice President and Controller. Prior to joining Otelco, he was controller for McPherson Oil Company for 14 years. He also worked in public accounting for 10 years, is licensed as a CPA by the state of Alabama and is a member in good standing of the American Institute of Certified Public Accountants.
Trina M. Bragdon became General Counsel in March 2013 after having served as Director of Legal and Regulatory Affairs for four years. In August 2019, she was appointed to the additional position of Assistant Secretary and Vice President - Human Resources and Regulatory. Prior to joining Otelco, she spent 11 years at the Maine Public Utilities Commission as Director of Telecommunications Policy and 6 years practicing in the litigation department of Saul Ewing in Philadelphia, PA. She led the formation of the CLEC Association of Northern New England and served as its president for two years.
Officers are not elected for a fixed term of office but hold their position until a successor is named.
PART II
Item 5.
Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Market Information
Our certificate of incorporation currently authorizes two separate classes of common stock, our Class A common stock, par value $0.01 per share, and our Class B common stock, par value $0.01 per share. Our Class A common stock began trading on the Nasdaq Global Market, under the trading symbol “OTEL,” on May 28, 2013, following our emergence from bankruptcy. On May 16, 2014, the listing of our Class A common stock was transferred to the Nasdaq Capital Market. No shares of our Class B common stock are currently outstanding and no established trading market exists for our Class B common stock.
Holders
As of March 9, 2020, there were approximately 1,800 record holders of our Class A common stock and no holders of our Class B common stock.
Dividends
We did not declare or pay cash dividends on any shares of our common stock during 2018 or 2019. We currently intend to retain any earnings that we may have for investment in our business and reduction of our debt and therefore do not currently anticipate paying any cash dividends on our common stock in the foreseeable future.
Item 6.
Item 6.
Selected Financial Data
The following table sets forth our selected consolidated financial information. The consolidated financial information as of December 31, 2018, and 2019, and for each of the three years in the period ended December 31, 2019, has been derived from, and should be read together with, our audited consolidated financial statements and the accompanying notes included in Item 8, Financial Statements and Supplementary Data. The consolidated financial information as of December 31, 2015, 2016, and 2017, and for each of the two years in the period ended December 31, 2016, has been derived from our audited consolidated financial statements not included in this report. The consolidated financial information set forth below should be read in conjunction with, and is qualified in its entirety by reference to, Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, and our audited consolidated financial statements and related notes in Item 8, Financial Statements and Supplementary Data.
(1)
Excludes loan costs.
Item 7.
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Overview
General
Since 1999, we have acquired and operate eleven RLECs serving subscribers in north central Alabama, central Maine, western Massachusetts, central Missouri, western Vermont and southern West Virginia. We also operate a CLEC serving subscribers in Maine, Massachusetts and New Hampshire. Our services include a broad suite of communications and information services including local and long distance telephone services; internet and broadband data services; network access to other wireline, long distance and wireless carriers for calls originated or terminated on our network; other telephone related services; cloud hosting and professional engineering services for small and mid-sized companies who rely on mission-critical software applications;
digital high-speed transport services (in our New England market); and video and security (in some markets). We view, manage and evaluate the results of operations from the various telecommunications services as one company and therefore have identified one reporting segment as it relates to providing segment information.
The FCC released the FCC ICC Order in November 2011. This order has made and continues to make substantial changes in the way telecommunication carriers are compensated for serving high cost areas and for completing traffic with other carriers. We began seeing the significant impact of the FCC ICC Order to our business in July 2012, with additional impacts beginning in July 2013 and July 2014. The initial consequence to our business was to reduce access revenue from intrastate calling in Maine and other states where intrastate rates were higher than interstate rates. A portion of this revenue loss for our RLEC properties is returned to us through the CAF. There is no recovery mechanism for the lost revenue in our CLEC. The impact of the FCC ICC Order is expected to continue reducing our revenue and net income through 2020.
Support under the A-CAM model-based approach is higher than the estimated support which would have been received under legacy rate-of-return regulation. Without the A-CAM model-based support, in 2017 our RLECs would have seen a normal year-over-year funding decrease under USF HCL and the FCC’s Budget Control mechanism. A-CAM support requires additional investment in plant and equipment to reach target broadband speeds and covered locations. A-CAM support will decline through 2028 as the additional investment is completed.
The Tax Cuts and Jobs Act (the “Tax Act”) passed in December 2017 reduces our cash tax liability. Specifically, both the lower income tax rate and the extension of bonus depreciation under the Tax Act positively affect our federal tax requirements. The limitation on interest deductibility under the Tax Act is not expected to impact our tax liabilities.
The following discussion and analysis should be read in conjunction with our consolidated financial statements and the related notes included in Item 8, Financial Statements and Supplementary Data, and the other financial information appearing elsewhere in this report. The following discussion and analysis relates to our financial condition and results of operations on a consolidated basis.
Revenue Sources
We derive our revenues from six sources:
•
Local services. We receive revenues from providing local exchange telecommunication services in our eleven rural territories. In addition, we receive revenues on a competitive basis through both wholesale and retail channels throughout Maine, New Hampshire and western Massachusetts. These revenues include monthly subscription charges for basic service, calling beyond the local territory on a fixed price and on a per minute basis, local private line services and enhanced calling features, such as voicemail, caller identification, call waiting and call forwarding. We also receive revenues from directory advertising. A significant portion of our rural subscribers take bundled service plans which include multiple services, including unlimited domestic calling, for a flat monthly fee.
•
Network access. We receive revenues from charges established to compensate us for the origination, transport and termination of calls of long distance, wireless and other interexchange carriers. These include subscriber line charges imposed on customers and switched and special access charges paid by carriers. Switched access charges for long distance services within Alabama, Maine, Massachusetts, Missouri, New Hampshire, Vermont and West Virginia have historically been based on rates approved by the APSC, MPUC, MDTC, MPSC, NHPUC, VPUC and WVPSC, respectively, where appropriate. The FCC ICC Order preempted the state commissions’ authority to set terminating intrastate access service rates, and required companies with terminating access rates higher than interstate rates to reduce their terminating intrastate access rates to a rate equal to interstate access service rates by July 1, 2013, and to move to a “bill and keep” arrangement by July 1, 2020, which will eliminate access charges between carriers. The FCC ICC Order prescribes a recovery mechanism for the recovery of any decrease in intrastate terminating access revenues through the CAF for RLEC companies. This recovery is limited to 95% of the previous year’s revenue requirement. Interstate access revenue is based on an FCC-regulated rate-of-return on investment and recovery of expenses and taxes. From 1990 through June 2016, the rate-of-return had been authorized up to 11.25%. In March 2016, the FCC reduced the authorized rate-of-return to 9.75% effective July 1, 2021, using a transitional approach to reduce the
impact of an immediate reduction. Rate-of-return transition began on July 1, 2016, with the authorized rate reduced to 11.0%, with further 25 basis points reductions each July 1 thereafter until the authorized rate reaches 9.75% on July 1, 2021. Switched and special access charges for interstate and international services are based on rates approved by the FCC. We also receive revenue from the USF for the deployment of voice and broadband services to end-user customers. Since January 1, 2017, ten of our RLECs receive support payments through A-CAM. One RLEC received support payments through modified legacy rate-of-return support mechanisms for USF HCL and ICLS for 2017 and 2018 and A-CAM support payments for 2019.
•
Internet. We receive revenues from monthly recurring charges for digital high-speed data lines and ancillary services, such as web hosting and computer virus protection.
•
Transport services. We receive monthly recurring revenues for the rental of fiber to transport data and other telecommunication services in Alabama, Maine and New Hampshire.
•
Video and security. We offer basic, digital, high-definition, digital video recording and pay-per-view cable television services to a portion of our telephone service territory in Alabama, including IPTV. We offer wireless security systems and system monitoring in Alabama and Missouri.
•
Managed services. We provide private/hybrid cloud hosting services, as well as consulting and professional IT engineering services, for mission-critical software applications for small and mid-sized North American companies. Revenues are generated from monthly recurring hosting IaaS fees, monthly maintenance fees, à la carte professional engineering services and pay-as-you-use SaaS fees. Services are domiciled in two diverse owned data centers.
Customer Trends
The number of voice and data customer services we provide has an impact on our revenue stability. Reflecting a general trend in the RLEC industry, the number of rural residential voice customers we serve has been decreasing each year, while residential data lines and business voice and data lines have been more stable. We expect that this trend will continue and may be further influenced by competition from cable and co-operative electric providers in our RLEC properties and the availability of alternative telecommunications products, such as cellular and IP-based services. The growth of data lines and the increase in data speed requirements of our customer base partially offsets the loss of residential voice lines. Our ability to grow CLEC and RLEC business voice and data lines will have an important impact on our future revenues. The expansion of fiber-to-the premise and increased data speeds in the second half of 2019 has reduced the customer attrition rate to 0.5% in fourth quarter 2019 and data service decline to 0.1% in fourth quarter 2019. Due to the billing conversion in July 2018, historically consistent customer and service information is not available for 2017 and seven months of 2018.
Otelco Inc. - Key Operating Statistics
The following is a discussion of the major factors affecting our customer and services operating statistics:
Competition. We face competition from cable providers or electric co-operatives in the majority of our RLEC territories, which primarily affects our residential voice and data lines. We also experience residential
voice line losses to wireless carrier substitution. We have responded to competition by offering bundled service packages, which include unlimited domestic calling; features like voice mail and caller identification; data lines; and, where possible, television services. These service bundles are designed to meet the broader communications needs of our customers at industry competitive prices. There are a number of established competitive providers in our Maine, Massachusetts and New Hampshire CLEC markets. The effectiveness of our sales force, the pricing of our products and the market perception of the quality of our service are critical to our success in these markets.
Cyclical Economic and Industry Factors. We believe that changes in global economic conditions have and will continue to have an impact on our voice line count. The rural nature of much of the territory we serve delays both the negative and positive response to the economy’s impact on our customer base.
Our Rate and Pricing Structure
Our CLEC enterprise pricing is based on market requirements. We combine varying services to meet individual customer requirements, including technical support, and provide multi-year contracts that are both market sensitive for the customer and profitable for us. The MPUC, MDTC and NHPUC impose minimum requirements on all CLECs operating in their markets for reporting and for interactions with the various incumbent local exchange and interexchange carriers. These requirements provide wide latitude in pricing and delivery of services.
Our RLECs operate in six states and have limited regulation by the respective state regulatory authorities. The impact on pricing flexibility varies by state. In Maine and Vermont, our wholly-owned subsidiaries have obtained authority to implement pricing flexibility while remaining under rate-of-return regulation. Our rates for other services we provide, including cable, long-distance, data lines and high-speed internet access, are not price regulated. The market for competitive services, such as wireless, also affects the ability to adjust prices. With the increase of bundled services offerings, including unlimited long distance, pricing for individual services takes on reduced importance to revenue stability. We expect this trend to continue into the immediate future.
Alabama RLECs have state service funds, which were implemented more than a decade ago as part of balancing local service pricing and long distance access rates. These funds were intended to neutralize the revenue impact on state RLECs from pricing shifts implemented to reduce access rates over time. The Alabama Transition Service Fund provided total compensation of  $0.3 million for the years ended December 31, 2017 and 2018, and $0.2 million for the year ended December 31, 2019, representing approximately 0.5%, 0.5% and 0.4% of our total revenue for the years ended December 31, 2017, 2018 and 2019, respectively. The revenue we receive from these funds is in the process of being phased out over a five-year period that began in June 2016. Reduction in fund revenue was 5% in each of 2016 and 2017, 10% in 2018, and 15% in each of 2019 and 2020. No revenue will be received after June 2021.
Categories of Operating Expenses
Our operating expenses are categorized as cost of services; selling, general and administrative expenses; and depreciation and amortization.
Cost of services. This includes expenses for salaries, wages and benefits relating to plant operation, maintenance, sales and customer service; other plant operations, maintenance and administrative costs; network access costs; and costs of services for long distance, cable television, internet and directory services.
Selling, general and administrative expenses. This includes expenses for salaries, wages and benefits and contract service payments (for example, legal fees) relating to engineering, financial, human resources and corporate operations; information management expenses, including billing; allowance for uncollectible revenue; expenses for travel, lodging and meals; internal and external communications costs; insurance premiums; stock exchange and banking fees; and postage.
Depreciation and amortization. This includes depreciation of our telecommunications, cable and internet networks and equipment, and amortization of intangible assets. Certain of these amortization expenses continue to be deductible for tax purposes.
Our Ability to Control Operating Expenses
We strive to control expenses in order to maintain our operating margins. As our revenue continues to shift to non-regulated services and CLEC customers, and our access and residential RLEC revenues continue to decline, operating margins decrease due to the lower margins associated with non-regulated services. Reductions in USF and intercarrier compensation payments based on FCC action in 2011 are difficult to fully offset through expense control and pricing action. However, A-CAM began providing support funding to increase capital investment in broadband services in our RLECs in 2017.
Results of Operations
The following discussion and analysis of our Results of Operations includes comparisons of our results for the year ended December 31, 2019 with the year ended December 31, 2018. For a similar discussion that compares our results for the year ended December 31, 2018 with the year ended December 31, 2017, see Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Results of Operations in Part II of our 2018 Annual Report on Form 10-K.
Year Ended December 31, 2019, Compared to Year Ended December 31, 2018
Total Revenues. Total revenues decreased 5.0% in 2019 to $62.8 million from $66.1 million in 2018. The table below provides the components of our revenues for 2019 compared to 2018.
Local services. Local services revenue in 2019 decreased 7.8% to $19.3 million from $20.9 million in 2018. Local and related service revenue, including directory revenue, decreased $0.7 million and long distance revenue decreased $0.5 million in 2019 compared to 2018, reflecting the decline in residential voice lines and the impact of the FCC ICC Order. Fiber and ethernet revenue decreased $0.2 million and customer special line fees decreased $0.2 million.
Network access. Network access revenue in 2019 decreased 2.1% to $21.2 million from $21.7 million in 2018. A-CAM revenue increased $1.1 million while CAF revenue decreased $0.7 million in 2019 compared to 2018. Switched and special access revenue decreased $0.5 million and transition support payments decreased $0.3 million as part of the FCC ICC Order. End-user based charges, including USF fees, decreased $0.1 million during the same period from lower residential voice customers.
Internet. Internet revenue in 2019 decreased 3.8% to $14.6 million from $15.2 million in 2018. Business and government fiber revenue of  $0.5 million in 2018 is reflected in transport services revenue in 2019. Market pricing and customer churn accounted for a decrease of  $0.1 million.
Transport services. Transport services revenue in 2019 decreased 11.3% to $4.2 million from $4.8 million in 2018. Business and government fiber revenue of  $0.5 million formerly included in internet revenue in 2018 accounted for an increase of  $0.5 million. The loss of CLEC customers and pricing of wide area network services accounted for a decrease of  $1.0 million.
Video and security. Video and security revenue in 2019 decreased 3.2% to $2.7 million from $2.8 million in 2018. A decrease in digital cable subscribers and pay-per-view was partially offset by an increase in IPTV subscribers.
Managed services. Managed services revenue in 2019 decreased 2.0% to remain at $0.6 million compared to 2018. Higher professional services revenue was offset by lower cloud hosting revenue during the period.
Operating expenses. Operating expenses decreased 0.7% in 2019 to $47.9 million from $48.3 million in 2018. The table below provides the components of our operating expenses for 2019 compared to 2018.
Cost of services. Cost of services decreased 1.7% to $30.1 million in 2019 from $30.6 million in 2018. Decreases in cost of toll and access expense of  $0.2 million, circuit expense of  $0.2 million and HPBX expense of  $0.1 million accounted for the change.
Selling, general and administrative expenses. Selling, general and administrative expenses decreased 2.4% to $10.2 million in 2019 from $10.5 million in 2018. The transition and conversion expense associated with implementing the company-wide billing and operations support system of  $0.5 million in 2018 had no comparable expense in 2019. Uncollectible revenue decreased by $0.3 million and other general and administrative expenses decreased by $0.2 million. These reductions in expense were partially offset by increases in Board projects of  $0.2 million and a change in our senior management bonus plan to a cash-based plan in 2019 from a cash-based and stock-based plan in 2018 of  $0.5 million.
Depreciation and amortization. Depreciation and amortization increased 5.7% to $7.6 million in 2019 from $7.2 million in 2018. RLEC depreciation increased $0.3 million, reflecting growth in fiber investment. Depreciation on the newly-completed integrated billing and operations support accounted for the balance of the increase in depreciation.
Interest expense. Interest expense decreased 9.8% in 2019 to $5.3 million from $5.9 million in 2018. Lower interest rates on our current credit facility and lower outstanding principal balance accounted for a decrease of  $0.5 million. Lower amortization of loan cost and lower cost associated with the purchase of a two-year 3% interest rate cap on $45.0 million of debt in 2018 decreased costs $0.1 million.
Other income. Other income increased 134.2% in 2019 to $0.6 million from $0.3 million in 2018. Higher dividends from CoBank accounted for the increase.
Income tax expense. The provision for income tax decreased 12.8% to $2.4 million in 2019 from $2.7 million in 2018. The effective income tax rate was 23.5% and 22.5% for 2019 and 2018, respectively.
Net income. As a result of the foregoing, there was net income of  $7.8 million in 2019 compared to $9.5 million in 2018.
Liquidity and Capital Resources
The following discussion and analysis of our Liquidity and Capital Resources includes comparisons of our cash flows for the year ended December 31, 2019 with the year ended December 31, 2018. For a similar discussion that compares our cash flows for the year ended December 31, 2018 with the year ended December 31, 2017, see Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources in Part II of our 2018 Annual Report on Form 10-K.
Our liquidity needs arise primarily from: (i) principal and interest payments related to our credit facility; (ii) capital expenditures for investment in our business, including A-CAM requirements; and (iii) working capital requirements. Historically, we have satisfied our operating cash requirements from the cash generated by our business and utilized borrowings under our credit facilities to support larger acquisitions. For the year ended December 31, 2019, we generated cash from our business to invest in additional property and equipment; pay scheduled principal payments on our credit facility; and pay interest on our debt. Cash decreased from $4.7 million at December 31, 2018, to $3.1 million at December 31, 2019. During 2019, we reduced the balance of our notes payable by $4.3 million from $74.5 million as of December 31, 2018, to $70.2 million as of December 31, 2019. Our credit facility requires annual principal reduction of  $4.3 million paid equally on a quarterly basis and an annual principal payment equal to 50% of our excess cash flow for the year. We utilized our voluntary prepayments made during 2018 to offset the excess cash flow payment due in March 2019.
Cash flows from operating activities for 2019 were $15.5 million compared to $20.8 million for 2018, primarily reflecting lower net income and an increase in materials and supplies supporting our increase in investment in property and equipment.
Cash flows used in investing activities for 2019 were $12.4 million compared to $8.0 million for 2018, reflecting the acquisition and construction of property and equipment in both years, including building fiber to support our A-CAM build requirements and customer demand for increased internet speeds.
Cash flows used in financing activities for 2019 were $4.6 million compared to $11.7 million for 2018, primarily reflecting costs associated with the voluntary debt prepayments made in 2018.
We do not use financial instruments as part of our business strategy. However, our new credit facility requires that we maintain an interest rate hedge on at least 50% of our outstanding notes payable balance for a period of at least two years. Accordingly, we purchased a two-year 3.0% interest rate cap on one-month LIBOR covering $45.0 million on February 26, 2018. The interest rate cap was not treated under the hedge accounting option and had no material value as of December 31, 2019, reflecting lower LIBOR interest rates.
We also have received patronage shares, primarily from one of our bank lenders, over a period of years for which there is a limited market to determine value until the shares are redeemed by the issuing institution. Historically, these shares have been redeemed at a value similar to their issued value. In 2017, we received $0.2 million for equity retirement of patronage shares, the fifth such retirement since we became a publicly traded company. During the period from February 2016 through October 2017, under our prior credit facilities, the issuing institution no longer provided patronage shares to us, as it was not a lender under either facility, and was expected to repatriate the remaining shares over the next nine years. Our new credit facility is with the same issuing institution. Accordingly, we began receiving dividends in cash and patronage shares in 2018. However, our patronage shares will no longer be redeemed until we reach the required holding level of patronage shares, which is likely to be several years in the future.
In 2016, we entered into a senior credit facility, providing for a five-year term loan facility in the aggregate principal amount of  $85.0 million and a five-year $5.0 million revolving credit facility, and a new subordinated credit facility, providing for a five and a half-year term loan facility in the aggregate principal amount of $15.3 million, which facilities replaced a prior credit facility that was scheduled to mature on April 30, 2016. On November 2, 2017, we replaced both of the credit facilities that we entered into in 2016 with a new five-year credit facility, providing for a term loan facility in the aggregate principal amount of  $87.0 million, a $5.0 million revolving credit facility, and an incremental term loan facility in an aggregate principal amount of up to $20.0 million, subject to the satisfaction of certain conditions and lender participation. See Item 8, Financial Statements and Supplementary Data - Note 7, Notes Payable, for additional information about our current credit facility with CoBank, ACB, and Management’s Discussion and Analysis of Financial Condition and Results of Operations - Subsequent Events for additional information about recent amendments to the credit agreement. The interest under the current credit facility will increase 0.25% in 2020 based on leverage as of December 31, 2019.
We anticipate that operating cash flow, together with borrowings under our revolving credit facility, will be adequate to meet our currently anticipated operating and capital expenditure requirements for at least the next 12 months. Our indebtedness levels have been reduced each year and the related debt service requirements have been reduced with our current credit facility. The Tax Act reduced our cash income taxes beginning with the 2017 tax year. These factors assist us in meeting our capital expenditure requirements under A-CAM. However, as a result of our capital expenditure requirements under A-CAM, we may not retain a sufficient amount of cash to finance growth opportunities or unanticipated capital expenditure needs or to fund our operations in the event of a significant business downturn. We may have to forego growth opportunities or capital expenditures that would otherwise be necessary or desirable if we do not find alternative sources of financing. If we do not have sufficient cash for these purposes, our financial condition and our business will suffer.
We use consolidated earnings before interest, taxes, depreciation and amortization, which we refer to as Consolidated EBITDA, and the ratio of our debt, net of cash, to Consolidated EBITDA for the last twelve months, which we refer to as the Leverage Ratio, as operational performance measurements. Consolidated EBITDA, as presented in this report, corresponds to the definition of Consolidated EBITDA in our credit facility. Consolidated EBITDA and the Leverage Ratio, as presented in this report, are supplemental measures of our performance that are not required by, or presented in accordance with, accounting principles generally accepted in the United States, which we refer to as U.S. GAAP. The lender under our credit facility uses Consolidated EBITDA to determine compliance with credit facility requirements. We report
Consolidated EBITDA and the Leverage Ratio in our quarterly earnings press release to allow current and potential investors to understand these performance metrics and because we believe that they provide current and potential investors with helpful information with respect to our operating performance, including our ability to generate earnings sufficient to service our debt, and enhance understanding of our financial performance and highlight operational trends. However, Consolidated EBITDA and the Leverage Ratio should not be considered as an alternative to net income or any other performance measures derived in accordance with U.S. GAAP. Our presentation of Consolidated EBITDA and the Leverage Ratio may not be comparable to similarly titled measures used by other companies. Consolidated EBITDA for the years ended December 31, 2019, and 2018, and its reconciliation to net income, is reflected in the table below:
The table below provides the calculation of the Leverage Ratio, net of cash, as of December 31, 2019 (dollar amounts in thousands).
Off-Balance Sheet Arrangements
We have no off-balance sheet arrangements.
Critical Accounting Policies and Accounting Estimates
The process of preparing consolidated financial statements requires us to use of estimates that affect the reported amounts of assets, liabilities, revenues and expenses. These estimates are based on our historical experience and current facts and circumstances, combined with various assumptions which we believe are reasonable in today’s understanding of our business, the results of which form the basis for making estimates about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. Certain of our accounting policies are considered critical as they are both important to the portrayal of our financial statements and require significant or complex judgment on the part of management. See Item 8, Financial Statements and Supplementary Data - Note 2, Summary of Significant Accounting Policies, for a description of our critical accounting policies and estimates. We believe that the following accounting estimates are the most critical to understanding and evaluating our reported financial results.
Intangible Assets and Goodwill
Our intangible assets, other than goodwill, consist primarily of the fair value of customer related intangibles, non-compete agreements and long-term customer contracts acquired in connection with previous
business combinations. The current value of these assets is $0.5 million, which will be fully amortized by December 31, 2021, and therefore does not represent a material estimation risk. See Item 8, Financial Statements and Supplementary Data - Note 3, Goodwill and Intangibles Assets, for a description of our intangible assets.
Goodwill is not amortized but instead evaluated for impairment annually or whenever an event occurs or circumstances change that would indicate potential impairment. The Company is evaluated as a single reporting unit. The carrying value of our goodwill at December 31, 2019, was $45.0 million on our Consolidated Balance Sheet from acquisitions since Otelco’s formation. The annual evaluation is conducted as of October 1 of each year by third party valuation experts, based on management projections of the performance of the business. Changes in the estimated trajectory of the performance of our business could materially impact the valuation of goodwill and potentially lower its value, negatively impacting net income. We had a sufficient margin in the projected value of the reporting unit compared to its carrying value to require no charge for impairment.
Depreciation
The calculation of depreciation expense is based upon the estimated useful lives of the underlying property and equipment. Depreciation expense of regulated property and equipment is computed principally using the straight-line method over the useful lives as determined by the relevant public utility commission in the state where the asset is place into service. Depreciation expense of unregulated property and equipment primarily employs the straight-line method utilizing industry standard estimated useful lives. A substantial portion of our assets have a useful life that exceeds ten years, Should the sources for our evaluation of the useful lives of plant and equipment change, we would adjust depreciation accordingly. A one year decrease in the estimated useful lives of our property and equipment would result in an increase of approximately $0.9 million in depreciation expense and a decrease of the same amount in net income. See Item 8, Financial Statements and Supplementary Data - Note 4, Property and Equipment for additional financial information.
Recently Adopted Accounting Pronouncements
See Item 8, Financial Statements and Supplementary Data - Note 2, Summary of Significant Accounting Policies - Recently Adopted Accounting Pronouncements, for a description of the recently adopted accounting pronouncements that are applicable to us.
Recent Accounting Pronouncements
See Item 8, Financial Statements and Supplementary Data - Note 2, Summary of Significant Accounting Policies - Recent Accounting Pronouncements, for a description of the recent accounting pronouncements that are applicable to us.
Subsequent Events
On March 2, 2020, we announced that our credit facility with CoBank, ACB, was amended to change the loan covenants, effective as of December 31, 2019. Among other things, the amendment to the New Credit Facility amends the financial covenants set forth in the New Credit Facility to: (i) remove the required minimum fixed charge coverage ratio; (ii) add a maximum annual aggregate capital expenditures covenant of $10.5 million for fiscal year 2020 and $10.0 million for each year fiscal year thereafter; (iii) modify the required maximum leverage ratio to the following maximum levels for each fiscal quarter end during the following periods (A) 3.50:1.00 for any fiscal quarter ending during the period from October 1, 2019 through March 30, 2021, (B) 3.25:1.00 for any fiscal quarter ending during the period from April 1, 2021 through December 31, 2021, and (C) 3.00:1.00 for any fiscal quarter ending on or after January 1, 2022; and (iv) add a new minimum debt service coverage ratio covenant of not less than 1.75:1.00, measured as of the end of each fiscal quarter. The executed amendment was filed on Form 8-K on March 3, 2020. See Item 8, Financial Statements and Supplementary Data - Note 7, Notes Payable, for additional information about our credit facility with CoBank, ACB.
Item 7A.
Item 7A.
Quantitative and Qualitative Disclosures about Market Risk
Our short-term excess cash balance is invested in short-term commercial paper. We do not invest in any derivative or commodity type instruments. Accordingly, we are subject to minimal market risk on our investments.
Interest rates applicable to the term loans (including any incremental term loans incurred under the accordion feature) and the revolving loans (other than the swing line loans) under our credit facility are set at a margin over an adjusted LIBOR rate (which is defined as the higher of  (1) LIBOR multiplied by the statutory reserve rate and (2) 0.0% per annum) or a base rate (which is defined as the highest of  (a) the prime rate, (b) the federal funds effective rate plus 0.50% per annum, (c) the adjusted LIBOR rate for an interest period of one month plus 1.00% per annum, and (d) 0.0% per annum), at our option. Interest rates applicable to the swing line loans under our credit facility are set at a margin over the above-mentioned base rate. Accordingly, we are exposed to interest rate risk. Based on the daily average amount of our outstanding variable rate debt during 2019, a one percentage point change in one-month LIBOR interest rates would have resulted in an increase of $0.7 million in our interest expense for the year ended December 31, 2019.
Item 8.
Item 8. Financial Statements and Supplementary Data
OTELCO INC.
CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Registered Public Accounting Firm
Shareholders and Board of Directors
Otelco, Inc.
Oneonta, Alabama
Opinion on the Consolidated Financial Statements
We have audited the accompanying consolidated balance sheets of Otelco Inc. (the “Company”) as of December 31, 2019 and 2018, the related consolidated statements of operations, stockholders’ equity (deficit), and cash flows for each of the three years in the period ended December 31, 2019, and the related notes (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company and subsidiaries at December 31, 2019 and 2018, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2019, in conformity with accounting principles generally accepted in the United States of America.
Basis for Opinion
These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s consolidated financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.
Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.
/s/ BDO USA, LLP
We have served as the Company’s auditor since 2004.
Atlanta, GA
March 9, 2020
OTELCO INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except share par values and share amounts)
The accompanying notes are an integral part of these consolidated financial statements.
OTELCO INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except share and per share amounts)
The accompanying notes are an integral part of these consolidated financial statements.
OTELCO INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (DEFICIT)
(in thousands, except share amounts)
The accompanying notes are an integral part of these consolidated financial statements.
OTELCO INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
The accompanying notes are an integral part of these consolidated financial statements.
OTELCO INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2019
1.
Nature of Business
Otelco Inc. (together with its consolidated subsidiaries, the “Company”) provides a broad range of telecommunication services on a retail and wholesale basis. These services include local and long distance calling; network access to and from the Company’s customers; data transport; digital high-speed internet access; cable and Internet Protocol television; other telephone related services; and cloud hosting and managed services. The principal markets for these services are business and residential customers residing in and adjacent to the exchanges the Company serves in Alabama, Maine, Massachusetts, Missouri, Vermont, and West Virginia and business customers throughout Maine and New Hampshire. The Company offers various communications services that are sold to economically similar customers in a comparable manner of distribution. The Company also offers cloud hosting and managed services for small and mid-sized companies who rely on mission-critical software applications. The majority of customers buy multiple services, often bundled together at a single price. The Company views, manages and evaluates the results of its operations from the various communications services as one company and therefore has identified one reporting segment as it relates to providing segment information.
Refinancings
The Company had a senior loan agreement (the “Senior Loan Agreement”), providing for a five year term loan facility in the aggregate principal amount of  $85.0 million and a five year $5.0 million revolving credit facility, and a subordinated loan agreement (the “Subordinated Loan Agreement”), providing for a five and a half year term loan facility in the aggregate principal amount of  $15.3 million. The Company borrowed $85.0 million under the term loan facility of the Senior Loan Agreement and $15.3 million under the Subordinated Loan Agreement. During second quarter 2017, the Company paid an amendment fee of $77.9 thousand to its senior lender under the Senior Loan Agreement to raise the capital expenditure limits under the Senior Loan Agreement to $8.5 million and $7.5 million for 2017 and 2018, respectively. The increased capital expenditures were necessary to fulfill build out requirements associated with the Federal Communications Commission’s (the “FCC’s”) Alternative Connect America Model (“A-CAM”) program.
On November 2, 2017, the Company refinanced the Senior Loan Agreement and the Subordinated Loan Agreement with a new $92 million, five-year credit facility from a consortium of banks led by CoBank, ACB (the “New Credit Facility”). The New Credit Facility includes an $87.0 million term loan and a $5.0 million revolving loan, which is undrawn. The New Credit Facility also includes a $20.0 million accordion feature that could be used to increase the term-loan portion of the New Credit Facility. Proceeds from the New Credit Facility and cash on hand were used to pay all amounts due in respect of principal, interest, prepayment premiums and fees under the Senior Loan Agreement and the Subordinated Loan Agreement, as well as fees associated with the transaction. The Company recorded costs of  $28 thousand and write-off of loan costs of $3.7 million in connection with this refinancing.
2.
Summary of Significant Accounting Policies
Basis of Presentation and Principles of Consolidation
The consolidated financial statements include the accounts of Otelco Inc. and its subsidiaries, all of which are either directly or indirectly wholly owned. These include: Blountsville Telephone LLC (“BTC”); Brindlee Mountain Telephone LLC; CRC Communications LLC; Granby Telephone LLC; Hopper Telecommunications LLC; Mid-Maine Telecom LLC; Mid-Maine TelPlus LLC; Otelco Mid-Missouri LLC and its wholly-owned subsidiary I-Land Internet Services LLC; Otelco Telecommunications LLC; Otelco Telephone LLC; Pine Tree Telephone LLC; Saco River Telephone LLC; Shoreham Telephone LLC (“STC”); and War Telephone LLC.
The accompanying consolidated financial statements include the accounts of Otelco Inc. and all of the aforesaid subsidiaries after elimination of all material intercompany balances and transactions.
Use of Estimates
The Company prepares its consolidated financial statements in accordance with accounting principles generally accepted in the United States of America, which require management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and disclosure of contingent assets and liabilities. The estimates and assumptions used in the accompanying consolidated financial statements are based upon management’s evaluation of the relevant facts and circumstances as of the date of the financial statements. Actual results may differ from the estimates and assumptions used in preparing the accompanying consolidated financial statements.
Significant accounting estimates include the recoverability of goodwill, identified intangibles, long-term assets, deferred tax valuation allowances and allowance for bad debt.
Regulatory Accounting
The Company follows the accounting for regulated enterprises, which is now part of Accounting Standards Codification (“ASC”) 980, Regulated Operations (“ASC 980”), as issued by the Financial Accounting Standards Board (the “FASB”). This accounting practice recognizes the economic effects of rate regulation by recording costs and a return on investment as such amounts are recovered through rates authorized by regulatory authorities. Accordingly, ASC 980 requires the Company to depreciate telecommunications property and equipment over the estimated useful lives approved by regulators, which could be different than the estimated useful lives that would otherwise be determined by management. ASC 980 also requires deferral of certain costs and obligations based upon approvals received from regulators to permit recovery of such amounts in future years. Criteria that would give rise to the discontinuance of accounting in accordance with ASC 980 include (1) increasing competition restricting the ability of the Company to establish prices that allow it to recover specific costs and (2) significant changes in the manner in which rates are set by regulators from cost-based regulation to another form of regulation. The Company periodically reviews the criteria to determine whether the continuing application of ASC 980 is appropriate for its rural local exchange carriers (“RLECs”). As of December 31, 2019, and 2018, 84.3% and 81.4%, respectively, of the Company’s net property, plant and equipment was accounted for under ASC 980.
The Company is subject to reviews and audits by regulatory agencies. The effect of these reviews and audits, if any, will be recorded in the period in which they first become known and determinable.
Intangible Assets and Goodwill
Intangible assets, other than goodwill, consist primarily of the fair values of customer related intangibles, non-compete agreements and long-term customer contracts acquired in connection with business combinations. Goodwill represents the excess of total acquisition cost over the assigned value of net identifiable tangible and intangible assets acquired through various business combinations, less any impairment. Due to the regulatory accounting required by ASC 980, the Company did not record acquired regulated telecommunications property and equipment at fair value as required by ASC 805, Business Combinations, through 2004. In accordance with 47 CFR 32.2000, the federal regulation governing acquired telecommunications property and equipment, such property and equipment is accounted for at original cost, and depreciation and amortization of property and equipment acquired is credited to accumulated depreciation.
The Company performs a quarterly review of its identified intangible assets to determine if facts and circumstances exist which indicate that the useful life is shorter than originally estimated or that the carrying amount of assets may not be recoverable. If such facts and circumstances do exist, the Company assesses the recoverability of identified intangible assets by comparing the projected undiscounted net cash flows associated with the related asset or group of assets over their remaining lives against their respective carrying amounts. Impairment, if any, is based on the excess of the carrying amount over the fair value of those assets.
ASC 350, Intangibles - Goodwill and Other (“ASC 350”), requires that goodwill be tested for impairment annually, unless potential interim indicators exist that could result in impairment. The Company performs an annual step 1 goodwill impairment test that compares the fair value of the reporting unit to the carrying amount. If the carrying amount exceeds the fair value, an impairment loss is recognized in an amount equal to that excess.
Revenue Recognition
Local services. Local services revenue for monthly recurring local services is billed in advance to a portion of the Company’s customers and in arrears to the balance of the customers. The Company records revenue for charges that have not yet been invoiced to its customers as unbilled revenue when services are rendered. The Company records revenue billed in advance as advanced billings and defers recognition until such revenue is earned. Long distance service is billed to customers in arrears based on actual usage. The Company records unbilled long distance revenue as unbilled revenue when services are rendered. Unlimited long distance in bundles is billed at a flat rate and recognized over the period of time the service is provided.
Network access. Network access revenue is derived from several sources. Revenue for interstate access services is received through tariffed access charges filed with the FCC. These access charges are billed by the Company to interstate interexchange carriers and retail voice customers. A portion of the access charge revenue received by the Company is based upon its actual cost of providing interstate access service, plus a return on the investment dedicated to providing that service. The balance of the access charge revenue received by the Company is based upon the nationwide average schedule costs of providing interstate access services. Rates for the Company’s competitive subsidiaries are set by FCC rule to be no more than the interconnecting interstate rate of the predominant local carrier. The Company also receives Connect America Fund (“CAF”) revenues from the Universal Service Administrative Company (“USAC”). The CAF revenues are known as Connect America Fund - Intercarrier Compensation (“CAF-ICC”), A-CAM, and Connect America Fund - Broadband Loop Support (“CAF-BLS”). CAF-ICC is based on the Company’s frozen traffic sensitive rate of return, less access charges billed to interexchange carriers and end user retail customers. A-CAM revenues are based on the FCC’s model, which calculates the cost to provide broadband services to rural areas of each state. All of the Company’s RLECs receive A-CAM revenues.
Revenue for intrastate access service is received through tariffed access charges billed by the Company to the originating intrastate carrier using access rates filed with the Alabama Public Service Commission (the “APSC”), the Maine Public Utilities Commission (the “MPUC”), the Massachusetts Department of Telecommunications and Cable (the “MDTC”), the Missouri Public Service Commission (the “MPSC”), the New Hampshire Public Utilities Commission (the “NHPUC”), the Vermont Public Utility Commission (the “VPUC”) and the West Virginia Public Service Commission (the “WVPSC”) and are retained by the Company.
Revenue for the intrastate/interLATA access service is received through tariffed access charges as filed with the APSC, MDTC, MPSC, MPUC, NHPUC, VPUC and WVPSC. These access charges are billed to the intrastate carriers and are retained by the Company. Revenue for terminating and originating long distance service is received through charges for providing usage of the local exchange network. Toll revenues are recognized when services are rendered.
The FCC’s Intercarrier Compensation order, issued in October 2011, has significantly changed the way telecommunication carriers receive compensation for exchanging traffic and state tariffed rates. All terminating intrastate rates that exceeded the interstate rate were reduced to the terminating interstate rate effective July 2013. Beginning in 2014, the interstate and intrastate rates began being reduced over a six year period to “bill and keep” in which carriers bill their customers for services and keep those charges but neither pay for nor receive compensation from traffic sent to or received from other carriers. In addition, subsidies to carriers serving high cost areas has been phased out over an extended period. STC was the only RLEC receiving a minimal high cost subsidy as of December 31, 2019.
Revenues for interstate access services are based on reimbursement of costs and an allowed rate of return. Revenues of this nature are received from USAC. The FCC’s Rate-of-Return Universal Service Fund Reform order, issued in March 2016, reduced the authorized rate-of-return by 25 basis points in 2016 and will reduce the authorized rate-of-return by 25 basis points in each subsequent year until 2021. The FCC’s Intercarrier Compensation order, issued in October 2011, capped each year’s revenue requirement (rate of return and reimbursement of costs) at 95.0% of the previous year’s revenue requirement. Such revenues amounted to 23.3%, 21.3%, and 20.7% of the Company’s total revenues for the years ended December 31, 2019, 2018, and 2017, respectively.
Internet, transport service, cable and satellite television and cloud hosting and managed services. Internet, transport service, cable and satellite television and cloud hosting and managed services revenues are recognized
when services are rendered. Operating revenues from the lease of dark fiber covered by indefeasible rights-of-use agreements are recorded as earned. In some cases, the entire lease payment is received at inception of the lease and recognized ratably over the lease term after recognition of expenses associated with lease inception. The Company has deferred revenue in the consolidated balance sheets as of December 31, 2019, and 2018, of  $2.1 million and $2.3 million, respectively, related to transport services, which is included as part of advanced billing and payments. The Company has deferred revenue in the consolidated balance sheets as of December 31, 2019, and 2018, of  $229 thousand and $126 thousand, respectively, related to other services, which is included as part of advanced billing and payments.
Cash and Cash Equivalents
Cash equivalents are stated at cost plus accrued interest, which approximates fair value. Cash equivalents are high-quality, short-term money market instruments and highly liquid debt instruments with an original maturity of three months or less when purchased. The cash equivalents are readily convertible to known amounts of cash and are so near maturity that they present insignificant risk of changes in value because of changes in interest rates.
Accounts Receivable
The Company extends credit to its business and residential customers based upon a written credit policy. Service interruption is the primary vehicle for controlling losses. Accounts receivable are recorded at the invoiced amount and do not bear interest. The allowance for doubtful accounts is the Company’s best estimate for the amount of probable credit losses in the Company’s existing accounts receivable. The Company establishes an allowance for doubtful accounts based upon factors surrounding the credit risk of specific customers, historical trends, and other information. Receivable balances are reviewed on an aged basis and account balances are charged off against the allowance after all means of collection have been exhausted and the potential for recovery is considered remote.
Materials and Supplies
Materials and supplies are stated at the lower of cost or realizable value. Cost is determined using an average cost basis.
Property and Equipment
Regulated property and equipment is stated at original cost less any impairment. Unregulated property and equipment purchased through acquisitions is stated at its fair value at the date of acquisition less any impairment. Expenditures for improvements that significantly add to productive capacity or extend the useful life of an asset are capitalized. Expenditures for maintenance and repairs are expensed when incurred. Depreciation of regulated property and equipment is computed principally using the straight-line method over useful lives determined by the APSC for Alabama locations, while the other regulated locations use similar useful lives as Alabama. Depreciation of unregulated property and equipment primarily employs the straight-line method over industry standard estimated useful lives.
Long-Lived Assets
The Company reviews its long-lived assets for impairment at each balance sheet date and whenever events or changes in circumstances indicate that the carrying amount of an asset should be assessed. To determine if impairment exists, the Company estimates the future undiscounted cash flows expected to result from the use of the asset being reviewed for impairment. If the sum of these expected future cash flows is less than the carrying amount of the asset, the Company recognizes an impairment loss in accordance with guidance included in ASC 360, Property, Plant, and Equipment. The amount of the impairment recognized is determined by estimating the fair value of the assets and recording a loss for the excess of the carrying value over the fair value.
Deferred Financing Costs
Deferred financing and loan costs consist of debt issuance costs incurred in obtaining long-term financing, which are amortized using the effective interest method. Amortization of deferred financing and
loan costs is classified as “Interest expense”. Deferred financing and loan costs are presented in the balance sheet as a direct deduction from the related debt liability. When amendments to debt agreements are considered to extinguish existing debt per guidance included in ASC 470, Debt, the remaining deferred financing costs are expensed at the time of amendment.
Income Taxes
The Company accounts for income taxes using the asset and liability approach in accordance with guidance included in ASC 740, Income Taxes (“ASC 740”). The asset and liability approach requires the recognition of deferred tax liabilities and assets for the expected future tax consequences of temporary differences between the carrying amounts and the tax basis of assets and liabilities using enacted tax rates. Any changes in enacted tax rates or tax laws are included in the provision for income taxes in the period of enactment. A valuation allowance is provided when it is more likely than not that some portion or all of the deferred tax assets will not be realized.
The provision for income taxes consists of an amount for the taxes currently payable and a provision for the tax consequences deferred to future periods.
Interest and penalties related to income tax matters would be recognized in income tax expense. As of December 31, 2019, there was no material amount recorded for interest and penalties.
The Company conducts business in multiple jurisdictions and, as a result, one or more subsidiaries file income tax returns in the U.S. federal, various state and local jurisdictions. All tax years since 2016 are open for examination by various tax authorities.
Fair Value of Financial Instruments
The carrying values of the Company’s financial instruments, including cash and cash equivalents, accounts receivable, prepaids, accounts payable and accrued liabilities, approximate their fair values as of December 31, 2019, and 2018, due to their short term nature. The fair value of debt instruments at December 31, 2019, and 2018, is disclosed in the notes to the consolidated financial statements.
Income per Common Share
The Company computes net income per common share in accordance with the provisions included in ASC 260, Earnings per Share (“ASC 260”). Under ASC 260, basic and diluted income per share is computed by dividing net income available to stockholders by the weighted average number of common shares and common share equivalents outstanding during the period. Basic income per common share excludes the effect of potentially dilutive securities, while diluted income per common share reflects the potential dilution that would occur if securities or other contracts to issue common shares were exercised for, converted into or otherwise resulted in the issuance of common shares.
Recently Adopted Accounting Pronouncements
In May 2014, the FASB issued Accounting Standards Update (“ASU”) 2014-09, Revenue from Contracts with Customers (Topic 606) (“ASU 2014-09”). This ASU requires that an entity recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. This ASU also provides a more robust framework for revenue issues and improves comparability of revenue recognition practices across industries. This ASU was the product of a joint project between the FASB and the International Accounting Standards Board to clarify the principles for recognizing revenue and to develop a common revenue standard. ASU 2014-09 permits the use of either a retrospective or modified retrospective application. This guidance was to be effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2016, with early adoption not permitted. In July 2015, the FASB issued ASU 2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date. This ASU confirmed a one-year delay in the effective date of ASU 2014-09, making the effective date for the Company the first quarter of fiscal 2018 instead of the first quarter of fiscal 2017.
In March 2016, the FASB issued ASU 2016-08, Revenue from Contracts with Customers (Topic 606): Principal versus Agent Consideration (Reporting Revenues Gross versus Net). This ASU is further guidance to ASU 2014-09, and clarifies principal versus agent considerations. In April 2016, the FASB issued ASU 2016-10, Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing. This ASU is also further guidance to ASU 2014-09, and clarifies the identification of performance obligations. In May 2016, the FASB issued ASU 2016-12, Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients. This ASU is also further guidance to ASU 2014-09, and clarifies assessing the narrow aspects of recognizing revenue. In December 2016, the FASB issued ASU 2016-20, Technical Corrections and Improvements to Topic 606, Revenue from Contracts with Customers. This ASU is also further guidance to ASU 2014-09, and clarifies technical corrections and improvements for recognizing revenue.
In January 2017, the FASB issued ASU 2017-03, Accounting Changes and Error Corrections (Topic 250) and Investments - Equity Method and Joint Ventures (Topic 323) (“ASU 2017-03”). This ASU requires registrants to evaluate the impact ASU 2014-09 will have on financial statements and adequately disclose this information to assist the reader in assessing the significance of ASU 2014-09 on the financial statements when adopted. The Company commenced its assessment of ASU 2014-09 beginning in June 2016. This assessment included analyzing ASU 2014-09’s impact on the Company’s various revenue streams, comparing the Company’s historical accounting policies and practices to the requirements of ASU 2014-09, and identifying potential differences from applying the requirements of ASU 2014-09 to the Company’s contracts. The Company has used a five-step process to identify the contract with the customer, identify the performance obligations, determine the transaction price, allocate the transaction price to the performance obligations and recognize revenue when or as the performance obligations are satisfied. The Company has implemented the appropriate changes to its business processes, systems and controls to support revenue recognition and disclosures under ASU 2014-09.
The Company adopted ASU 2014-09 at the beginning of its 2018 fiscal year using the modified retrospective method applied to those contracts which were not completed as of January 1, 2018. Prior period amounts have not been adjusted and continue to be reported in accordance with historic accounting standards in effect during those periods. The adoption of ASU 2014-09 and related amendments did not have a material impact on the Company’s consolidated financial statements.
In January 2016, the FASB issued ASU 2016-01, Financial Instruments - Overall (Subtopic 825-10) (“ASU 2016-01”). This ASU addresses certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. ASU 2016-01 requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset (that is, securities or loans and receivables) on the balance sheet or in the accompanying notes to the financial statements. That presentation provides financial statement users with more decision-useful information about an entity’s involvement in financial instruments. The provisions of this ASU were to be effective for annual periods beginning after December 15, 2017, and interim periods within those years, with early adoption permitted. In February 2018, the FASB issued ASU 2018-03, Technical Corrections and Improvements to Financial Instruments - Overall (Subtopic 825-10), which made targeted improvements to address certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. This ASU also confirmed a six-month delay in the effective date of ASU 2016-01, making the effective date for the Company the second quarter of fiscal 2018 instead of the first quarter of fiscal 2018, with early adoption permitted. The Company adopted ASU 2016-01 as of March 31, 2018, and that adoption did not have a material impact on the Company’s consolidated financial statements.
In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842) (“ASU 2016-02”). This ASU requires lessees to recognize most leases on the balance sheet. The provisions of this guidance are effective for annual periods beginning after December 15, 2018, and interim periods within those years, with early adoption permitted. In January 2017, the FASB issued ASU 2017-03, which requires registrants to evaluate the impact ASU 2016-02 will have on financial statements and adequately disclose this information to assist the reader in assessing the significance of ASU 2016-02 on the financial statements when adopted. In January 2018, the FASB issued ASU 2018-01, Leases (Topic 842): Land Easement Practical Expedient for Transition to Topic 842. This ASU provides an optional transition practical expedient to not evaluate under ASU 2016-02 existing or expired land easements that were not previously accounted for as leases under ASC Topic 840,
Leases. An entity that elects this practical expedient should evaluate new or modified land easements under ASU 2016-02 beginning at the date that the entity adopts ASU 2016-02. In July 2018, the FASB issued ASU 2018-10, Codification Improvements to Topic 842, Leases, which provides improvements and clarifications for ASU 2016-02. In July 2018, the FASB issued ASU 2018-11, Leases (Topic 842): Targeted Improvements (“ASU 2018-11”). This ASU provides an additional transition method by allowing entities to initially apply the new lease standard at the date of adoption with a cumulative effect adjustment to the opening balances of retained earnings in the period of adoption. This ASU also gives lessors the option of electing, as a practical expedient by class of underlying asset, not to separate the lease and non-lease components of a contract when those lease contracts meet certain criteria. In December 2018, the FASB issued ASU 2018-20, Narrow-Scope Improvements for Lessors. This ASU clarifies lessor treatment for sales taxes and other similar taxes collected from lessees, certain lessor costs, and recognition of variable payments for contracts with lease and non-lease components. In March 2019, the FASB issued ASU 2019-01, Codification Improvements. This ASU clarifies determining the fair value of the underlying asset by lessors that are not manufacturers or dealers, presentation on the statement of cash flows for sales-type and direct financing leases, and transition disclosures related to Topic 250, Accounting Changes and Error Corrections. The Company has completed its evaluation of the requirements of this guidance and implemented the processes necessary to adopt ASU 2016-02, as amended. The Company has elected certain practical expedients available at adoption. The Company elected the package of practical expedients upon transition not to reassess whether expired or existing contracts contain leases under the new definition of a lease; not to reassess the lease classification for expired or existing leases; and not to reassess whether previously capitalized initial direct costs would qualify for capitalization under ASU 2016-02. In evaluating certain equipment rental arrangements such as cable, internet and security service contracts, the Company considered the practical expedient that allows lessors to elect, by class of underlying asset, to not separate non-lease components from the associated lease components if the non-lease components otherwise would be accounted for in accordance with the new revenue recognition standard. The Company elected this practical expedient as the following two criteria are met; the lease component and the associated non-lease components have the same timing and pattern of transfer; and the lease component, if accounted for separately, would be classified as an operating lease. The Company elected to adopt the new standard using the transition method provided by ASU 2018-11; therefore, prior periods will not be restated. The Company has determined that the impact of adoption is limited to real property leases and is consistent with industry practices. Adoption of the new standard resulted in the Company recognizing an aggregate of $1,073,919 in lease liabilities and corresponding right of use (“ROU”) assets and no impact on the opening retained earnings balances. The adoption of ASU 2016-02 had an immaterial impact on the consolidated statements of operations and consolidated statements of cash flows as of December 31, 2019.
In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments. This ASU addresses how certain cash receipts and cash payments are presented and classified in the statement of cash flows under Topic 230, Statement of Cash Flows, and other Topics. This ASU is effective for annual reporting periods, and interim periods therein, beginning after December 15, 2017, with early adoption permitted. The Company adopted this ASU and that adoption did not have a material impact on the Company’s consolidated financial statements.
In May 2017, the FASB issued ASU 2017-09, Compensation-Stock Compensation (Topic 718) (“ASU 2017-09”). ASU 2017-09 provides guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting in ASC Topic 718, Stock Compensation. ASU 2017-09 is effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. Early adoption is permitted for any interim period for which financial statements have not been issued. ASU 2017-09 should be applied prospectively to an award modified on or after the adoption date. The Company adopted this ASU and that adoption did not have a material impact on the Company’s consolidated financial statements.
In May 2017, the FASB issued ASU 2017-10, Service Concession Arrangements (Topic 853) (“ASU 2017-10”). The objective of this ASU is to specify that an operating entity should not account for a service concession arrangement that meets certain criteria as a lease in accordance with ASC Topic 840, Leases. ASU 2017-10 further states that the infrastructure used in a service concession arrangement should not be recognized as property, plant, and equipment of the operating entity. The provisions of this ASU are effective for annual periods beginning after December 15, 2017, and interim periods within those years, with early
adoption permitted. The Company adopted this ASU and that adoption did not have a material impact on the Company’s consolidated financial statements.
In March 2018, the FASB issued ASU 2018-05, Income Taxes (Topic 740). The objective of this ASU is to amend ASC 740, Income Taxes to reflect Staff Accounting Bulletin No. 118, issued by the staff of the Securities and Exchange Commission (“SAB 118”), which addresses the enactment of the Tax Cuts and Jobs Act (the “Tax Act”). SAB 118 outlines the approach companies may take if they determine that the necessary information is not available (in reasonable detail) to evaluate, compute, and prepare accounting entries to recognize the effects of the Tax Act by the time the financial statements are required to be filed. Companies may use this approach when the timely determination of some or all of the income tax effects from the Tax Act are incomplete by the due date of the financial statements. A reporting entity must act in good faith and update provisional amounts as soon as more information becomes available, evaluated and prepared, during a measurement period that cannot exceed one year from the enactment date. Initial reasonable estimates and subsequent changes to provisional amounts should be reported in income tax expense or benefit from continuing operations in the period in which they are determined. As of December 31, 2017, the provisional amount recorded related to the remeasurement of the Company’s deferred tax liability balance was $9.3 million and reflected a one-time reduction in the Company’s income tax provision. As of December 31, 2017, the Company finalized its accounting estimates for income tax effects related to the Tax Act. The Company elected not to utilize the measurement window provided under SAB 118. The Company did not record any adjustments to its 2017 income tax effects resulting from the Tax Act.
In June 2018, the FASB issued ASU 2018-07, Compensation - Stock Compensation (Topic 718) (“ASU 2018-07”). This ASU expands the scope of ASU 2017-09, which currently only includes share-based payments issued to employees, to also include share-based payments issued to nonemployees for goods and services. The amendments in this ASU are effective for public companies for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. Early adoption is permitted, but no earlier than the Company’s adoption date of ASU 2014-09. The Company adopted this ASU and that adoption did not have a material impact on the Company’s consolidated financial statements.
Recent Accounting Pronouncements
During 2018, the FASB issued ASUs 2018-01 through 2018-20 and, during 2019, the FASB has issued ASUs 2019-01 through 2019-12. Except for the ASUs discussed above and below, these ASUs provide technical corrections or simplifications to existing guidance and to specialized industries or entities and therefore have minimal, if any, impact on the Company.
In January 2017, the FASB issued ASU 2017-04, Intangibles - Goodwill and Other (Topic 350) (“ASU 2017-04”). The objective of this ASU is to simplify how an entity is required to test goodwill for impairment by eliminating Step 2 from the goodwill impairment test. ASU 2017-04 is effective for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. The Company does not expect this ASU to have a material impact on its consolidated financial statements.
In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820) (“ASU 2018-13”). This ASU modifies the disclosure requirements on fair value measurements in ASU 2018-13, based on the concepts in the Concepts Statement, including the consideration of costs and benefits. This ASU eliminates, adds and modifies certain disclosure requirements for fair value measurements as part of its disclosure framework project. ASU 2018-13 is effective for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. An entity is permitted to early adopt any removed or modified disclosures upon issuance of this ASU and delay adoption of the additional disclosures until their effective date. The Company does not expect this ASU to have a material impact on its consolidated financial statements.
In November 2018, the FASB issued ASU 2018-19, Codification Improvements to Topic 326, Financial Instruments - Credit Losses (“ASU 2018-19”). This ASU improves the disclosure requirements in ASU 2016- 13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (“ASU 2016-13”) issued in June 2016, to make a cumulative-effect adjustment to opening retained earnings as of the beginning of the first reporting period in which the amendments are effective. The effective date and transition requirements for the amendments in this update are the same as the effective dates and
transition requirements in ASU 2016-13, as amended by ASU 2018-19. In April 2019, the FASB issued ASU 2019-04, Codification Improvements to Topic 326, Financial Instruments - Credit Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments. This ASU improves the disclosure requirements in ASU 2016-13 issued in June 2016, to allow the measurement of allowance for credit losses on accrued interest receivable balances separately from other components of the amortized cost basis of associated financial assets. In May 2019, the FASB issued ASU 2019-05,Financial Instruments - Credit Losses (Topic 326). This ASU improves the disclosure requirements in ASU 2016-13 issued in June 2016, to allow companies to irrevocably elect, upon adoption of ASU 2016-13, the fair value option on financial instruments that (1) were previously recorded at amortized cost and (2) are within the scope of ASC 326-20 if the instruments are eligible for the fair value option under ASC 825-10. The effective date and transition requirements for the amendments in this update are the same as the effective dates and transition requirements in ASU 2016-13, as amended by ASU 2018-19. In November 2019, the FASB issued ASU 2019-10, Financial Instruments - Credit Losses (Topic 326), Derivatives and Hedging (Topic 815), and Leases (Topic 842) (“ASU 2019-10”). This ASU defers certain major updates not yet effective due to the challenge’s private companies, smaller public companies, and not-for-profit organizations are having with implementation. In November 2019, the FASB issued ASU 2019-11, Codification Improvements to Topic 326, Financial Instruments - Credit Losses. The amendments in this ASU clarify and address stakeholders’ specific issues about certain aspects in update 2016-13. ASU 2019-10 has deferred the effective date for credit losses for smaller reporting companies to years beginning after December 15, 2022, including interim periods within those fiscal years. An entity is still permitted to early adopt as of the fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. The Company does not expect this ASU to have a material impact on its consolidated financial statements.
In November 2019, the FASB issued ASU 2019-08, Compensation - Stock Compensation (Topic 718) and Revenue from Contracts with Customers (Topic 606); Codification Improvements - Share-Based Consideration Payable to a Customer (“ASU 2019-08”). ASU 2019-08 requires that an entity apply the guidance in ASU 2018-07 to measure and classify share-based payment awards granted to a customer. The amount recorded as a reduction in the transaction price should be based on the grant-date fair value of the share-based payment award. The amendments in ASU 2019-08 are effective for public companies for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. Early adoption is permitted, but no earlier than the Company’s adoption of the amendments in ASU 2018-07. As of December 31, 2019, the Company does not have any share-based payment awards to customers, therefore the Company does not expect this ASU to have a material impact on its consolidated financial statements.
In December 2019, the FASB issued ASU 2019-12, Income Taxes (Topic 740) (“ASU 2019-12”). This ASU simplifies the accounting for income taxes by removing certain exceptions to the general principles in Topic 740. The amendments in ASU 2019-12 are effective for public companies for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2020. Early adoption of the amendments is permitted, including adoption in any interim period for which financial statements have not yet been issued. An entity that elects to early adopt the amendments in an interim period should reflect any adjustments as of the beginning of the annual period that includes that interim period. Additionally, an entity that elects early adoption must adopt all the amendments in the same period. The Company does not expect this ASU to have a material impact on its consolidated financial statements.
3.
Goodwill and Intangible Assets
ASC 350 requires that goodwill be tested for impairment annually, unless potential interim indicators exist that could result in impairment. Although the Company has only one reporting segment, it has historically considered its three regions (Alabama, Missouri, and New England) to be reporting units for purposes of goodwill impairment testing. The Company changed its approach to managing its business from three semi-autonomous regions to a functional management approach with leadership for functions spanning the whole Company. In 2018, the Company implemented a single billing and operations support system covering all customers. Additionally, a chief operating officer position was established and filled during fourth quarter 2018 to lead all operations. Therefore, the Company measures goodwill for impairment as a single reporting unit beginning in 2019.
The Company performed its annual goodwill impairment testing as of October 1, 2019. The Company used the discounted cash flow (“DCF”) method under the income approach as well as the guideline public
company method (“GPCM”) under the market approach to value the reporting units. The Company utilized weightings of 50.0% for the DCF method and 50.0% for the GPCM to derive a concluded fair value of total assets. The Company concluded that no impairment was present during the impairment review as of October 1, 2019, and 2018. The Company determined that no events or circumstances from October 1, 2019, through December 31, 2019, indicated that a further assessment was necessary.
There was no change in the carrying amount of goodwill during 2019 or 2018, with a balance of $45.0 million as of both December 31, 2019, and 2018.
The Company also found no impairment in the other intangible assets and the only change in the carrying amounts for the years ended December 31, 2019, and 2018, is due to the amortization for each current year.
Intangible assets are summarized as follows (in thousands):
These intangible assets had a range of 2 to 15 years of useful lives at inception and utilize both the sum-of-the-years’ digits and straight-line methods of amortization, as appropriate. The following tables present historical and expected amortization expense of the existing intangible assets as of December 31, 2019, for each of the following periods (in thousands):
4.
Property and Equipment
A summary of property and equipment is shown as follows (in thousands, except estimated life):
Depreciation expense for the years ended December 31, 2019, 2018 and 2017, was $7,344 thousand, $6,906 thousand and $7,001 thousand, respectively. Amortization expense for telephone plant adjustment was $(90) thousand, $(82) thousand and $(82) thousand for the years ended December 31, 2019, 2018 and 2017, respectively.
5.
Other Accounts Receivable
Other accounts receivable consists of the following (in thousands) as of:
6.
Investments
Investments consist of the following (in thousands) as of:
The investment in CoBank stock is carried at historical cost due to no readily determinable fair value for those instruments being available. Management believes there has been no other than temporary impairment in such investment. This investment consists of patronage certificates that represent ownership in the financial institution where the Company previously had and currently has debt. These certificates yield dividends on an annual basis, and the investment is redeemed ratably subsequent to the repayment of the debt. The Company
purchased a two year interest rate cap associated with the New Credit Facility and it had a value of  $4 thousand as of December 31, 2018. The interest rate cap expires February 26, 2020 and has a value of zero as of December 31, 2019.
7.
Notes Payable
Notes payable consists of the following (in thousands, except percentages) as of:
The Senior Loan Agreement was fully repaid on November 2, 2017. Associated with the Senior Loan Agreement, the Company had $4.9 million in deferred financing cost. Amortization expense for the deferred financing cost associated with the Senior Loan Agreement was $896 thousand for the year ended December 31, 2017, which is included in interest expense. The Company wrote off  $3,070 thousand of prior deferred financing cost and incurred $14 thousand in external legal fees during the year ended December 31, 2017, as a result of the extinguishment of the Senior Loan Agreement, which is included in interest expense.
The Subordinated Loan Agreement was fully repaid on November 2, 2017. Associated with the Subordinated Loan Agreement, the Company had $892 thousand in deferred financing cost. Amortization expense for the deferred financing cost associated with the Subordinated Loan Agreement was $133 thousand for the year ended December 31, 2017, which is included in interest expense. The Company wrote off $621 thousand of prior deferred financing cost and incurred $14 thousand in external legal fees during the year ended December 31, 2017, as a result of the extinguishment of the Subordinated Loan Agreement, which is included in interest expense.
Associated with the New Credit Facility, the Company has $2.1 million in deferred financing cost. Amortization expense for the deferred financing cost associated with the New Credit Facility was $452 thousand, $476 thousand and $75 thousand for the years ended December 31, 2019, 2018 and 2017, respectively, which is included in interest expense.
The Company had a revolving credit facility of  $5.0 million associated with the Senior Loan Agreement. There was no balance outstanding during 2017. The Senior Loan Agreement was terminated on November 2, 2017. The Company paid a monthly fee of 0.75% per annum on the unused portion of the revolver loan under the Senior Loan Agreement, payable in arrears. The fee expense was $32 thousand for the year ended December 31, 2017.
The revolving credit facility associated with the Company’s New Credit Facility has a maximum borrowing capacity of  $5.0 million. The revolving credit facility is available until November 3, 2022. There was no balance outstanding as of December 31, 2019 or 2018. The Company pays a commitment fee, payable quarterly in arrears, on the unused portion of the revolver loan under the New Credit Facility. The rate declined from 0.50% per annum to 0.38% per annum on October 22, 2018. The commitment fee expense was $19 thousand, $24 thousand and $4 thousand for the years ended December 31, 2019, 2018 and 2017, respectively.
Maturities of notes payable for the next four years, assuming no annual excess cash flow payments, are as follows (in thousands):
The Company’s notes payable agreements are subject to certain financial covenants and restrictions on indebtedness, financial guarantees, business combinations and other related items. As of December 31, 2019, the Company was in compliance with all such covenants and restrictions.
8.
Income Tax
Income tax expense for the years ended December 31, 2019, 2018, and 2017 is summarized below (in thousands):
Public Law No: 115-97, also known as the Tax Act, was enacted on December 22, 2017. The Tax Act reduced the U.S. federal corporate tax rate from 35% to a flat rate of 21%. ASC 740 requires deferred tax assets and liabilities to be remeasured as of the date the Tax Act was enacted based on the rates at which they are expected to reverse in the future, which is generally now 21%. The Securities and Exchange Commission staff issued SAB 118, which provides guidance on accounting for the impact of the Tax Act and states a reasonable estimate of the Tax Act’s effects on the Company’s deferred tax balances should be included in the Company’s consolidated financial statements. Based on the Company’s understanding of the Tax Act, it made a reasonable estimate of the Tax Act’s effects on the Company’s deferred tax balances. As of December 31, 2017, the provisional amount recorded related to the remeasurement of the Company’s deferred tax liability balance was $9.3 million and reflected a one-time reduction in the Company’s income tax provision. As of December 31, 2017, the Company finalized its accounting estimates for income tax effects related to the Tax Act. The Company elected not to utilize the measurement window provided under SAB 118. As of December 31, 2019, the Company did not record any adjustments to its 2017 income tax effects resulting from the Tax Act.
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities as of December 31, 2019, and 2018, are presented below (in thousands):
As of December 31, 2019, the Company had no U.S. federal and state net operating loss carryforwards. As of December 31, 2018, the Company had U.S. federal and state net operating loss carryforwards of  $0 and $43 thousand, respectively. The Company had no alternative minimum tax credit carryforwards as of December 31, 2019, or December 31, 2018. The Company establishes valuation allowances when necessary to reduce deferred tax assets to amounts expected to be realized. As of December 31, 2019, the Company had no valuation allowance recorded.
The effective income tax rates as of December 31, 2019, 2018, and 2017, were 23.5%, 22.5% and (184.5)%, respectively.
ASC 740 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. For each year ended December 31, 2019, 2018, and 2017, the Company did not identify any material uncertain tax positions. Tax years from 2016 forward remain open for audit.
Total income tax expense was different than that computed by applying U.S. federal income tax rates to income before income taxes for the years ended December 31, 2019, 2018, and 2017. The reasons for the differences are presented below (in thousands, except percentages):
9.
Employee Benefit Program
Employees of all subsidiaries except BTC participate in a Company-sponsored defined contribution savings plan under Section 401(k) of the Internal Revenue Code. The terms of the plan provide for an elective contribution from employees not to exceed $18.5 thousand for 2019, 2018 and 2017. The Company matched the employee’s contribution up to 4.5% of the employee’s annual compensation during 2019, 2018 and 2017. For the years ended December 31, 2019, 2018, and 2017, the total contributions and expense associated with this plan was $449 thousand, $470 thousand and $486 thousand, respectively.
The employees of BTC participate in a multiemployer Retirement and Security Program (“RSP”) as a defined benefit plan and a Savings Plan (“SP”) provided through the National Telecommunications Cooperative Association (“NTCA”). The risks associated with participating in a multiemployer plan are different from a single-employer plan. Contributions to the multiemployer plan by the Company may be used to provide benefits to employees of other participating employers. If a participating employer stops contributing to the plan, the unfunded obligations of the plan may be borne by the remaining participating employers. The NTCA has sponsored the RSP since 1959. Currently, the Company represents approximately 0.3% of the employers and less than 0.1% of the employees covered by the RSP. As of December 2018, the RSP’s ongoing funded status decreased to 94%. Program assets as of December 31, 2018 were over $1.9 billion, placing the RSP among the 500 largest pension plans in the United States. Participation in the RSP requires a minimum employee contribution of 1.0% of their annual compensation. For each of 2019, 2018 and 2017, the Company contributed 4.5% of annual compensation for every participating employee. SP is a defined contribution savings plan under Section 401(k) of the Internal Revenue Code to which the Company made no contribution for 2019, 2018 or 2017. The employee can make voluntary contributions to the SP as desired. For the years ended December 31, 2019, 2018, and 2017, the total expense associated with these plans was $19 thousand, $21 thousand and $16 thousand, respectively.
10.
Net Income per Common Share
Basic net income per common share is computed by dividing net income by the weighted-average number of common shares outstanding for the period. Diluted net income per common share reflects the potential dilution that would occur should all of the shares of Class A common stock underlying restricted stock units (“RSUs”) be issued.
A reconciliation of the common shares for purposes of the calculation of the Company’s basic and diluted net income per common share is as follows (weighted average number of common shares outstanding in whole numbers and net income in thousands):
11.
Revenue Streams and Concentrations
Revenue Streams
The Company identifies its revenue streams with similar characteristics as follows (in thousands):
ASU 2014-09 requires that an entity recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. As stated above in Note 2, Summary of Significant Accounting Policies - Recently Adopted Accounting Pronouncements, the Company has used a five-step process to identify the contract with the customer, identify the performance obligations, determine the transaction price, allocate the transaction price to the performance obligations and recognize revenue when or as the performance obligations are satisfied. The majority of the Company’s revenue is recognized over time as the service is transferred to the customer. For certain other services, such as unlimited long distance, revenue is recognized over the period of time the service is provided.
The following table identifies revenue generated from customers (in thousands):
The following table summarizes the revenue generated from contracts with customers among each revenue stream for the years ended December 31, (in thousands, except percentages):
*
Fixed fees charged to MTM customers and CLEC business customers.
**
Revenue generated from sources not within the scope of ASU 2014-09. See Note 2, Summary of Significant Accounting Policies - Revenue Recognition, for accounting policies associated with these sources of revenue.
*
Fixed fees charged to MTM customers and CLEC business customers.
**
Revenue generated from sources not within the scope of ASU 2014-09. See Note 2, Summary of Significant Accounting Policies - Revenue Recognition, for accounting policies associated with these sources of revenue.
Payment terms vary by customer. The Company typically invoices customers in the month following when the service was provided. The term between invoicing and when payment is due is less than a year and is not considered significant. Certain customers are invoiced in advance of the service being provided. Revenue is deferred until the point in time control of the service is transferred to the customer, or over the term the service is provided.
Revenue is recognized net of taxes collected on behalf of third parties.
As of December 31, 2019, the Company had approximately $7.2 million of unsatisfied performance obligations. As of December 31, 2019, the Company expected to recognize approximately $1.2 million of revenue within the next year and $6.0 million in the next two to five years related to such unsatisfied performance obligations. The Company does not disclose the value of unsatisfied performance obligations for contracts with an original expected life of one year or less or for contracts for which the Company has a right to invoice for services performed.
The deferred revenue balance as of September 30, 2019, was $3.6 million. Approximately $1.4 million of revenue from that balance was recognized as revenue during the three months ended December 31, 2019, offset by payments received as of December 31, 2019, in advance of control of the service being transferred to the customer.
12.
Leases
ASU 2016-02 requires lessees to recognize most leases on the balance sheet. As stated above in Note 2, Summary of Significant Accounting Policies - Recently Adopted Accounting Pronouncements, the Company has elected certain practical expedients available at adoption. The Company elected the package of practical expedients upon transition not to reassess whether expired or existing contracts contain leases under the new definition of a lease; not to reassess the lease classification for expired or existing leases; and not to reassess whether previously capitalized initial direct costs would qualify for capitalization under ASU 2016-02. In evaluating certain equipment rental arrangements such as cable, internet and security service contracts, the Company considered the practical expedient that allows lessors to elect, by class of underlying asset, to not separate non-lease components from the associated lease components if the non-lease components otherwise would be accounted for in accordance with the new revenue recognition standard. The Company elected this practical expedient as the following two criteria are met; the lease component and the associated non-lease components have the same timing and pattern of transfer; and the lease component, if accounted for separately, would be classified as an operating lease. The Company elected to adopt the new standard using the transition method provided by ASU 2018-11; therefore, prior periods will not be restated. The Company has determined that the impact of adoption is limited to real property leases and is consistent with industry practices. This ASU was effective January 1, 2019, the Company recognized an aggregate of  $1,073,919 in lease liabilities and corresponding ROU assets and no impact on the opening retained earnings balances.
In consideration of whether an agreement contains a lease as defined under ASU 2016-02, the Company answered these three questions; has an asset been identified, is the asset physically distinct, and does the customer have the right to control the asset. The Company determined based on the three-step questions above, the arrangements pertaining to real property building and office facilities in Alabama, Maine and Massachusetts are within the scope of ASU 2016-02.
In calculating the lease liability, the Company considered the lease term in which the Company would include any periods covered by an option to extend the lease if the lessee is reasonably certain to exercise that option. The Company evaluated factors that might create an economic incentive to exercise options to extend, including contract, asset, entity and market-based factors. The Company determined that there would be no significant relocation and interruption costs associated with moving to alternative space that would disincentivize a move at renewal; therefore, renewals to extend the lease term are not included in the ROU asset and lease liabilities.
A lessee may recognize the lease payments in profit or loss on a straight-line basis over the lease term and variable lease payments in the period in which the obligation for those payments is incurred. The accounting policy election for short-term leases shall be made by class of underlying asset to which the right of use relates. A short-term lease is defined as a lease that, at the commencement date, has a lease term of 12 months or less and does not include an option to purchase the underlying asset that the lessee is reasonably certain to exercise. The Company elected to exclude short-term leases from the recognition requirements.
In discounting the liability, ASU 2016-02 indicates that the incremental rate used must be comparable to a rate attributable to a similar amount, for a similar term, and with similar collateral as the assets in the lease.
The Company observed that published commercial borrowing rates were generally between 5.0% to 7.0% for loans collateralized by the real estate for terms ranging from 5-10 years.
Maturities of lease liabilities as of December 31, 2019 are as follows (in thousands):
Supplemental cash flow information related to operating leases was as follows (in thousands, except years and percentages):
13.
Fair Value Measurement
The Company adopted ASC 820, Fair Value Measurements and Disclosures (“ASC 820”), which defines fair value, establishes a framework for measuring fair value and requires disclosures about fair value measurements. The framework that is set forth in this standard is applicable to the fair value measurements where it is permitted or required under other accounting pronouncements.
ASC 820 defines fair value as the exit price, which is the price that would be received to sell an asset or paid to transfer a liability in a transaction between market participants at the measurement date. ASC 820 establishes a three-tier value hierarchy that prioritizes inputs to valuation techniques used for fair value measurement.
•
Level 1 consists of observable market data in an active market for identical assets or liabilities.
•
Level 2 consists of observable market data, other than that included in Level 1, that is either directly or indirectly observable.
•
Level 3 consists of unobservable market data. The input may reflect the assumptions of the Company, not a market participant, if there is little available market data and the Company’s own assumptions are considered by management to be the best available information.
Fair Value Notes Payable
The fair value of the Company’s notes payable is determined using various methods, including quoted market prices for notes with similar terms of maturity, which is a Level 2 measurement, and discounted cash flows, which is a Level 3 measurement. The fair values listed below are for complying with ASC 820 and do not appear in the consolidated financial statements. The carrying amounts and estimated fair values of notes payable are as follows (in thousands):
New Credit Facility
14.
Commitments and Contingencies
From time to time, the Company may be involved in various claims, legal actions and regulatory proceedings incidental to and in the ordinary course of business, including administrative hearings of the APSC, the MPUC, the MDTC, the MPSC, the NHPUC, the VPUC and the WVPSC, relating primarily to rate making and customer service requirements. In addition, the Company may be involved in similar proceedings with interconnection carriers and the FCC. Currently, none of the Company’s legal proceedings are expected to have a material adverse effect on the Company’s business.
15.
Stock Plans
The Company has previously granted RSUs underlying 366,356 shares of Class A common stock as of December 31, 2017. These RSUs (or a portion thereof) vest with respect to each recipient over a one to three year period from the date of grant, provided the recipient remains in the employment or service of the Company as of the vesting date and, in selected instances, certain performance criteria are attained. Additionally, these RSUs (or a portion thereof) could vest earlier in the event of a change in control of the Company, or upon involuntary termination without cause. Of the 366,356 previously granted RSUs, RSUs underlying 267,413 shares of Class A common stock have vested or were cancelled as of December 31, 2017. During the twelve months ended December 31, 2018, 34,755 RSUs were granted by the Company. There were no RSUs granted by the Company during 2019. The previous RSU grants were made primarily to executive-level personnel at the Company and, as a result, no compensation costs have been capitalized.
The following table summarizes RSU activity for the year ended December 31, 2018:
The following table summarizes RSU activity for the year ended December 31, 2019:
Stock-based compensation expense related to RSUs was $167 thousand and $290 thousand for the years ended December 31, 2019, and 2018, respectively. Stock-based compensation related to RSUs is recognized over the 39-month vesting schedule. Accounting standards require that the Company estimate forfeitures for RSUs and reduce compensation expense accordingly. The Company has reduced its expense by the assumed forfeiture rate and will evaluate actual experience against the assumed forfeiture rate going forward. The
forfeiture rate has been developed using historical performance metrics which could impact the size of the final issuance of Class A common stock. The Company has no history before 2014 with RSU forfeiture.
As of December 31, 2019, and 2018, the unrecognized total compensation cost related to unvested RSUs was $48 thousand and $216 thousand, respectively. That cost is expected to be recognized by the end of 2021.
The tax benefit recognized with respect to RSUs during the years ended December 31, 2019, and 2018, was $68 thousand and $144 thousand, respectively.
On October 15, 2018, the Company granted 29,460 incentive stock options (“ISOs”) and 20,540 non-qualified (“NQ”) stock options to purchase shares of Class A common stock. These options vest with respect to the recipient thereof over a five year period with 20% becoming exercisable on each anniversary of the vesting commencement date of October 15, 2019, provided the recipient remains in the employment or service of the Company as of the vesting date. Additionally, these options (or a portion thereof) could vest earlier in the event of a change in control of the Company. These option grants were made to one executive-level employee of the Company and, as a result, no compensation costs have been capitalized.
The following table summarizes ISO and NQ stock option activity as of December 31, 2019:
Stock-based compensation expense related to ISOs and NQ stock options was $87 thousand and $18 thousand for the years ended December 31, 2019, and 2018, respectively.
As of December 31, 2019, and 2018, the unrecognized total compensation cost related to unvested ISOs and NQ stock options was $329 thousand and $416 thousand, respectively. That cost is expected to be recognized by the end of 2023.
16.
Selected Quarterly Financial Data (unaudited and in thousands, except per share amounts)
17.
Subsequent Events
On March 2, 2020, the Company announced that its New Credit Facility was amended to change the loan covenants, effective as of December 31, 2019. Among other things, the amendment to the New Credit Facility amends the financial covenants set forth in the New Credit Facility to: (i) remove the required minimum fixed charge coverage ratio; (ii) add a maximum annual aggregate capital expenditures covenant of  $10.5 million for fiscal year 2020 and $10.0 million for each year fiscal year thereafter; (iii) modify the required maximum leverage ratio to the following maximum levels for each fiscal quarter end during the following periods (A) 3.50:1.00 for any fiscal quarter ending during the period from October 1, 2019 through March 30, 2021, (B) 3.25:1.00 for any fiscal quarter ending during the period from April 1, 2021 through December 31, 2021, and (C) 3.00:1.00 for any fiscal quarter ending on or after January 1, 2022; and (iv) add a new minimum debt service coverage ratio covenant of not less than 1.75:1.00, measured as of the end of each fiscal quarter. The executed amendment was filed on Form 8-K on March 3, 2020. See Note 7, Notes Payable, for additional information about the New Credit Facility.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A.
Item 9A. Controls and Procedures
Disclosure Controls and Procedures
With the participation of the Chief Executive Officer and the Chief Financial Officer, management has evaluated the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934). Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of December 31, 2019.
Management’s Report on Internal Control over Financial Reporting
The management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting for the Company. The Securities Exchange Act of 1934 defines internal control over financial reporting in Rule 13a-15(f) and 15d-15(f) as a process designed by, or under the supervision of, the Company’s principal executive and principal financial officers and effected by the Company’s board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles and includes those policies and procedures that:
•
Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the Company;
•
Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and
•
Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the consolidated financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
The Company’s management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2019. In making this assessment, the Company’s management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control - Integrated Framework, as updated in May 2013.
Based upon its assessment, management concluded that, as of December 31, 2019, the Company’s internal control over financial reporting was effective based upon those criteria.
This report does not include an attestation report of our independent registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by our independent registered public accounting firm pursuant to rules of the SEC that permit us to provide only management’s report on internal control over financial reporting in this report.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting during the fourth quarter of fiscal 2019 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Item 9B.
Item 9B. Other Information
None.
PART III
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance
The information required by this Item is incorporated herein by reference to the applicable information in the definitive proxy statement for our 2020 annual meeting of stockholders, including the information set forth under the captions “Election of Directors,” “Delinquent Section 16(a) Reports” and “Governance of the Company - Audit Committee.” See Information About Our Executive Officers regarding our executive officers.
Code of Ethics
We have a code of ethics that applies to each of our directors and employees, including our Chief Executive Officer, Chief Financial Officer and principal accounting officer. Our code of ethics is available on our website at http://www.Otelco.com under the Investors section titled Corporate Governance. We intend to disclose any amendment to, or waiver from, a provision of our code of ethics that applies to our Chief Executive Officer, Chief Financial Officer or principal accounting officer by posting such information on the Investors section of our website.
Item 11.
Item 11. Executive Compensation
The information required by this Item is incorporated herein by reference to the applicable information in the definitive proxy statement for our 2020 annual meeting of stockholders, including the information set forth under the captions “Executive Compensation,” “Director Compensation” and “Compensation Committee Interlocks and Insider Participation.”
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Securities Authorized for Issuance Under Equity Compensation Plans
The following table summarizes equity compensation plans that were approved by our stockholders and equity compensation plans that were not approved by our stockholders as of December 31, 2019.
Equity Compensation Plan Information
(1)
Represents 17,648 shares of our Class A common stock that may be issued upon the vesting of restricted stock units granted under the Otelco Inc. 2018 Stock Incentive Plan and 50,000 shares of our Class A common stock that may be issued upon the exercise of options granted under the Otelco Inc. 2018 Stock Incentive Plan.
(2)
The weighted-average exercise price relates only to the options described above. Shares of common stock underlying restricted stock units are deliverable without the payment of any consideration, and therefore awards of restricted stock units have not been taken into account in calculating the weighted-average exercise price.
(3)
Represents shares of common stock remaining to be issued under the Otelco Inc. 2018 Stock Incentive Plan, excluding shares reflected in column (a). If any shares of common stock underlying awards granted under the Otelco Inc. 2018 Stock Incentive Plan or the Otelco Inc. 2014 Stock Incentive Plan are not delivered due to forfeiture, termination or cancellation, those shares will again become available to be delivered under the Otelco Inc. 2018 Stock Incentive Plan. Shares of common stock remaining available for future issuance are also subject to adjustment for certain changes in corporate structure as permitted under the Otelco Inc. 2018 Stock Incentive Plan.
Security Ownership of Certain Beneficial Owners and Management
The other information required by this Item is incorporated herein by reference to the applicable information in the definitive proxy statement for our 2020 annual meeting of stockholders, including the information set forth under the caption “Beneficial Ownership of Common Stock.”
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence
The information required by this Item is incorporated herein by reference to the applicable information in the definitive proxy statement for our 2020 annual meeting of stockholders, including the information set forth under the caption “Election of Directors” and “Other Relationships and Transactions with Related Persons.”
Item 14.
Item 14. Principal Accounting Fees and Services
The information required by this Item is incorporated herein by reference to the applicable information in the definitive proxy statement for our 2020 annual meeting of stockholders, including the information set forth under the caption “Our Relationship with Our Independent Registered Public Accounting Firm.”
PART IV
Item 15.
Item 15. Exhibits and Financial Statement Schedules
(a)(1) Financial Statements
(a)(2) Financial Statement Schedules
None.
(a)(3) Exhibits
Exhibit No.
Description
3.1
Amended and Restated Certificate of Incorporation of Otelco Inc. (filed as Exhibit 3.1 to the Company’s Registration Statement on Form 8-A (File No. 001-32362) filed on May 24, 2013, and incorporated herein by reference)
3.2
Fourth Amended and Restated By-laws of Otelco Inc., as amended (filed as Exhibit 3.1 to the Company’s Current Report on Form 8-K filed on March 31, 2014, and incorporated herein by reference)
4.1
Form of stock certificate for Class A common stock, $0.01 par value per share (filed as Exhibit 4.1 to the Company’s Registration Statement on Form 8-A (File No. 001-32362) filed on May 24, 2013, and incorporated herein by reference)
4.2
Form of stock certificate for Class B common stock, $0.01 par value per share (filed as Exhibit 4.4 to the Company’s Current Report on Form 8-K filed on May 24, 2013, and incorporated herein by reference)
4.3
Description of the Company’s Securities
10.1
Amended and Restated Employment Agreement, dated as of March 11, 2009, between Otelco Inc. and Curtis L. Garner, Jr. (filed as Exhibit 10.2 to the Company’s Current Report on Form 8-K filed on March 12, 2009, and incorporated herein by reference)*
10.2
Employment Agreement, dated as of August 24, 2006, between Otelco Inc. and Dennis Andrews (filed as Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on August 29, 2006, and incorporated herein by reference)*
10.3
Employment Agreement, dated as of November 15, 2006, between Otelco Inc. and Jerry C. Boles (filed as Exhibit 10.2 to the Company’s Current Report on Form 8-K filed on November 15, 2006, and incorporated herein by reference)*
10.4
Amendment, dated as of December 17, 2008, to the Employment Agreement, dated as of August 24, 2006, between Otelco Inc. and Dennis Andrews (filed as Exhibit 10.10 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2008, and incorporated herein by reference)*
10.5
Amendment, dated as of December 17, 2008, to the Employment Agreement, dated as of November 15, 2006, between Otelco Inc. and Jerry C. Boles (filed as Exhibit 10.11 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2008, and incorporated herein by reference)*
Exhibit No.
Description
10.6
Third Amended and Restated Employment Agreement, dated as of December 10, 2014, between Otelco Inc. and Robert Souza (filed as Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on December 10, 2014, and incorporated herein by reference)*
10.7
Otelco Inc. 2014 Stock Incentive Plan (filed as Appendix A to the Company’s Definitive Proxy Statement on Schedule 14A filed on April 11, 2014, and incorporated herein by reference)*
10.8
Amendment, dated as of March 5, 2010, to the Amended and Restated Employment Agreement, dated as of March 11, 2009, between Otelco Inc. and Curtis L. Garner, Jr. (filed as Exhibit 10.14 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2009, and incorporated herein by reference)*
10.9
Second Amendment, dated as of March 4, 2011, to the Employment Agreement, dated as of August 24, 2006, between Otelco Inc. and Dennis Andrews, as previously amended on December 17, 2008 (filed as Exhibit 10.14 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2010, and incorporated herein by reference)*
10.10
Second Amendment, dated as of March 4, 2011, to the Employment Agreement, dated as of November 15, 2006, between Otelco Inc. and Jerry C. Boles, as previously amended on December 17, 2008 (filed as Exhibit 10.15 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2010, and incorporated herein by reference)*
10.11
Credit Agreement, dated as of November 2, 2017, by and among Otelco Inc., as borrower, each subsidiary of Otelco Inc. listed as a guarantor on the signature pages thereto, as guarantors, the lenders from time to time party thereto, as lenders, and CoBank, ACB, as administrative agent, as issuer of letters of credit, and as provider of the swing line commitment (filed as Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on November 6, 2017, and incorporated herein by reference)
10.12
Agreement Regarding Amendments to Credit Agreement, dated as of March 2, 2020, by and among Otelco Inc., as borrower, each subsidiary of Otelco Inc. listed as a guarantor on the signature pages thereto, as guarantors, the lenders from time to time party thereto, as lenders, and CoBank, ACB, as a lender and administrative agent (filed as Exhibit 10.1 to the Company’s current Report on Form 8-K filed on March 3, 2020, and incorporated herein by reference)
10.13
Otelco Inc. 2018 Stock Incentive Plan (filed as Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on May 10, 2018, and incorporated herein by reference)*
10.14
Employment Agreement, dated as of October 15, 2018, by and between Otelco Inc. and Richard Clark (filed as Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on October 16, 2018, and incorporated herein by reference)*
10.15
Confidential Separation Agreement and General Release, dated as of July 1, 2019, effective as of September 30, 2019, by and between Otelco Inc. and Dennis K. Andrews (filed as Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on July 8, 2019, and incorporated herein by reference)*
10.16
First Amended and Restated Employment Agreement, dated as of December 19, 2019 (filed as Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on December 20, 2019, and incorporated herein by reference) *
10.17
Separation and Consulting Agreement, dated as of December 19, 2019, between Otelco Inc. and Robert J. Souza (filed as Exhibit 10.2 to the Company’s Current Report on Form 8-K filed on December 20, 2019, and incorporated herein by reference)*
21.1
List of subsidiaries of Otelco Inc.
23.1
Consent of BDO USA, LLP, Independent Registered Public Accounting Firm
31.1
Certificate pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934 of the Chief Executive Officer
31.2
Certificate pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934 of the Chief Financial Officer
Exhibit No.
Description
32.1
Certificate pursuant to 18 U.S.C. §1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, of the Chief Executive Officer
32.2
Certificate pursuant to 18 U.S.C. §1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, of the Chief Financial Officer
The following information from the Company’s Annual Report on Form 10-K for the year ended December 31, 2019 formatted in Extensible Business Reporting Language (XBRL): (i) Consolidated Balance Sheets; (ii) Consolidated Statements of Operations; (iii) Consolidated Statements of Stockholders’ Equity (Deficit); (iv) Consolidated Statements of Cash Flows; and (v) Notes to Consolidated Financial Statements
*
Management contract or compensatory plan or arrangement
Item 16. Form 10-K Summary
None.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
OTELCO INC.
By:
/s/ Richard A. Clark
Richard A. Clark
President and Chief Executive Officer
Date: March 9, 2020
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated:
Signature
Title
Date
/s/ Richard A. Clark
Richard A. Clark
President, Chief Executive Officer and Director
(Principal Executive Officer)
March 9, 2020
/s/ Curtis L. Garner, Jr.
Curtis L. Garner, Jr.
Chief Financial Officer
(Principal Financial and Accounting Officer)
March 9, 2020
/s/ Stephen P. McCall
Stephen P. McCall
Chairman and Director
March 9, 2020
/s/ Barbara Dondiego-Stewart
Barbara Dondiego-Stewart
Director
March 9, 2020
/s/ Norman C. Frost
Norman C. Frost
Director
March 9, 2020
/s/ Howard J. Haug
Howard J. Haug
Director
March 9, 2020
/s/ Dayton R. Judd
Dayton R. Judd
Director
March 9, 2020
/s/ Brian A. Ross
Brian A. Ross
Director
March 9, 2020
/s/ Gary L. Sugarman
Gary L. Sugarman
Director
March 9, 2020