Item 1. Business
“NU Telecom” or “the Company” refers to New Ulm Telecom, Inc. alone or with its wholly owned subsidiaries as the context requires. When this report uses the words “we,” “our” or “us,” it refers to NU Telecom and its subsidiaries unless the context otherwise requires.
Company Overview and History
General Development of Business
NU Telecom is a diversified communications company headquartered in New Ulm, Minnesota with more than 106 years of experience in the local telephone exchange business. We operate in one principal business segment: the Telecom Segment.
Our principal line of business is the operation of four local telephone companies or incumbent local exchange carriers (ILECs) and the operation of two competitive local exchange carriers (CLECs) telephone companies. Our original business consisted of the operation of a single ILEC (New Ulm Rural Telephone Company) and began in 1905. In 1984, we changed our name to New Ulm Telecom, Inc. In 1986, we acquired our second ILEC, Western Telephone Company. In 1993, we acquired our third ILEC, Peoples Telephone Company. In 2008, we acquired our fourth ILEC, Hutchinson Telephone Company. Our ILEC businesses consist of connecting customers to our telephone network, providing switched service and dedicated private lines, connecting customers to long distance service providers and providing many other services associated with ILECs. Our ILECs also provide cable television services (CATV), Internet access services, including both dial-up and high-speed broadband access, and long distance service. We also install and maintain telephone systems to the areas in and around our ILEC service territories in southern Minnesota and northern Iowa. In 2002, we formed a CLEC in the city of Redwood Falls, Minnesota and acquired our second CLEC in 2008, with the acquisition of Hutchinson Telephone Company. This CLEC operates in and around the city of Litchfield, Minnesota. Our CLECs offer the same services as our ILECs. In 2000, we changed our marketing name to NU-Telecom and currently operate under that name in our markets.
On June 14, 2010, NU Telecom completed the acquisition of all of the assets of the CATV system located in and around Glencoe, Minnesota from Midcontinent Communications (MIDCO) for approximately $1.6 million pursuant to the Asset Purchase Agreement dated March 30, 2010. NU Telecom funded the purchase with current cash reserves. The acquisition resulted in the addition of approximately 1,200 connections to our video and Internet services. Additional information pertaining to this acquisition is available in Note 3 - “Acquisitions and Dispositions” to the Consolidated Financial Statements of this Annual Report on Form 10-K.
On June 30, 2009 we entered into an Equity Securities Purchase Agreement with Iowa Telecommunications Services, Inc. (Iowa Telecom) under which we agreed to sell our equity ownership interests in SHAL Networks, Inc.; SHAL, LLC; Direct Communications, LLC and En-Tel Communications, LLC to Iowa Telecom. On September 24, 2009, we announced that we had completed the sale to Iowa Telecom of these equity ownership interests for approximately $1.9 million in cash and fiber facilities valued at $67,500. Additional information on this disposition is available in Note 3 - “Acquisitions and Dispositions” to the Consolidated Financial Statements of this Annual Report on Form 10-K. In addition, we were released from loan guarantees related to these entities. See Note 13 - “Guarantees” to the Consolidated Financial Statements of this Annual Report on Form 10-K. The sale of these minority-owned investments allowed us to monetize our non-core investments.
On November 10, 2008, we opened TechTrends, Inc. in New Ulm, Minnesota. TechTrends is a wholly-owned subsidiary of NU Telecom that operates as a retail store offering wireless communications services, computers and computer accessories, in addition to providing computer repair and website design services.
On January 4, 2008, we completed the acquisition of Hutchinson Telephone Company that operates as a wholly-owned subsidiary of NU Telecom. Our acquisition of Hutchinson Telephone Company has increased our voice, video and Internet services to approximately 50,000 connections in various communities in Minnesota and Iowa. Additional information pertaining to this acquisition is available in Note 3 - “Acquisitions and Dispositions” to the Consolidated Financial Statements of this Annual Report on Form 10-K.
On November 3, 2006, we acquired a 33.33% subsidiary equity ownership interest in Hector Communications Corporation, which provides voice, video and Internet services to various communities in Minnesota and Wisconsin.
Prior to October 2, 2006, we had a 9.88% subsidiary equity ownership interest in Midwest Wireless Holdings (MWH), which provided wireless telephone services to customers in Minnesota, Iowa and Wisconsin. On November 17, 2005, MWH and Alltel Corporation (Alltel) entered into a definitive purchase agreement under which Alltel agreed to purchase MWH. The total compensation to be paid by Alltel was $1.075 billion, including payments to MWH stockholders and minority interest holders in MWH properties as well as the assumption of MWH’s outstanding debt. The transaction was completed on October 2, 2006. We received 90% of our share of the gross proceeds or approximately $74.0 million on October 6, 2006. We received our remaining share of the gross proceeds held in escrow in April 2007 (approximately $3.1 million) and January 2008 (approximately $5.1 million).
As of December 31, 2010 we also held:
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A 25.18% subsidiary equity ownership interest in FiberComm, LC, which is a CLEC located in Sioux City, Iowa;
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A 16.26% subsidiary equity ownership interest in Broadband Visions, LLC, which provides video headend and Internet services; and
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A 14.29% subsidiary equity ownership interest in Independent Emergency Services, LLC, a provider of E-911 services to the State of Minnesota as well as a number of counties located in Minnesota.
Our operations are currently conducted through the following subsidiaries:
Telecom Segment
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ILECs:
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New Ulm Telecom, Inc. (New Ulm), the parent company;
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Hutchinson Telephone Company (HTC), a wholly-owned subsidiary of New Ulm;
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Western Telephone Company (WTC), a wholly-owned subsidiary of New Ulm;
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Peoples Telephone Company (PTC), a wholly-owned subsidiary of New Ulm;
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CLECs:
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New Ulm, located in Redwood Falls, Minnesota;
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Hutchinson Telecommunications, Inc. (HTI), a wholly-owned subsidiary of HTC, located in Litchfield, Minnesota;
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Our investments and interests in the following entities include some management responsibilities:
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Hector Communications Corporation (HCC) - 33.33% ownership interest;
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FiberComm, LC - 25.18% ownership interest;
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Broadband Visions, LLC - 16.26% ownership interest; and
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Independent Emergency Services, LLC - 14.29% ownership interest.
We report the business operations of our four ILECs and two CLECs and their associated services as a single segment that we refer to as the Telecom Segment.
The Telecom Segment operates four ILECs (New Ulm, HTC, PTC and WTC) and two CLECs located in the cities of Redwood Falls and Litchfield, Minnesota. New Ulm, HTC and WTC are independent telephone companies that are regulated by the Minnesota Public Utilities Commission (MPUC), while PTC is an independent telephone company that is regulated by the Iowa Utilities Board (IUB). Our two CLECs are currently not under the same level of regulatory oversight as our ILECs. As of December 31, 2010 we serve approximately 28,200 access lines in the Minnesota communities of New Ulm, Courtland, Klossner, Searles, Redwood Falls (city only), Springfield, Sanborn, Hutchinson and Litchfield (city only), as well as the adjacent rural areas of Brown, Nicollet, Blue Earth, Redwood, McLeod and Meeker counties in south central Minnesota. In addition, we provide telephone services for the community of Aurelia, Iowa. The Telecom Segment also operates multiple CATV systems in Minnesota (including the cities of New Ulm, Courtland, Redwood Falls, Springfield, Sanborn, Jeffers, Hutchinson, Litchfield, Glencoe, Cologne, Mayer and New Germany) and one CATV system in Aurelia, Iowa. These CATV systems serve approximately 10,100 customers.
The Telecom Segment derives its principal revenues from (i) local service charges to its residential and business subscribers, (ii) access charges to Interexchange Carriers (IXCs) for providing the carriers access to our local phone networks and (iii) the provisioning of video and data services. We also receive revenue from long distance carriers for providing the billing and collection of long distance toll calls to our subscribers.
Neither our ILECs nor CLECs are dependent upon any single customer or small group of customers. No single customer accounted for 10% or more of our consolidated revenues in any of the last three years.
We receive the majority of our revenues through the following revenue sources:
Local Service - We receive recurring revenue for basic local services that enable end-user customers to make and receive telephone calls within a defined local calling area for a flat monthly fee. In addition to subscribing to basic local telephone services, our customers may choose from a variety of custom calling features such as call waiting, call forwarding, caller identification and voicemail. We also receive reciprocal compensation revenue based on interconnection agreements with wireless carriers using our network to terminate calls for their wireless subscribers.
Network Access - We provide access services to other telecommunications carriers for the use of our facilities to terminate or originate long distance calls on our network. Additionally, we bill subscriber line charges (SLC) to substantially all of our end-user customers for access to the public switched network. These monthly SLCs are regulated and approved by the Federal Communications Commission (FCC). In addition, network access revenue is derived from several federally administered pooling arrangements designed to provide support and distribute funding to the ILECs.
Cellular - We provide the retail sales and service of cellular phones and accessories through Telespire, a national wireless provider. We resell these wireless services as TechTrends Wireless, our branded product. We receive both recurring revenue for the wireless product as well as revenue collected for the sale of wireless phones and accessories. In addition, we also act as an authorized agent and receive commission revenue for sale of wireless services through Unicel, which is a regional wireless provider.
Video - We provide a variety of enhanced data network services on a monthly recurring basis to our end-user customers. This includes the broadband access portion of traditional Telecom broadband service. We also receive monthly recurring revenue from our end-user subscribers for the provisioning of commercial TV programming in competition with local CATV, satellite dish TV and off-air TV service providers. We serve ten communities with our digital TV services and five communities with our CATV services.
Data - We provide Internet services, including dial-up and high-speed Internet to business and residential customers. Our revenue is received in various flat rate packages based on the level of service, data speeds and features. We also provide e-mail and web hosting services.
Long Distance - Our end-user customers are billed for toll or long distance services on either a per call or flat rate basis. This also includes the offering of directory assistance, operator service and long distance private lines.
Other - We generate revenue from directory publishing, sales and service of customer premise equipment (CPE), bill processing and add/move/change services. Our directory publishing revenue is monthly recurring revenue from end-user subscribers for Yellow Page advertising in our telephone directories.
Competition
As a result of the Telecommunications Act of 1996 (TA96), telephone companies no longer have an exclusive franchise service area. Under the TA96, competitors may offer telephone service to our customers and request access to our local network facilities. The TA96 also permits existing telephone companies to offer telephone services outside their existing franchise service areas. The TA96 includes universal service provisions, interconnection requirements and rules mandating how competition will be implemented. The FCC and state regulatory agencies are responsible for establishing rule-making procedures to implement the TA96. The rule-making procedures are not complete and a number of court cases have already been filed challenging various aspects of the rules and procedures. Until the rule-making procedures are complete and the court issues settled, we cannot predict how TA96 will affect our business.
One of our business strategies has been to position ourselves as a “one-stop” communications provider. We believe our customer base places a value on the fact that we are a local company whose goal is to meet all of our customers’ total communications needs. We believe that we have several advantages over our competition, including competitive pricing and costs, outstanding service quality and a good reputation, a high level of commitment to the communities we serve, our strong investment in technology and the fact that we have a direct billing relationship with a large majority of the customers we serve in our service territories.
The long-range effect of competition on the delivery of communications services and equipment will depend on technological advances, regulatory actions at both the federal and the state levels, court decisions, and possible additional future federal and state legislation. Past federal and state legislation have tended to expand competition in the telecommunications industry.
Alternatives to our service, include customers leasing private line switched voice and data services in or adjacent to our service territories that permit the bypassing of our local telephone facilities. In addition, microwave transmission services, wireless communications, fiber optic coaxial cable deployment, Voice over Internet Protocol (VoIP), satellite and other services also permit the bypassing of our local exchange network. These alternatives to local exchange service represent a potential threat to our long-term ability to provide local exchange services at economical rates.
In order to meet the competition present in our industry, our ILECs have deployed new technology to enable our local exchange networks to increase operating efficiencies and to provide new services to our new and existing customer base. These new technologies include the latest release of digital switching technology on all of our ILEC switches and the installation of a new Common Channel Signaling System No. 7 (SS7) out-of-band system for all of our access lines. Our ILECs have also connected fiber rings (redundant route designs that allow traffic to be re-routed in case of network problems) that protect our local networks and enable them to provide a reliable level of service to our customers. The value of our local network is also enhanced by the ability of our operating companies to offer access to high-speed Internet with broadband access to over 92% of our access lines. Broadband technology allows customer access to high-speed Internet and traditional voice connectivity over the same connection. In addition, our ILECs have further enhanced our networks to allow the offering of video services over the same facilities that provide our customers with voice and Internet access. This technology is available to approximately 92% of our access lines.
We currently compete as a CLEC in the cities of Redwood Falls, Minnesota and Litchfield, Minnesota. Qwest is the existing ILEC in these markets. NU Telecom entered the Redwood Falls market as a CLEC in September of 2002, while HTI operates as a CLEC in the Litchfield market. Competition also currently exists in the other communities and areas served by our ILECs for traditional telephone service from wireless communications providers and we also expect competition to increase from service providers offering VoIP. We are also experiencing competition in the Minnesota communities of New Ulm, Redwood Falls, Springfield, Glencoe, Hutchinson and Litchfield in the provisioning of video services. Comcast is the existing incumbent provider of video services in the New Ulm market. Mediacom is the existing incumbent provider of video services in the Redwood Falls, Springfield, Hutchinson and Litchfield markets. Several other communications providers also compete with us in our markets in providing Internet services. Our ILECs and CLECs have responded to these competitive pressures by creating active programs to market our products, bundle our services and enhance our infrastructure to create higher customer satisfaction.
We are experiencing competition for some of our other services from IXCs, such as customer billing services, dedicated private lines and network switching. The provisioning of these services is contractual in nature and is primarily directed by the IXCs. Other services, such as directory advertising, operator services and cellular communications are open to competition, based primarily on service and customer experience.
Regulation
The following summary does not describe all present and proposed federal, state and local legislation and regulations affecting the telecommunications industry. Some legislation and other regulations are currently the subject of judicial proceedings, legislative hearings and administrative proposals that could change the manner in which this industry operates. At this time, we cannot predict the outcome of any of these developments or their potential impact on us. Regulation can change rapidly in the telecommunications industry and these -changes may have an adverse effect on us in the future. See Part I - Item 1A
Item 1A.
Risk Factors.
Our businesses face many risks, the most important of which we attempt to describe in the following section. If any of the events or circumstances described in the following risks actually occurred, our business financial condition or results of operations may suffer and affect the trading price of our stock.
Risks Related to Our Business and Our Industry
Unfavorable general economic conditions in the United States could negatively affect our operating results and financial condition. While it is often difficult for us to predict the impact of general economic conditions on our business, these conditions could adversely affect the affordability of and demand for some of our products and services and could cause customers to shift to lower-priced products and services or to delay or forgo purchases of our products and services. We have, for example, noticed a reduction in our local services and network access product lines as customers are deferring capital investments and moving to other communication options. Also, our customers may not be able to obtain adequate access to credit, which could affect their ability to make timely payments to us. If that were to occur, we could be required to increase our allowance for doubtful accounts and the number of days outstanding for our accounts receivable could increase. In addition, as discussed below under the heading “Risks Related to our Indebtedness and Our Capital Structure,” due to increased financing credit restrictions by banks and other lending institutions, we may not be able to refinance our maturing debt at terms that are as favorable as our current terms or at terms that are acceptable to us, or at all. For these reasons, among others, if the current economic conditions decline, they could adversely affect our operating results and financial condition, as well as our ability to service debt and pay other obligations.
The telecommunications industry is generally subject to substantial regulatory changes, rapid development and introduction of new technologies and intense competition that could cause us to suffer price reductions, reduced operating margins or loss of market share. The telecommunications industry has been, and we believe will continue to be, characterized by several trends, including the following:
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Substantial regulatory change due to the passage and implementation of the TA96, which included changes designed to stimulate competition for both local and long distance telecommunications services;
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Rapid development and introduction of new technologies and services;
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Increased competition within established markets from current and new market entrants that may provide competing or alternative services;
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The distortion of traditional dividing lines between, and the bundling of, different services, such as local dial tone, long distance, wireless, CATV, data and Internet services; and
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An increase in mergers and strategic alliances that allow telecommunications providers to offer increased services or access to wider geographic markets.
Some of these changes have resulted in increased competition, decreased rates and decreased profitability in our traditional wireline local exchange business. We cannot ensure that further changes will not adversely affect our business.
The telecommunications industry is highly competitive and increased competition in our core business segment may have an adverse effect. The TA96 permitted competition among communication companies for the rights to interconnect with established networks and to establish new networks in order to offer telephone service to customers in a franchised area. We serve as an ILEC in a number of franchised areas, as well as a CLEC in several other markets. As most of our markets are primarily rural, we have historically experienced limited competition; however, other telecommunications carriers have the authority under this legislation to provide new networking routes, points of interconnection, technology or signaling protocol, creating competition that could have a material adverse effect on our profitability. Many of our voice and data competitors, such as CATV operators, Internet access providers, wireless service providers and long distance carriers, have significantly greater brand name recognition and financial, personnel, marketing and other resources. In addition, due to consolidation and strategic alliances within the telecommunications industry, we cannot predict the number of competitors that will emerge, especially as a result of existing or new federal and state regulatory or legislative actions. This increased competition from existing and new entities could lead to price reductions and reduced operating margins or loss of market share. Although we attempt to differentiate our products and services through technology, reputation, service and price, competition has increased in our markets. This competition has affected our profitability in the past and we cannot ensure that it will not continue to affect our profitability in the future.
The above competition may lead to a loss of revenues and profitability as a result of numerous factors, including but not limited to:
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Loss of customers;
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Reduced usage of our network by our existing customers who may use alternative providers for long distance and data services;
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Reductions in our prices to maintain our current customer base in order to meet competitive pressures; and
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Increases in marketing expenditures and other costs to secure new customers.
Our possible pursuit of acquisitions could be expensive, may not be successful and, even if successful may be more costly than anticipated. Our ability to complete future acquisitions will depend on our ability to identify suitable acquisition candidates, negotiate acceptable terms for their acquisition and, if necessary, finance those acquisitions, in each case, before any attractive candidates are purchased by other parties, some of who may have greater financial resources than us. Whether or not any particular acquisition is closed successfully, these activities are expensive and require our management to spend considerable time and effort to accomplish them, which may detract from their ability to run our current business. We may face unexpected challenges in receiving any required approvals from the FCC or other applicable state regulatory commissions, which could result in the delay or our not being able to consummate the acquisition. Although we may spend considerable expense and effort to pursue acquisitions, we may not be successful in closing them.
If we are successful in closing acquisitions, we would face several risks associated with the integration of that acquisition’s operations into our current operations. In addition, any due diligence we perform may not prove to have been accurate. For example, we may face unexpected difficulties in entering markets in which we have little or no direct experience or in generating unexpected revenue and cash flow from the acquired companies or assets.
If we do pursue an acquisition or a strategic transaction and any of these risks materialize, they could have a material adverse effect on our business and our ability to achieve sufficient cash flow, provide adequate working capital, service and repay our indebtedness and leave sufficient funds to pay dividends.
We may not accurately predict technological trends or the success of new products in our markets. New product development often requires long-term forecasting of market trends, development and implementation of new technologies and processes and substantial capital investment. If we fail to anticipate or respond in a cost-effective and timely manner to technological developments, changes in industry standards or customer requirements, our business, operating results and financial condition could be materially adversely affected.
We may not be able to successfully introduce new products and services. Our success depends, in part, upon our ability to successfully introduce new products and services, such as the ability of our CLEC businesses, one that we initiated in 2002 in the City of Redwood Falls, MN, and the other acquired with the HTC acquisition in Litchfield, MN in 2008, to provide CLEC services in those new markets. Our success is also dependent on our ability to offer bundled service packages on terms attractive to our customers and our ability to successfully expand our service offerings into other geographical locations. New product development often requires long-term forecasting of market trends, development and implementation of new technologies and processes and substantial capital investment. In addition, our new products and services may not meet with market acceptance or be profitable. If we fail to anticipate or respond in a cost-effective and timely manner to technological developments, changes in industry standards or customer requirements, experience any significant delays in product development or introduction, or if any of our relationships with our vendors deteriorate significantly, our business operating results and financial condition could be materially adversely affected.
Shifts in our product mix may result in declines in our operating profitability. Possible changes in demand for our products and services including lower demand for our telephone services, reductions in access lines per household or reductions in minutes of use associated with our telephone service, migration in technology from circuit-switched to IP-based technology for services and other network solutions, may result in lower gross margins and operating profitability. Our traditional ILEC services carry higher margins than many of our newer services. Changes in product mix may also cause some of our inventory to become obsolete. We currently manage potential obsolescence through reserves, but future technology changes may exceed our current reserves.
Consolidation among our customers could result in our losing customers or experiencing a slowdown as integration takes place. Consolidation may affect our business as our customers focus on integrating their operations. We believe that customers engaged in integrating large-scale solutions may scale back their purchases of network equipment and services. Further, once consolidation occurs, our customers may choose to reduce the number of vendors they use to source their equipment or consolidate their circuits or network routing. After a consolidation occurs, there is no assurance that we will be selected to continue to supply equipment or network services to the surviving customer. The impact of significant mergers on our business is likely to be unclear until sometime after such transactions have closed.
We depend on third parties, over whom we have no control, to deliver our services. Because of the interconnected nature of the communications industry, we depend heavily on other telecommunications companies, network providers, program service providers and equipment vendors to deliver our services. In addition, we are dependent on easements, franchises and licenses from various private and public entities in order to construct and to operate our networks. The failure to maintain these necessary third party arrangements on acceptable terms would have an adverse effect on our ability to conduct our business.
Risks Related to the Management of Our Operations
A failure in our operational systems or infrastructure could impair our liquidity, disrupt our business, damage our reputation and result in losses. Flaws or failures in our internal processes, people or systems could impair our liquidity, disrupt our business, result in liability to customers or regulatory intervention, damage our reputation or result in financial loss. For example, our telephone operations rely on a central switch to complete local and long distance phone calls to customers. An interruption in the switch operations could lead to interrupted service for customers. In addition, financial, accounting, data processing or other operating systems and facilities may fail to operate properly or become disabled as a result of events that are wholly or partially beyond our control, thereby adversely affecting our ability to process transactions.
Despite the existence of contingency plans, our ability to conduct business may be adversely affected by a disruption in the infrastructure that supports our businesses and the communities where these businesses are located.
Our business may be harmed if we are unable to maintain data security. We are dependent upon automated information technology processes. Any failure to maintain the security of our data and our employees’ and customers’ confidential information, including via the penetration of our network security and the misappropriation of confidential information, could result in fines, penalties and private litigation. Any such failure could adversely affect our business, financial condition and results of operations.
Our businesses may be adversely affected if we are unable to hire and retain qualified employees. Our performance is largely dependent on the talents and efforts of highly skilled individuals in the operation of our communications businesses. Technological advances require our employees to continually upgrade their knowledge base. Our ability to compete and grow our business effectively depends upon our ability to attract qualified employees and retain and motivate our existing employees. Our inability to attract and retain highly qualified technical employees in the future could have a material adverse effect on our business, financial condition and results of operations. In addition, we may acquire new businesses in the future and our success will depend, in part, upon our ability to retain and integrate personnel from acquired businesses, who are critical to the continued success or the successful integration of these acquired businesses.
We depend on the continued contributions of our executive officers and other key management personnel, each of whom would be difficult to replace. Our future success depends to a significant degree upon the continued contributions of our senior management and our ability to attract and retain other highly qualified management personnel. We face competition for management personnel from other companies and organizations. Therefore we may not be able to retain our existing management personnel or fill new management positions or vacancies created by expansion or turnover at our existing compensations levels. The loss of any of our executive officers would disrupt our operations and divert the time and attention of our remaining officers. Additionally, our failure to attract and retain highly qualified management personnel may damage our business prospects.
We may have unanticipated increases in capital spending, operating or administrative costs, or seek new business opportunities that require significant up-front investments. We operate in cash-flow-dependent businesses. Our existing networks require large capitalized up-front investments for growth and maintenance. Our operating expenses, in the form of payroll for a highly trained workforce and the maintenance cost of communications networks are large uses of cash. Our debt service obligation and any dividends to stockholders also require significant cash each year. New business development may require additional up-front investment in assets and funding of early stage operating losses. Although we establish financial plans to attempt to ensure cash is adequate to fund operations, a sudden unanticipated increase in cash outflow after we have already initiated our business plans could alter our future business plans and could possibly affect our growth or ability to maintain our current network infrastructure.
Risks Related to Regulations
The telecommunications industry in which we operate is subject to extensive federal, state and local regulation that could change in a manner adverse to us. Our local telephone businesses in Minnesota and Iowa are subject to extensive regulations that affect the rates we charge, the areas we service, our contracts with suppliers and virtually every facet of our business. Laws and regulations may be, and in some cases have been, challenged in the courts and could be changed by Congress, state legislatures or regulators at any time. New regulations could be imposed by federal or state authorities further affecting our operating costs or capital requirements or that is otherwise adverse to us. We cannot predict the impact of future developments or changes to the regulatory environment or the impact these developments or changes may have on us. Adverse rulings, legislation or changes in governmental policy on issues material to us could increase our competition, potentially causing us to lose customers to competitors and decrease our revenue or increase our costs, thus decreasing our profitability.
Legislative or regulatory changes could reduce the revenue our ILEC or CLEC operations receive from network access charges. Access charges that are intended to compensate our ILEC and CLEC operations for originating, terminating or transporting long distance and other carriers’ calls in our service areas, accounted for approximately 16.3% of our total revenue in 2010. The amount of network access charges we receive is based on interstate rates set by the FCC and intrastate rates set by the MPUC and the IUB. The large national carriers who pay these charges have advocated in the past that access charges should be reduced and some network providers have argued that access charges do not apply to specific types of their traffic. As our business becomes increasingly competitive, the regulatory disparities regarding network access revenue, the marketplace forces on its pricing levels and our ability to enforce the historical rules for collecting this revenue, could have a material adverse effect on our business. We cannot predict whether or when action may be taken on any of these issues, or what effect any action may have on revenue and costs of our ILEC and CLEC operations.
In 2001, the FCC adopted rules reforming the network access charge system for rural carriers, including reductions in per-minute access charges and increases in both FUSF support and flat-rate monthly per line charges on end-user customers. The FCC is considering more change in network access charges that could materially reduce our access charge revenue and we do not know whether increases in other revenue, such as federal support and monthly line charges, would be sufficient to offset any such reductions. The MPUC and IUB may also make changes in our intrastate network access charges that could cause reductions in our revenue.
We believe that there has been a general increase in the unauthorized use of telecommunications providers’ networks without payment of appropriate access charges, or so-called “phantom traffic,” due in part to advances in technology that have made it easier to use networks while also avoiding payment for traffic. As a general matter, we believe this phantom traffic is due to unintended usage and, in some cases, fraud. While we perform revenue assurance tests regularly, we are at risk for potential claims made against us contesting the applicability of network access charges. If there is a successful dispute or avoidance of the applicability of network access charges, our revenue could decrease causing a material impact to our operations.
Legislative or regulatory changes could reduce or eliminate the governmental support we receive. The federal system of support, from which we derive a portion of our revenue, is subject to modification. Our ILEC operations receive significant federal support payments.
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For the year ended December 31, 2010 we received an aggregate of $2,784,420 from the FUSF that comprised 8.7% of our revenue for the year;
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For the year ended December 31, 2009 we received an aggregate of $2,048,646 from the FUSF that comprised 6.3% of our revenue for the year; and
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For the year ended December 31, 2008 we received an aggregate of $1,886,668 from the FUSF that comprised 5.4% of our revenue for the year.
During the past several years, the FCC has made modifications to the FUSF system that changed the sources of support and the method for determining the level of support to FUSF recipients. It is unclear whether the changes in methodology will continue to accurately reflect the costs incurred by our ILEC operations and whether we will continue to receive the same amount of FUSF support that we have received in the past. The FCC is also currently considering a number of issues regarding the source and amount of contributions to, and eligibility for payment from, the FUSF, and these issues may also be the subject of legislative amendments to the TA96.
In addition, under the TA96, our competitors may obtain the same level of FUSF support we do if the MPUC or IUB, as applicable, determines that granting this support to competitors would be in the public interest and the competitors offer and advertise telephone services as required by the TA96 and the FCC. Under current rules, any such payments to our competitors would not affect the level of support received by our ILEC and CLEC operations, but they would facilitate competitive entry into our ILEC and CLEC service areas and we may not be able to compete as effectively or otherwise continue to operate as profitably. Because of the growing number of competitors receiving USF support, the FCC is considering universal service reforms to limit the size of the fund.
Legislative and regulatory changes in the telecommunications industry could raise our costs by facilitating greater competition against us and reduce potential revenue. Legislative and regulatory changes in the telecommunications industry could adversely affect our business by facilitating greater competition against us, reducing our revenue or raising our costs. For example, federal or state legislatures or regulatory commissions could impose new requirements relating to standards or quality of service, credit and collection policies, or obligations to provide new or enhanced services.
Increased regulation of the Internet could decrease our revenue. Currently, there exists only a small body of law and regulation applicable to access to, or commerce on, the Internet. As the significance of the Internet expands, federal, state and local governments may adopt new rules and regulations or apply existing laws and regulations to the Internet. The FCC is currently reviewing the appropriate regulatory framework governing broadband consumer protections for high-speed access to the Internet through telephone and CATV providers’ communications networks. The outcome of these proceedings may affect our regulatory obligations and costs and competition for our services that could have a material adverse effect on our revenue.
Our operations are subject to environmental, health and safety laws and regulation that increase our costs of operations and could subject us to liability. Our operations and properties are subject to federal, state and local laws and regulations relating to the protection of the environment, natural resources and worker health and safety that could adversely affect our profitability. We operate under a number of environmental and health and safety laws, including laws and regulations governing and creating liability to the management, storage and disposal of hazardous materials, asbestos, petroleum products and other regulated materials. We are subject to environmental laws and regulations governing air emissions from our fleets of vehicles. As a result, we face several risks, including the following:
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Under certain environmental laws, we could be held liable, jointly and severally and without regard to fault, for the costs of investigating and the remediation of any actual or threatened environmental contamination at currently and formerly owned or operated properties, and those of our predecessors, and for contamination associated with disposal by us or our predecessors of hazardous materials at third party disposal sites;
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The presence of contamination can adversely affect the value of our properties and our ability to sell any such affected property or to use it as collateral;
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We could be held responsible for third party property damage claims, personal injury claims or natural resource damage claims relating to any such contamination;
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The cost of complying with existing environmental requirements could be significant;
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Adoption of new environmental laws, regulations or changes in existing laws or regulations or their interpretations could result in significant compliance costs or as yet identified environmental liabilities;
l
Future acquisition of businesses or properties subject to environmental requirements or affected by environmental contamination could require us to incur substantial costs relating to such matters; and
l
In addition, environmental laws regulating wetland, endangered species and other land use and natural resource issues may increase costs associated with future business or expansion opportunities; delay, alter or interfere with such plans; or otherwise adversely affect such plans.
In addition we are subject to environmental, health and safety laws regulating air emissions, storm water management and other issues arising in our business. While these obligations do not normally impose material costs upon our operations, unexpected events, equipment malfunctions and human error, among other factors, can lead to violations of environmental laws, regulations or permits. Furthermore, environmental laws and regulations change frequently and may require additional investment to maintain compliance. Noncompliance with existing, or adoption of more stringent, environmental or health and safety laws and regulations or the discovery of previously unknown contamination could require us to incur costs or become the basis of new or increased liabilities that could be material.
Fossil fuel combustion creates greenhouse gas (GHG) emissions that are linked to global climate change. Regulations to limit GHG emissions are in force in the European Union in an effort to prevent or reduce climate change. In the United States, federal legislative proposals that are being actively considered would, if adopted, implement some form of regulation or taxation to reduce or mitigate GHG emissions. In addition, the United States Environmental Protection Agency (EPA) is taking steps towards using its existing authority under the Clean Air Act to regulate GHG emissions. Among other steps, the EPA published the final rule for the “endangerment finding” on December 15, 2009 that declares that GHG emissions cause global warming and that global warming endangers the public health and welfare. This finding could lead to the regulation of GHG emissions from various sources, potentially affecting some of the facilities we operate.
Several states within the United States have adopted laws intended to limit fossil fuel consumption or encourage renewable energy development for the same purpose. For example, California enacted AB-32, the Global Warming Solutions Act of 2006, prescribing a statewide cap on global warming pollution with a goal of reaching (i) 1990 GHG emission levels by 2020, (ii) 80% below 1990 levels by 2050 and (iii) establishing a mandatory emissions reporting program.
Federal, regional, state and international regulatory programs are still developing. In their final form, they may include a tax on carbon, a carbon “cap-and-trade” market, and other restrictions on carbon and GHG emissions. The area of GHG limitations and regulation is rapidly changing and will continue to change as additional legislation is considered and adopted, and regulations are finalized that implement existing laws.
We do not anticipate that climate change-related laws and regulations would directly limit the emissions of GHG by our operations. We could, however, be directly subject to taxes, fees or costs, or could indirectly be required to reimburse electricity providers for such costs that would represent the amount of GHG we emit. The expected controls on GHG emissions are likely to increase the costs of electricity or fossil fuels, and these cost increases could materially increase our cost of operations or limit the availability of electricity or emergency generator fuels. The physical effects of climate change, including extreme weather conditions such as increased snowfall or rain, or heat waves, could materially increase our costs of operation due to, for example, an increase in our energy use in order to maintain the temperature and internal environment of our facilities necessary for our operations. To the extent any environmental laws enacted or regulations passed by the United States, or any domestic or foreign jurisdiction in which we perform business, impose new or unexpected costs, our business, results of operations or financial condition may be adversely affected.
Our business could be harmed by prolonged electrical power outages or shortages, increased costs of energy or a general lack of availability of electrical resources. Our facilities are susceptible to regional costs of power, electrical power shortages, planned or unplanned power outages and limitations on the availability of adequate power resources.
Power outages, such as those that occurred in California during 2001, in the Northeast in 2003, and from the tornados on the United States east coast in 2004, could harm our customers and our business. We attempt to limit exposure to system downtime by using backup generators and power supplies; however, we may not be able to limit our exposure entirely, even with those protections in place.
In each of our markets, we rely on third parties to provide a sufficient amount of power for current and future customers. At the same time, power and cooling requirements are growing on a per unit basis. As a result, some customers are consuming an increasing amount of power per cabinet. We generally do not control the amount of electric power our customers draw from their installed circuits. This means that we could face power limitations for our facilities. This could have a negative impact of the effective available capacity of our facilities and limit our ability to grow our business, which could have a negative impact on our financial performance, operating results and cash flows.
We may also have difficulty obtaining sufficient power capacity for potential expansion sites in new or existing markets. We may experience significant delays and substantial increased costs demanded by the utilities to provide the level of electrical service required by our current facilities.
A lack of parity between us and our competitors concerning assessments and tax laws could adversely affect our ability to profitably compete. The telecommunications industry is heavily taxed and assessed. As regulated entities, we serve as the pass-through entity responsible for charging and collecting the fees and taxes from our end-user customers and remitting the funds collected to the taxing and regulatory authorities. Unless regulators and taxing authorities change or clarify their rules and regulations to include our competitors, or deregulate and exclude us, the lack of parity could adversely affect our ability to effectively compete on price.
The high costs of regulatory compliance could make it more difficult for us to enter new markets, make acquisitions or change our prices. Regulatory compliance results in significant costs for us and diverts the time and effort of our management and officers away from running the business. In addition, because regulations differ from state to state, we could face significant costs in obtaining information necessary to compete effectively if we try to provide services, such as long distance services, in different states. These information barriers could cause us to incur substantial costs and to encounter significant obstacles and delays in entering these markets. Compliance costs and information barriers could also affect our ability to evaluate and compete for new opportunities to acquire local access lines or business as they arise.
Our intrastate services are also generally subject to certification, tariff filing and other ongoing state regulatory requirements. Challenges to our tariffs by regulators or third parties or delays in obtaining certifications and regulatory approvals could cause us to incur substantial legal and administrative expenses. If successful, these challenges could adversely affect the rates that we are able to charge customers and would negatively affect our revenue.
We may incur significant costs from lawsuits and regulatory inquiries. Any such claims or regulatory inquiries, whether successful or not, may require us to devote significant amounts of monetary or human resources to defend ourselves. It could be necessary to spend significant amounts on our legal defense and senior management may be required to divert their attention that could detract from their ability to run our business. If as a result of any proceedings, a judgment is rendered or a decree is entered against us, it may adversely affect our business, financial condition and results of operation.
Risks Related to Our Indebtedness and Our Capital Structure
The amount of debt we have outstanding, as well as any debt we may incur in the future, could have an adverse effect on our operational and financial flexibility. As of December 31, 2010 we had approximately $46.8 million of debt outstanding, of which approximately $43.3 million is long-term debt. The debt is secured by assets of NU Telecom and its subsidiaries. The assets have been pledged to CoBank, ACB for performance under the loans. In addition, NU Telecom and its subsidiaries have guaranteed all the obligations under the credit facility. The loan agreements place restrictions on us, including adhering to specified financial ratios, and places restrictions on our ability to pay cash dividends to our stockholders if we fail to comply with all loan covenants. At December 31, 2010 we were in compliance with all loan covenants and have achieved all acceptable financial ratios outlined in the loan agreements. Our level of debt could have significant consequences to our business, including the following:
l
Depending on interest rates and debt maturities, a substantial portion of our cash flow from operations could be dedicated to paying principal and interest on our debt, thereby reducing funds available for our acquisition strategy, capital expenditures or other purposes;
l
A significant amount of debt could make us more vulnerable to changes in economic conditions or increases in prevailing interest rates;
l
Our ability to obtain additional financing for acquisitions, capital expenditures or for other purposes could be impaired;
l
The increase in the amount of debt we have outstanding increases the risk of non-compliance with some of the covenants in our debt agreements that require us to maintain specified financial ratios; and
l
We may be more leveraged than some of our competitors that may result in a competitive disadvantage.
We cannot ensure that we will generate sufficient revenue to service and repay our debt and have sufficient funds left over to achieve or sustain profitability in our operations, meet our working capital and capital expenditure needs, compete successfully in our markets or pay dividends to our stockholders.
We may not be able to refinance our current debt on favorable terms. Most of the indebtedness under our credit facility matures in 2014 and we anticipate refinancing at that time. Due to turmoil in the credit markets and the economic conditions impacting our business, we may not be able to refinance maturing debt on terms that are as favorable as those currently in effect, on terms that are acceptable to us or at all.
If we seek additional financing, we may not be able to obtain favorable terms, or at all, and our stockholders may experience dilution of their ownership interest if we seek equity financing. We currently anticipate that our available cash resources, which include our ability to generate net cash flow from our operations, our credit facility, existing cash and cash equivalents, will be sufficient to meet our anticipated needs for working capital and capital expenditures to execute our near-term business plan, based on current business operations and economic conditions. If our estimates are incorrect and we are unable to generate sufficient cash flows from operations and we expend our credit facility, we may need to raise additional funds. In addition, if one or more of our strategic acquisition opportunities exceeds our existing resources, we may be required to seek additional capital. If we raise additional funds through the issuance of equity or equity-related securities, our stockholders may experience dilution of their ownership interests and the newly issued securities may have rights superior to those of common stock. If we raise additional funds by issuing additional debt, we may be subject to restrictive covenants that could limit our operating flexibility, and increased interest payments could dilute earnings per share.
We are subject to risks associated with changes in interest rates. We face market risks from changes in interest rates that could adversely affect our results of operations and financial condition. Although we attempt to reduce risk through the use of derivative financial instruments, we do not enter into derivative instruments for the purpose of speculation. In March of 2008, we entered into an interest rate protection agreement on $39.0 million of our variable-interest rate debt in order to manage our exposure to interest rate movements. Interest rate protection agreements on $5.0 million of this debt mature in March of 2011, and on $33.0 million of this debt mature in March of 2013. In June of 2008, we entered into a second interest-rate swap agreement, effectively locking in the interest rate on an additional $6.0 million of variable-interest rate debt. Interest rate protection agreements on $3.0 million of this debt mature in June of 2011, and an additional $3.0 million in June of 2013. If interest rates fail to rise as anticipated when the instruments were acquired, we will experience higher-than-market-rate interest expense and would have paid for protection that we did not need. We also risk entering a higher interest rate environment when the interest rate protection agreements expire in 2011 and 2013. This could affect our future interest expense level.
We are subject to restrictive debt covenants and other requirements related to our outstanding debt that limits our business flexibility by imposing operating and financial restrictions on us. We are subject to the following negative loan covenants, unless authorization to do so is obtained from CoBank, ACB:
l
Prohibition on mergers and acquisitions, and equity issuances;
l
Limitation on additional indebtedness other than existing permitted indebtedness;
l
Prohibition on liens, leases (as lessor) and encumbrances and negative pledges to other parties, other than existing permitted liens (including existing pledges of equity interests to CoBank, ACB) and liens on permitted indebtedness;
l
Prohibition on transfer of assets except in the ordinary course of business;
l
Restriction on investments other than (1) securities and deposits guaranteed by the United States of America or any agency thereof, (2) equity in CoBank, ACB, (3) existing investments, and (4) an additional $250,000 in aggregate in other investments;
l
Restriction on guarantees and contingent liabilities other than existing permitted contingent liabilities and guarantees of indebtedness of our subsidiary guarantors to CoBank, ACB, plus up to an additional $200,000 in aggregate;
l
Prohibition of transactions with affiliates, except in the ordinary course of business and on no less favourable than a comparable arm’s length transaction with a non-affiliate; and
l
Prohibition on management fees.
These restrictions could limit our ability to obtain future financing, make acquisitions or fund capital expenditures, withstand downturns in our business or take advantage of business opportunities. Furthermore, the credit facilities also require us to maintain specified total leverage and minimum interest coverage ratios and to satisfy specified financial condition tests, and may require us to make annual mandatory prepayments with a portion of our available cash. Our ability to comply with the ratios may be affected by events beyond our control including prevailing economic, financial and industry conditions.
A breach of any of these covenants contained in our credit agreement could result in a default under our credit facilities. If we were to default, the lenders could elect to declare all amounts outstanding under the credit facilities to be due and payable. If the amounts outstanding under our credit facilities were to be accelerated, we cannot ensure that our assets would be sufficient to repay in full the money owed to the lenders or to our other debt holders.
Risks Related to Financial Aspects of Our Company
Our future financial results could be adversely affected by asset impairment charges. We are required to test both acquired goodwill and other indefinite-lived intangible assets for impairment on an annual basis based upon a fair value approach, rather than amortizing them over time. We have chosen to perform our annual impairment reviews of goodwill and other indefinite-lived intangible assets during the fourth quarter of each fiscal year. We also are required to test goodwill for impairment between annual tests if events occur or circumstances change that would more likely than not reduce our enterprise fair value below its book value. These events or circumstances could include a significant change in the business climate, including a significant sustained decline in an entity’s market value, legal factors, operating performance indicators, competition, sale or disposition of a significant subsidiary, sale or disposition of a significant portion of the business or other factors. If the fair market value is less than the book value of goodwill, we could be required to record an impairment charge. The valuation of reporting units requires judgement in estimating future cash flows, discount rates and estimated product life cycles. In making these judgements, we evaluate the financial health of the business, including such factors as industry performance, changes in technology and operating cash flows.
As we have grown through acquisitions, we have accumulated approximately $29.7 million of goodwill, and have $3.0 million of indefinite-lived intangible assets out of total assets of approximately $120.4 million at December 31, 2010. As a result, the amount of any annual or interim impairment could be significant and could have a material adverse effect on our reported financial results for the period in which the charge is taken. We performed our impairment review for fiscal 2010 in the fourth quarter of 2010, and our Step One analysis indicates no impairment of goodwill and other indefinite-lived assets exists. As of December 31, 2009, management determined that our trade name useful life was no longer indefinite due to rebranding efforts occurring at HTC and we are now amortizing the trade name. An impairment test was required to be performed to value the trade name at fair value and resulted in no impairment charge. In connection with the goodwill acquired in the HTC acquisition, we did recognize approximately a $2.3 million goodwill impairment charge for fiscal year 2008 as of December 31, 2008.
A long-lived asset to be disposed of is reported at the lower of its carrying value or fair value less cost to sell. An asset to be used in our operations (other than goodwill and indefinite-lived intangible assets) is considered impaired when estimated future cash flows are less than the carrying amount of the asset. In the event the carrying amount of such asset is not deemed recoverable, the asset is adjusted to its estimated fair value. Fair value is generally determined based upon estimated discounted future cash flows. As we have grown through acquisitions, we have accumulated approximately $19.3 million, net of accumulated amortization, of definite-lived intangible assets. As a result, the amount of any annual or interim impairment could be significant and could have a material adverse effect on our reported financial results for the period that the charge is taken.
Customer payment defaults could have an adverse effect on our financial condition and results of operations. As a result of adverse market conditions, some of our customers may experience serious financial difficulties. Some of the IXCs and long distance companies that use our network are our largest customers when it comes to recurring revenue. In some cases, these difficulties have resulted or may result in bankruptcy filings or cessation of operations. If customers experiencing financial problems default on amounts owed to us, we may not be able to recognize expected revenue. Although we currently manage this exposure through an allowance for doubtful accounts, an unexpected bankruptcy or default by a customer may not be fully reserved for in our allowance.
Risks Related to Our Common Stock
Our Board of Directors could, in its discretion, depart from or change our dividend payment practices at any time. We are not required to pay dividends and our stockholders are not guaranteed, and do not have contractual or other rights, to receive dividends. Although we have paid cash dividends for years, in the third quarter of 2009, our Board of Directors decided to reduce our quarterly dividends from $0.10 per share to $0.08 per share. Our Board of Directors may decide at any time, at its discretion, to decrease the amount of dividends, otherwise change or revoke our past dividend payment practices or discontinue entirely the payment of dividends. In addition, if we do not pay dividends for whatever reason, your shares of our common stock could become less liquid and the market price of our common stock could decline.
Our ability to pay dividends, and our Board of Directors’ determination to maintain our past dividend payment practices, will depend on numerous factors, including the following:
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The state of our business, the environment that we operate in and the various risk factors we face, including, but not limited to competition, technological change, changes in our industry, regulatory and other risks summarized in this Annual Report on Form 10-K;
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Our future results of operations, financial condition, liquidity needs and capital resources;
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Our cash needs, including interest and any future principal payments on our indebtedness, capital expenditures, taxes, pension and other post-retirement contributions and other costs; and
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Potential sources of liquidity, including borrowing under our revolving credit facility or possible asset sales.
While our cash flow available to pay dividends for the year ended December 31, 2010 was sufficient to pay dividends in accordance with our past dividend payment practices, if our estimated cash flow available to pay dividends were to fall below our expectations, our assumptions as to estimated cash needs are too low or if other applicable assumptions were to prove incorrect, we may need to:
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Either reduce or eliminate dividends;
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Fund dividends by incurring additional debt (to the extent we were permitted to do so under agreements governing our then existing debt), which would increase our leverage, debt repayment obligations and interest expense and decrease our interest coverage, resulting in, among other things, reduced capacity to incur debt for other purposes, including to fund future dividend payments;
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Amend the terms of our credit agreement, if our lenders agreed, to permit us to pay dividends or make other payments if we are otherwise not permitted to do so;
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Fund dividends from future issuances of equity securities that could be dilutive to our stockholders and negatively affect the price of our common stock;
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Fund dividends from other sources, such as by asset sales or by working capital that would leave us with less cash available for other purposes; and
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Reduce other expected uses of cash, such as capital expenditures.
If we continue to pay dividends at the level currently anticipated under our current dividend payment practices, our ability to pursue growth opportunities may be limited. We believe that our current dividend payment practices could limit, but not preclude, our ability to grow. If we continue paying dividends at the level currently anticipated under our current dividend payment practices, we may not retain a sufficient amount of cash and may need to seek financing to fund a material expansion of our business, including any significant acquisitions or to pursue growth opportunities requiring capital expenditures significantly beyond our current expectations.
Our stock price is volatile. Based on the trading history of our common stock and the nature of the market for publically traded securities of companies in our industry, we believe that some factors have caused and are likely to continue to cause the market price of our common stock to fluctuate. These fluctuations could occur day-to-day or over a longer period of time and may be accentuated by the lack of liquidity in our stock. The factors that may cause such fluctuations include, without limitation:
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Announcements of new products and services by us or our competitors;
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Consolidation among our competitors or customers;
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Developments in telecommunications regulations;
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Disputes concerning intellectual property rights;
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Due to our low liquidity of stock trading volume, any imbalance between period supply and demand in shares offered;
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General economic conditions in the United States or internationally;
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Increased competition with our competitors or among our customers;
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Our financial health and the financial health of our competitions or our customers;
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Quarterly fluctuations in our financial results or the financial results of our competitors or customers;
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Rumours or speculation regarding our future business results and actions; and
In addition, stocks of companies in our industry in the past have experienced significant price and volume fluctuations that are often unrelated to the operating performance of such companies. This market volatility may adversely affect the market price of our common stock.
Item 1B.
Item 1B.
Unresolved Staff Comments
None.
Item 2.
Item 2.
Properties
Our business is primarily focused on the provision of service, and our properties are used primarily to house and safeguard our operating equipment. On December 31, 2010, our gross property, plant and equipment of $104,577,573 (net balance of $36,390,716) consisted primarily of telephone switches, cable, fiber optic networks and network equipment. We own the telephone property, plant and equipment that we use to operate our telephone systems. Our four ILECs own the central office equipment (COE) that we use to record, switch and transmit telephone calls, as described below:
New Ulm’s host COE was purchased in 1991 and consists of a Nortel Networks DMS-100/200 digital switch. New Ulm also has remote switching sites in four locations: three located in the city of New Ulm and one in the city of Courtland. The equipment at these remote switching sites is housed within specially designed COE buildings. In 2005, we installed a Tekelec T7000 soft switch in the New Ulm central office.
HTC’s COE includes a Lucent 5E system (installed in 1990) and a Meta-E Soft switch that was put into service in 2005. HTC houses the switch location for customers of HTC and HTI. Additionally, the shared headend satellite reception site and equipment for Broadband Visions, LLC is located at HTC.
PTC’s COE was installed in 1999 and consists of a Nortel Networks RSC digital remote switch. PTC leases host switching facilities from FiberComm, LC, in which we own a 25.18% equity interest.
WTC installed Nortel Networks remote COE in 1996. This remote switching equipment uses the host switch located in the city of New Ulm. WTC also has a remote switching site located in the city of Sanborn. The equipment located in Sanborn is housed within a specially designed COE building.
We believe our properties are suitable and adequate to provide modern and effective communications services within our service areas, including local dial-tone, long distance service, broadband, digital TV and dedicated and switched long-haul transport. We also believe our properties and equipment are adequately insured. See Note 6 - “Long-Term Debt” to the Consolidated Financial Statements of this Annual Report on Form 10-K for descriptions of the mortgages and collateral relating to the above and below referenced properties. See Item 7 - “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Property, Plant and Equipment” and Note 2 - “Property, Plant and Equipment” to the Consolidated Financial Statements of this Annual Report on Form 10-K for a description of our depreciation policies and information relating to the above and below referenced properties and equipment and their respective depreciation.
Our principal property locations are the following:
(1)
New Ulm owns the building located at 400 Second Street North, New Ulm, Minnesota. The building was originally constructed in 1918 and contains some of our back office functions and COE. The building also contains warehouse and garage space and contains approximately 23,700 square feet of floor space.
(2)
New Ulm owns the warehouse located at 1201 North Front Street, New Ulm, Minnesota. The warehouse contains 13,680 square feet of space and is used primarily as a storage facility for trucks, generators, trailers, plows and inventory used in outside plant construction, and office space for customer service technicians.
(3)
New Ulm owns four remote central office buildings that are located on the north, south and west sides of the city of New Ulm, Minnesota and in Courtland, Minnesota. These buildings contain COE that remote off New Ulm’s main COE.
(4)
New Ulm owns three towers and the land on which they are located. One tower is located east of the city of New Ulm, Minnesota along Highway 14 in Nicollet County. Another tower is located north of Saint George, Minnesota. The third tower is located at 400 Second Street North, New Ulm, Minnesota.
(5)
New Ulm owns land located at the corner of 7th Street South and Valley Street in New Ulm, Minnesota. This lot is utilized as storage for poles and cable inventory and contains approximately 5,000 square feet of fenced-in storage area.
(6)
New Ulm leases a building located at 27 North Minnesota, New Ulm, Minnesota. This building contains approximately 14,000 square feet of space and is used primarily as a retail location housing customer support services and our corporate business offices.
(7)
New Ulm owns a building located at 137 East 2nd Street, Redwood Falls, Minnesota. This building contains business offices and COE and contains approximately 1,540 square feet of floor space.
(8)
New Ulm owns three remote equipment office buildings located at 1105 South Mill Street, 220 Veda Drive and 620 Walnut Street, all in Redwood Falls, Minnesota. These buildings contain COE that remote off New Ulm’s main COE.
(9)
New Ulm owns two additional parcels within the city limits of New Ulm, Minnesota. The first parcel, legally described as Lot 3 - Block 1 and Lot 2 - Block 3, Airport Industrial Park contains a new remote and retail facility. This building contains approximately 2,400 square feet of floor space, with approximately 1,350 square feet used as retail space. The remaining space is used as a remote central office. The second parcel is legally described as Lot 3 - Block 1, Bridge Street Industrial Park First Addition is currently vacant and available for future use.
(10)
New Ulm owns a building located at 2104 East 10th Street, Glencoe, Minnesota that houses a business office, COE and CATV head-end equipment. The building contains approximately 962 square feet of floor space.
(11)
WTC owns a building located at 22 South Marshall, Springfield, Minnesota. This building houses the business office and COE and contains approximately 2,100 square feet of floor space.
(12)
WTC owns a building located in Sanborn, Minnesota that contains COE that remotes off WTC’s COE.
(13)
WTC owns a warehouse and lot located at 22 South Marshall, Springfield, Minnesota. This building is used as a storage facility for vehicles, other work equipment and inventory used in outside plant construction and contains approximately 3,750 square feet of space.
(14)
WTC owns a tower located in the city of Sanborn and leases the land on which the tower is located.
(15)
PTC owns a building located at 221 Main Street, Aurelia, Iowa that houses a business office, COE and CATV head-end equipment. The building contains approximately 1,875 square feet of floor space.
(16)
PTC owns the building adjacent to its main office building located at 217 Main Street, Aurelia, Iowa. This building has the capacity to expand the present main office building and contains approximately 1,875 square feet of floor space.
(17)
PTC owns a building located at 133 Main Street, Aurelia, Iowa. This building contains approximately 1,100 square feet of warehouse space and 525 square feet of office space.
(18)
PTC also owns a vacant lot located at 121 Main Street, Aurelia, Iowa. This lot is 25 feet by 100 feet.
(19)
HTC owns a building located at 235 Franklin Street South West, Hutchinson, Minnesota. This building houses a business office and central office and contains approximately 22,616 square feet of floor space.
(20)
HTC owns three buildings located at 345 Michigan Street South East, Hutchinson, Minnesota. These buildings house HTC’s outside plant equipment and contain office space for customer service technicians. The three buildings have approximately 19,200 square feet of space.
(21)
HTC owns a tower located at 345 Michigan Street South East, Hutchinson, Minnesota.
(22)
HTI owns a building located at 421 South CSAH 34, Litchfield, Minnesota. This building houses HTI’s business office and COE, and contains approximately 6,100 square feet of floor space.
(23)
HTI owns a tower located at 28077 County Road 9, Darwin, Minnesota.
(24)
HTI owns a second tower located at 55106 County Road 38, Buffalo Lake, Minnesota.
(25)
HTC owns a point-of -presence Hut located at 101 11th Street East, Glencoe, Minnesota. This Hut contains approximately 600 square feet.
In addition, New Ulm, HTC, PTC, WTC and HTI own the lines, cables and associated outside physical plant for use in providing telephone and CATV services. We also own equipment leased to subscribers such as telephone sets and other similarly-used instruments.
Item 3.
Item 3.
Legal Proceedings
From time to time we are involved in legal proceedings arising in the ordinary course of our business. There is no litigation pending that could have a material adverse effect on our results of operations and financial condition.
Item 4.
Item 4.
Reserved
PART II
Item 5.
Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Our common stock is quoted on the Over The Counter (OTC) Bulletin Board under the symbol “NULM.” As of March 1, 2011, there were 1,386 registered stockholders and approximately 341 beneficial owners of New Ulm Telecom, Inc. stock. The following table sets forth the end-of-day high and low prices for our common stock quoted on the OTC Bulletin Board during 2010 and 2009. These over-the-counter market quotations reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not necessarily reflect actual transactions.
Dividends and Restrictions
We declared dividends on our common stock of $0.08 per share for each of the four quarters ending December 31, 2010, which totaled approximately $409,235 for each quarter. We declared a quarterly dividend on our common stock of $0.10 per share for both the first and second quarters of 2009, which totaled approximately $511,543 for each of those two quarters; and a quarterly dividend of $0.08 per share for the third and fourth quarters of 2009, which totaled approximately $409,235 for each of those two quarters. We declared a quarterly dividend on our common stock of $0.10 per share in 2008, which totaled approximately $511,543 for each quarter. A quarterly cash dividend of $0.08 per share was paid on March 15, 2011 to stockholders of record at the close of business on March 4, 2011.
In 2009, we lowered our quarterly dividends on our common stock from $0.10 per share to $0.08 per share. Our Board of Directors has adopted dividend payment practices that reflect its judgment that our stockholders would be better served if we retained a higher portion of the cash generated by our business in excess of our expected cash needs to use for other purposes, such as to make investments in our business, rather than distribute this cash to our stockholders. We expect to continue to pay quarterly dividends during 2011, but only if and to the extent declared by our Board of Directors on a quarterly basis and subject to various restrictions on our ability to do so (described below). Dividends on our common stock are not cumulative.
There are security and loan agreements underlying our current CoBank, ACB credit facility that contain restrictions on our distributions to stockholders and investment in, or loans, to others. See below and Note 6 - “Long-Term Debt” to the Consolidated Financial Statements of this Annual Report on Form 10-K for additional information.
Our loan agreements have put restrictions on our ability to pay cash dividends to our stockholders. However, we are allowed to pay dividends (a) (i) in an amount up to $2,050,000 in any year and (ii) in any amount if NU Telecom’s “Total Leverage Ratio,” that is, the ratio of our “Indebtedness” to “EBITDA” (in each case as defined in our loan documents) is equal to or less than 3.50 to 1.00, and (b) in either case if NU Telecom is not in default or potential default under the loan agreements. If we fail to comply with these covenants, our ability to pay dividends would be limited.
At December 31, 2010 and December 31, 2009, we were in compliance with the financial ratios in our loan agreements. At December 31, 2008, we did not meet our “Equity to Total Asset Ratio” requirement of 40.0%, but had an “Equity to Total Asset Ratio” of 39.59%. We obtained a waiver from CoBank, ACB for our non-compliance with this covenant at December 31, 2008. At December 31, 2008, we were in compliance with all other financial ratios contained in our loan agreements. In connection with the granting of the waiver, CoBank, ACB amended our Master Loan Agreements (MLA) to lower our Total Leverage Ratio for the period from March 31, 2008 through December 31, 2010 to 4.25 to 1.00. Our Total Leverage Ratio had previously been 4.50 to 1.00 for the period from March 31, 2008 through December 31, 2009. At December 31, 2010, our Total Leverage Ratio was 3.46 to 1.00.
Our Board of Directors reviews quarterly dividend declarations based on our anticipated earnings, capital requirements and our operating and financial condition. The cash requirements of our current dividend payment practices are in addition to our other expected cash needs, both of which we expect to be funded with cash flow from operations. In addition, we expect we will have sufficient availability under our revolving credit facility to fund dividend payments in addition to any expected fluctuations in working capital and other cash needs, although we do not intend to borrow under this facility to pay dividends.
Issuer Purchases of Common Stock
We did not repurchase any shares of common stock in 2010, 2009 or 2008, respectively. Currently, we do not anticipate the repurchase of any common stock in 2011, and our Board of Directors has not authorized the repurchase of any common stock.
Item 6.
Item 6.
Selected Financial Data
Selected Income Statement Data for the Company (consolidated):
Selected Balance Sheet Data:
Information contained in the above tables for 2010, 2009 and 2008 is affected by the acquisition of HTC on January 4, 2008.
Item 7.
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion should be read in conjunction with our historical financial statements and the related notes contained elsewhere in this report.
Overview
NU Telecom offers a diverse array of communications products and services. Our ILEC businesses provide local telephone service and network access to other telecommunications carriers for calls originated or terminated on our network. In addition, we provide long distance service, dial-up and broadband Internet access, and video services. In 2002, we expanded our geographic service area by competitively providing service as a CLEC in the city of Redwood Falls, Minnesota. This CLEC provides local telephone service, long distance service, dial-up and broadband Internet access, and video services using our facilities. In 2008, we completed our acquisition of HTC, adding both an ILEC and a CLEC to our portfolio of operations. In 2010, we acquired the assets of the CATV system located in and around Glencoe, Minnesota, continuing the expansion of our service area. We also sell and service other communications products.
Our operations consist primarily of providing services to customers for a monthly charge. Because many of these services are recurring in nature, backlog orders and seasonality are not significant factors. Our working capital requirements include financing the construction of our networks, which consists of switches and cable, data, IP and digital TV. We also need capital to maintain our networks and infrastructure; fund the payroll costs of our highly skilled labor force; maintain inventory to service capital projects, our network and our telephone equipment customers; and to provide for the carrying value of trade accounts receivable, some of which may take several months to collect in the normal course of business.
Highlights
2010 Compared to 2009
l
Despite a challenging economic climate and in light of declining revenues, we were able to increase net income in 2010 through a combination of cost saving measures implemented throughout the company in 2010; lower interest expense by continuing to service and reduce our debt; and favorable tax adjustments related to uncertain tax positions related to gains on our MWH investment sold in 2006.
l
Traditional telephone services revenues from local and network access services declined 1.6%, reflecting the continued decline in our traditional access customers and network minutes of use. It should be noted that the declines in our access lines and telephone services revenues we experienced in 2010 and 2009, respectively, are below the industry average for access line and revenue loss.
l
Our sales of Internet and video services increased 4.0%, reflecting the Company’s expansion into Glencoe, Minnesota and targeted marketing effects of the Company for these services.
l
Our sales of cellular services declined in 2010 as a result of Alltel’s termination of its agreement with us to act as an authorized agent, effective August 31, 2009. In late 2009, we rolled out new cellular service options for our customers. We continued to develop this product line in 2010.
l
Our 2010 net income increased approximately $408,000 or 24.8%, primarily due to the cost saving measures and favorable tax adjustments related to uncertain tax positions related to gains on our MWH investment sold in 2006, both mentioned above.
l
We used cash flow from operations to reduce our outstanding long-term debt balance by $2,957,965 in 2010.
2009 Compared to 2008
l
Traditional telephone services revenues from local and network access services declined 5.8%, reflecting the continued decline in our traditional access customers and network minutes of use.
l
Our sales of Internet and video services declined 5.1%, reflecting the effects of the current United States economic downturn and competition in the marketplace we serve for these services.
l
Our sales of cellular services declined in 2009 as a result of Alltel’s termination of its agreement with us to act as an authorized agent, effective August 31, 2009. In late 2009, we rolled out new cellular service options for our customers.
l
Revenue from the sale of CPE declined in 2009, primarily due to the current United States economic downturn that delayed customer purchases.
l
Our 2009 net income decreased approximately $1,050,000 or 39.0%, primarily due to decline in our operating revenues.
l
We used cash flow from operations and investing activities to reduce our outstanding long-term debt balance by $2,419,004 in 2009.
l
Our capital expenditures increased by $1,430,539 in 2009 compared to 2008 as we continue to invest in our infrastructure and technology advancements.
Trends
During 2010, we continued to be affected by both increasing competition and the effects of the continuing current United States economic decline. Despite these challenging economic times, we have continued to expand our services and product offerings. By offering customers outstanding customer service and the products and services they desire, we believe that we have positioned ourselves to take advantage of an improving economic climate in which consumers enhance their utilization of communication services.
As the quantity and type of competitors within the telecommunications industry continue to grow, competition will remain intense. We have continued to experience competition from CATV providers, VoIP providers, wireless and other competitors during the past several years. Competition, combined with consumers substituting other methods for traditional voice services, has and will continue to negatively affect our current and future local and network access revenue streams. Access line losses totaled 969 or 3.3% in 2010 compared to 2009, and 769 or 2.6% in 2009 compared to 2008. The declines in access lines we experienced in 2010 and 2009, respectively, are below the industry average for access line loss.
As we experience access line losses, our network access revenue will continue to decline consistent with industry-wide trends. A combination of changing minutes of use, carriers optimizing their network costs and lower demand for dedicated lines may affect our future network access revenue. Network access revenue may also be significantly affected by potential changes in rate regulation at the state and federal levels. We continue to monitor regulatory changes as we believe that rate regulation will continue to be scrutinized and may be subject to change.
We have built a state-of-the-art broadband network and continue to increase connectivity speeds to customers, along with the bundling of our voice, Internet and video services, allowing us to meet customer demands for products and services. We continue to focus on the research and deployment of advanced technological products that include broadband services, private line, VoIP, digital video and IPTV services.
Financial results for the Telecom Segment for the years ended December 31, 2010, 2009 and 2008, are included below:
Telecom Segment
Revenue
Local Service - This recurring revenue is generated primarily through the sales of basic voice telephone services, enhanced calling features, local private lines and circuits, reciprocal compensation from wireless carriers and other miscellaneous local services. Local service revenue was $6,728,131, which is $347,325 or 4.9% lower in 2010 than in 2009 and was $7,075,456, which is $311,271 or 4.2% lower in 2009 than in 2008. Local service revenue was lower in both years primarily due to decreases in access lines of 969 or 3.3% in 2010 compared to 2009 and 769 or 2.6% in 2009 compared to 2008. Also contributing to the decrease in local service revenue in both years were customers cancelling other features including call waiting, caller identification, etc. Our access lines are decreasing as customers are increasingly using other technologies, such as wireless phones and IP services, as well as customer eliminating second phone lines when they move their Internet service from a dial up platform to a broadband platform.
The number of access lines we serve as an ILEC and CLEC has been decreasing, which is consistent with a general industry trend. To help offset declines in local service revenue, we implemented an overall strategy that continues to focus on selling a competitive bundle of services. Our focus on marketing competitive service bundles to our customers helps create value for the customer and aids in the retention of our voice lines.
Network Access - We receive a variety of fees and settlements to compensate us for the origination, transport and termination of calls and traffic on our network. These include fees assessed to IXCs, SLCs imposed on end-users and settlements from nationally administered revenue pools. Network access revenue was $13,599,055, which is $6,467 or 0.04% higher in 2010 than in 2009. Lower minutes of use were offset by a $155,437 increase in special access in 2010 compared to 2009. Network access revenue was $13,592,588, which is $962,610 or 6.6% lower in 2009 than in 2008. A bi-annual interstate rate decrease that went into effect on July 1, 2009, the decrease in access lines that has resulted in lowering our minutes of use, and IXCs optimizing their networks, lowering the demand for special access circuits, all contributed to the decline in network access revenues in 2009 compared to 2008.
Video - We receive monthly recurring revenue from end-user subscribers for providing commercial TV programming. Video revenue was $4,664,183, which is $344,192 or 8.0% higher in 2010 than in 2009, and was $4,319,991, which is $173,227 or 3.9% lower in 2009 than in 2008. The increase in revenues in 2010 compared to 2009 was primarily due to the addition of the Glencoe CATV system we purchased in June 2010. Also contributing to the increase in revenues were rate increases introduced into several of our markets over the course of the year and the launching of IPTV services in New Ulm, Courtland, Redwood Falls, Hutchinson, and Litchfield, Minnesota and Aurelia, Iowa. This new enhanced service offering provides customers with desired features and options, such as digital video recording.
Data - We receive monthly recurring revenue by providing dial-up and high speed Internet access to residential and business customers. Internet revenue was $2,402,180, which is $73,780 or 3.0% lower in 2010 than in 2009. The decrease in data revenue in 2010 compared to 2009 was primarily due to the loss of 499 dial-up Internet customers, partially offset by the addition of 300 broadband customers acquired in our purchase of the CATV system in Glencoe in June 2010. Internet revenue was $2,475,960, which is $195,196 or 7.3% lower in 2009 than in 2008. The decrease in data revenue in 2009 compared to 2008 was primarily due to a decrease of 764 dial-up Internet customers. Despite the decline in data revenues and dial-up Internet customers, data operating margins have increased due to the increase in higher margin broadband customers. We expect future growth in this area will be driven by customer migration from dial-up Internet to broadband products such as our broadband services; expansion of service areas, including Glencoe, Minnesota, and our aggressively packaging and selling service bundles.
Long Distance - Our end-user customers are billed for toll or long distance services on either a per-call or flat-rate basis. This includes the provision of directory assistance and operator services. Long distance revenue was $700,951, which is $53,447 or 7.1% lower in 2010 than in 2009. This decrease was primarily the result of the loss of 3.3% of our customer base in 2010 compared to 2009 as customers continue to use other technologies such as wireless and IP services to satisfy their long distance communication needs. Long distance revenue was $754,038, which is $138,815 or 15.5% lower in 2009 than in 2008. This decrease was primarily the result of the loss of 2.6% of our customer base in 2009 compared to 2008.
Other - Other revenue consists primarily of directory publishing, bill processing and collection as a service to other telephone service providers, sales and service of cellular phones and accessories, sales of CPE, transport services, maintenance and adds/moves/change revenue. Other revenue was $3,825,023, which is $570,617 or 13.0% lower in 2010 than in 2009. This decrease was primarily due to a change in our cellular revenue structure in 2009. We ceased being an authorized agent for Alltel as of September 1, 2009, and began offering a Company-branded service (Tech Trends Wireless) and agency sales for Unicel. The offering of these new services created lower revenues in 2010 compared to 2009. Other revenue was $4,395,640, which is $899,539 or 17.0% lower in 2009 than in 2008. This decrease was primarily due to a decrease in CPE revenue as a result of the current United States economic downturn as customers are delaying the replacement and upgrades of their equipment.
Cost of Services (Excluding Depreciation and Amortization)
Cost of services (excluding depreciation and amortization) was $11,836,346, which is $118,829 or 1.0% higher in 2010 than in 2009. This increase was primarily due to higher programming costs associated with the increase in our video customer base due to the acquisition of the Glencoe CATV system we purchased in June 2010.
Cost of services (excluding depreciation and amortization) was $11,717,517, which is $1,504,417 or 11.4% lower in 2009 than in 2008. This decrease was primarily due to lower costs associated with a declining customer base in 2009 and management efforts to contain costs in the current economic climate.
Selling, General and Administrative Expenses
Selling, general and administrative expenses were $6,189,076, which is $867,108 or 12.3% lower in 2010 than in 2009. This decrease was primarily due to continuing management efforts to contain costs in the current economic climate.
Selling, general and administrative expenses were $7,056,184, which is $33,680 or 0.5% lower in 2009 than in 2008. This decrease was primarily due to management efforts to contain costs in the current economic climate.
Depreciation and Amortization
Depreciation and amortization was $9,499,788, which is $83,602 or 0.9% higher in 2010 than in 2009. At December 31, 2009 NU Telecom management determined that our trade name intangible asset acquired with the purchase of HTC had become a definite-lived intangible asset. This resulted in the recognition of an additional $266,667 of amortization expense for 2010 compared to 2009.
Depreciation and amortization was $9,416,186, which is $433,981 or 4.8% higher in 2009 than in 2008. The increase in 2009 compared to 2008 was primarily due to capital expenditures made to support our technological and infrastructure enhancements.
Operating Income
Operating income was $4,393,953, which is $29,833 or 0.7% lower in 2010 than in 2009. This decrease was primarily due to decreases in revenue combined with an increase in depreciation and amortization expenses, partially offset by decreases in cost of services and selling, general and administrative expenses, all of which are described above.
Operating income was $4,423,786, which is $1,576,542 or 26.3% lower in 2009 than in 2008. This decrease was primarily due to decreases in revenue combined with an increase in depreciation and amortization expenses, all of which are described above.
Consolidated Results
Other Income and Interest Expense
Our gain on the sale of equity investments was $4,338, $1,045,599 and $5,123,797 in 2010, 2009 and 2008, respectively. The gain on sale of equity investments in 2010 reflects our pro-rata share of the distribution of remaining amounts that had been held in a Trust Account to cover potential additional expenses (including audit, legal and miscellaneous expenses) in connection with the MWH sale to Alltel. This distribution represents the final distribution of all remaining funds from the MWH/Alltel transaction. The gain on sale of equity investments in 2009 was the result of a gain recognized through the sale of our equity ownerships in SHAL Networks, Inc.; SHAL, LLC; Direct Communications, LLC and En-Tel Communications, LLC. See Note 3 - “Acquisitions and Dispositions” to the Consolidated Financial Statements of this Annual Report on Form 10-K. The gain on the sale of our equity investments for 2008 was a result of our receipt of our pro-rata share of escrow payments received from the sale of our MWH ownership to Alltel. See Note 4 - “Sale of Midwest Wireless Holdings LLC” to the Consolidated Financial Statements of this Annual Report on Form 10-K.
HCC investment income decreased $69,690 in 2010 compared to 2009 and increased $80,734 in 2009 compared to 2008. These decreases and increases reflect our equity portion of HCC net income. HCC net income decreased in 2010 primarily due to declining revenues and decreased profitability. HCC net income increased in 2009 primarily due to HCC’s management cost containment initiatives and reduction of debt.
Other income in 2010 and 2009 included a patronage credit earned with CoBank, ACB as a result of our debt agreements with them. The patronage credit allocated and received in 2010 amounted to $513,436, compared to $556,318 allocated and received in 2009. CoBank, ACB determines and pays the patronage credit annually, generally in the first quarter of the calendar year based on its results from the prior year. We record these patronage credits as income when they are received.
Interest income decreased $16,896 in 2010 compared to 2009 and decreased $390,229 in 2009 compared to 2008. As a result of servicing our debt, excess cash available to purchase investments was lower, and combined with lower interest rates offered by banks and other investment institutions, our interest income has declined.
Interest expense decreased $159,840 in 2010 compared to 2009 and decreased $369,974 in 2009 compared to 2008. These decreases for both years were primarily the result of lower outstanding debt balances.
Other investment income increased $303,010 in 2010 compared to 2009 and decreased $89,773 in 2009 compared to 2008. Other investment income includes our equity ownerships in several partnerships and limited liability corporations. We recorded $250,243 of income from equity investments in 2010, a $45,578 loss in 2009 and a $20,228 loss in 2008.
In 2008, we recorded a non-cash impairment charge of $2,291,000. This impairment was due to the negative effect of the changes in financial and credit markets, and overall valuations of telecommunications properties, on HTC’s financial position.
Income Taxes
Income tax expense decreased by $813,666 to $1,101,889 in 2010 compared to 2009. The effective income tax rate was 35.0%, 53.8% and 59.7% for 2010, 2009 and 2008, respectively. The effective income tax rate in 2010 was lower than in 2009 due to the recognition in 2010, of approximately $124,000 in net tax benefits, see Note 8 - “Income Taxes” to the Consolidated Financial Statements of this Annual Report on Form 10-K. Excluding the impact of the recognition of the tax benefit, the December 31, 2010 effective income tax rate would have been approximately 38.9%. The effective income tax rate in 2009 was lower than 2008 due to the effect of state income taxes and as a result of the goodwill impairment recorded in 2008. Excluding the impact of the goodwill impairment recorded in 2008, the December 31, 2008 effective income tax rate would have been approximately 48.07%. The effective tax rate differs from the federal statutory tax rate primarily due to state income taxes and other permanent differences.
Hector Communications Corporation Investment
The pro forma information for our investment in HCC is shown in the following table using the proportionate consolidation method. We are providing this pro forma information to show the effect that our HCC investment has on our net income and would have on our operating income before interest, taxes, depreciation and amortization (OIBITDA) if we included these earnings in our operating income. HCC contributed $637,025, $706,715 and $625,981 to our net income for the years ended December 31, 2010, 2009 and 2008, respectively.
If we included our proportionate share of HCC’s operating income in the operating income of NU Telecom, our OIBITDA would have increased from $13,893,741, $13,839,972 and $14,982,533 for the years ended December 31, 2010, 2009 and 2008, respectively, for NU Telecom alone, to $18,954,951, $19,237,599 and $20,294,216 for the years ended December 31, 2010, 2009 and 2008, respectively, as shown below.
Adjusted OBITDA is a common measure of operating performance in the telecommunications industry. The presentation of OBITDA is not a measure of financial performance under GAAP and should not be considered in isolation or as a substitute for consolidated net income (loss) as a measure of performance and may not be comparable to similarly titled measures used by other companies.
A recap of our net income, using the equity method to record earnings on our investment in HCC is contained in the following table.
Inflation
It is the opinion of our management that the effects of inflation on operating revenue and expenses over the past three years have been immaterial. Our management anticipates that this trend will continue in the near future.
Liquidity and Capital Resources
Capital Structure
NU Telecom’s total capital structure (long-term and short-term debt obligations, plus stockholders’ equity) was $99,239,628 at December 31, 2010, reflecting 52.8% equity and 47.2% debt. This compares to a capital structure of $101,632,365 at December 31, 2009, reflecting 51.0% equity and 49.0% debt. In the telecommunications industry, debt financing is most often based on operating cash flows. Specifically, our current use of the our credit facilities is in a ratio of approximately 3.46 times debt to EBITDA (earnings before interest, taxes, depreciation and amortization) as defined in our credit agreement; well within acceptable limits for our agreement and our industry. Management believes adequate operating cash flows and other internal and external resources, such as our cash on hand and revolving credit facility, are available to finance ongoing operating requirements, including capital expenditures, business development, debt service and temporary financing of trade accounts receivable.
Liquidity Outlook
Our short-term and long-term liquidity needs arise primarily from: (i) capital expenditures; (ii) working capital requirements needed to support the growth of our business; (iii) debt service; (iv) dividend payments on our common stock and (v) potential acquisitions.
Our primary sources of liquidity for the year ended December 31, 2010 were proceeds from cash generated from operations and cash reserves held at the beginning of the period. At December 31, 2010 we had a working capital deficit of $1,848. However, at December 31, 2010 we also had $6 million available under our revolving credit facility to fund any short-term working capital needs.
We have not conducted a public equity offering. We operate with original equity capital, retained earnings and additions to indebtedness in the form of senior debt and bank lines of credit.
Cash Flows
We expect our liquidity needs to arise from payment of dividends, interest and principal payments on our indebtedness, income taxes and capital expenditures. We use our revolving credit facility to manage the temporary increases and decreases in our cash balances.
Unfavorable general economic conditions, including the economic conditions in the United States, could negatively affect our business and the related cash flows. While it is often difficult for us to predict the impact of general economic conditions on our business, we believe that we will be able to meet our current and long-term cash commitments through our cash flows. We were in full compliance with our debt covenants as of December 31, 2010, and anticipate that we will be able to plan for and match future liquidity needs with future internal and external resources.
While we periodically seek to add growth initiatives by either expanding our network or our markets through organic/internal investments or through strategic acquisitions, we feel we can adjust the timing or the number of our initiatives according to any limitations which may be imposed by our capital structure or sources of financing. At this time, we do not anticipate our capital structure will limit our growth initiatives over the next twelve months.
The following table summarizes our cash flow:
Cash generated by operations for the year ended December 31, 2010 was $11,377,645, compared to cash generated by operations of $6,297,837 in 2009 and cash generated by operations of $9,520,678 in 2008. The 2010 increase was primarily due to the timing of changes in income taxes receivable and accrued income taxes. The 2009 decrease was primarily due to the timing of changes in income taxes receivable, accrued income taxes and deferred income taxes. The 2008 increase was primarily due to the acquisition of HTC and the timing of tax payments related to the gain on the MWH sale.
Cash generated by operations continues to be our primary source of funding for existing operations, capital expenditures, debt service and dividend payments to stockholders. At December 31, 2010, we had a working capital deficit of $1,848, compared to working capital of $1,691,572 at December 31, 2009. Cash and cash equivalents at December 31, 2010 were $2,394,703, compared to $2,526,490 at December 31, 2009.
Cash Flows from Investing Activities
We operate in a capital intensive business. We continue to upgrade our local networks for changes in technology in order to provide advanced services to our customers.
Cash flows used in investing activities were $6,914,528 for the year ended December 31, 2010, compared to $3,231,296 used in investing activities in 2009 and $65,073,753 in 2008. On June 14, 2010, we completed the acquisition of the CATV system in and around Glencoe, Minnesota for $1,600,000. In 2009, we received $1,890,000 in proceeds from the sale of equity investments to Iowa Telecom. In addition, in 2009 we reached a settlement on the escrow true-up due from HTC stockholders in the amount of $651,419. In 2008, cash used in the purchase of HTC was $65,900,719. We received proceeds from the MWH sale of its cellular investment of $5,123,797 in 2008. Capital expenditures relating to on-going operations were $5,026,623 in 2010, $5,540,308 in 2009 and $4,109,769 in 2008. We expect total plant additions of approximately $6,300,000 in 2011.
We used current working capital in 2010 to complete the $1.6 million acquisition of the CATV System in and around Glencoe, Minnesota and to fund our other capital expenditures. Our investing expenditures have been financed with cash flows from our current operations. We believe that our current operations will provide adequate cash flows to fund our plant additions for the upcoming year; however, funding from our revolving credit facility is available if the timing of our cash flows from operations does not match our cash flow requirements. We currently have $6 million available under our existing credit facility to fund capital expenditures and other operating needs.
Cash Flows used in Financing Activities
Cash used in financing activities for the year ended December 31, 2010 was $4,594,904. This included long-term debt repayments of $2,957,965 and the distribution of $1,636,939 of dividends to stockholders. Cash used in financing activities in 2009 was $3,860,561. This included loan proceeds of $400,000, which was the result of our accessing our revolving debt, offset by long-term debt repayments of $2,419,004 and the distribution of $1,841,557 of dividends to stockholders. In 2008, cash provided by financing activities was $49,363,276, due to the issuance of long-term debt of $59,700,000, offset by long-term debt repayments of $8,018,087, loan issuance costs of $272,465 and the distribution of $2,046,172 in dividends to stockholders.
Working Capital
We had a working capital deficit (i.e. current assets minus current liabilities) of $1,848 as of December 31, 2010, with both current assets and current liabilities of approximately $7.4 million, compared to positive working capital of $1,691,572 as of December 31, 2009. The ratio of current assets to current liabilities was 1.0 and 1.2 as of December 31, 2010 and 2009, respectively. In addition, if it becomes necessary, we will have sufficient availability under our revolving credit facility to fund any fluctuations in working capital and other cash needs.
Long-Term Debt and Revolving Credit Facilities
Our long-term debt obligations as of December 31, 2010, were $43,334,883, excluding current debt maturities of $3,458,976. Long-term debt obligations as of December 31, 2009, were $46,793,859, excluding current debt maturities of $2,957,965.
On January 4, 2008, in connection with our acquisition of HTC, we entered into a $59,700,000 credit facility with CoBank, ACB. Under the credit facility, we entered into separate MLAs and a series of supplements to the respective MLAs. Under the terms of the two MLAs and the supplements, we initially borrowed $59,700,000 and entered into promissory notes on the following terms:
MLA RX0583
NU Telecom and its respective subsidiaries also have entered into security agreements under which substantially all the assets of NU Telecom and its respective subsidiaries have been pledged to CoBank, ACB for performance under the loans. In addition, NU Telecom and its respective subsidiaries have guaranteed all the obligations under the credit facility.
Our credit facility requires us to comply with specified financial ratios and tests. These financial ratios and tests include total leverage ratio, debt service coverage ratio, equity to total assets ratio and maximum annual capital expenditures tests. At December 31, 2010 and 2009, we were in compliance with all financial ratios in the loan agreements. At December 31, 2008, we did not meet our “Equity to Total Asset Ratio” requirement of 40.0%, as we had an “Equity to Total Asset Ratio” of 39.59%. We obtained a waiver from CoBank, ACB for our non-compliance with this covenant at December 31, 2008.
Our loan agreements have placed restrictions on our ability to pay cash dividends to our stockholders. However, we are allowed to pay dividends (a) (i) in an amount up to $2,050,000 in any year and (ii) in any amount if NU Telecom’s “Total Leverage Ratio,” that is, the ratio of our “Indebtedness” to “EBITDA” (in each case as defined in the loan documents) is equal to or less than 3.50 to 1.00, and (b) in either case if NU Telecom is not in default or potential default under the loan agreements. If we fail to comply with these covenants, our ability to pay dividends would be limited. At December 31, 2010, our Total Leverage Ratio was 3.46 to 1.00.
Our credit facility contains restrictions that, among other things, limits or restricts our ability to enter into guarantees and contingent liabilities, incur additional debt, issue stock, transact asset sales, transfers or dispositions, and engage in mergers and acquisitions, without CoBank, ACB approval.
See Note 6 - “Long-Term Debt” to the Consolidated Financial Statements of this Annual Report on Form 10-K for information pertaining to our long-term debt.
Obligations and Commitments
As discussed above, in connection with our acquisition of HTC in 2008, NU Telecom entered into a credit facility with CoBank, ACB. Information about our contractual obligations, including obligations under the credit facility, and along with the cash principal payments due each period on our unsecured note payable and long-term debt is set forth in the following table.
A.
Interest on long-term debt is estimated using rates in effect as of December 31, 2010. We use interest rate swap agreements to manage our cash flow exposure to interest rate movements on a portion of our variable rate debt obligations (see Note 7 - “Interest Rate Swaps” to the Consolidated Financial Statements of this Annual Report on Form 10-K).
B.
Purchase obligations consist primarily of commitments incurred for capital improvements. We have a contract for plant upgrades in Glencoe, Minnesota. Other than this contract, there were no purchase obligations outstanding as of December 31, 2010.
Guarantees
We have guaranteed the obligations of our New Ulm subsidiary joint venture investment in FiberComm, LC. See Note 13 - “Guarantees” to the Consolidated Financial Statements of this Annual Report on Form 10-K.
Critical Accounting Policies and Estimates
Management’s discussion and analysis of financial condition and results of operations stated in this 2010 Annual Report on Form 10-K, are based upon NU Telecom’s consolidated financial statements that have been prepared in accordance with GAAP and, where applicable, conform to the accounting principles as prescribed by federal and state telephone utility regulatory authorities. We presently give accounting recognition to the actions of regulators where appropriate, as prescribed by Accounting Standards Codification (ASC) Topic 980 - Regulated Operations. The preparation of these financial statements requires our management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities. Our senior management has discussed the development and selection of accounting estimates and the related Management Discussion and Analysis disclosure with our Audit Committee. For a summary of our significant accounting policies, see Note 1 - “Summary of Significant Accounting Policies” to the Consolidated Financial Statements of this Annual Report on Form 10-K. There were no significant changes to these accounting policies during the year ended December 31, 2010.
Revenue Recognition
We recognize revenue when (i) persuasive evidence of an arrangement exists, (ii) delivery of the product has occurred or a service has been provided, (iii) the price is fixed or determinable and (iv) collectability is reasonably assured.
Revenues are earned from our customers primarily through the connection to our local network, digital and CATV services, and Internet services (both dial-up and broadband). Revenues for these services are billed based on set rates for monthly service or based on the amount of time the customer is utilizing our facilities. The revenue for these services is recognized when the service is rendered.
Revenues earned from IXCs accessing our network are based on the utilization of our network by these carriers as measured by minutes of use on the network by the individual carriers. Revenues are billed at tariffed access rates for both interstate and intrastate calls. Revenues for these services are recognized based on the period the access is provided.
Interstate access rates are established by a nationwide pooling of companies known as NECA. The FCC established NECA in 1983 to develop and administer interstate access service rates, terms and conditions. Revenues are pooled and redistributed on the basis of a company’s actual or average costs. New Ulm’s settlements from the pools are based on its actual costs to provide service, while the settlements for NU Telecom subsidiaries - WTC, PTC and HTC are based on nationwide average schedules. Access revenues for New Ulm include an estimate of a cost study each year that is trued-up subsequent to the end of any given year. Our management believes the estimates included in our preliminary cost study are reasonable. We cannot predict the future impact that industry or regulatory changes will have on interstate access revenues in 2011.
Intrastate access rates are filed with state regulatory commissions in Minnesota and Iowa.
We derive revenues from system sales and services through the sale, installation and servicing of communication systems. In accordance with ASC Topic 605 - Revenue Recognition, these deliverables are accounted for separately. We recognize revenue from customer contracts for sales and installations using the completed-contract method, which recognizes income when the contract is substantially complete. We recognize rental revenues over the rental period.
Allowance for Doubtful Accounts
We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. In making the determination of the appropriate allowance for doubtful accounts, we consider specific accounts, historical write-offs, changes in customer relationships, credit worthiness and concentrations of credit risk. Specific accounts receivable are written off once a determination is made that the account is uncollectible. Additional allowances may be required if the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments. Our allowance for doubtful accounts was $794,637 and $549,000 as of December 31, 2010 and 2009, respectively.
Inventories
Inventory includes parts, materials and supplies stored in our warehouses to support basic levels of service and maintenance as well as scheduled capital projects and equipment awaiting configuration for customers. Inventory also includes (i) parts and equipment shipped directly from vendors to customer locations while in transit and (ii) parts and equipment returned from customers that are being returned to vendors for credit. Our inventory value as of December 31, 2010 and December 31, 2009 was $1,708,042 and $1,295,638, respectively.
Inventories are valued using the lower of cost or market method. Similar to our allowance for doubtful accounts, we make estimates related to the valuation of inventory. As of December 31, 2010 and 2009, respectively, our inventory reserve was $0. We adjust our inventory carrying value for estimated obsolescence or unmarketable inventory to the estimated market value based upon assumptions about future demand and market conditions. As market and other conditions change, additional inventory reserves may be established at a time when the facts that give rise to a lower value are warranted.
Financial Derivative Instruments and Fair Value Measurements
We have adopted the rules prescribed under ASC Topic 820 - Fair Value Measurements and Disclosures, for our financial assets and liabilities. Our adoption of ASC Topic 820 did not affect our financial position, results of operations, liquidity or disclosures, as we did not have any financial assets or liabilities that were measured at fair value on a recurring basis as of January 1, 2008. In accordance with ASC Topic 820, we elected to defer the adoption for all non-financial assets and liabilities that are not recognized or disclosed at fair value in the financial statements on a recurring basis until January 1, 2009. This includes goodwill and non-financial long-lived assets that are measured at fair value in impairment testing. ASC Topic 820 defines fair value as the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When determining the fair value measurements for assets and liabilities that are required to be recorded at fair value, we consider (i) the principal or most advantageous market in which we would transact business related to those assets and liabilities, and (ii) the market-based risk measurements or assumptions, such as inherent risk, transfer restrictions and credit risk that market participants would use in pricing the asset or liability.
ASC Topic 820 includes a fair value hierarchy that is intended to increase consistency and comparability in fair value measurements and related disclosures. The fair value hierarchy is based on inputs to valuation techniques used to measure fair value that are either observable or unobservable. Observable inputs reflect assumptions market participants would use in pricing an asset or liability based on market data obtained from independent sources, while unobservable inputs reflect a reporting entity’s pricing based upon its own market assumptions. The fair value hierarchy consists of the following three levels:
Level 1:
Inputs are quoted prices in active markets for identical assets or liabilities.
Level 2:
Inputs are quoted prices for similar assets or liabilities in an active market, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable, and market-corroborated inputs that are derived principally from or corroborated by observable market data.
Level 3:
Inputs are derived from valuation techniques where one or more significant inputs or value drivers are unobservable.
We use financial derivative instruments to manage our overall cash flow exposure to fluctuations in interest rates. We account for derivative instruments in accordance with ASC Topic 815 - Derivatives and Hedging that requires derivative instruments to be recorded on the balance sheet at fair value. Changes in fair value of derivative instruments must be recognized in earnings unless specific hedge accounting criteria are met, in which case, the gains and losses are included in other comprehensive income rather than in earnings.
In 2008, we entered into interest rate swaps to manage our cash flow exposure to fluctuations in interest rates. These instruments were designated as cash flow hedges and were effective at mitigating the risk of fluctuations on interest rates in the market place. Any gains or losses related to changes in the fair value of these derivatives are accounted for as a component of accumulated other comprehensive income for as long as the hedge remains effective.
The fair value of our interest rate swap agreements is discussed in Note 7 - “Interest Rate Swaps” to the Consolidated Financial Statements of this Annual Report on Form 10-K. Our swap agreements were determined based on Level 2 inputs.
Intangible Assets
We amortize our definite-lived intangible assets over their estimated useful lives. Customer lists are amortized over fourteen to fifteen years, regulatory rights are amortized over fifteen years and non-competition agreements are amortized over five years. In addition, we have determined that our HTC trade name intangible asset no longer has an indefinite life due to our re-branding initiatives. We have determined that the HTC trade name will be amortized over three years, beginning in 2010, as the re-branding initiatives are completed. Intangible assets with finite lives are amortized over their respective estimated useful lives. Identifiable intangible assets that are subject to amortization are evaluated for impairment annually. In accordance with ASC Topic 350 - Intangibles - Goodwill and Other, assets determined to have an indefinite useful life are not amortized.
Valuation of Goodwill
We have goodwill on our books related to prior acquisitions of telephone properties. As discussed more fully in Note 5 - “Goodwill and Intangibles” to the Consolidated Financial Statements of this Annual Report on Form 10-K, and in accordance with ASC Topic 350, goodwill is reviewed for impairment annually or more frequently if an event occurs or circumstances change that would reduce the fair value below its carrying value. We perform our annual fair value evaluation in the fourth quarter of each year.
The impairment test for goodwill involves a two-step process: step one consists of a comparison of the fair value of a reporting unit with its carrying amount, including the goodwill allocated to each reporting unit. If the carrying amount is in excess of the fair value, step two requires the comparison of the implied fair value of the reporting unit goodwill with the carrying amount of the reporting unit goodwill. Any excess of the carrying value of the reporting unit goodwill over the implied fair value of the reporting unit goodwill will be recorded as an impairment loss.
In 2010, 2009 and 2008, we engaged an independent valuation firm to complete an annual impairment test for goodwill acquired. For 2010 and 2009, the testing resulted in no impairment to goodwill as the determined fair value was sufficient to pass the first step of the impairment test. Our independent valuation firm used a combination of Income and Market Approaches (Discounted Cash Flow Method or DCF Method) to estimate the fair value of the goodwill on our books related to prior acquisitions of telephone properties. The assumptions used in the estimates of fair value were based on projections provided by our management and a rate of return based on market information observed in debt and traded equity securities.
Their Market Approaches considered market multiples observed in companies comparable to ours, traded on public exchange or over-the-counter, or transacted in a merger or acquisition transaction.
Assumptions used in our 2010 DCF model include the following:
●
A 11.00% weighted average cost of capital based on an industry weighted average cost of capital; and
●
A 1.75% terminal growth rate.
The most significant amount of goodwill recorded on our books was due to the acquisition of HTC. The carrying value of that goodwill was $26,297,418 as of December 31, 2010. Based on the DCF models, and income and market-based approaches we used, we determined the estimated enterprise fair value of our reporting unit exceeded the carrying amount of that reporting unit by approximately $4.1 million, which indicated that we had no impairment as of December 31, 2010. The market-based approaches used in our evaluations are subject to change as a result of changing economic and competitive conditions. Future negative changes relating to our financial operations could result in a potential impairment of goodwill.
See Note 5 - “Goodwill and Intangibles” to the Consolidated Financial Statements of this Annual Report on Form 10-K for further details and a discussion of our recording of a $2,291,000 goodwill impairment in the fourth quarter of 2008.
Income Taxes
The provision for income taxes consists of an amount for taxes currently payable and a provision for tax consequences deferred to future periods. Deferred income taxes are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities, and their respective tax basis. Significant components of our deferred taxes arise from differences (i) in the basis of property, plant and equipment due to the use of accelerated depreciation methods for tax purposes, as well as (ii) in partnership investments and intangible assets due to the difference between book and tax basis. Our effective income tax rate is generally higher than the United States tax rate due to state income taxes and permanent differences.
We account for income taxes in accordance with ASC Topic 740 - Income Taxes. As required by ASC Topic 740, we recognize the financial statement benefit of tax positions only after determining that the relevant tax authority would more-likely-than-not sustain the position following an audit. For tax positions meeting the more-likely-than-not threshold, the amount recognized in the financial statements is the largest benefit that has a greater than 50 percent likelihood of being realized upon ultimate settlement with the relevant tax authority. On April 29, 2010, the Minnesota Department of Revenue completed its audit of our state tax returns for the years 2006, 2007 and 2008. Following the completion of that audit, we recognized approximately $124,000 in net tax benefits in April 2010 to reduce our accrual for unrecognized tax positions related to gains on our MWH investment sold in 2006. The above mentioned tax examination also resulted in an additional state tax liability of $22,944, including interest.
In accordance with ASC Topic 740, we had approximately $36,300 of net unrecognized tax benefits at December 31, 2010 that, if recognized, would favorably affect the income tax provision when recorded. See Note 8 - “Income Taxes” to the Consolidated Financial Statements of this Annual Report Form 10-K.
We are primarily subject to United States, Minnesota and Iowa income taxes. Tax years subsequent to 2006 remain open to examination by federal and state tax authorities. Our policy is to recognize interest and penalties related to income tax matters as income tax expense. As of December 31, 2010 we had $8,316 accrued for interest or penalties related to income tax matters.
Property, Plant and Equipment
We record impairment losses on long-lived assets used in operations when events and circumstances indicate the assets might be impaired and the undiscounted cash flows estimated to be generated by those assets are less than the carrying amounts of those assets. In assessing the recoverability of long-lived assets, we compare the carrying value to the undiscounted future cash flows the assets are expected to generate. If the total of the undiscounted future cash flows is less than the carrying amount of the assets, we would write down those assets based on the excess of the carrying amount over the fair value of the assets. Fair value is generally determined by calculating the discounted future cash flows expected from those assets. Changes in these estimates could have a material adverse effect on the assessment of long-lived assets, thereby requiring a write-down of the assets. Write-downs of long-lived assets are recorded as impairment charges and are a component of operating expenses. We have reviewed our long-lived assets and concluded that no impairment charge on these long-lived assets is necessary.
We use the group life method (mass asset accounting) to depreciate the assets of our telephone companies. Telephone plant acquired in a given year is grouped into similar categories and depreciated over the remaining estimated useful life of the group. When an asset is retired, both the asset and accumulated depreciation associated with that asset are removed from the balance sheet. Due to rapid changes in technology, selecting the estimated economic life of telecommunications plant and equipment requires a significant amount of judgment. We periodically review data on expected utilization of new equipment, asset retirement activity and net salvage values to determine adjustments to our depreciation rates. We have not made any significant changes to the lives of assets in the three-year period ended December 31, 2010.
Equity Method Investment
We are an investor in several partnerships and limited liability corporations. Our percentages of ownership in these joint ventures range from 14.29% to 33.33%. We use the equity method of accounting for these investments, which reflects original cost and the recognition of our share of the net income or losses from the respective operations.
Incentive Compensation
We engaged an outside consultant in 2005 to advise us in our development of an Employee Incentive Plan for employees other than executive officers and a Management Incentive Plan for our executive officers. Both plans were implemented in 2006. Both of these plans are cash-based incentive plans. Payments on each plan are based on an achievement of objectives of measurable corporate performance, with financial and customer related targets. The financial targets are based on an achievement of specified operating revenues and net income, based on our budget, while the customer service targets are based on several factors, including (i) “uptime” (the amount of time that our phone, cable and Internet services are available to customers) and restoration time (our ability to restore service when an interruption occurs), (ii) customer retention and (iii) customer service (derived from customer service data).
We accrue an estimated liability each year for these potential payouts and reverse that accrual if the incentive payout targets are not met and paid out. Incentive payouts, if earned, are typically paid in late March or early April of the year following the target year and after the filing of our Annual Report on Form 10-K.
Off-Balance Sheet Arrangements/Contingent Commitments
We are not engaged in any transactions, arrangements or other relationships with unconsolidated entities or other third parties that are reasonably likely to have a material effect on our liquidity, or on our access to, or requirements for capital resources. In addition, we have not established any special purpose entities.
Other
We have not conducted any public equity offerings in our recent history and operate with original equity capital, retained earnings and financing in the form of bank term debt with revolving lines of credit. By utilizing cash flow from operations and current asset balances, we believe that we have adequate resources to meet the anticipated operating, capital expenditures and debt service requirements of our current business plan.
Recent Accounting Developments
See Note 1 - “Summary of Significant Accounting Policies” to the Consolidated Financial Statements of this Annual Report on Form 10-K, for a discussion of recent accounting developments.
Item 7A.
Item 7A.
Quantitative and Qualitative Disclosures about Market Risk
We do not have operations subject to risks of foreign currency fluctuations. We do, however, use derivative financial instruments that qualify as cash-flow hedges to manage our exposure to interest rate fluctuations on a portion of our variable-interest rate debt. Our objectives for holding derivatives are to minimize interest rate risks using the most effective methods to eliminate or reduce the impact of these exposures. Variable rate debt instruments are subject to interest rate risk. On March 19, 2008, we executed interest-rate swap agreements, effectively locking in the interest rate on $6.0 million of our variable-rate debt through March 2011, and $33.0 million of our variable-rate debt through March 2013. On June 23, 2008 we executed interest-rate swap agreements, effectively locking in the interest rate on $3.0 million of our variable-rate debt through June 2011, and $3.0 million of variable-rate debt through June 2013. A summary of these agreements is contained in Note 7 - “Interest Rate Swaps” to the Consolidated Financial Statements of this Annual Report on Form 10-K.
We report the cumulative gain or loss on current derivative instruments as a component of accumulated other comprehensive income (loss) in stockholders’ equity. If the protection agreement is concluded prior to reaching full maturity, the cumulative gain or loss is recognized in earnings. At the conclusion of the full term maturity of the protection agreement, no gain or loss is recognized. Our earnings are affected by changes in interest rates as a portion of our long-term debt has variable interest rates based on LIBOR. If interest rates for the portion of our long-term debt based on variable rates had averaged 10% more for the years ended December 31, 2010 and 2009, our interest expense would have increased approximately $10,000 and $20,000, respectively.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
New Ulm Telecom, Inc.
We have audited the accompanying consolidated balance sheets of New Ulm Telecom, Inc. (a Minnesota corporation) and subsidiaries as of December 31, 2010 and 2009, and the related consolidated statements of income, stockholders’ equity and cash flows for each of the years in the three year period ended December 31, 2010. New Ulm Telecom, Inc.’s management is responsible for these consolidated financial statements. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, 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. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above, present fairly, in all material respects, the consolidated financial position of New Ulm Telecom, Inc. and subsidiaries as of December 31, 2010 and 2009, and the consolidated results of their operations and their cash flows for each of the years in the three year period ended December 31, 2010 in conformity with accounting principles generally accepted in the United States of America.
/s/ Olsen Thielen & Co., Ltd.
St. Paul, Minnesota
March 28, 2011
Item 8.
Item 8.
Financial Statements and Supplementary Data
NEW ULM TELECOM, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
FOR THE THREE YEARS ENDED DECEMBER 31, 2010, 2009 AND 2008
The accompanying notes are an integral part of these consolidated financial statements.
NEW ULM TELECOM, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2010 AND 2009
ASSETS
The accompanying notes are an integral part of these consolidated financial statements.
NEW ULM TELECOM, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (continued)
DECEMBER 31, 2010 AND 2009
LIABILITIES AND STOCKHOLDERS’ EQUITY
The accompanying notes are an integral part of these consolidated financial statements.
NEW ULM TELECOM, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2010, 2009, AND 2008
The accompanying notes are an integral part of these consolidated financial statements.
NEW ULM TELECOM, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2010, 2009, AND 2008
The accompanying notes are an integral part of these consolidated financial statements.
NEW ULM TELECOM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accounting policies of NU Telecom conform with GAAP and, where applicable, to the accounting principles as prescribed by federal and state telephone utility regulatory authorities. We presently give accounting recognition to the actions of regulators where appropriate, as prescribed by ASC Topic 980 - Regulated Operations. ASC Topic 980 provides guidance in preparing general purpose financial statements for most public utilities. In general, the type of regulation covered by this statement permits rates (prices) for some services to be set at levels intended to recover the estimated costs of providing regulated services or products, including the cost of capital (interest costs and a provision for earnings on stockholders’ investments).
Principles of Consolidation
Our consolidated financial statements report the financial condition and results of operations for NU Telecom and its subsidiaries in one business segment: the telecom segment. Inter-company transactions have been eliminated from the consolidated financial statements.
Classification of Costs and Expenses
Cost of services includes all costs related to delivery of communication services and products. These operating costs include all costs of performing services and providing related products including engineering, network monitoring and transportation costs.
Selling, general and administrative expenses include direct and indirect selling expenses, customer service, billing and collections, advertising and all other general and administrative costs associated with the operations of the business.
Use of Estimates
Preparing consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses, and disclosure of contingent assets and liabilities. The estimates and assumption used in the accompanying consolidated financial statements are based on our management’s evaluation of the relevant facts and circumstances as of the date of the financial statements. Actual results may differ from those estimates and assumptions.
Revenue Recognition
We recognize revenue when (i) persuasive evidence of an arrangement exists, (ii) delivery of the product has occurred or a service has been provided, (iii) the price is fixed or determinable and (iv) collectability is reasonably assured.
Revenues are earned from our customers primarily through the connection to our local network, digital and CATV services, and Internet services (both dial-up and high-speed broadband). Revenues for these services are billed based on set rates for monthly service or based on the amount of time the customer is utilizing our facilities. The revenue for these services is recognized when the service is rendered.
Revenues earned from IXCs accessing our network are based on the utilization of our network by these carriers as measured by minutes of use on the network by the individual carriers. Revenues are billed at tariffed access rates for both interstate and intrastate calls. Revenues for these services are recognized based on the period the access is provided.
NEW ULM TELECOM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Interstate access rates are established by a nationwide pooling of companies known as NECA. The FCC established NECA in 1983 to develop and administer interstate access service rates, terms and conditions. Revenues are pooled and redistributed on the basis of a company’s actual or average costs. New Ulm’s settlements from the pools are based on its actual costs to provide service, while the settlements for NU Telecom subsidiaries - WTC, PTC and HTC are based on nationwide average schedules. Access revenues for New Ulm include an estimate of a cost study each year that is trued-up subsequent to the end of any given year. Our management believes the estimates included in our preliminary cost study are reasonable. We cannot predict the future impact that industry or regulatory changes will have on interstate access revenues in 2011.
Intrastate access rates are filed with state regulatory commissions in Minnesota and Iowa.
We derive revenues from system sales and services through the sale, installation and servicing of communication systems. In accordance with ASC Topic 605 - Revenue Recognition, these deliverables are accounted for separately. We recognize revenue from customer contracts for sales and installations using the completed-contract method, which recognizes income when the contract is substantially complete. We recognize rental revenues over the rental period.
Advertising Expense
Advertising is expensed as incurred. Advertising expense charged to operations was $220,474, $205,665 and $181,816 in 2010, 2009 and 2008, respectively.
Cash Equivalents
All highly liquid investments (primarily United States Government Bonds and Agency Bonds) with a maturity of three months or less at the time of purchase are considered cash equivalents.
Accounts Receivables
As of December 31, 2010 and 2009, our consolidated accounts receivables totaled $1,662,224 and $1,696,270, respectively, net of the allowance for doubtful accounts. We believe our accounts receivable as of December 31, 2010, are recorded at their fair value. As there may be exposure or risk with accounts receivable, we routinely monitor our accounts receivable and adjust the allowance for doubtful accounts when events occur that may potentially affect the collection of accounts receivable.
Allowance for Doubtful Accounts
We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. To estimate the appropriate allowance for doubtful accounts, we consider specific accounts, historical write-offs, changes in customer financial condition and credit worthiness, and concentrations of credit risk. Specific accounts receivable are written off once we determine the account is uncollectible. The allowance for doubtful accounts was $794,637 and $549,000 as of December 31, 2010 and 2009, respectively.
Inventories
Inventory includes parts, materials and supplies stored in our warehouses to support basic levels of service and maintenance as well as scheduled capital projects and equipment awaiting configuration for customers. Inventory also includes parts and equipment shipped directly from vendors to customer locations while in transit and parts and equipment returned from customers which is being returned to vendors for credit. Our inventory value as of December 31, 2010 and 2009, was $1,708,042 and $1,295,638, respectively.
NEW ULM TELECOM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
We value inventory using the lower of cost or market method. Similar to our allowance for doubtful accounts, we make estimates related to the valuation of inventory. We adjust our inventory carrying value for estimated obsolescence or unmarketable inventory to the estimated market value based upon assumptions about future demand and market conditions. As market and other conditions change, we may establish additional inventory reserves at a time when the facts that give rise to a lower value are warranted. We use the first-in, first-out (FIFO) method of inventory costing for our non-retail inventory. We use the average cost method of inventory costing for our retail inventory.
Property, Plant and Equipment
We record impairment losses on long-lived assets used in operations when events and circumstances indicate the assets might be impaired and the undiscounted cash flows estimated to be generated by those assets are less than the carrying amounts of those assets. In assessing the recoverability of long-lived assets, we compare the carrying value to the undiscounted future cash flows the assets are expected to generate. If the total of the undiscounted future cash flows is less than the carrying amount of the assets, we would write down such assets based on the excess of the carrying amount over the fair value of the assets. Fair value is generally determined by calculating the discounted future cash flows expected from those assets. Changes in these estimates could have a material adverse effect on the assessment of its long-lived assets, thereby requiring a write-down of the assets. Write-downs of long-lived assets are recorded as impairment charges and are a component of operating expenses. We have reviewed our long-lived assets and concluded that no impairment charge on our long-lived assets is necessary.
We use the group life method (mass asset accounting) to depreciate the assets of our telephone companies. Telephone plant acquired in a given year is grouped into similar categories and depreciated over the remaining estimated useful life of the group. When an asset is retired, both the asset and accumulated depreciation associated with that asset are removed from the books. Due to rapid changes in technology, selecting the estimated economic life of telecommunications plant and equipment requires a significant amount of judgment. We periodically review data on expected utilization of new equipment, asset retirement activity and net salvage values to determine adjustments to our depreciation rates. We have not made any significant changes to the lives of these assets in the three year period ended December 31, 2010.
Recoverability of Long-Lived Assets
We review our long-lived assets annually or when events or changes in circumstances indicate the carrying amount of the assets may not be recoverable. We determine potential impairment by comparing the carrying value of our assets with the sum of the undiscounted cash flows expected to be provided by operating and eventually disposing of the assets. Should the sum of the expected future net cash flows be less than carrying values, we would determine whether an impairment loss should be recognized. No impairment losses have been identified in the financial statements as of December 31, 2010.
Investments and Other Assets
We are an investor in several partnerships and limited liability corporations. We use the equity method of accounting for these investments that reflects original cost and recognition of our share of the net income or losses from the respective operations.
Long-term investments in other companies that are not intended for resale or are not readily marketable are valued at the lower of cost or net realizable value.
Goodwill and Intangible Assets
Goodwill and intangible assets with indefinite useful lives are not amortized, but tested for impairment at least annually. See Note 5 - “Goodwill and Intangibles” to the Consolidated Financial Statements of this Annual Report on Form 10-K for a more detailed discussion of the intangible assets and goodwill. The carrying value of our goodwill and intangible assets increased in 2010 due to our acquisition of the Glencoe, Minnesota CATV system. Our goodwill balance was $29,707,100 and $29,516,324 as of December 31, 2010 and 2009, respectively. As of December 31, 2010 and 2009 we completed our annual impairment tests for acquired goodwill. This testing resulted in no impairment charges to goodwill at December 31, 2010 and 2009.
NEW ULM TELECOM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Interest During Construction
We include an average cost of debt for the construction of plant in our communications plant accounts.
Income Taxes
We account for income taxes in accordance with ASC Topic 740 - Income Taxes, which requires an asset and liability approach to financial accounting and reporting for income taxes. Accordingly, deferred tax assets and liabilities arise from the difference between the tax basis of an asset or liability and its reported amount in the financial statements. Deferred tax amounts are determined using the tax rates expected to be in effect when the taxes will actually be paid or refunds received, as provided under currently enacted tax law. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. Income tax expense or benefit is the tax payable or refundable, respectively, for the period plus or minus the change in deferred tax assets and liabilities during the period.
ASC Topic 740 requires us to recognize the financial statement benefit of a tax position only after determining that the relevant tax authority would more likely than not sustain the position following an audit. For tax positions meeting the more likely than not threshold, the amount recognized in the financial statements is the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement with the relevant tax authority. See Note 8 - “Income Taxes” to the Consolidated Financial Statements of this Annual Report on Form 10-K for additional information regarding income taxes.
We recognize interest and penalties accrued on unrecognized tax benefits as well as interest received from favorable tax settlements in our income tax expense. As of December 31, 2010 we had approximately $36,317 of net unrecognized tax benefits that, if recognized, would favorably affect our income tax provision when recorded. As of December 31, 2010 and December 31, 2009 we had $8,316 and $32,804, respectively, accrued for interest related to income tax matters. We are primarily subject to United States, Minnesota and Iowa income taxes. Our effective income tax rate differs from the United States income tax rate due to the effect of state income taxes and changes in other permanent differences. Tax years subsequent to 2006 remain open to examination by federal and state tax authorities.
Credit Risk
Financial instruments that potentially subject us to concentrations of credit risk consist primarily of cash investments and receivables. We deposit some of our cash investments in high credit quality financial institutions accounts which, at times, may exceed federally insured limits. We have not experienced any losses in these accounts and do not believe we are exposed to any significant credit risk. Concentrations of credit risk with respect to trade receivables are limited due to our large number of customers.
Collection of Taxes from Customers
Sales, excise and other taxes are imposed on most of our sales to nonexempt customers. We collect these taxes from our customers and remit the entire amounts to governmental authorities. Our accounting policies dictate that we exclude these taxes collected and remitted from our revenues and expenses.
NEW ULM TELECOM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Fair Value Measurements
We have adopted the rules prescribed under ASC Topic 820 - Fair Value Measurements and Disclosures, for our financial assets and liabilities. Our adoption of ASC Topic 820 did not affect our financial position, results of operations, liquidity or disclosures, as we did not have any financial assets or liabilities that were measured at fair value on a recurring basis as of January 1, 2008. In accordance with ASC Topic 820, we elected to defer the adoption for all non-financial assets and liabilities that are not recognized or disclosed at fair value in the financial statements on a recurring basis until January 1, 2009. This includes goodwill and non-financial long-lived assets that are measured at fair value in impairment testing. ASC Topic 820 defines fair value as the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When determining the fair value measurements for assets and liabilities that are required to be recorded at fair value, we consider (i) the principal or most advantageous market that we would transact business related to those assets and liabilities, and (ii) the market-based risk measurements or assumptions, such as inherent risk, transfer restrictions and credit risk that market participants would use in pricing the asset or liability.
ASC Topic 820 includes a fair value hierarchy that is intended to increase consistency and comparability in fair value measurements and related disclosures. The fair value hierarchy is based on inputs to valuation techniques used to measure fair value that are either observable or unobservable. Observable inputs reflect assumptions market participants would use in pricing an asset or liability based on market data obtained from independent sources, while unobservable inputs reflect a reporting entity’s pricing based upon its own market assumptions. The fair value hierarchy consists of the following three levels:
Level 1:
Inputs are quoted prices in active markets for identical assets or liabilities.
Level 2:
Inputs are quoted prices for similar assets or liabilities in an active market; quoted prices for identical or similar assets or liabilities in markets that are not active; inputs other than quoted prices that are observable; and market-corroborated inputs that are derived principally from or corroborated by observable market data.
Level 3:
Inputs are derived from valuation techniques in which one or more significant inputs or value drivers are unobservable.
In 2008, we entered into interest rate swaps with our lender CoBank, ACB to manage our cash flow exposure to fluctuations in interest rates. These instruments were designated as cash flow hedges and were effective at mitigating the risk of fluctuations on interest rates in the market place. Any gains or losses related to changes in the fair value of these derivatives are accounted for as a component of accumulated other comprehensive income (loss) for as long as the hedge remains effective.
The fair value of our interest rate swap agreements is discussed in Note 7 - “Interest Rate Swaps” to the Consolidated Financial Statements of this Annual Report on Form 10-K. The fair value of our interest rate swap agreements were determined based on Level 2 inputs.
Other Financial Instruments
Equity Investments - It is difficult to estimate a fair value for equity investments in companies carried on the equity or cost basis due to a lack of quoted market prices. We conducted an evaluation of our investments in all of our companies in connection with the preparation of our audited financial statements at December 31, 2010. We believe the carrying value of our investments is not impaired.
Debt - We estimate the fair value of our long-term debt based on the discounted future cash flows we expect to pay using current rates of borrowing for similar types of debt. Fair value of the debt approximates carrying value.
Other Financial Instruments - Our financial instruments also include cash equivalents, trade accounts receivable and accounts payable where the current carrying amounts approximate fair market value.
NEW ULM TELECOM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Earnings And Dividends Per Share
Basic earnings per share are computed by dividing net income by the weighted average number of shares of common stock outstanding during the year. Our basic and diluted earnings per share are based on our weighted average number of shares outstanding of 5,115,435.
Dividends per share are declared quarterly by the NU Telecom Board of Directors.
Recent Accounting Developments
Effective February 10, 2010 we adopted ASU 2010-09 - Subsequent Events, which provides amendments to ASC Topic 855 - Subsequent Events, removing the requirement for SEC filers to disclose the date through which an entity has evaluated subsequent events. The adoption of ASU 2010-09 did not have a significant impact on our disclosures.
Issued in January, 2010 ASU 2010-06 - Fair Value Measures and Disclosures, provides amendments to ASC Topic 820 - Fair Value Measurements and Disclosures, and provides guidance related to disclosures about the transfer in and out of Levels 1 and 2 and the activity in Level 3 fair value measurements. It also clarifies disclosures about the level of disaggregation, inputs and valuation techniques. Our adoption of this guidance, which was effective in the first quarter of 2010 except for the new requirements relating to a Level 3 activity, did not have a material impact on our disclosures. Level 3 requirements are effective in the first quarter of 2011 and are not expected to have a material impact.
Issued in October, 2009 ASU 2009-13 - Revenue Recognition (Topic 605): Multiple-Deliverable Revenue Arrangements, provides guidance for separating consideration in multiple-deliverable arrangements. The guidance will be effective for us January 1, 2011. We do not anticipate the adoption of ASU 200-13 to have a material effect on our financial statements or our disclosures.
We reviewed all other significant newly issued accounting pronouncements and determined they are either not applicable to our business or that no material effect is expected on our financial position and results of operations.
NOTE 2 - PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment as of December 31, 2010 and 2009, include the following:
Depreciation is computed using the straight-line method based on the estimated service or remaining useful lives of the various classes of depreciable assets. Depreciation expense was $7,427,957, $7,615,944 and $7,182,058 in 2010, 2009 and 2008, respectively. The composite depreciation rates on communications plant and equipment for the three years ended December 31, 2010, 2009 and 2008 were 7.1%, 7.7% and 7.6%. Other property is depreciated over estimated useful lives of three to fifteen years.
NEW ULM TELECOM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 3 - ACQUISITIONS AND DISPOSITIONS
Acquisition of CATV Assets
On June 14, 2010 NU Telecom completed the acquisition of all of the assets of the CATV system located in and around Glencoe, Minnesota from MIDCO for approximately $1.6 million pursuant to the Asset Purchase Agreement dated March 30, 2010. NU Telecom funded the purchase with current cash reserves. The acquisition resulted in the addition of approximately 1,200 connections to our video and Internet services.
The allocation of the purchase price for the CATV assets has been based on the assets’ fair values. ASC Topic 805 - Business Combinations, establishes criteria for determining whether intangible assets should be recognized separately from goodwill. ASC Topic 350 - Intangibles - Goodwill and Other, states that goodwill and intangible assets with indefinite lives are not amortized, but rather are tested for impairment on at least an annual basis.
The allocation of the net purchase price of the CATV assets is shown below:
This acquisition was accounted for using the acquisition method of accounting for business combinations, and accordingly, the acquired assets were recorded at estimated fair values as of the date of acquisition. Based upon our final purchase price allocation, the excess of the purchase price and acquisition costs over the fair value of the net identifiable tangible assets acquired was $338,435, which is deductible for income tax purposes. The estimated useful life of the customer relationships intangible asset is 14 years.
Our operations reflect the business activity of Glencoe from the date of its acquisition on June 14, 2010. These operations were not material to our overall business.
Acquisition of Hutchinson Telephone Company
On January 4, 2008 we completed the acquisition of HTC for approximately $83.0 million pursuant to the terms of the Agreement and Plan of Merger dated August 3, 2007 as amended. This transaction was structured as a reverse triangular merger where a newly formed subsidiary of New Ulm merged into HTC at closing, with HTC continuing as a subsidiary of New Ulm. The acquisition has resulted in a combined company that provides phone, video and Internet services with approximately 50,000 connections in a number of Minnesota and Iowa communities.
Under the Merger Agreement, approximately $72.0 million was distributed to former stockholders of HTC. An additional $5.7 million was placed in an escrow account primarily (i) to cover working capital adjustments from the January 4, 2008 closing date balance sheet and (ii) to provide indemnification of New Ulm for the representations and warranties of HTC in the Merger Agreement, 15 months from closing.
In April, 2009 we informed the escrow agent and the Stockholder Representative that we were claiming a $1,158,412 working capital true-up that New Ulm requested under the Merger Agreement in January, 2008 plus interest. We made no other claims on the escrow account balance. On October 29, 2009 NU Telecom and the Stockholder Representative agreed to settle the $1,158,412 through a payment to New Ulm of $651,419 from the escrow account and to agree to dismiss the pending court and arbitration proceedings related to this matter. Final documentation was subsequently completed in November, 2009. The loss of $506,993 has been reflected in the 2009 financial statements.
NEW ULM TELECOM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Our operations reflect the business activity of HTC from the date of its acquisition on January 4, 2008.
ASC Topic 805 - Business Combinations, establishes criteria for determining whether intangible assets should be recognized separately from goodwill. ASC Topic 350 provides that goodwill and intangible assets with indefinite useful lives are not amortized, but rather are tested for impairment on at least an annual basis.
The total allocation of the net purchase price of HTC based on an independent valuation is shown below:
This acquisition was accounted for using the purchase method of accounting for business combinations, and accordingly, the acquired assets and liabilities were recorded at estimated fair values as of the date of acquisition. Based upon our final purchase price allocation, the excess of the purchase price and acquisition costs over the fair value of the net identifiable tangible assets acquired was approximately $56.0 million. We recorded intangible assets related to our acquired customer relationships of $19,200,000, trade names of $800,000, regulatory rights of $4,000,000, video franchises of $3,000,000 and a non-compete agreement of $800,000. The estimated useful life of the customer relationships intangible asset is 14 years, regulatory rights intangible asset is 15 years and non-compete agreement intangible asset is 5 years. The trade names intangible asset and video franchises intangible asset were originally determined to have indefinite lives and were not subject to amortization. As of December 31, 2009, our management determined that our trade name intangible was no longer an indefinite-lived intangible asset due to the rebranding of HTC’s products and services. We cannot deduct the goodwill on this transaction for income tax purposes.
Disposition of Equity Investments
On September 24, 2009 NU Telecom completed the sale of its ownership interests in SHAL Networks, Inc.; SHAL, LLC; Direct Communications, LLC and En-Tel Communications, LLC to Iowa Telecom for approximately $1.9 million in cash and fiber facilities valued at $67,500, including specified customary adjustments. The sale of these equity investments resulted in a gain of $1,045,599.
NEW ULM TELECOM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The sale of these minority-owned investments allowed NU Telecom to monetize non-core investments. In addition, this transaction released NU Telecom from approximately $5.7 million of loan guarantees to Rural Telephone Finance Cooperative (RTFC) for loans to SHAL, LLC and En-Tel Communications, LLC.
NOTE 4 - SALE OF MIDWEST WIRELESS HOLDINGS LLC
Prior to the sale of MWH, we owned approximately 9.88% of MWH. In November 2005, MWH and Alltel entered into an agreement for Alltel to purchase MWH. The transaction was closed October 2, 2006 after the satisfaction of conditions and the receipt of regulatory approvals. Under the terms of the agreement, all of the members of MWH sold their membership interests to Alltel. Upon closing, we received approximately 90% of the gross sale proceeds, or approximately $74.0 million, on October 6, 2006. Alltel delivered the other 10% of the gross proceeds to an escrow agent. We received our pro rata share of the amount in escrow (i) in April 2007 (approximately $3.1 million, plus accrued interest) and (ii) in January 2008 (approximately $5.1 million, plus accrued interest).
NOTE 5 - GOODWILL AND INTANGIBLES
We account for goodwill and other intangible assets under ASC Topic 350 - Intangibles - Goodwill and Other. Under the provisions of this accounting standard, goodwill and intangible assets with indefinite useful lives are not amortized, but are instead tested for impairment (i) on at least an annual basis and (ii) when changes in circumstances indicate that the fair value of goodwill may be below its carrying value. At December 31, 2010 our goodwill totaled $29,707,100. Goodwill increased in 2010 by $190,776, due to the acquisition of the CATV system in Glencoe, Minnesota.
As required by ASC Topic 350, we do not amortize goodwill and other intangible assets with indefinite lives, but test for impairment on an annual basis or earlier if an event occurs or circumstances change that would reduce the fair value of a reporting unit below its carrying amount. These circumstances include, but are not limited to (i) a significant adverse change in the business climate, (ii) unanticipated competition or (iii) an adverse action or assessment by a regulator. Determining impairment involves estimating the fair value of a reporting unit using a combination of (i) the income or DCF approach and (ii) the market approach that utilizes comparable companies’ data. If the carrying amount of a reporting unit exceeds its fair value, then the amount of the impairment loss must be measured. The impairment loss is calculated by comparing the implied fair value of the reporting unit’s goodwill to its carrying amount. In calculating the implied fair value of the reporting unit’s goodwill, the fair value of the reporting unit is allocated to all of the assets and liabilities of the reporting unit. The excess of the fair value of a reporting unit over the amount assigned to its other assets and liabilities is the implied value of goodwill. We recognize impairment loss when the carrying amount of goodwill exceeds its implied fair value.
In 2010, 2009 and 2008, we engaged an independent valuation firm to complete an annual impairment test for goodwill acquired. For 2010 and 2009, the testing resulted in no impairment charge to goodwill as the determined fair value was sufficient to pass the first step of the impairment test.
During 2008, we assessed the events and changes in circumstances that could result in an impairment of goodwill. Due to the changes in financial and credit markets, and overall valuations of telecommunications properties, we, through an independent valuation firm, tested our goodwill in the fourth quarter of 2008. As a result of this testing, we determined that the carrying value of the reporting unit exceeded the fair value and recorded a non-cash impairment charge of $2,291,000. The non-cash impairment charge did not and is not expected to have any impact on our operations.
NEW ULM TELECOM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Our intangible assets subject to amortization consist of acquired customer relationships, regulatory rights and a noncompetition agreement. As of December 31, 2009, our management determined that our trade name intangible was no longer an indefinite-lived intangible asset due to the rebranding of HTC’s products and services. Our management anticipates that this rebranding process will take approximately three years to complete. We anticipate an additional charge to amortization expense of $266,667 per year, over the three years beginning in 2010, due to this rebranding process. Amortization expense was $2,071,831, $1,800,242 and $1,800,147 for 2010, 2009 and 2008, respectively. Amortization expense for the next five years is estimated to be:
We amortize intangible assets with finite lives over their respective estimated useful lives. Identifiable intangible assets that are subject to amortization are evaluated for impairment. The components of our identified intangible assets are as follows:
NOTE 6 - LONG-TERM DEBT
Substantially all of our assets are pledged as security for our long-term debt under loan agreements with CoBank, ACB. These mortgage notes are required to be paid in quarterly installments covering principal and interest, beginning in the year of issue and maturing on December 31, 2014.
The security and loan agreements underlying the CoBank, ACB notes contain restrictions on distributions to stockholders, investment in or loans to others. In addition, we are required to maintain financial ratios for total leverage, equity to total assets and debt service.
Secured Credit Facility:
On January 4, 2008, in connection with our acquisition of HTC, we entered into a $59,700,000 credit facility with CoBank, ACB. Under the credit facility, we entered into separate MLAs and a series of supplements to the respective MLAs. Under the terms of the two MLAs and the supplements, we initially borrowed $59,700,000 and entered into promissory notes on the following terms:
MLA RX0583
●
RX0583-T1 - $15,000,000 term note with interest payable monthly. Twelve quarterly principal payments of $125,000 are due commencing March 31, 2008 through December 31, 2010. Sixteen quarterly principal payments of $250,000 are due commencing March 31, 2011 through December 31, 2014. A final balloon payment of $9,500,000 is due at maturity of the note on December 31, 2014.
NEW ULM TELECOM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MLA RX0584
NU Telecom and its respective subsidiaries also entered into security agreements under which substantially all of the assets of NU Telecom and its respective subsidiaries have been pledged to CoBank, ACB as collateral. In addition, NU Telecom and its respective subsidiaries have guaranteed all obligations under the credit facility.
The loan agreements also put restrictions on the ability of NU Telecom to pay cash dividends to its stockholders. NU Telecom is allowed to pay dividends (a) (i) in an amount up to $2,050,000 in any year and (ii) in any amount if NU Telecom’s “Total Leverage Ratio,” that is, the ratio of its “Indebtedness” to “EBITDA” (in each case as defined in the loan documents), is equal to or less than 3:50 to 1:00 and (b) in either case if NU Telecom is not in default or potential default under the loan agreements.
NEW ULM TELECOM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Long-term debt is as follows:
As of December 31, 2010 and 2009 we were in compliance with the financial ratios in our loan agreements. As of December 31, 2008 we did not meet our “Equity to Total Asset Ratio” requirement of 40.0%, but instead realized an “Equity to Total Asset Ratio” of 39.59%. We obtained a waiver from CoBank, ACB for our non-compliance with this covenant. As of December 31, 2008 we were in compliance with all other financial ratios contained in our loan agreement. In connection with the granting of the waiver, CoBank, ACB amended our MLA to lower the Total Leverage Ratio for the period from March 31, 2008 through December 31, 2010 to 4.25:1.0. The Total Leverage Ratio had been 4.5:1.0 for the period from March 31, 2008 through December 31, 2009.
As described in Note 7 - “Interest Rate Swaps” to the Consolidated Financial Statements of this Annual Report on Form 10-K, we entered into interest rate swaps that effectively fix our interest rates and cover $44.0 million at a weighted average rate of 5.72%, as of December 31, 2010. The additional $8.8 million ($6.0 million available under the credit facility and $2.8 million currently outstanding) remains subject to variable interest rates, at an effective weighted average interest rate of 2.72%, as of December 31, 2010.
Required principal payments for the five years 2011 through 2015 are as follows:
NEW ULM TELECOM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 7 - INTEREST RATE SWAPS
We assess interest rate cash flow risk by continually identifying and monitoring changes in interest rate exposures that may adversely affect expected future cash flows and by evaluating hedging opportunities.
We generally use variable-rate debt to finance our operations, capital expenditures and acquisitions. These variable-rate debt obligations expose us to variability in interest payments due to changes in interest rates. The terms of our credit facility with CoBank, ACB require that we enter into interest rate agreements designed to protect us against fluctuations in interest rates, in an aggregate principal amount and for a duration determined under the credit facility.
To meet this objective, we entered into Interest Rate Swap Agreements with CoBank, ACB dated February 26, 2008. Under these Interest Rate Swap Agreements and subsequent swaps that each cover a specified notional dollar amount, we have changed the variable-rate cash flow exposure on the debt obligations to fixed cash flows. Under the terms of these interest rate swaps, we pay a fixed contractual interest rate and (i) make an additional payment if the LIBOR variable rate payment is below a contractual rate or (ii) receive a payment if the LIBOR variable rate payment is above the contractual rate.
Each month, we make interest payments to CoBank, ACB under our loan agreements based on the current applicable LIBOR Rate plus the contractual LIBOR margin then in effect with respect to each applicable loan, without reflecting any interest rate swaps. At the end of each calendar quarter, CoBank, ACB adjusts our aggregate interest payments based upon the difference, if any, between the amounts paid by us during the quarter and the current effective interest rate set forth in the table below. All net interest payments made by us are reported in our consolidated income statement as interest expense.
Pursuant to these interest rate swap agreements, we entered into interest rate swaps covering (i) $39.0 million of our aggregated indebtedness to CoBank, ACB effective March 19, 2008 and (ii) an additional $6.0 million of our aggregated indebtedness to CoBank, ACB effective June 23, 2008. These swaps effectively lock in the interest rate on (i) $6.0 million of variable-rate debt through March 2011, (ii) $33.0 million of variable-rate debt through March 2013, (iii) $3.0 million of variable-rate debt through June 2011 and (iv) $3.0 million of variable-rate debt through June 2013.
On January 1, 2011, we entered into a cash management agreement with CoBank, ACB. This agreement reduces our borrowing expense in the form of lower interest expense by ensuring there are no idle funds in our bank accounts as those excess funds are used to reduce our debt. The program works as follows: i) when we have excess cash in our bank accounts, our surplus cash is automatically applied to our outstanding loan balances in our revolver debt facilities and ii) when we have a cash deficit position in our bank accounts, CoBank, ACB advances funds on our revolver debt facilities to fund the deficit position. Over time, our interest expense is reduced as we are in a cash surplus position more often than a deficit position. In connection with this agreement, on December 30, 2010, we broke out $1,000,000 of the interest rate swap agreements on Loan RX0583-T1. We recognized a realized loss of $6,345 for the early termination of this interest rate swap agreement as of December 31, 2010.
As of December 31, 2010 we had the following interest rate swaps in effect.
(1) As described in Note 6 - “Long-Term Debt” to the Consolidated Financial Statements of this Annual Report on From 10-K, each note above initially bears interest at a LIBOR rate determined by the maturity of the note, plus a “LIBOR Margin” rate equal to either 2.25% or 2.50% according to the individual secured credit facility. The LIBOR Margin decreases as the borrower’s “Leverage Ratio” decreases. The “Current Effective Interest Rate” in the table reflects the rate we pay giving effect to the swaps.
NEW ULM TELECOM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
These interest rate swaps qualify as cash flow hedges for accounting purposes under ASC Topic 815 - Derivatives and Hedging. We have reflected the effect of these hedging transactions in the financial statements for the periods ended December 31, 2010, 2009 and 2008, respectively. As of December 31, 2010 we recognized an unrealized loss, net of tax, of $56,445. As of December 31, 2009 we recognized an unrealized gain, net of tax, of $201,468. As of December 31, 2008 we recognized an unrealized loss, net of tax, of $1,413,713. The unrealized losses and gain were reported in other comprehensive income (loss). If we were to terminate our interest rate swap agreements, the cumulative change in fair value at the date of termination would be reclassified from accumulated other comprehensive income (loss), which is classified in stockholders’ equity, into earnings on the consolidated statements of income.
The fair value of the Company’s interest rate swap agreements is determined based on valuations received from CoBank, ACB and are based on the present value of expected future cash flows using discount rates appropriate with the terms of the swap agreements. The fair value indicates an estimated amount we would have to pay if the contracts were canceled or transferred to other parties. At December 31, 2010, the fair value loss on the swaps was $2,131,177, which has been recorded net of deferred tax benefit of $862,487, for the $1,268,690 in other comprehensive loss. At December 31, 2009, the fair value loss on the swaps was $2,036,361, which has been recorded net of deferred tax benefit of $824,116, for the $1,212,245 in other comprehensive loss. As of December 31, 2008, the fair value loss on the swaps was $2,374,793, which has been recorded net of a deferred tax benefit of $961,080, resulting in the $1,413,713 in other comprehensive loss.
NOTE 8 - INCOME TAXES
Income taxes recorded in our consolidated statements of income consists of the following:
NEW ULM TELECOM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Effective January 1, 2007, we adopted ASC Topic 740 - Income Taxes. As required under ASC Topic 740, the financial statement benefit of a tax position is recognized only after determining that the relevant tax authority would more likely than not sustain the position following an audit. For tax positions meeting the more-likely-than-not threshold, the amount recognized in the financial statements is the largest benefit that has a greater than 50 percent likelihood of being realized upon ultimate settlement with the relevant tax authority.
A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows:
Included in the balance as of December 31, 2010, are unrecognized tax benefits related to positions taken on state income tax return filings.
As of December 31, 2010 we had $21,142 of unrecognized tax benefits, net of a federal tax benefit of $15,175, which if recognized would affect the effective tax rate. As of December 31, 2009 we had $121,245 of unrecognized tax benefits, net of a federal tax benefit of $79,358, which if recognized would affect the effective tax rate.
We are primarily subject to United States, Minnesota and Iowa income taxes. Tax years subsequent to 2006 remain open to examination by United States and state tax authorities. Our policy is to recognize interest and penalties related to income tax matters in income tax expense. The Internal Revenue Service examined our 2006 and 2007 Federal tax returns. The examination of these returns was completed in the second quarter of 2009. The examination resulted in approximately $173,000 of additional tax expense in 2009. On April 29, 2010, the Minnesota Department of Revenue completed its audit of our state tax returns for the years 2006, 2007 and 2008. Following the completion of that audit, we recognized approximately $124,000 in net tax benefits in April 2010 to eliminate unrecognized benefits for uncertain tax positions related to gains on our MWH investment sold in 2006. The above mentioned tax examination also resulted in an additional state tax liability plus interest of $22,944. As of December 31, 2010 we had accrued $8,316 of interest related to income tax matters.
The differences between the statutory federal tax rate and the effective tax rate were as follows:
NEW ULM TELECOM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Deferred income taxes and unrecognized tax benefits reflected in our consolidated balance sheets are summarized as follows:
NOTE 9 - RETIREMENT PLAN
We have a 401(k) employee savings plan in effect for employees who meet age and service requirements. Our contributions to our 401(k) employee savings plan were $297,893, $186,396 and $426,266 in 2010, 2009 and 2008, respectively.
NOTE 10 - COMMITMENTS AND CONTINGENCIES
We are involved in certain contractual disputes in the ordinary course of business. We do not believe the ultimate resolution of any of these existing matters will have a material adverse effect on our financial position, results of operations or cash flows. We did not experience any changes to material contractual obligations in the year ended December 31, 2010.
Our capital budget for 2011 is approximately $6,300,000 and will be financed through internally generated funds. In September 2010, we signed an agreement for the upgrade to the existing hybrid fiber coaxial cable network in Glencoe, Minnesota for $286,692. As of December 31, 2010 we had an outstanding commitment on this contract for $241,016. There were no other purchase commitments as of December 31, 2010.
NOTE 11 - NONCASH INVESTING ACTIVITIES
Noncash investing activities included $130,522, $343,327 and $999,180 during the years ended December 31, 2010, 2009 and 2008, respectively. These activities related to plant and equipment additions placed in service and are recorded in our accounts payable at year-end.
NOTE 12 - OTHER INVESTMENTS
We are a co-investor with other rural telephone companies in several partnerships and limited liability corporations. These joint ventures make it possible to offer services to customers, including digital video services and fiber optic transport services that we would have difficulty offering on our own. These joint ventures also make it possible to invest in new technologies with a lower level of financial risk. We recognize income and losses from these investments on the equity method of accounting. For a listing of our investments, see Note 17 - “Segment Information” to the Consolidated Financial Statements of this Annual Report on Form 10-K.
NEW ULM TELECOM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
On June 30, 2009 we entered into an Equity Securities Purchase Agreement with Iowa Telecom where we agreed to sell our ownership interests in SHAL Networks, Inc.; SHAL, LLC; Direct Communications, LLC and En-Tel Communications, LLC to Iowa Telecom. On September 24, 2009 we completed the sale of our ownership interests for approximately $1.9 million in cash and fiber facilities valued at $67,500, including specified customary adjustments. The sale of these equity investments resulted in a gain of $1,045,599 in the third quarter of 2009. The sale of these minority-owned investments allowed us to monetize non-core investments. In addition, this transaction released us approximately $5.7 million in loan guarantees to FRGC for loans to SHAL, LLC and En-Tel Communications, LLC. See Note 13 - “Guarantees” to the Consolidated Financial Statements of this Annual Report on Form 10-K for more information regarding our guarantees.
NOTE 13 - GUARANTEES
On January 30, 2004 we guaranteed a portion of the indebtedness of FiberComm, LC in connection with the refinancing of a fifteen-year loan, maturing in January, 2019 made by American State Bank to FiberComm, LC. As of December 31, 2010 we had recorded a liability of $330,919 in connection with this guarantee.
In 2009, we guaranteed additional indebtedness of FiberComm, LC in connection with an additional loan entered into on March 23, 2009 maturing January 1, 2015 made by American State Bank to FiberComm, LC. As of December 31, 2010 we have recorded an additional liability of $149,615 in connection with the guarantee on this loan. As a result of these two guarantees, we have guaranteed a total of $480,534 of indebtedness of FiberComm, LC as of December 31, 2010. Either of these two guarantees may be exercised if FiberComm, LC does not make its required payments on these notes.
On September 24, 2009 we sold our ownership interests in SHAL Networks, Inc.; SHAL, LLC; Direct Communications, LLC and En-Tel Communications, LLC to Iowa Telecom. In conjunction with this sale, RTFC released us from approximately $5.7 million in loan guarantees for loans made by RTFC to SHAL, LLC and En-Tel Communications, LLC. Our consolidated financial statements for 2010 and 2009 reflect the removal of all recorded loan guarantees for these companies.
NOTE 14 - DEFERRED COMPENSATION
As part of the acquisition of HTC, we have recorded other deferred compensation relating to the estimated present value of executive compensation payable to certain former executives of HTC.
Compensation over the next five years includes deferred wages totaling $925,333 and continuation of employee benefits. The difference between the recorded deferred compensation on the balance sheet and compensation to be paid over the next five years is due to life-time employee benefits.
NOTE 15 - COMPREHENSIVE INCOME (LOSS)
Our comprehensive income includes two items in addition to net income. The first is an unrealized gain (loss) resulting from our one-third ownership share of HCC’s accumulated other comprehensive income (loss). HCC’s accumulated comprehensive income (loss) differs from the “HCC investment income” reported on our consolidated statements of income. The second item reflects the change in the unrealized gains (losses) of the interest rate swap agreements, net of deferred income taxes that we have entered into with CoBank, ACB. These interest rate swap agreements cover $44.0 million of our indebtedness to CoBank, ACB, and are described in Note 7 - “Interest Rate Swaps” to the Consolidated Financial Statements of this Annual Report on Form 10-K.
NEW ULM TELECOM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Components of our comprehensive income consist of the following:
NOTE 16 - INVESTMENT IN HECTOR COMMUNICATION CORPORATION
On November 3, 2006 we acquired a one-third interest in HCC. HCC is equally owned by NU Telecom, Blue Earth Valley Communications, Inc. and Arvig Enterprises, Inc. Each of the owners provides management and other operational services to HCC and its subsidiaries.
Our President and Chief Executive Officer, Mr. Bill D. Otis, has been named Chairman of the Board of Directors and President of HCC. Ms. Barbara A.J. Bornhoft, our Vice-President and Chief Operating Officer, also serves on the Board of Directors of HCC.
Our HCC investment consists of the following:
The cumulative undistributed earnings from HCC were as follows for the years ended December 31, 2010, 2009 and 2008, respectively:
NEW ULM TELECOM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table summarizes financial information of HCC as of the years ended December 31, 2010, 2009 and 2008, respectively:
The audited financial statements of HCC are included in this Annual Report on Form 10-K.
NOTE 17 - SEGMENT INFORMATION
We operate in the Telecom Segment and have no other significant business segments. The Telecom Segment consists of voice, data and video communication services delivered to the customer over our local communications network. The Telecom Segment operates the following ILECs and CLECs and has investment ownership interests as follows:
Telecom Segment
l
ILECs:
§
New Ulm Telecom, Inc., the parent company;
§
Hutchinson Telephone Company, a wholly-owned subsidiary of New Ulm;
§
Western Telephone Company, a wholly-owned subsidiary of New Ulm;
§
Peoples Telephone Company, a wholly-owned subsidiary of New Ulm;
l
CLECs:
§
New Ulm Telecom, Inc. located in Redwood Falls, Minnesota; and
§
Hutchinson Telecommunications, Inc., a wholly-owned subsidiary of HTC, located in Litchfield, Minnesota;
l
Our investments and interests in the following entities include some management responsibilities:
§
Hector Communications Corporation - 33.33% ownership interest;
§
FiberComm, LC - 25.18% ownership interest;
§
Broadband Visions, LLC - 16.26% ownership interest; and
§
Independent Emergency Services, LLC - 14.29% ownership interest.
No single customer accounted for a material portion of our consolidated revenues in any of the last three years.
NEW ULM TELECOM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 18 - UNAUDITED QUARTERLY OPERATING RESULTS
UNAUDITED QUARTERLY OPERATING RESULTS
NOTE 19 - TRANSACTIONS WITH EQUITY METHOD INVESTMENTS
We receive and provide services to various partnerships and limited liability companies where we are an investor. Services received include directory services, digital video, special access, central office switching and communications circuits. Services provided include Board of Director meeting attendance, labor and materials to extend an existing fiber route, Internet help desk services, management services and labor. Cost of services we receive from affiliated parties may not be the same as the costs of such services had they been obtained from different parties.
Total revenues from transactions with affiliates were $1,489,898, $1,936,115, and $2,049,451 for 2010, 2009 and 2008, respectively. Total expenses from transactions with affiliates were $401,267, $626,855 and $663,693 for 2010, 2009 and 2008, respectively.
NOTE 20 -- SUBSEQUENT EVENTS
NU Telecom’s Board of Directors has declared a regular quarterly dividend on our common stock of $0.08 per share, payable on March 15, 2011 to stockholders of record at the close of business on March 4, 2011.
We have evaluated and disclosed subsequent events through the filing date of this Annual Report on Form 10-K.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A.
Item 9A. Controls and Procedures
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES AND CHANGES IN INTERNAL CONTROLS
As of the end of the period covered by this Annual Report on Form 10-K, our management carried out an evaluation under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934. Disclosure controls and procedures are designed to ensure that information required to be disclosed in our reports filed under the Securities Exchange Act of 1934 (the “Exchange Act”) is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and that such information is accumulated and communicated to our management, including the Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosure. Based on that evaluation and the identification of the material weakness in our internal control structure over financial reporting described below, our Chief Executive Officer and Chief Financial Officer concluded that, as of December 31, 2010, our disclosure controls and procedures were not effective.
MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in the rules promulgated under the Securities Exchange Act of 1934. Under the supervision and with the participation of our management, including our principal executive, financial and accounting officers, we have conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in “Internal Control-Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission.
A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis by our internal controls. In connection with our assessment of our internal control over financial reporting as required under Section 404 of the Sarbanes-Oxley Act of 2002, we identified the following material weakness in our internal control structure over financial reporting as of December 31, 2010:
There was an improper review of several financial account reconciliations at December 31, 2010 that resulted in several significant audit adjustments. It should be noted that the net effect of these audit adjustments did not materially affect our financial position or results of operations for the year ended December 31, 2010.
Remediation of Material Weakness in Internal Control Structure Over Financial Reporting
We are in the process of implementing remediation efforts with respect to our control environment and the material weakness noted above as follows:
We plan, over the course of the next year, to implement a more robust review of our financial account reconciliations to ensure they are completed properly and reviewed for any discrepancies to avoid any misstatements of our financial position or results of operations.
Our management continues to evaluate the ongoing effectiveness and sustainability of the changes it made in internal controls over financial reporting, and, as a result of ongoing evaluation, may identify additional changes to improve our internal control over financial reporting.
This annual report does not include an attestation report of Olsen Thielen & Co., Ltd., our independent registered public accounting firm, regarding internal control over financial reporting. Our management’s report was not subject to attestation by the our registered public accounting firm pursuant to rules of the SEC that permit us to provide only our management’s report in this annual report.
Pursuant to Item 308T(a) of Regulation S-K, this Management’s Report on Internal Control Over Financial Reporting shall not be deemed filed for purposes of Section 18 of the Exchange Act or otherwise subject to the liabilities of that section.
Item 9B.
Item 9B. Other Information
None.
PART III
Item 10.
Item 10. Directors, Executive Officers of the Registrant and Corporate Governance
Information contained under the captions “Proposal No. 1: Election of Directors,” “The Board of Directors and Committees” and “Section 16(a) Beneficial Ownership Reporting Compliance” in our definitive proxy statement for the annual meeting of stockholders to be held May 26, 2011 is incorporated by reference.
Pursuant to General Instruction G(3) to Form 10-K and Instruction 3 to Item 401(b) of Regulation S-K, information regarding executive officers of ours is provided in Part I of this Form 10-K under a separate caption.
We have adopted a code of conduct that applies to all officers, directors, and employees. This code of conduct is available on our Website at www.nutelecom.net and in print upon written request to New Ulm Telecom, Inc., 27 North Minnesota Street, New Ulm, Minnesota 56073, Attention: Chief Financial Officer. Any amendment to, or waiver from, a provision of our code of conduct will be posted to the above-referenced Website.
Item 11.
Item 11. Executive Compensation
Information contained under the captions “Executive Compensation” and “Non-Employee Director Compensation” in our definitive proxy statement for the annual meeting of stockholders to be held May 26, 2011 is incorporated by reference.
Item 12.
Item 12. Security Ownership of Beneficial Owners and Management and Related Stockholder Matters
Information contained under the caption “Security Ownership of Beneficial Owners and Management” in our definitive proxy statement for our annual meeting of stockholders to be held May 26, 2011 is incorporated by reference.
We do not maintain any equity compensation plans.
Item 13.
Item 13. Certain Relationships and Related Transactions and Director Independence
Information contained under the caption “Relationships and Related Transactions” in our definitive proxy statement for the annual meeting of stockholders to be held May 26, 2011 is incorporated by reference.
Item 14.
Item 14. Principal Accountant Fees and Services
The information contained under the caption “Independent Registered Public Accounting Firm” in our definitive proxy statement for the annual meeting of stockholders to be held May 26, 2011 is incorporated by reference.
PART IV
Item 15.
Item 15. Exhibits and Financial Statement Schedules
(a) 1.
Consolidated Financial Statements
Included in Part II, Item 8, of this report:
Pages
Report of Independent Registered Public Accounting Firm
Consolidated Statements of Income for the Three Years Ended December 31, 2010, 2009, and 2008
Consolidated Balance Sheets at December 31, 2010 and 2009
52-53
Consolidated Statements of Cash Flows for the Three Years Ended December 31, 2010, 2009, and 2008
Consolidated Statements of Stockholders’ Equity for the Three Years Ended Ended December 31, 2010, 2009, and 2008
Notes to Consolidated Financial Statements
56-75
(a) 2.
Consolidated Financial Statement schedules:
Report of Independent Registered Public Accounting Firm on Financial Statement Schedule
Schedule II - Valuation and Qualifying Accounts
Other schedules are omitted because they are not required or are not applicable, or the required information is shown in the financial statements or notes thereto. financial statements or notes thereto.
(a) 3.
See “Index to Exhibits”
(b)
Separate financial statements of HCC a 50 percent or less owned equity method investment, are included as part of this report because this entity constitutes a “significant subsidiary” pursuant to the provisions of Regulation S-X, Article 3-09.
82-100
(c)
Exhibits Required
See “Index to Exhibits”
102-103
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ON
FINANCIAL STATEMENT SCHEDULE
Board of Directors and Stockholders
New Ulm Telecom, Inc.
Our audits of the consolidated financial statements referred to in our report dated March 28, 2011 also included an audit of the financial statement schedules listed in Item 15(a)2 of this Form 10-K for the year ended December 31, 2010. This financial statement schedule is the responsibility of the Company’s Management. Our responsibility is to express an opinion on this financial statement schedule based on our audit. In our opinion, this financial statement schedule presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements.
/s/ Olsen Thielen & Co., Ltd.
St. Paul, Minnesota
March 28, 2011
Schedule II - Valuation and Qualifying Accounts
Allowance for Uncollectible Accounts
HECTOR COMMUNICATIONS CORPORATION
Consolidated Financial Statements
December 31, 2010
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors
Hector Communications Corporation
New Ulm, Minnesota
We have audited the accompanying consolidated balance sheets of Hector Communications Corporation and subsidiaries as of December 31, 2010 and 2009, and the related consolidated statements of income, comprehensive income (loss), stockholders’ equity and cash flows for each of the years in the three year period ended December 31, 2010. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, 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. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Hector Communications Corporation and subsidiaries as of December 31, 2010 and 2009, and the results of their operations and their cash flows for the years in the three year period ended December 31, 2010 in conformity with accounting principles generally accepted in the United States of America.
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
DECEMBER 31, 2010 AND 2009
See the notes to the consolidated financial statements.
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF INCOME
FOR THE YEARS ENDED DECEMBER 31, 2010, 2009 AND 2008
See the notes to the consolidated financial statements.
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME (LOSS)
FOR THE YEARS ENDED DECEMBER 31, 2010, 2009 AND 2008
See notes to consolidated financial statements.
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2010, 2009, 2008
See notes to consolidated financial statements
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2010, 2009 AND 2008
See the notes to the consolidated financial statements.
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Description of business: On November 3, 2006, Hector Acquisition Corporation (HAC) acquired all of the Company’s outstanding common stock. Simultaneous with the acquisition, HAC was merged into the Company and the new legal entity was renamed Hector Communication Corporation. In connection with this acquisition, the accounts of the Company were adjusted using the push down basis of accounting to recognize the allocation of the consideration paid for the common stock to the respective net assets acquired.
Hector Communications Corporation owns a 100% interest in five local exchange telephone subsidiaries. The Company also owns a 100% interest in Alliance Telecommunications Corporation, which owns and operates four local exchange telephone companies. At December 31, 2010, the Company’s subsidiaries provided telephone service to 24,397 access lines in 28 rural communities in Minnesota, Wisconsin and North Dakota and cable television services to 4,964 subscribers in Minnesota. The Company also provides internet service to 11,774 subscribers in their service area. The Company is also an investor in partnerships and corporations providing other telecommunications related services.
Principles of consolidation: The consolidated financial statements include the accounts of Hector Communications Corporation and its subsidiaries (“Hector” or the “Company”). All material intercompany transactions and accounts have been eliminated.
Regulatory accounting: Accounting practices prescribed by regulatory authorities have been considered in the preparation of the financial statements and formulation of accounting policies for telephone subsidiaries. These policies conform to accounting principles generally accepted in the United States of America as applied to regulated public utilities.
Estimates: The presentation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, and disclosure of contingent assets and liabilities at the balance sheet date, and the reported amounts of revenues and expenses during the reporting period. 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 time of the financial statements. Actual results could differ from those estimates. The Company’s financial statements are also affected by depreciation rates prescribed by regulators, which may result in different depreciation rates than for an unregulated enterprise.
Subsequent Events: In preparing these financial statements, the Company has evaluated for recognition or disclosure the events or transactions that occurred through March 21, 2011, the date the financial statements were available to be issued.
Revenue recognition: Revenues are recognized when earned, regardless of the period in which they are billed. Network access revenues are based upon interstate tariffs filed with the Federal Communications Commission by the National Exchange Carriers Association (NECA) and state tariffs filed with state regulatory agencies. Interstate network access revenues are furnished in conjunction with interexchange carriers and are determined by cost separation studies and nationwide average schedules. Access charges billed to interexchange carriers for interstate access are pooled with like revenues from all NECA member companies. A portion of the pooled access revenue the Company receives from the pool is based on the Company’s actual costs of providing the interstate access service. The remaining interstate revenue settlements are based upon nationwide average schedule costs of providing interstate access service. Revenues include estimates pending finalization of cost studies for those subsidiaries receiving cost based access settlements. Management believes recorded revenues are reasonable based on estimates of final cost separation studies, which are typically settled within two years.
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Presentation of taxes collected from customers: Sales, excise, and other taxes are imposed on most of the Company’s sales to nonexempt customers. The Company collects the taxes from customers and remits the entire amounts to the governmental authorities. The Company’s accounting policy is to exclude the taxes collected and remitted from revenues and expenses.
Income taxes: The provision for income taxes consists of an amount for taxes currently payable and a provision for tax consequences deferred to future periods. Deferred income taxes are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. Significant components of the Company’s deferred taxes arise from differences in the basis of property, plant and equipment due to the use of accelerated depreciation methods for tax purposes, partnerships due to the differences between book and tax income, and intangible assets which are amortized for book purposes but not deductible for tax purposes.
The Company reviews income tax positions taken or expected to be taken in income tax returns to determine if there are any income tax uncertainties. The Company recognizes tax benefits from uncertain tax positions only if it is more likely than not that the tax positions will be sustained on examination by taxing authorities, based on the technical merits of the positions. For any uncertain tax position, the tax benefit recognized is measured at the largest amount of the benefit that carries a greater than 50% likelihood of being realized upon settlement. The Company has identified no significant income tax uncertainties. The Company’s federal and state income returns are open to examination for tax years 2007 through 2009. There is a state income tax audit in process for 2006 through 2008.
Net income per share: Basic and diluted net income per common share is based on the weighted average number of common shares outstanding during the period presented.
Cash and cash equivalents: The Company considers temporary cash investments with an original maturity of three months or less to be cash equivalents. The Company places its cash investments with high credit quality financial institutions. The Company maintains its cash in bank deposit accounts. The account balances at times exceed the federally insured limits. The Company has not experienced losses in these accounts and does not believe they are exposed to any significant credit risk.
Accounts receivable: Receivables are stated at the amount the Company expects to collect from outstanding balances. The Company provides for probable uncollectible amounts through a charge to earnings and a credit to a valuation allowance based on its assessment of the current status of individual accounts. Balances that are still outstanding after the Company has used reasonable collection efforts are written off through a charge to the valuation allowance and a credit to the receivable accounts.
A significant portion of the Company’s revenues is received from long distance carriers in the telephone industry. Consequently, the Company is directly affected by the financial well-being of that industry. The credit risk associated with these accounts is minimized due to the large number of long distance carriers.
Materials, supplies and inventories: Materials, supplies and inventories are valued at the lower of average cost or market.
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Property, plant and equipment: Property, plant and equipment is recorded at cost. Depreciation is computed using principally the straight-line method based on estimated service or remaining useful lives of the various classes of depreciable assets. Maintenance and repairs are charged to operations and additions or improvements are capitalized. Items of telecommunications property sold, retired or otherwise disposed of in the ordinary course of business are removed from assets and any gains or losses are included in accumulated depreciation. Any gains or losses on non-telecommunications property and equipment retirements are reflected in the current year operations. The Company reviews long lived assets for impairment if certain events or changes in circumstances indicate that impairment may exist. The Company has not recorded any impairment losses on property, plant and equipment for the years ended December 31, 2010, 2009 or 2008.
Investments in unconsolidated affiliates: The Company is an investor in several partnerships and limited liability corporations (Note 5). The Company’s percentage of ownership in these joint ventures ranges from 5% to 20%. The Company uses the equity method of accounting for these investments, which reflects original cost and recognition of the Company’s share of operating income or losses from the respective operations.
Other investments: The Company owns CoBank stock and investments in the stock of other telecommunications service providers. Long-term investments in corporations that are not intended for resale or are not readily marketable and in which the Company does not exercise significant influence are valued using the cost method. The cost method requires the Company to periodically evaluate these investments for impairment and if impairment is found, reduce the investment’s valuation to its net realizable value. No impairment charges have been taken against these investments
Other intangibles and other assets: Other intangible assets owned by the Company include customer relationships, trade names, and regulatory rights acquired and customer lists purchased. Other assets owned by the Company include deferred debt issuance costs, and other deferred charges. Intangible assets determined to have an indefinite useful life are not amortized. Intangible assets with a determinable life are amortized over the useful life.
Disclosures about fair value of financial instruments: Under generally accepted accounting principles, fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The accounting standards establish a three-level fair value hierarchy that prioritizes information used in developing assumptions when pricing an asset or liability as follows:
Level 1 - Observable inputs such as quoted prices in active markets;
Level 2 - Inputs, other than quoted prices in active markets, that are observable either directly or indirectly; and,
Level 3 - Unobservable inputs where there is little or no market data, which requires the reporting entity to develop its own assumptions.
The Company uses observable market data, when available, in making fair value measurements. Fair value measurements are classified according to the lowest level input that is significant to the valuation.
The Company holds certain assets and liabilities that are required to be measured at fair value on a recurring basis. The fair value of the Company’s investment securities were determined based on Level 1 inputs. The fair value of the interest rate swap agreements were determined based on Level 2 inputs.
The fair value of the Company’s other financial instruments approximate carrying value except for long-term investments in other companies. Other long-term investments are not intended for resale and are not readily marketable, thus a reasonable estimate of fair value is not practicable. The fair value of long-term debt is estimated based on current rates offered to the Company for debt with similar terms and maturities. The fair value of the Company’s debt approximates carrying value.
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Recently issued accounting principles: In January 2010, the FASB issued new guidance related to disclosures about the transfer in and out of levels 1 and 2 and the activity in level 3 fair value measurements. It also clarifies disclosures about the level of disaggregation, inputs and valuation techniques. Our adoption of this guidance did not have a material impact on our disclosures.
In October 2009, the FASB issued new guidance for separating consideration in multiple-deliverable arrangements. This guidance addresses how to determine whether an arrangement involving multiple deliverables contains more than one unit of accounting, and how the arrangement consideration should be allocated among the separate units of accounting. The guidance is effective beginning in 2011. We do not anticipate the adoption of the guidance to have a significant impact on our consolidated financial statements.
We reviewed all other significant newly issued accounting pronouncements and determined they are either not applicable to our business or that no material effect is expected on our financial position and results of operations.
NOTE 2 - PROPERTY, PLANT AND EQUIPMENT
The cost of property, plant and equipment and the estimated useful lives are as follows:
Depreciation expense included in costs and expenses from operations was $6,451,323, $6,152,640 and $6,186,392 for the years ended December 31, 2010, 2009 and 2008.
NOTE 3 - GOODWILL AND OTHER INTANGIBLE ASSETS
The Company’s goodwill balance relates to the Company’s acquisition by HAC as discussed in Note 1. A preliminary purchase price allocation resulted in goodwill of $86,347,040. During 2007, the Company obtained an independent appraisal of the identifiable intangible assets acquired as a result of the business combination and revised the purchase price allocation in accordance with the independent appraisal. Along with the valuation of identifiable intangible assets acquired, the appraisal also determined the estimated useful lives of those amortizable assets based on historical customer churn statistics for the customer relationship intangible asset, and the estimated useful life of the Company’s regulated investment base for the identified regulatory rights intangible asset.
In addition, in 2008 and 2007, the Company received $4,323,450 and $2,699,833, respectively, of funds released from an escrow account related to the pre-acquisition sale of Midwest Wireless Holdings as discussed in Note 4. These funds were not recorded in the allocation of the purchase price of the Company as they were contingent on future events. In 2008 and 2007, when the contingency was resolved and the funds were released, they were recorded against goodwill net of the related income taxes.
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 3 - GOODWILL AND OTHER INTANGIBLE ASSETS (Continued)
A summary of changes to the Company’s goodwill is as follows:
Under generally accepted accounting principles, goodwill and other intangible assets with indefinite useful lives are not amortized but are instead tested for impairment on at least an annual basis and when changes in circumstances indicate that the value of goodwill may be below its carrying value. In 2010, 2009 and 2008, the Company engaged an independent valuation firm to complete its annual impairment test for goodwill acquired. Such testing resulted in no impairment charge to goodwill, as the determined fair value was sufficient to pass the first step of the impairment test in all three years.
The components of the Company’s identified other intangible assets are as follows:
Amortization expense of definite-lived other intangible assets was $3,104,600 for the year ended December 31, 2010, $3,099,600 for the year ended December 31, 2009, and $3,104,600 for the year ended December 31, 2008. Amortization expense for the next five years is estimated at $3,104,600, annually.
NOTE 4 - MIDWEST WIRELESS HOLDINGS LLC
Hector Communications Corporation owned approximately 8% of Midwest Wireless Holdings L.L.C (MWH). In November of 2005, Midwest Wireless Holdings L.L.C. (MWH) and Alltel Corporation (Alltel) entered into an agreement for Alltel to purchase MWH. The transaction was closed October 2, 2006 after the satisfaction of conditions and the receipt of regulatory approvals, which was prior to Hector Acquisition Corporation’s purchase of the Company. Under the terms of the agreement, all of the members of MWH sold their membership interests to Alltel. Upon closing, the members received approximately 90% of the sale proceeds. Alltel delivered the other 10% to the escrow agent. The escrow account was to be used for any true-up adjustments, indemnifications, and other specified costs.
In 2008 and 2007, the Company received $4,323,450 and $2,699,883 of the escrowed funds. These funds net of related income taxes were recorded against goodwill as they related to a pre-acquisition contingency which was resolved subsequent to the acquisition of the Company by HAC.
A portion of the Company’s investment in MWH was held in a subsidiary which was 49% owned by United States Cellular Corporation (USCC). This subsidiary was liquidated in 2008 upon receipt of the final indemnification escrow payments. At December 31, 2007, the Company had a balance payable to USCC which represents the amount of proceeds from the MHW sale due to USCC from the Company. The full liability was paid to USCC in 2008.
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 5 - INVESTMENTS IN UNCONSOLIDATED AFFILIATES
The Company is a co-investor with other rural telephone companies in several partnerships and limited liability corporations. These joint ventures make it possible to offer certain services to customers, including centralized switching or fiber optic transport of messaging, that the Company could not afford to offer on its own. These joint ventures also make it possible to invest in new technologies with a lower level of financial risk. The Company recognizes income and losses from these investments on the equity method of accounting. The following table summarizes the Company’s ownership percentage, investment at December 31, 2010 and 2009 and income or loss from these investments for the years ended December 31, 2010, 2009 and 2008.
In 2009, the Company received $706,595 in cash for its ownership of Independent Pinnacle Services. The proceeds exceeded the investment of $688,423 by $18,172, which was recorded as a gain in 2009.
Summarized financial information for all unconsolidated affiliates as of December 31, 2010 and 2009 and for the years then ended is as follows:
NOTE 6 - MARKETABLE SECURITIES
The Company holds investments in marketable securities that are classified as non-current other investments. Marketable securities consist of equity securities of other telecommunications companies. The Company’s marketable securities portfolio was classified as available-for-sale at December 31, 2010 and 2009. The cost and fair value of available-for-sale investment securities were as follows:
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 6 - MARKETABLE SECURITIES (Continued)
The following table shows the Company’s investments’ gross unrealized losses, fair value, and the length of time that individual security have been in a continuous unrealized loss position at December 31, 2010 and 2009.
The investment security in an unrealized loss position is traded on the over-the-counter bulletin board market. The unrealized losses on the Company’s investment in this equity security is considered to be a reflection of current economic conditions in the United States and global economy over the past three years which have placed unwarranted downward pressure on the investment’s stock price, and that price is not believed to be directly correlated with the net worth of the investment’s stock value. In addition, the Company also believes that there has been no deterioration in the financial condition or overall fundamentals of the individual security held. The Company has the intent and ability to hold this security until the unrealized losses are recovered. Based on this analysis, the Company has concluded that this investment is not other-than-temporarily impaired at December 31, 2010.
Realized gains on the sales of securities are based on the book value of the securities sold using the specific identification method. There were no marketable security sales in 2010, 2009 or 2008.
As of December 31, 2010 and 2009, the amount of unrealized loss on available-for-sale securities included in accumulated other comprehensive income (loss) included in stockholders’ equity was $539,679 and $516,043, net of deferred tax benefits of $215,892 and $206,438, respectively.
NOTE 7 - INCOME TAXES
Hector Communications Corporation and its subsidiaries file a consolidated tax return. Income tax expenses (benefits) were as follows:
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 7 - INCOME TAXES (Continued)
Deferred tax liabilities and assets as of December 31 related to the following:
The provision for income taxes varied from the federal statutory tax rate as follows:
NOTE 8 - LONG-TERM DEBT
The Company’s long-term debt is as follows:
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 8 - LONG-TERM DEBT (Continued)
The Term Loan Facility payable to CoBank by the Company was the main vehicle to finance the acquisition by HAC. Principal payments on this facility were deferred for one year and began in December 2007. Principal payments will be due quarterly until September 30, 2013 when the remaining balance of $37,565,000 is due. Interest is payable quarterly at a variable rate plus the LIBOR margin rate (2.31%, 2.56%, and 4.56% at December 31, 2010, 2009 and 2008). The LIBOR margin rate which can range from .75% to 3.0% will increase or decrease based on how the Company’s “leverage ratio” increases or decreases as defined in the loan agreement. As mentioned in Note 9, the Company has effectively fixed the interest rates and payments on $51,000,000 of this debt through interest rate swap agreements. CoBank syndicated $25,000,000 of the original term loan facility to other financial institutions, but remains the administrative agent for the loan.
The Company also has available a Revolving Credit Facility payable to CoBank which is payable in full on November 3, 2013. This revolving credit facility allows the Company to borrow up to $10,000,000 of which $8,660,146 is available on December 31, 2010. Interest is payable quarterly at a variable rate (4.25% at December 31, 2010).
The RDUP economic development loan consists of a non-interest bearing note payable to the RDUP in equal monthly payments of $3,743. The loan was made to one of the Company’s subsidiaries. This loan matures in 2012. Proceeds from the loan were lent to a city in the subsidiaries’ service territory under identical repayment terms.
As a condition of maintaining the Company’s loan with CoBank, the Company owns stock in the bank. The Company’s investment in CoBank stock was $2,550,214 and $2,647,533 as of December 31, 2010 and 2009.
CoBank is a cooperative, owned and controlled by its customers. Each customer borrowing from the bank on a patronage basis shares in the bank’s net income through payment of patronage refunds. Patronage refunds receivable included in accounts receivable were $396,421 and $416,126 at December 31, 2010 and 2009. Approximately 65% of patronage refunds are received in cash, with the balance in stock in the bank. The accrued patronage refund is reflected in the Company’s operating statement as a reduction of interest expense. The Company recorded patronage refunds of $396,421 and $406,074 for the years ending December 31, 2010 and 2009. The Company cannot predict what patronage refunds might be in future years.
Pledges of the parent company assets and the stock of the Company’s subsidiaries secure the CoBank loans.
The security and loan agreements underlying the CoBank notes contain certain restrictions on distributions to stockholders, capital additions and investments in or loans to others. In addition, the Company is required to maintain certain financial ratios relating to leverage, debt service and interest coverage, and equity to total assets. The Company was in compliance with these covenants at December 31, 2010 and 2009.
The annual requirements for principal payments on notes payable and long-term debt are as follows:
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 9 - INTEREST RATE SWAP
The Company assesses interest rate cash flow risk by continually identifying and monitoring changes in interest rate exposures that may adversely impact expected future cash flows and by evaluating hedging opportunities.
The Company uses variable-rate debt to finance its capital expenditures and acquisitions. The variable-rate debt obligations expose the Company to variability in interest payments due to changes in interest rates. The Company and its primary lender, CoBank, believe it is prudent to limit the variability of a portion of its interest payments. To meet this objective, the Company has entered into interest rate swap agreement to manage fluctuations in cash flows resulting from interest rate risk. The swaps change the variable-rate cash flow exposure on the debt obligations to fixed cash flows. Under the terms of the interest rate swaps, the Company pays a fixed contractual interest rate plus an additional payment if the variable rate (LIBOR) payment is below a contractual rate, or it receives a payment if the variable rate payment is above the contractual rate.
In 2006, the Company entered into a swap for a notional amount of $38,000,000 delivered November 2006. The term was 3 years and the fixed contractual interest rate is 5.10% plus leverage margin. This swap expired November 2009. The Company entered into another swap agreement for $38,000,000 delivered November 2009. This swap delivery is concurrent with the maturity of first swap of $38,000,000. The term is 2 years and the fixed contractual interest rate will be 4.18% plus leverage margin. This swap expires November 2011.
In 2008, the Company entered into a swap for $13,000,000 delivered September 2008. The term is 3 years and the fixed contractual interest rate is 3.76% plus leverage margin. This swap expires November 2011. Subsequent to year end, $800,000 of this swap was broken out from the swap. The termination fee for breaking this portion of the swap was $21,000. The remaining $12,200,000 remains under the terms of the original agreement.
The interest rate swaps qualify as cash flow hedges for accounting purposes under generally accepted accounting principles and as such, the gains or losses in the fair value of the swaps are recorded as a separate component of other comprehensive income (loss) rather than in earnings. The fair value of the Company’s interest rate swap agreement is determined from a valuation received from CoBank which is based on the present value of expected future cash flows using discount rates appropriate with the terms of the swaps. The fair value indicates an estimated amount the Company would receive or pay if the contracts were canceled or transferred to other parties. If the Company were to terminate its interest rate swap agreements, the cumulative change in fair value at the date of termination would be reclassified from accumulated other comprehensive income (loss), which is classified in stockholders’ equity, into earnings on the consolidated statements of income. At December 31, 2010 and 2009, the fair value loss of the swaps was $1,617,761 and $2,681,427 which has been recorded, net of deferred tax of $647,099 and $1,072,562 as a decrease in comprehensive income (loss).
NOTE 10 - EMPLOYEE BENEFIT PLANS
The Company has 401(k) savings plans for its employees. Employees who are under the age of fifty and most certain service requirements may contribute up to $16,500 of their salaries to the plan on a pretax basis. The Company matches a portion of employee contributions. Contributions to the plan by the Company were $78,964, $79,764, and $84,166 for the years ended December 31, 2010, 2009 and 2008.
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 10 - EMPLOYEE BENEFIT PLANS (Continued)
The Company has a deferred compensation agreement with two former officers of one of its subsidiaries. Under the agreement, the salaries of these officers were continued after their retirement based on a formula stated in the agreement. The Company is responsible for 68% of the remaining deferred compensation, with former partners responsible for the remaining 32%. In 2009, one of the officers died and the Company’s obligation for that officer ceased. The Company adjusted the liability for this change in circumstances. Deferred compensation (benefit) expense included in operations were $36,961, ($390,055), and $216,857 for the years ended December 31, 2010, 2009 and 2008. Payments made under the agreement by the Company were $54,354, $78,070, and $106,694 for the years ended December 31, 2010, 2009 and 2008.
NOTE 11 - TRANSACTIONS WITH AFFILIATES
The Company receives and provides services to various partnerships and limited liability corporations in which it is a minority investor. Services received include transport, directory services, centralized equal access and digital television signals. Services provided include commissioned sales and transport. Revenues from transactions with these affiliates were $470,159, $448,176, and $436,564 for the years ended December 31, 2010, 2009 and 2008. Expenses from transactions with these affiliates were $491,264, $524,568, and $521,764 or the years ended December 31, 2010, 2009 and 2008.
Costs of services the Company receives from affiliated parties may not be indicative of the costs of such services had they been obtained from different parties.
The Company has entered into management agreements with each of its three shareholders as of November 3, 2006. The terms of the management agreements are one year and will be automatically renewed unless either the Company or the shareholder elects to terminate the service with 120 days written notice. Either party can terminate the agreement at any time with 120 days written notice. The annual management fee began January 1, 2007 and was $300,000, $325,000, and $399,000 for the years ended December 31, 2010, 2009 and 2008.
The Company has also contracted with certain shareholders for corporate overhead functions such as accounting, billing and human resources, maintenance of plant, and internet help desk services. Each contract was effective November 3, 2006 and has duration of one year. Each contract will automatically renew unless either party elects to terminate the service with 120 days written notice. The fees for these services are billed at cost plus 20%. Costs include all direct costs and related employee overhead costs. Fees for these services were $1,387,537, $1,399,306 and $1,329,982 for the years ended December 31, 2010, 2009 and 2008.
In addition, the Company’s shareholders provided labor, materials and equipment related to construction of the Company’s property, plant and equipment. The total of these services provided by the Company’s shareholder was $1,345,647, $1,608,177, and $1,096,700 and for the years ended December 31, 2010, 2009 and 2008.
The total balances due from the Company to its shareholders for routine services provided at December 31, 2010 and 2009 were $248,734 and $366,630.
HECTOR COMMUNICATIONS CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 12 - SEGMENT INFORMATION
The Company operates in the communication segment and has no other significant business segments. The communication segment consists of voice, data and video communication services delivered to the customer over the Company’s local communications network.
No single customer accounted for a material portion of the Company’s revenues from the years ended December 31, 2010, 2009 and 2008. The Company has no foreign operations.
NOTE 13 - SHAREHOLDER AGREEMENT
The shareholders of the Company have entered into a Shareholder Agreement that requires any shareholder who is selling or otherwise transferring their shares of stock in the Company to first offer to sell those shares to the Company. In the event the Company elects to not purchase such shares, the other shareholders may elect to purchase the shares. Upon occurrence of certain other events specified in the Shareholder Agreement, the Company and the remaining shareholders may purchase the shares owned by a shareholder. The selling price is determined based upon provisions set forth in the agreement.
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.
Pursuant to the requirements of the Securities Exchange Act of 1934, the following persons on behalf of the registrant and in the capacities and on the dates indicated have signed this report.
/s/ James P. Jensen
March 28,
James P. Jensen, Chair
/s/ Bill D. Otis
March 28,
Bill D. Otis, President and Chief Executive Officer
(Principal Executive Officer)
/s/ Curtis O. Kawlewski
March 28,
Curtis O. Kawlewski, Chief Financial Officer
(Principal Financial Officer and Principal Accounting Officer)
/s/ Rosemary J. Dittrich
March 28,
Rosemary Dittrich, Director
/s/ Mary Ellen Domeier
March 28,
Mary Ellen Domeier, Director
/s/ Paul W. Erick
March 28,
Paul W. Erick, Director
/s/ Duane D. Lambrecht
March 28,
Duane Lambrecht, Director
/s/ Perry L. Meyer
March 28,
Perry Meyer, Director
/s/ Dennis E. Miller
March 28,
Dennis Miller, Director
INDEX TO EXHIBITS
Exhibits required to be filed by Item 601 of Regulation S-K are included as Exhibits to this report as follows:
3.1
Restated Articles of Incorporation, as amended (incorporated by reference to Exhibit 3.1 contained in the Company’s Form 8-K (file No. 000-03024) filed on June 3, 2009)
3.2
Restated By-Laws (incorporated by reference to the New Ulm Telecom, Inc. annual report on Form 10-K for the fiscal year ended December 31, 1986)
10.1+
Employment Agreement dated as of July 1, 2006, by and between New Ulm Telecom, Inc. and Mr. Bill D. Otis (incorporated by reference to Exhibit 10.1 contained in the Company’s Form 8-K filed on July 18, 2006)
10.2+
Employment Agreement dated as of July 1, 2006, by and between New Ulm Telecom, Inc. and Ms. Barbara A.J. Bornhoft (incorporated by reference to Exhibit 10.2 contained in the Company’s Form 8-K filed on July 18, 2006)
10.3
Stockholder Agreement dated as of November 1, 2006, by and among New Ulm Telecom, Inc., Arvig Enterprises, Inc., and Blue Earth Valley Communications, Inc. and each individually (incorporated by reference to Exhibit 10.1 contained in the Company’s Form 10-Q for the quarterly period ended September 30, 2006)
10.4+
New Ulm Telecom, Inc. Management Incentive Plan (incorporated by reference to Exhibit 10.4 contained in the Company’s 2007 Form 10-K)
10.5+
Amended Director Separation Compensation Policy dated May 26, 2009 (incorporated by reference to Exhibit 10.1 contained in the Company’s Form 10-Q for the quarterly period ended June 30, 2009)
10.6
Master Loan Agreement RX0583, dated as of January 4, 2008 between CoBank, ACB and New Ulm Telecom, Inc. (incorporated by reference to Exhibit 10.2 contained in the Company’s Form 8-K filed on January 7, 2008).
10.7
First Supplement dated January 4, 2008 to the Master Loan Agreement between CoBank, ACB and New Ulm Telecom, Inc. (incorporated by reference to Exhibit 10.3 contained in the Company’s Form 8-K filed on January 7, 2008)
10.8
New Ulm Telecom, Inc. $15,000,000 Term Promissory Note (incorporated by reference to Exhibit 10.4 contained in the Company’s Form 8-K filed on January 7, 2008)
10.9
Second Supplement dated January 4, 2008, to the Master Loan Agreement between CoBank, ACB and New Ulm Telecom, Inc. (incorporated by reference to Exhibit 10.5 contained in the Company’s Form 8-K filed on January 7, 2008)
10.10
New Ulm Telecom, Inc. $10,000,000 Revolving Promissory Note (incorporated by reference to Exhibit 10.6 contained in the Company’s Form 8-K filed on January 7, 2008)
10.11
Interest Rate Swap Agreement dated February 26, 2008 between CoBank, ACB and New Ulm Telecom, Inc. (incorporated by reference to Exhibit 10.1 contained in the Company’s 10-Q for the quarter ended March 31, 2008)
10.12
Waiver and Amendment Letter dated March 27, 2009 between CoBank, ACB and New Ulm Telecom, Inc. and Subsidiaries (incorporated by reference to Exhibit 10.1 contained in the Company’s annual report on Form 10- K filed on May 8, 2009)
10.13
Master Loan Agreement RX0584, dated January 4, 2008 between CoBank, ACB and Hutchinson Telephone Company (as successor to Hutchinson Acquisition Corp) (incorporated by reference to Exhibit 10.7 contained in the Company’s Form 8-K filed on January 7, 2008)
10.14
First Supplement dated January 4, 2008 to the Master Loan Agreement between CoBank, ACB and Hutchinson Telephone Company (incorporated by reference to Exhibit 10.8 contained in the Company’s Form 8-K filed on January 7, 2008)
10.15
Hutchinson Telephone Company $29,700,000 Promissory Note, (incorporated by reference to Exhibit 10.9 contained in the Company’s Form 8-K filed on January 7, 2008)
10.16
Second Supplement dated January 4, 2008 to the Master Loan Agreement between CoBank, ABC and Hutchinson Telephone Company, (incorporated by reference to Exhibit 10.10 contained in the Company’s Form 8-K filed on January 7, 2008)
10.17
Hutchinson Telephone Company $2,000,000 Revolving Promissory Note, (incorporated by reference to Exhibit 10.11 contained in the Company’s Form 8-K filed on January 7, 2008)
10.18
Form of Security Agreement, entered into in connection with January 2008 credit facility from CoBank, ACB (incorporated by reference to Exhibit 10.14 contained in the Company’s Form 8-K filed on January 7, 2008)
10.19
Form of Guarantee, entered into in connection with January 2008 credit facility from CoBank, ACB (incorporated by reference to Exhibit 10.15 contained in the Company’s Form 8-K filed on January 7, 2008)
10.20
Interest Rate Swap Agreement dated February 26, 2008 between CoBank, ACB and Hutchinson Telephone Company (incorporated by reference to Exhibit 10.2 contained in the Company’s 10-Q for the quarter ended March 31, 2008)
10.21
Waiver, Release and Amendment letter dated September 14, 2009 between CoBank, ACB and New Ulm Telecom, Inc. and Subsidiaries (incorporated by reference to Exhibit 10.1 contained in the Company’s 10-Q for the quarter ended September 30,2009)
10.22*
Amendment letter dated March 25, 2011 between CoBank, ACB and New Ulm Telecom, Inc. and between CoBank, ACB and Hutchinson Telephone Company.
16.1
Letter Regarding the Change in Certifying Accountant - Kiesling Associates LLP (incorporated by reference to exhibit 16.1 contained in the Company’s Form 8-K filed on June 27, 2008)
21*
Subsidiaries of the New Ulm Telecom, Inc.
31.1*
Certification of Chief Executive Officer Under Rule 13a-14(a) Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2*
Certification of Chief Financial Officer Under Rule 13a-14(a) Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.1*
Certification of Chief Executive Officer Under 18 U.S.C. Section 1350 Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2*
Certification of Chief Financial Officer Under 18 U.S.C. Section 1350 Pursuant to Section 906 of the Sarbanes- Oxley Act of 2002
* Filed Herewith
+ Management compensation plan or arrangement required to be filed as an exhibit