UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549

 

FORM 10-Q

(Mark One)

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended September 30, 2019

 

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from __________ to __________

 

Commission file number: 1-32362

 

OTELCO INC.

(Exact Name of Registrant as Specified in Its Charter)
     

Delaware

 

52-2126395

(State or Other Jurisdiction of Incorporation or
Organization) 		  (I.R.S. Employer Identification No.)
     

505 Third Avenue East, Oneonta, Alabama

 

35121

(Address of Principal Executive Offices)   (Zip Code)
     

(205) 625-3574

(Registrant’s Telephone Number, Including Area Code)
     

N/A

(Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report)
 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class:   Trading Symbol:   Name of exchange on which
registered:
Class A Common Stock ($0.01 par value per share)   OTEL   The Nasdaq Stock Market LLC

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

 

Yes     x     No     ¨

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).

 

Yes     x     No     ¨

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer ¨ Accelerated filer ¨ Non-accelerated filer x Smaller reporting company x Emerging growth company ¨

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

 

Yes     ¨     No     x

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

Class

 

Outstanding at November 5, 2019

Class A Common Stock ($0.01 par value per share)   3,410,936
Class B Common Stock ($0.01 par value per share)   0

 

 

 

 

 

 

OTELCO INC.
FORM 10-Q
For the three-month period ended September 30, 2019

 

TABLE OF CONTENTS

 

  Page
   
PART I FINANCIAL INFORMATION 2
   
Item 1.   Financial Statements 2
   
Condensed Consolidated Balance Sheets as of September 30, 2019 (unaudited) and December 31, 2018 (audited) 2
Condensed Consolidated Statements of Operations for the Three Months and Nine Months Ended September 30, 2019 and 2018 (unaudited) 3
Condensed Consolidated Statements of Stockholders’ Equity for the Nine Months Ended September 30, 2019 and 2018 (unaudited) 4
Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2019 and 2018 (unaudited) 5
Notes to Condensed Consolidated Financial Statements (unaudited) 6
   
Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations 17
Item 3.   Quantitative and Qualitative Disclosures about Market Risk 25
Item 4.   Controls and Procedures 26
   
PART II OTHER INFORMATION 27
   
Item 6.   Exhibits 27

 

i

 

 

Unless the context otherwise requires, the words “we,” “us,” “our,” the “Company” and “Otelco” refer to Otelco Inc., a Delaware corporation, and its consolidated subsidiaries as of September 30, 2019.

 

FORWARD-LOOKING STATEMENTS

 

This report contains forward-looking statements that are subject to risks and uncertainties. Forward-looking statements give our current expectations relating to our financial condition, results of operations, plans, objectives, future performance and business. These statements may include words such as “anticipate,” “estimate,” “expect,” “project,” “plan,” “intend,” “believe” and other words and terms of similar meaning in connection with any discussion of the timing or nature of future operating or financial performance or other events. These forward-looking statements are based on assumptions that we have made in light of our experience in the industry in which we operate, as well as our perceptions of historical trends, current conditions, expected future developments and other factors we believe are appropriate under the circumstances. Although we believe that these forward-looking statements are based on reasonable assumptions, you should be aware that many factors could affect our actual financial condition or results of operations or cause our actual results to differ materially from those in the forward-looking statements, including the factors under “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2018.

 

1

 

 

PART I FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

OTELCO INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except share par value and share amounts)
(unaudited with the exception of December 31, 2018 being audited)

 

    September 30,
2019 		    December 31,
2018 		 
Assets                
Current assets                
Cash and cash equivalents   $ 5,298     $ 4,657  
Accounts receivable:                
Due from subscribers, net of allowance for doubtful accounts of $283 and $577, respectively     3,943       4,183  
Other     1,914       1,899  
Materials and supplies     4,250       2,802  
Prepaid expenses     1,182       1,198  
Other assets     260       –  
Total current assets     16,847       14,739  
                 
Property and equipment, net     54,283       52,073  
Goodwill     44,976       44,976  
Intangible assets, net     625       919  
Operating lease right-of-use asset     907       –  
Investments     1,479       1,498  
Interest rate cap     –       4  
Other assets     496       143  
Total assets   $ 119,613     $ 114,352  
                 
Liabilities and Stockholders’ Equity                
Current liabilities                
Accounts payable   $ 1,997     $ 1,331  
Accrued expenses     6,131       5,054  
Advance billings and payments     1,508       1,614  
Customer deposits     45       48  
Current operating lease liability     325       –  
Current maturity of long-term notes payable, net of debt issuance cost     3,922       3,904  
Total current liabilities     13,928       11,951  
                 
Deferred income taxes     20,145       20,145  
Advance billings and payments     2,092       2,234  
Other liabilities     1       13  
Long-term operating lease liability     582       –  
Long-term notes payable, less current maturities and debt issuance cost     66,157       69,107  
Total liabilities     102,905       103,450  
                 
Stockholders’ equity                
Class A Common Stock, $.01 par value-authorized 10,000,000 shares; issued and outstanding 3,410,936 and 3,388,624 shares, respectively     34       34  
Additional paid in capital     4,203       4,213  
Retained earnings     12,471       6,655  
Total stockholders’ equity     16,708       10,902  
Total liabilities and stockholders’ equity   $ 119,613     $ 114,352  

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

2

 

 

OTELCO INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except share and per share amounts)
(unaudited)

 

    Three Months Ended September 30,     Nine Months Ended September 30,  
    2019     2018     2019     2018  
Revenues   $ 15,762     $ 16,252     $ 47,175     $ 49,867  
                                 
Operating expenses                                
Cost of services     7,542       7,578       22,630       23,026  
Selling, general and administrative expenses     2,506       2,382       7,535       7,691  
Depreciation and amortization     1,873       1,756       5,698       5,382  
Total operating expenses     11,921       11,716       35,863       36,099  
                                 
Income from operations     3,841       4,536       11,312       13,768  
                                 
Other income (expense)                                
Interest expense     (1,315 )     (1,459 )     (4,044 )     (4,384 )
Other income     5       83       604       252  
Total other expense     (1,310 )     (1,376 )     (3,440 )     (4,132 )
                                 
Income before income tax expense     2,531       3,160       7,872       9,636  
Income tax expense     (712 )     (834 )     (2,056 )     (2,406 )
                                 
Net income   $ 1,819     $ 2,326     $ 5,816     $ 7,230  
                                 
Weighted average number of common shares outstanding:                                
Basic     3,410,936       3,388,624       3,410,936       3,388,624  
Diluted     3,431,229       3,454,936       3,431,229       3,438,386  
                                 
Basic net income per common share   $ 0.53     $ 0.69     $ 1.71     $ 2.13  
                                 
Diluted net income per common share   $ 0.53     $ 0.67     $ 1.70     $ 2.10  

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

3

 

 

OTELCO INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(in thousands, except share amounts)

(unaudited)

 

    Class A
Common Stock 		    Additional
Paid-In 		          Total
Stockholders 		 
    Shares     Amount     Capital     Retained Earnings     Equity  
Balance, January 1, 2019     3,388,624     $ 34     $ 4,213     $ 6,655     $ 10,902  
                                         
Net income                             2,281       2,281  
Stock-based compensation expense                     71               71  
Tax withholdings paid on behalf of employees for restricted stock units                     (183 )             (183 )
Issuance of Class A Stock     22,312       -                       -  
Balance, March 31, 2019     3,410,936       34       4,101       8,936       13,071  
                                         
Net income                             1,716       1,716  
Stock-based compensation expense                     43               43  
Balance, June 30, 2019     3,410,936       34       4,144       10,652       14,830  
                                         
Net income                             1,819       1,819  
Stock-based compensation expense                     59               59  
Balance, September 30, 2019     3,410,936     $     34     $ 4,203     $      12,471     $   16,708  

 

    Class A
Common Stock 		    Additional
Paid-In 		    (Accumulated
Deficit)/ 		    Total
Stockholders’ 		 
    Shares     Amount     Capital     Retained Earnings     Equity  
Balance, January 1, 2018     3,346,689     $    34     $ 4,285     $          (2,812 )   $      1,507  
                                         
Net income                             1,996       1,996  
Stock-based compensation expense                     71               71  
Tax withholdings paid on behalf of employees for restricted stock units                     (380 )             (380 )
Issuance of Class A Stock     41,935       -                       -  
Balance, March 31, 2018     3,888,624       34       3,976       (816 )     3,194  
                                         
Net income                             2,908       2,908  
Stock-based compensation expense                     80               80  
Balance, June 30, 2018     3,888,624       34       4,056       2,092       6,182  
                                         
Net income                             2,326       2,326  
Stock-based compensation expense                     56               56  
Balance, September 30, 2018     3,888,624     $ 34     $ 4,112     $ 4,418     $ 8,564  

  

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

4

 

 

OTELCO INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)
(unaudited)

 

    Nine Months Ended September 30,  
    2019     2018  
Cash flows from operating activities:                
Net income   $ 5,816     $ 7,230  
Adjustments to reconcile net income to cash flows provided by operating activities:                
Depreciation     5,465       5,135  
Amortization     233       247  
Amortization of loan costs     342       354  
Non-cash lease amortization     166       –  
Provision for uncollectible accounts receivable     163       283  
Stock-based compensation     173       207  
Changes in operating assets and liabilities                
Accounts receivable     (198 )     (704 )
Materials and supplies     (1,448 )     (73 )
Prepaid expenses and other assets     (337 )     2,030  
Accounts payable and accrued expenses     1,743       959  
Advance billings and payments     (248 )     (223 )
Other liabilities     (182 )     15  
Net cash from operating activities     11,688       15,460  
                 
Cash flows used in investing activities:                
Acquisition and construction of property and equipment     (7,594 )     (5,710 )
Net cash used in investing activities     (7,594 )     (5,710 )
                 
Cash flows used in financing activities:                
Loan origination costs     (12 )     (37 )
Principal repayment of long-term notes payable     (3,262 )     (9,262 )
Interest rate cap     4       (40 )
Retirement of CoBank equity     –       119  
Tax withholdings paid on behalf of employees for restricted stock units     (183 )     (380 )
Net cash used in financing activities     (3,453 )     (9,600 )
                 
Net increase in cash and cash equivalents     641       150  
Cash and cash equivalents, beginning of period     4,657       3,570  
                 
Cash and cash equivalents, end of period   $ 5,298     $ 3,720  
                 
Supplemental disclosures of cash flow information:                
Interest paid   $ 3,717     $ 4,029  
                 
Income taxes paid (refund)   $ 1,243     $ (563 )

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

5

 

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2019
(unaudited)

 

1. Organization and Basis of Financial Reporting

 

Basis of Presentation and Principles of Consolidation

 

The condensed consolidated financial statements include the accounts of Otelco Inc. (the “Company”) and its subsidiaries, all of which are either directly or indirectly wholly owned. These include: Blountsville Telephone LLC; Brindlee Mountain Telephone LLC; CRC Communications LLC; Granby Telephone LLC; Hopper Telecommunications LLC; Mid-Maine Telecom LLC; Mid-Maine TelPlus LLC; Otelco Mid-Missouri LLC and its wholly owned subsidiary I-Land Internet Services LLC; Otelco Telecommunications LLC; Otelco Telephone LLC; Pine Tree Telephone LLC; Saco River Telephone LLC; Shoreham Telephone LLC; and War Telephone LLC.

 

The accompanying condensed consolidated financial statements include the accounts of the Company and all of the aforesaid subsidiaries after elimination of all material intercompany balances and transactions. The unaudited operating results for the nine months ended September 30, 2019, are not necessarily indicative of the results that may be expected for the year ending December 31, 2019, or any other period.

 

The condensed consolidated financial statements and notes included in this Quarterly Report on Form 10-Q should be read in conjunction with the audited consolidated financial statements and notes thereto in the Company’s Annual Report on Form 10-K for the year ended December 31, 2018. The interim condensed consolidated financial information herein is unaudited, with the condensed consolidated balance sheet as of December 31, 2018, being derived from the Company’s audited consolidated financial statements. The information reflects all adjustments which are, in the opinion of management, necessary for a fair presentation of the financial position and results of operations for the periods included in this report.

 

Certain items in prior year’s condensed consolidated financial statements have been reclassified to conform with 2019 presentation.

 

Recently Adopted Accounting Pronouncements

 

In May 2014, the Financial Accounting Standards Board (the “FASB”) issued Accounting Standards Update (“ASU”) 2014-09, Revenue from Contracts with Customers (Topic 606) (“ASU 2014-09”). This ASU requires that an entity recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. This ASU also provides a more robust framework for revenue issues and improves comparability of revenue recognition practices across industries. This ASU was the product of a joint project between the FASB and the International Accounting Standards Board to clarify the principles for recognizing revenue and to develop a common revenue standard. ASU 2014-09 permits the use of either a retrospective or modified retrospective application. This guidance was to be effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2016, with early adoption not permitted. In July 2015, the FASB issued ASU 2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date. This ASU confirmed a one-year delay in the effective date of ASU 2014-09, making the effective date for the Company the first quarter of fiscal 2018 instead of the first quarter of fiscal 2017.

 

In March 2016, the FASB issued ASU 2016-08, Revenue from Contracts with Customers (Topic 606): Principal versus Agent Consideration (Reporting Revenues Gross versus Net). This ASU is further guidance to ASU 2014-09, and clarifies principal versus agent considerations. In April 2016, the FASB issued ASU 2016-10, Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing. This ASU is also further guidance to ASU 2014-09, and clarifies the identification of performance obligations. In May 2016, the FASB issued ASU 2016-12, Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients. This ASU is also further guidance to ASU 2014-09, and clarifies assessing the narrow aspects of recognizing revenue. In December 2016, the FASB issued ASU 2016-20, Technical Corrections and Improvements to Topic 606, Revenue from Contracts with Customers. This ASU is also further guidance to ASU 2014-09, and clarifies technical corrections and improvements for recognizing revenue.

 

In January 2017, the FASB issued ASU 2017-03, Accounting Changes and Error Corrections (Topic 250) and Investments-Equity Method and Joint Ventures (Topic 323) (“ASU 2017-03”). This ASU requires registrants to evaluate the impact ASU 2014-09 will have on financial statements and adequately disclose this information to assist the reader in assessing the significance of ASU 2014-09 on the financial statements when adopted. The Company commenced its assessment of ASU 2014-09 beginning in June 2016. This assessment included analyzing ASU 2014-09’s impact on the Company’s various revenue streams, comparing the Company’s historical accounting policies and practices to the requirements of ASU 2014-09, and identifying potential differences from applying the requirements of ASU 2014-09 to the Company’s contracts. The Company has used a five-step process to identify the contract with the customer, identify the performance obligations, determine the transaction price, allocate the transaction price to the performance obligations and recognize revenue when or as the performance obligations are satisfied. The Company has implemented the appropriate changes to its business processes, systems and controls to support revenue recognition and disclosures under ASU 2014-09.

 

6

 

 

The Company adopted ASU 2014-09 at the beginning of its 2018 fiscal year using the modified retrospective method applied to those contracts which were not completed as of January 1, 2018. Prior period amounts have not been adjusted and continue to be reported in accordance with historic accounting standards in effect during those periods. The adoption of ASU 2014-09 and related amendments did not have a material impact on the Company’s condensed consolidated financial statements.

 

In January 2016, the FASB issued ASU 2016-01, Financial Instruments - Overall (Subtopic 825-10) (“ASU 2016-01”). This ASU addresses certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. ASU 2016-01 requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset (that is, securities or loans and receivables) on the balance sheet or in the accompanying notes to the financial statements. That presentation provides financial statement users with more decision-useful information about an entity’s involvement in financial instruments. The provisions of this ASU were to be effective for annual periods beginning after December 15, 2017, and interim periods within those years, with early adoption permitted. In February 2018, the FASB issued ASU 2018-03, Technical Corrections and Improvements to Financial Instruments - Overall (Subtopic 825-10), which made targeted improvements to address certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. This ASU also confirmed a six-month delay in the effective date of ASU 2016-01, making the effective date for the Company the second quarter of fiscal 2018 instead of the first quarter of fiscal 2018, with early adoption permitted. The Company adopted ASU 2016-01 as of March 31, 2018, and that adoption did not have a material impact on the Company’s condensed consolidated financial statements.

 

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842) (“ASU 2016-02”). This ASU requires lessees to recognize most leases on the balance sheet. The provisions of this guidance are effective for annual periods beginning after December 15, 2018, and interim periods within those years, with early adoption permitted. In January 2017, the FASB issued ASU 2017-03, which requires registrants to evaluate the impact ASU 2016-02 will have on financial statements and adequately disclose this information to assist the reader in assessing the significance of ASU 2016-02 on the financial statements when adopted. In January 2018, the FASB issued ASU 2018-01, Leases (Topic 842): Land Easement Practical Expedient for Transition to Topic 842. This ASU provides an optional transition practical expedient to not evaluate under ASU 2016-02 existing or expired land easements that were not previously accounted for as leases under ASC Topic 840, Leases. An entity that elects this practical expedient should evaluate new or modified land easements under ASU 2016-02 beginning at the date that the entity adopts ASU 2016-02. In July 2018, the FASB issued ASU 2018-10, Codification Improvements to Topic 842, Leases, which provides improvements and clarifications for ASU 2016-02. In July 2018, the FASB issued ASU 2018-11, Leases (Topic 842): Targeted Improvements (“ASU 2018-11”). This ASU provides an additional transition method by allowing entities to initially apply the new lease standard at the date of adoption with a cumulative effect adjustment to the opening balances of retained earnings in the period of adoption. This ASU also gives lessors the option of electing, as a practical expedient by class of underlying asset, not to separate the lease and non-lease components of a contract when those lease contracts meet certain criteria. In December 2018, the FASB issued ASU 2018-20, Narrow-Scope Improvements for Lessors. This ASU clarifies lessor treatment for sales taxes and other similar taxes collected from lessees, certain lessor costs, and recognition of variable payments for contracts with lease and non-lease components. In March 2019, the FASB issued ASU 2019-01, Codification Improvements. This ASU clarifies determining the fair value of the underlying asset by lessors that are not manufacturers or dealers, presentation on the statement of cash flows for sales-type and direct financing leases, and transition disclosures related to Topic 250, Accounting Changes and Error Corrections. The Company has completed its evaluation of the requirements of this guidance and implemented the processes necessary to adopt ASU 2016-02, as amended. The Company has elected certain practical expedients available at adoption. The Company elected the package of practical expedients upon transition not to reassess whether expired or existing contracts contain leases under the new definition of a lease; not to reassess the lease classification for expired or existing leases; and not to reassess whether previously capitalized initial direct costs would qualify for capitalization under ASU 2016-02. In evaluating certain equipment rental arrangements such as cable, internet and security service contracts, the Company considered the practical expedient that allows lessors to elect, by class of underlying asset, to not separate non-lease components from the associated lease components if the non-lease components otherwise would be accounted for in accordance with the new revenue recognition standard. The Company elected this practical expedient as the following two criteria are met; the lease component and the associated non-lease components have the same timing and pattern of transfer; and the lease component, if accounted for separately, would be classified as an operating lease. The Company elected to adopt the new standard using the transition method provided by ASU 2018-11; therefore, prior periods will not be restated. The Company has determined that the impact of adoption is limited to real property leases and is consistent with industry practices. Adoption of the new standard resulted in the Company recognizing an aggregate of $1,073,919 in lease liabilities and corresponding right of use (“ROU”) assets and no impact on the opening retained earnings balances. The adoption of ASU 2016-02 had an immaterial impact on the condensed consolidated statements of operations and condensed consolidated statements of cash flows for the nine months ended September 30, 2019.

 

7

 

 

In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments. This ASU addresses how certain cash receipts and cash payments are presented and classified in the statement of cash flows under Topic 230, Statement of Cash Flows, and other Topics. This ASU is effective for annual reporting periods, and interim periods therein, beginning after December 15, 2017, with early adoption permitted. The Company adopted this ASU and that adoption did not have a material impact on the Company’s condensed consolidated financial statements.

 

In May 2017, the FASB issued ASU 2017-09, Compensation-Stock Compensation (Topic 718) (“ASU 2017-09”). ASU 2017-09 provides guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting in Accounting Standards Codification (“ASC”) Topic 718, Stock Compensation. ASU 2017-09 is effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. Early adoption is permitted for any interim period for which financial statements have not been issued. ASU 2017-09 should be applied prospectively to an award modified on or after the adoption date. The Company adopted this ASU and that adoption did not have a material impact on the Company’s condensed consolidated financial statements.

 

In May 2017, the FASB issued ASU 2017-10, Service Concession Arrangements (Topic 853) (“ASU 2017-10”). The objective of this ASU is to specify that an operating entity should not account for a service concession arrangement that meets certain criteria as a lease in accordance with ASC Topic 840, Leases. ASU 2017-10 further states that the infrastructure used in a service concession arrangement should not be recognized as property, plant, and equipment of the operating entity. The provisions of this ASU are effective for annual periods beginning after December 15, 2017, and interim periods within those years, with early adoption permitted. The Company adopted this ASU and that adoption did not have a material impact on the Company’s condensed consolidated financial statements.

 

In March 2018, the FASB issued ASU 2018-05, Income Taxes (Topic 740). The objective of this ASU is to amend ASC 740, Income Taxes to reflect Staff Accounting Bulletin No. 118 (“SAB 118”), issued by the staff of the Securities and Exchange Commission, which addresses the enactment of the Tax Cuts and Jobs Act (the “Tax Act”). SAB 118 outlines the approach companies may take if they determine that the necessary information is not available (in reasonable detail) to evaluate, compute, and prepare accounting entries to recognize the effects of the Tax Act by the time the financial statements are required to be filed. Companies may use this approach when the timely determination of some or all of the income tax effects from the Tax Act are incomplete by the due date of the financial statements.  A reporting entity must act in good faith and update provisional amounts as soon as more information becomes available, evaluated and prepared, during a measurement period that cannot exceed one year from the enactment date. Initial reasonable estimates and subsequent changes to provisional amounts should be reported in income tax expense or benefit from continuing operations in the period in which they are determined.  As of December 31, 2017, the provisional amount recorded related to the remeasurement of the Company’s deferred tax liability balance was $9.3 million and reflected a one-time reduction in the Company’s income tax provision. As of December 31, 2017, the Company finalized its accounting estimates for income tax effects related to the Tax Act. The Company elected to not utilize the measurement window provided under SAB 118 that ended in 2018. The Company did not record any adjustments to its 2017 income tax effects resulting from the Tax Act.

 

In June 2018, the FASB issued ASU 2018-07, Compensation – Stock Compensation (Topic 718). This ASU expands the scope of ASU 2017-09, which currently only includes share-based payments issued to employees, to also include share-based payments issued to nonemployees for goods and services. The amendments in this ASU are effective for public companies for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years.  Early adoption is permitted, but no earlier than the Company’s adoption date of ASU 2014-09. The Company adopted this ASU and that adoption did not have a material impact on the Company’s condensed consolidated financial statements.

 

Recent Accounting Pronouncements

 

During 2018, the FASB issued ASUs 2018-01 through 2018-15 and, during 2019, the FASB has issued ASUs 2019-01 through 2019-07. Except for the ASUs discussed above and below, these ASUs provide technical corrections or simplifications to existing guidance and to specialized industries or entities and therefore have minimal, if any, impact on the Company.

 

In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820) (“ASU 2018-13”). This ASU modifies the disclosure requirements on fair value measurements in ASU 2018-13, based on the concepts in the Concepts Statement, including the consideration of costs and benefits. This ASU eliminates, adds and modifies certain disclosure requirements for fair value measurements as part of its disclosure framework project. ASU 2018-13 is effective for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. An entity is permitted to early adopt any removed or modified disclosures upon issuance of this ASU and delay adoption of the additional disclosures until their effective date. The Company does not expect this ASU to have a material impact on its condensed consolidated financial statements.

 

8

 

 

In November 2018, the FASB issued ASU 2018-19, Codification Improvements to Topic 326, Financial Instruments – Credit Losses (“ASU 2018-19”). This ASU improves the disclosure requirements in ASU 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (“ASU 2016-13”) issued in June 2016, to make a cumulative-effect adjustment to opening retained earnings as of the beginning of the first reporting period in which the amendments are effective. The effective date and transition requirements for the amendments in this update are the same as the effective dates and transition requirements in ASU 2016-13, as amended by ASU 2018-19. In April 2019, the FASB issued ASU 2019-04, Codification Improvements to Topic 326, Financial Instruments – Credit Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments. This ASU improves the disclosure requirements in ASU 2016-13 issued in June 2016, to allow the measurement of allowance for credit losses on accrued interest receivable balances separately from other components of the amortized cost basis of associated financial assets. In May 2019, the FASB issued ASU 2019-05, Financial Instruments – Credit Losses (Topic 326). This ASU improves the disclosure requirements in ASU 2016-13 issued in June 2016, to allow companies to irrevocably elect, upon adoption of ASU 2016-13, the fair value option on financial instruments that (1) were previously recorded at amortized cost and (2) are within the scope of ASC 326-20 if the instruments are eligible for the fair value option under ASC 825-10. The effective date and transition requirements for the amendments in this update are the same as the effective dates and transition requirements in ASU 2016-13, as amended by ASU 2018-19. ASU 2016-13 is effective for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. An entity is permitted to early adopt as of the fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. The Company does not expect this ASU to have a material impact on its consolidated financial statements.

 

2. Notes Payable

 

Notes payable consists of the following (in thousands, except percentages) as of:

 

                September 30,     December 31,  
    Current     Long-term     2019     2018  
Loan with CoBank, ACB (the “Credit Facility”); variable interest rate of 6.36% at September 30, 2019, interest is monthly, paid in arrears on the last business day of each month.  The Credit Facility is secured by the total assets of the subsidiary guarantors.  The unpaid balance is due November 3, 2022.   $ 4,350     $ 66,950     $ 71,300     $ 74,562  
                                 
Debt issuance cost     (428 )     (793 )     (1,221 )     (1,551 )
                                 
Notes payable, net of debt issuance cost   $ 3,922     $ 66,157     $ 70,079     $ 73,011  

 

Associated with the Credit Facility, the Company incurred $2.1 million in deferred financing cost. Amortization expense for the deferred financing cost associated with the Credit Facility was $342 thousand and $354 thousand for the nine months ended September 30, 2019, and 2018, respectively, which is included in interest expense.

 

The revolving credit facility associated with the Company’s Credit Facility had a maximum borrowing capacity of $5.0 million on September 30, 2019. The revolving credit facility is available until November 3, 2022. There was no balance outstanding as of September 30, 2019. The Company pays a commitment fee of 0.50% per annum, payable quarterly in arrears, on the unused portion of the revolver loan under the Credit Facility. The rate declined from 0.50% per annum to 0.38% per annum on October 22, 2018. The commitment fee expense was $14 thousand and $19 thousand for the nine months ended September 30, 2019, and 2018, respectively.

 

Maturities of notes payable for the next five years, assuming no future annual excess cash flow payments, are as follows (in thousands):

 

2019 (remaining)   $ 1,088  
2020     4,350  
2021     4,350  
2022     61,512  
2023     —  
Total   $ 71,300  

 

A total of $2.1 million of debt issuance cost is being amortized over the life of the loan and is recorded net of the notes payable on the condensed consolidated balance sheets.

 

The Company’s notes payable agreements are subject to certain financial covenants and restrictions on indebtedness, financial guarantees, business combinations and other related items. As of September 30, 2019, the Company was in compliance with all such covenants and restrictions.

 

9

 

 

3. Income Tax

 

For the nine months ended September 30, 2019, the effective tax rate was 26.1%, compared to 25.0% for the nine months ended September 30, 2018. The effective tax rate varies from the federal corporate tax rate of 21.0% largely due to state income taxes and other permanent differences.

 

4. Net Income per Common Share

 

Basic net income per common share is computed by dividing net income by the weighted-average number of common shares outstanding for the period. Diluted net income per common share reflects the potential dilution that would occur should all of the shares of Class A common stock underlying restricted stock units (“RSUs”) be issued.

 

A reconciliation of the common shares for purposes of the calculation of the Company’s basic and diluted net income per common share is as follows (weighted average number of common shares outstanding in whole numbers and net income in thousands):

 

   

Three Months

Ended September 30,

   

Nine Months

Ended September 30,

 
    2019     2018     2019     2018  
Weighted average number of common shares outstanding - basic     3,410,936       3,388,624       3,410,936       3,388,624  
                                 
Effect of dilutive securities     20,293       66,312       20,293       49,762  
                                 
Weighted average number of common shares and potential common shares - diluted     3,431,229       3,454,936       3,431,229       3,438,386  
                                 
Net income   $ 1,819     $ 2,326     $ 5,816     $ 7,230  
                                 
Net income per common share - basic   $ 0.53     $ 0.69     $ 1.71     $ 2.13  
                                 
Net income per common share - diluted   $ 0.53     $ 0.67     $ 1.70     $ 2.10  

 

5. Revenue Streams and Concentrations

 

Revenue Streams

 

The Company identifies its revenue streams with similar characteristics as follows (in thousands):

 

    Three Months Ended
September 30, 2019 		    Nine Months Ended
September 30, 2019 		 
Local services   $ 4,717     $ 14,585  
Network access     5,436       15,970  
Internet     3,673       10,996  
Transport services     1,091       3,143  
Video and security     691       2,028  
Managed services     154       453  
Total revenues   $ 15,762     $ 47,175  

 

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The Company identifies its revenue streams with similar characteristics as follows (in thousands):

 

    Three Months Ended
September 30, 2018 		    Nine Months Ended
September 30, 2018 		 
Local services   $ 5,162     $ 15,799  
Network access     5,261       16,338  
Internet     3,774       11,484  
Transport services     1,211       3,613  
Video and security     689       2,143  
Managed services     155       490  
Total revenues   $ 16,252     $ 49,867  

 

ASU 2014-09 requires that an entity recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. As stated above in Note 1, Organization and Basis of Financial Reporting – Recently Adopted Accounting Pronouncements, the Company has used a five-step process to identify the contract with the customer, identify the performance obligations, determine the transaction price, allocate the transaction price to the performance obligations and recognize revenue when or as the performance obligations are satisfied. The majority of the Company’s revenue is recognized at the point in time control of the service is transferred to the customer. For certain other services, such as unlimited long distance, revenue is recognized over the period of time the service is provided. The Company has implemented the appropriate changes to its business processes, systems and controls to support revenue recognition and disclosures under ASU 2014-09.

 

The following table identifies revenue generated from customers (in thousands):

 

    Three Months Ended
September 30, 2019 		    Nine Months Ended
September 30, 2019 		 
Local services   $ 4,717     $ 14,585  
Network access     1,086       3,273  
Internet     3,673       10,996  
Transport services     1,054       3,030  
Video and security     691       2,028  
Managed services     154       453  
Total revenues generated from customers   $ 11,375     $ 34,365  

 

The following table identifies revenue generated from customers (in thousands):

 

    Three Months Ended
September 30, 2018 		    Nine Months Ended
September 30, 2018 		 
Local services   $ 5,162     $ 15,799  
Network access     1,130       3,551  
Internet     3,774       11,484  
Transport services     1,173       3,500  
Video and security     689       2,143  
Managed services     155       490  
Total revenues generated from customers   $ 12,083     $ 36,967  

 

11

 

 

The following table summarizes the revenue generated from contracts with customers among each revenue stream for the three and nine month periods (in thousands, except percentages):

 

    Three Months Ended              
    September 30, 2019     % In-Scope     % Total  
Month to month (“MTM”) customers   $ 6,847       61.0 %     43.4 %
Competitive local exchange carrier (“CLEC”) business customers     3,288       29.3       20.9  
Network access     640       5.7       4.1  
Total revenue streams     10,775       96.0       68.4  
Global access*     446       4.0       2.8  
Total revenue from contracts with customers     11,221       100.0 %     71.2  
Managed services**     154                        n/a       1.0  
Total revenue generated from customers     11,375                        n/a       72.2  
Indefeasible rights-of-use agreements**     37                        n/a       0.2  
Network access**     4,350                        n/a       27.6  
Total revenues   $ 15,762               100.0 %

 

*Fixed fees charged to MTM customers and CLEC business customers.

** Revenue generated from sources not within the scope of ASU 2014-09.

 

    Nine Months Ended              
    September 30, 2019     % In-Scope     % Total  
MTM customers   $ 20,769       61.3 %     44.0 %
CLEC business customers     9,870       29.1       20.9  
Network access     1,908       5.6       4.1  
Total revenue streams     32,547       96.0       69.0  
Global access*     1,365       4.0       2.9  
Total revenue from contracts with customers     33,912       100.0 %     71.9  
Managed services**     453                        n/a       1.0  
Total revenue generated from customers     34,365                        n/a       72.9  
Indefeasible rights-of-use agreements**     113                        n/a       0.2  
Network access**     12,697                        n/a       26.9  
Total revenues   $ 47,175               100.0 %

 

*Fixed fees charged to MTM customers and CLEC business customers.

** Revenue generated from sources not within the scope of ASU 2014-09.

 

12

 

 

The following table summarizes the revenue generated from contracts with customers among each revenue stream for the three and nine month periods (in thousands, except percentages):

 

    Three Months Ended              
    September 30, 2018     % In-Scope     % Total  
MTM customers   $ 7,351       61.6 %     45.2 %
CLEC business customers     3,447       28.9       21.2  
Network access     666       5.6       4.1  
Total revenue streams     11,464       96.1       70.5  
Global access*     464       3.9       2.9  
Total revenue from contracts with customers     11,928       100.0 %     73.4  
Managed services**     155                        n/a       1.0  
Total revenue generated from customers     12,083                        n/a       74.4  
Indefeasible rights-of-use agreements**     38                        n/a       0.2  
Network access**     4,131                        n/a       25.4  
Total revenues   $ 16,252               100.0 %

 

*Fixed fees charged to MTM customers and CLEC business customers.

** Revenue generated from sources not within the scope of ASU 2014-09.

 

    Nine Months Ended              
    September 30, 2018     % In-Scope     % Total  
MTM customers   $ 22,337       61.2 %     44.8 %
CLEC business customers     10,589       29.1       21.2  
Network access     2,074       5.7       4.2  
Total revenue streams     35,000       96.0       70.2  
Global access*     1,477       4.0       3.0  
Total revenue from contracts with customers     36,477       100.0 %     73.2  
Managed services**     490                        n/a       1.0  
Total revenue generated from customers     36,967                        n/a       74.2  
Indefeasible rights-of-use agreements**     113                        n/a       0.2  
Network access**     12,787                        n/a       25.6  
Total revenues   $ 49,867               100.0 %

 

*Fixed fees charged to MTM customers and CLEC business customers.

** Revenue generated from sources not within the scope of ASU 2014-09.

 

Payment terms vary by customer. The Company typically invoices customers in the month following when the service was provided. The term between invoicing and when payment is due is less than a year and is not considered significant. Certain customers are invoiced in advance of the service being provided. Revenue is deferred until the point in time control of the service is transferred to the customer or over the term the service is provided.

 

Revenue is recognized net of taxes collected on behalf of third parties.

 

As of September 30, 2019, the Company had approximately $8.1 million of unsatisfied performance obligations. As of September 30, 2019, the Company expected to recognize approximately $1.2 million of revenue within the next year and $6.9 million in the next two to five years related to such unsatisfied performance obligations. The Company does not disclose the value of unsatisfied performance obligations for contracts with an original expected life of one year or less or for contracts for which the Company has a right to invoice for services performed.

 

The deferred revenue balance as of June 30, 2019, was $3.7 million. Approximately $1.4 million of revenue from that balance was recognized as revenue during the three months ended September 30, 2019, offset by payments received as of September 30, 2019, in advance of control of the service being transferred to the customer.

 

Revenue Concentrations

 

Revenues from the Federal Communications Commission’s (the “FCC”) Universal Service Fund, Connect America Fund, and Alternative Connect America Cost Model funding are used to improve and upgrade the Company’s network to promote support for the availability and affordability of advanced telecommunications services. Revenues from these sources amounted to 23.1% and 21.2% of the Company’s total revenues for the nine months ended September 30, 2019, and 2018, respectively.

 

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6. Commitments and Contingencies

 

From time to time, the Company may be involved in various claims, legal actions and regulatory proceedings incidental to and in the ordinary course of business, including administrative hearings of the Alabama Public Service Commission, the Maine Public Utilities Commission, the Massachusetts Department of Telecommunications and Cable, the Missouri Public Service Commission, the New Hampshire Public Utilities Commission, the Vermont Public Utility Commission and the West Virginia Public Service Commission, relating primarily to rate making and customer service requirements. In addition, the Company may be involved in similar proceedings with interconnection carriers and the FCC. Currently, none of the Company’s legal proceedings are expected to have a material adverse effect on the Company’s business.

 

7. Leases

 

ASU 2016-02 requires lessees to recognize most leases on the balance sheet. As stated above in Note 1, Organization and Basis of Financial Reporting – Recently Adopted Accounting Pronouncements, the Company has elected certain practical expedients available at adoption. The Company elected the package of practical expedients upon transition not to reassess whether expired or existing contracts contain leases under the new definition of a lease; not to reassess the lease classification for expired or existing leases; and not to reassess whether previously capitalized initial direct costs would qualify for capitalization under ASU 2016-02. In evaluating certain equipment rental arrangements such as cable, internet and security service contracts, the Company considered the practical expedient that allows lessors to elect, by class of underlying asset, to not separate non-lease components from the associated lease components if the non-lease components otherwise would be accounted for in accordance with the new revenue recognition standard. The Company elected this practical expedient as the following two criteria are met; the lease component and the associated non-lease components have the same timing and pattern of transfer; and the lease component, if accounted for separately, would be classified as an operating lease. The Company elected to adopt the new standard using the transition method provided by ASU 2018-11; therefore, prior periods will not be restated. The Company has determined that the impact of adoption is limited to real property leases and is consistent with industry practices. This ASU was effective January 1, 2019, the Company recognized an aggregate of $1,073,919 in lease liabilities and corresponding ROU assets and no impact on the opening retained earnings balances.

 

In consideration of whether an agreement contains a lease as defined under ASU 2016-02, the Company answered these three questions; has an asset been identified, is the asset physically distinct, and does the customer have the right to control the asset. The Company determined based on the three-step questions above, the arrangements pertaining to real property building and office facilities in Alabama, Maine and Massachusetts are within the scope of ASU 2016-02.

 

In calculating the lease liability, the Company considered the lease term in which the Company would include any periods covered by an option to extend the lease if the lessee is reasonably certain to exercise that option. The Company evaluated factors that might create an economic incentive to exercise options to extend, including contract, asset, entity and market-based factors. The Company determined that there would be no significant relocation and interruption costs associated with moving to alternative space that would disincentivize a move at renewal; therefore, renewals to extend the lease term are not included in the ROU asset and lease liabilities.

 

A lessee may recognize the lease payments in profit or loss on a straight-line basis over the lease term and variable lease payments in the period in which the obligation for those payments is incurred. The accounting policy election for short-term leases shall be made by class of underlying asset to which the right of use relates. A short-term lease is defined as a lease that, at the commencement date, has a lease term of 12 months or less and does not include an option to purchase the underlying asset that the lessee is reasonably certain to exercise. The Company elected to exclude short-term leases from the recognition requirements.

 

In discounting the liability, ASU 2016-02 indicates that the incremental rate used must be comparable to a rate attributable to a similar amount, for a similar term, and with similar collateral as the assets in the lease. The Company observed that published commercial borrowing rates were generally between 5.0% to 7.0% for loans collateralized by the real estate for terms ranging from 5-10 years. The Company has elected to use a discount rate of 6.5% for all leases.

 

14

 

 

Maturities of lease liabilities as of September 30, 2019 are as follows (in thousands):

 

    Leased Real
Property and
Office Facilities 		 
2019 (remaining)   $ 109  
2020     312  
2021     203  
2022     185  
2023     166  
Thereafter     42  
Total lease payments   $ 1,017  
Less: Interest     (110 )
Present value of lease liabilities   $ 907  

 

Supplemental cash flow information related to operating leases was as follows (in thousands, except years and percentages):

 

    Three Months Ended
September 30, 2019 		    Nine Months Ended
September 30, 2019 		  
Cash paid for amounts included in the measurement of lease liabilities:                
Operating cash outflow from operating leases   $       (108 )   $ (325 )
Weighted-average remaining lease term – operating leases (in years)     3.6       3.6  
Weighted average discount rate – operating leases     6.5 %     6.5 %

 

8. Stock Plans

 

The Company has previously granted RSUs underlying 401,111 shares of Class A common stock. These RSUs (or a portion thereof) vest with respect to each recipient over a one to three year period from the date of grant, provided the recipient remains in the employment or service of the Company as of the vesting date and, in selected instances, certain performance criteria are attained. Additionally, these RSUs (or a portion thereof) could vest earlier in the event of a change in control of the Company, or upon involuntary termination without cause. Of the 401,111 previously granted RSUs, RSUs underlying 334,799 shares of Class A common stock have vested or were cancelled as of December 31, 2018. During the nine months ended September 30, 2019, no RSUs were granted by the Company. The previous RSU grants were made primarily to executive-level personnel at the Company and, as a result, no compensation costs have been capitalized.

 

The following table summarizes RSU activity for the nine months ended September 30, 2019:

 

    RSUs    

Weighted Average
Grant Date
Fair Value

 
Outstanding at December 31, 2018     66,312     $ 9.06  
Granted     —     $ —  
Vested     (34,202 )   $ 5.09  
Forfeited or cancelled     (11,817 )   $ 13.30  
Outstanding at September 30, 2019     20,293     $ 13.30  

 

Stock-based compensation expense related to RSUs was $108 thousand and $207 thousand for the nine months ended September 30, 2019, and 2018, respectively. Stock-based compensation related to RSUs is recognized over the 39-month vesting schedule. Accounting standards require that the Company estimate forfeitures for RSUs and reduce compensation expense accordingly. The Company has reduced its expense by the assumed forfeiture rate and will evaluate actual experience against the assumed forfeiture rate going forward. The forfeiture rate has been developed using historical performance metrics which could impact the size of the final issuance of Class A common stock. The Company has no history before 2014 with RSU forfeiture.

 

As of September 30, 2019, the unrecognized total compensation cost related to unvested RSUs was $108 thousand. That cost is expected to be recognized by the end of 2021.

 

15

 

 

On October 15, 2018, the Company granted 29,460 incentive stock options (“ISOs”) and 20,540 non-qualified (“NQ”) stock options to purchase shares of Class A common stock. These options vest with respect to the recipient thereof over a five year period with 20% becoming exercisable on each anniversary of the vesting commencement date of October 15, 2019, provided the recipient remains in the employment or service of the Company as of the vesting date. Additionally, these options (or a portion thereof) could vest earlier in the event of a change in control of the Company. These option grants were made to one executive-level employee of the Company and, as a result, no compensation costs have been capitalized.

 

The following table summarizes ISO and NQ stock option activity for the nine months ended September 30, 2019:

 

    ISOs and NQ Stock Options    

Weighted Average
Grant Date
Fair Value

 
Outstanding at December 31, 2018     50,000     $ 16.97  
Granted     —     $ —  
Vested     —     $ —  
Forfeited or cancelled     —     $              —  
Outstanding at September 30, 2019     50,000     $ 16.97  

 

Stock-based compensation expense related to ISOs and NQ stock options was $65 thousand for the nine months ended September 30, 2019.

 

As of September 30, 2019, the unrecognized total compensation cost related to unvested ISOs and NQ stock options was $351 thousand. That cost is expected to be recognized by the end of 2023.

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Overview

 

General

 

Since 1999, we have acquired and operate eleven rural local exchange carriers (“RLECs”) serving subscribers in north central Alabama, central Maine, western Massachusetts, central Missouri, western Vermont and southern West Virginia. We also operate a competitive local exchange carrier (“CLEC”) serving subscribers in Maine, Massachusetts and New Hampshire. Our services include a broad suite of communications and information services including local and long distance telephone services; internet and broadband data services; network access to other wireline, long distance and wireless carriers for calls originated or terminated on our network; other telephone related services; cloud hosting and professional engineering services for small and mid-sized companies who rely on mission-critical software applications; digital high-speed transport services (in our New England market); and video and security (in some markets). The majority of our revenue comes from providing local and long distance voice services and internet broadband data services to both enterprise and residential customers. In addition, a significant portion of our revenue comes from providing access to our customers for other service providers and the associated funds from programs initiated by the Federal Communications Commission (the “FCC”). Our organization is structured functionally across all states in which we operate. Therefore, we view, manage and evaluate the results of operations from the various telecommunications services as one company and have identified one reporting segment as it relates to providing segment information.

 

The FCC released its Universal Service Fund and Intercarrier Compensation Order (the “FCC ICC Order”) in November 2011. This order has made and continues to make substantial changes in the way telecommunication carriers are compensated for serving high cost areas and for exchanging traffic with other carriers. We began seeing the significant impact of the FCC ICC Order to our business in July 2012, with additional impacts beginning in July 2013 and July 2014. The initial consequence to our business was to reduce access revenue from intrastate calling in Maine and other states where intrastate rates were higher than interstate rates. A portion of this revenue loss for our RLEC properties has been replaced with the Connect America Fund (the “CAF”). There is no recovery mechanism for the lost revenue in our CLEC. The impact of the FCC ICC Order is expected to continue reducing our revenue and net income through 2020.

 

The FCC made additional offers for us to receive increased Alternative Connect America Model (“A-CAM”) model-based support in 2019. One company will receive an additional $442,000 in A-CAM support each year, and the overall 10-year A-CAM support program was extended two years for all ten of our companies that receive A-CAM support. One company, not included in previous A-CAM support offers, received an offer of A-CAM support on May 2, 2019, and filed a letter with the FCC on June 17, 2019, to accept the A-CAM support offer, which is effective as of January 1, 2019. The A-CAM support replaces the legacy rate-of-return support it currently receives. A-CAM support requires additional investment in plant and equipment to reach target broadband speeds and covered locations. A-CAM support will decline through 2028 as the additional investment is completed.

 

The Tax Cuts and Jobs Act, which we refer to as the Tax Act, passed in December 2017, has reduced, and is expected to continue to reduce, our cash tax liability. Specifically, both the lower income tax rate and the extension of bonus depreciation under the Tax Act have positively impacted, and are expected to continue to positively impact, our federal tax requirements. The limitation on interest deductibility under the Tax Act is not expected to impact our tax liabilities.

 

The following discussion and analysis should be read in conjunction with our unaudited condensed consolidated financial statements and the related notes included in Item 1 of Part I and the other financial information appearing elsewhere in this report. The following discussion and analysis relates to our financial condition and results of operations on a consolidated basis.

 

Revenue Sources

 

Our revenues are derived from six sources:

 

· Local services. We receive revenues from providing local exchange telecommunication services in our eleven rural territories. In addition, we receive revenues on a competitive basis through both wholesale and retail channels throughout Maine, New Hampshire and western Massachusetts. These revenues include monthly subscription charges for basic service, calling beyond the local territory on a fixed price and on a per minute basis, local private line services and enhanced calling features, such as voicemail, caller identification, call waiting and call forwarding. We also provide billing and collections services for other carriers under contract and receive revenues from directory advertising. A significant portion of our rural subscribers take bundled service plans, which include multiple services, including unlimited domestic calling, for a flat monthly fee.

 

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· Network access. We receive revenues from charges established to compensate us for the origination, transport and termination of calls of long distance, wireless and other interexchange carriers. These include subscriber line charges imposed on customers and switched and special access charges paid by carriers. Switched access charges for long distance services within Alabama, Maine, Massachusetts, Missouri, New Hampshire, Vermont and West Virginia have historically been based on rates approved by the Alabama Public Service Commission, the Maine Public Utilities Commission, the Massachusetts Department of Telecommunications and Cable, the Missouri Public Service Commission, the New Hampshire Public Utilities Commission, the Vermont Public Utility Commission and the West Virginia Public Service Commission, respectively, where appropriate. The FCC ICC Order preempted the state commissions’ authority to set terminating intrastate access service rates, and required companies with terminating access rates higher than interstate rates to reduce their terminating intrastate access rates to a rate equal to interstate access service rates by July 1, 2013, and to move to a “bill and keep” arrangement by July 1, 2020, which will eliminate access charges between carriers. The FCC ICC Order prescribes a recovery mechanism for the recovery of any decrease in intrastate terminating access revenues through the CAF for RLEC companies. This recovery is limited to 95% of the previous year’s revenue requirement. Interstate access revenue is based on an FCC-regulated rate-of-return on investment and recovery of expenses and taxes. From 1990 through June 2016, the rate-of-return had been authorized up to 11.25%. In March 2016, the FCC reduced the authorized rate-of-return to 9.75% effective July 1, 2021, using a transitional approach to reduce the impact of an immediate reduction. Rate-of-return transition began on July 1, 2016, with the authorized rate reduced to 11.0%, with further 25 basis points reductions each July 1 thereafter until the authorized rate reaches 9.75% on July 1, 2021. Switched and special access charges for interstate and international services are based on rates approved by the FCC. The FCC’s Order of October 23, 2018 (the “BDS Order”) provides an option for ten of our RLECs to move Special Access services (BDS) from a cost-based rate development (cost studies) to incentive regulation. We have exercised this option, which becomes effective July 1, 2019. We also receive revenue from the Universal Service Fund (“USF”) for the deployment of voice and broadband services to end-user customers. Since January 1, 2017, ten of our RLECs receive support payments through A-CAM and one of our RLECs receives support payments through modified legacy rate-of-return support mechanisms for USF, High Cost Loop and Interstate Common Line Support. Our RLEC currently receiving legacy rate-of-return support filed a letter on June 17, 2019 to accept the FCC’s offer to begin receiving A-CAM support in place of the legacy rate-of-return support, which will be effective retroactively to January 1, 2019.

 

· Internet. We receive revenues from monthly recurring charges for digital high-speed data lines delivered on fiber, coaxial and copper networks and ancillary services such as web hosting and computer virus protection.

 

· Transport services. We receive monthly recurring revenues for the rental of fiber to transport data and other telecommunication services in Maine and New Hampshire.

 

· Video and security. We offer basic, digital, high-definition, digital video recording and pay per view cable television services to a portion of our telephone service territory in Alabama, including Internet Protocol (“IP”) television (“IPTV”). We offer wireless security systems and system monitoring in Alabama and Missouri.

 

· Managed services. We provide private/hybrid cloud hosting services, as well as consulting and professional engineering services, for mission-critical software applications for small and mid-sized North American companies. Revenues are generated from monthly recurring hosting Infrastructure as a Service fees, monthly maintenance fees, à la carte professional engineering services and pay-as-you-use Software as a Service fees. Services are domiciled in two diverse owned data centers.

 

Customer and Service Trends

 

With the implementation of our new billing system supporting all of our customers, we have adopted managerial systems that focus on retaining customers and offering them a variety of service options. We offer competitively priced location-specific bundled service packages tailored to the varying telecommunications requirements of our customers.

 

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Key Operating Statistics

 

    September 30,     June 30,     Change from     March 31,     December 31,     Change from     September 30,  
    2019     2019     June 30, 2019     2019     2018     December 31, 2018     2018  
Customers served                                                                        
Business/Enterprise     5,438       5,547       (109 )     (2.0 )%     5,605       5,769       (331 )     (5.7 )%     6,005  
Residential     26,971       27,067       (96 )     (0.4 )%     27,346       27,734       (763 )     (2.8 )%     28,226  
Customers served     32,409       32,614       (205 )     (0.6 )%     32,951       33,503       (1,094 )     (3.3 )%     34,231  
                                                                         
Services provided                                                                        
Hosted PBX(1)     8,784       8,898       (114 )     (1.3 )%     8,962       9,008       (224 )     (2.5 )%     9,164  
Voice     34,695       35,529       (834 )     (2.3 )%     36,181       36,899       (2,204 )     (6.0 )%     38,043  
Data(1)     22,265       22,287       (22 )     (0.1 )%     22,333       22,514       (249 )     (1.1 )%     22,859  
Video     2,700       2,690       10       0.4 %     2,714       2,734       (34 )     (1.2 )%     2,808  
Services provided     68,444       69,404       (960 )     (1.4 )%     70,190       71,155       (2,711 )     (3.8 )%     72,874  

 

(1) Services provided metrics for 2018 have been adjusted to reflect current service definitions.

 

One of our key performance measures is to track the number of business and residence customers served and the number of telecommunications services provided to these customers. The table above provides a summary of the change in customers and the change in the four largest telecommunications services beginning with September 30, 2018, shortly after our consolidated billing and operations system was completed.

 

For the three months ended September 30, 2019, customers served decreased 0.6%, or 205 customers, an improvement when compared to a decrease of 1.0% and 1.6%, or 337 and 552 customers, in the three months ended June 30, 2019, and March 31, 2019, respectively. For the three months ended September 30, 2019, services provided to these customers decreased 1.4%, or 960 services, compared to 1.1% and 1.4%, or 786 and 965 services, in the three months ended June 30, 2019, and March 31, 2019, respectively. Data and video services have lower percentage decreases for the first nine months of 2019 than voice services, reflecting our focus on increasing data speeds available throughout our network. The continued deployment over the next two years of fiber-based services, the transition to VDSL in all of our networks and the deployment of DOCSIS 3.1 in our cable network are expected to improve the speed of our service offerings and further reduce the level of customer and service churn.

 

Our Rate and Pricing Structure

 

Our CLEC enterprise pricing is based on market requirements. We combine varying services to meet individual customer requirements, including technical support and managed services, and provide multi-year contracts which are both market sensitive for the customer and stabilizing for our sales process.

 

Our RLECs operate in six states and have limited regulation by the respective state regulatory authorities. The impact on pricing flexibility varies by state. Our rates for other services we provide, including cable, Internet Protocol (IP) television, long distance, data lines and high-speed internet access, are not price regulated. The market for competitors’ services, including wireless and IP based services, and the nationwide scope of their offering also affects our ability to adjust prices. We expect this trend to continue into the immediate future.

 

Categories of Operating Expenses

 

Our operating expenses are categorized as cost of services; selling, general and administrative expenses; and depreciation and amortization.

 

Cost of services. This includes expenses for salaries, wages and benefits relating to our telephone central office and outside plant operation, maintenance, sales and customer service; other plant operations, maintenance and administrative costs; network access costs; data center operations; and costs of services for long distance, cable television, internet and directory services.

 

Selling, general and administrative expenses. This includes expenses for salaries, wages and benefits and contract service payments (for example, legal fees and market studies) relating to engineering, financial, human resources and corporate operations; information management expenses, including billing; allowance for uncollectible accounts receivable; expenses for travel, lodging and meals; internal and external communications costs; insurance premiums; stock exchange and banking fees; and postage.

 

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Depreciation and amortization. This includes depreciation of our telecommunications, cable and internet networks and equipment, and amortization of intangible assets. Certain of these amortization expenses continue to be deductible for tax purposes.

 

Our Ability to Control Operating Expenses

 

We strive to control expenses in order to maintain our operating margins. As our revenue continues to shift to non-regulated services and our residential RLEC revenue continues to decline, operating margins decrease, reflecting the lower margins associated with non-regulated services and the level of fixed cost in our network. The years of reductions in FCC-controlled payments has made it difficult to fully offset revenue decline through expense control and pricing action. The introduction of A-CAM funding in 2017 provided support for additional capital investment in our network to enhance broadband speeds and coverage. The funds received through A-CAM funding will decline over the remaining years of the program.

 

Results of Operations

 

The following table sets forth our results of operations as a percentage of total revenues for the periods indicated:

 

    Three Months Ended September 30,     Nine Months Ended September 30,  
    2019     2018     2019     2018  
Revenues                                
Local services     29.9 %     31.8 %     30.9 %     31.7 %
Network access     34.5       32.4       33.8       32.8  
Internet     23.3       23.2       23.3       23.0  
Transport services     6.9       7.4       6.7       7.2  
Video and security     4.4       4.2       4.3       4.3  
Managed services     1.0       1.0       1.0       1.0  
Total revenues     100.0 %     100.0 %     100.0 %     100.0 %
Operating expenses                                
Cost of services     47.8 %     46.6 %     48.0 %     46.2 %
Selling, general and administrative expenses     15.9       14.7       15.9       15.4  
Depreciation and amortization     11.9       10.8       12.1       10.8  
Total operating expenses     75.6       72.1       76.0       72.4  
                                 
Income from operations     24.4       27.9       24.0       27.6  
                                 
Other income (expense)                                
Interest expense     (8.4 )     (9.0 )     (8.6 )     (8.8 )
Other income     —       0.5       1.3       0.5  
Total other expense     (8.4 )     (8.5 )     (7.3 )     (8.3 )
                                 
Income before income tax expense     16.0       19.4       16.7       19.3  
Income tax expense     (4.5 )     (5.1 )     (4.4 )     (4.8 )
                                 
Net income available to common stockholders     11.5 %     14.3 %     12.3 %     14.5 %

 

Revenues by category for the three months and nine months ended September 30, 2018, have been adjusted to be consistent with the revenues by category for the three months and nine months ended September 30, 2019.

 

Three Months and Nine Months Ended September 30, 2019, Compared to Three Months and Nine Months Ended September 30, 2018

 

Total revenues. Total revenues decreased 3.0% in the three months ended September 30, 2019, to $15.8 million from $16.3 million in the three months ended September 30, 2018. Total revenues decreased 5.4% in the nine months ended September 30, 2019, to $47.2 million from $49.9 million in the nine months ended September 30, 2018. The decrease was primarily due to the decrease in residential local services and traditional access revenue affected by the FCC ICC Order. The tables below provide the components of our revenues for the three months and nine months ended September 30, 2019, compared to the same periods of 2018.

 

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For the three months ended September 30, 2019, and 2018

 

    Three Months Ended September 30,     Change  
    2019     2018     Amount     Percent  
    (dollars in thousands)  
Local services   $ 4,717     $ 5,162     $ (445 )     (8.6 )%
Network access     5,436       5,261       175       3.3 %
Internet     3,673       3,774       (101 )     (2.7 )%
Transport services     1,091       1,211       (120 )     (9.9 )%
Video and security     691       689       2       0.3 %
Managed services     154       155       (1 )     (0.6 )%
Total   $ 15,762     $ 16,252     $ (490 )     (3.0 )%

 

Local services. Local services revenue decreased 8.6% in the three months ended September 30, 2019, to $4.7 million from $5.2 million in the three months ended September 30, 2018. RLEC residential voice line revenue, including long distance and other related services, decreased $0.3 million. Revenue associated with the FCC ICC Order decreased $0.1 million, and fiber installation and rental revenue decreased $0.1 million.

 

Network access. Network access revenue increased 3.3% in the three months ended September 30, 2019, to $5.4 million from $5.3 million in the three months ended September 30, 2018. A-CAM and CAF revenue increased $0.4 million, reflecting the FCC’s year-to-date adjustment of funding for our conversion of Vermont to A-CAM. Other transition support payments decreased $0.1 million. Switched and special access and end-user fees decreased $0.1 million.

 

Internet. Internet revenue decreased 2.7% in the three months ended September 30, 2019, to $3.7 million from $3.8 million in the three months ended September 30, 2018. A decrease in customers and related equipment rental charges accounted for the decline.

 

Transport services. Transport services revenue decreased 9.9% in the three months ended September 30, 2019, to $1.1 million from $1.2 million in the three months ended September 30, 2018, reflecting customer losses and market pricing.

 

Video and security. Video and security revenue was unchanged at just under $0.7 million in the three months ended September 30, 2019, and the three months ended September 30, 2018. An increase in IPTV customers offset a decline in traditional cable customers.

 

Managed services. Managed services revenue was basically unchanged at under $0.2 million in the three months ended September 30, 2019, and the three months ended September 30, 2018, reflecting slightly lower cloud hosting revenue offset by slightly higher professional services revenue.

 

For the nine months ended September 30, 2019, and 2018

 

    Nine Months Ended September 30,     Change  
    2019     2018     Amount     Percent  
    (dollars in thousands)  
Local services   $ 14,585     $ 15,799     $ (1,214 )     (7.7 )%
Network access     15,970       16,338       (368 )     (2.3 )%
Internet     10,996       11,484       (488 )     (4.2 )%
Transport services     3,143       3,613       (470 )     (13.0 )%
Video and security     2,028       2,143       (115 )     (5.4 )%
Managed services     453       490       (37 )     (7.6 )%
Total   $ 47,175     $ 49,867     $ (2,692 )     (5.4 )%

 

Local services. Local services revenue decreased 7.7% in the nine months ended September 30, 2019, to $14.6 million from $15.8 million in the nine months ended September 30, 2018. RLEC residential voice line revenue, including long distance and other related services, decreased $1.0 million. Revenue associated with the FCC ICC Order decreased $0.2 million.

 

Network access. Network access revenue decreased 2.3% in the nine months ended September 30, 2019, to $16.0 million from $16.3 million in the nine months ended September 30, 2018. A-CAM and CAF revenue increased $0.2 million, reflecting the FCC’s year-to-date adjustment of funding for our conversion of Vermont to A-CAM. Other transition support payments decreased $0.2 million. Switched and special access and end-user fees decreased $0.4 million.

 

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Internet. Internet revenue decreased 4.2% in the nine months ended September 30, 2019, to $11.0 million from $11.5 million in the nine months ended September 30, 2018. Customers and equipment rental charges decreased $0.4 million and wireless internet and related services decreased $0.1 million.

 

Transport services. Transport services revenue decreased 13.0% in the nine months ended September 30, 2019, to $3.1 million from $3.6 million in the nine months ended September 30, 2018, reflecting a wholesale carrier disconnect, two retail customer disconnects and market pricing.

 

Video and security. Video and security revenue decreased 5.4% in the nine months ended September 30, 2019, to $2.0 million from $2.1 million in the nine months ended September 30, 2018, reflecting a decrease in traditional cable customers, partially offset by an increase in IPTV customers.

 

Managed services. Managed services revenue decreased 7.6% in the nine months ended September 30, 2019, to under $0.5 million from just under $0.5 million in the nine months ended September 30, 2018, reflecting slightly lower professional services and cloud hosting revenue.

 

Operating expenses. Operating expenses in the three months ended September 30, 2019, increased 1.7% to $11.9 million from $11.7 million in the three months ended September 30, 2018. Operating expenses in the nine months ended September 30, 2019, decreased 0.7% to $35.9 million from $36.1 million in the nine months ended September 30, 2018. The tables below provide the components of our operating expenses for the three months and nine months ended September 30, 2019, compared to the same periods of 2018.

 

For the three months ended September 30, 2019, and 2018

 

    Three Months Ended September 30,     Change  
    2019     2018     Amount     Percent  
    (dollars in thousands)  
Cost of services   $ 7,542     $ 7,578     $ (36 )     (0.5 )%
Selling, general and administrative expenses     2,506       2,382       124       5.2 %
Depreciation and amortization     1,873       1,756       117       6.7 %
Total   $ 11,921     $ 11,716     $ 205       1.7 %

 

Cost of services. Cost of services decreased 0.5% to $7.5 million in the three months ended September 30, 2019, from $7.6 million in the three months ended September 30, 2018. Customer service and sales costs decreased $0.1 million and network operations costs decreased by $0.1 million, which were partially offset by an increase in network access and toll expense of $0.1 million.

 

Selling, general and administrative expenses. Selling, general and administrative expenses increased 5.2% to $2.5 million in the three months ended September 30, 2019, from $2.4 million in the three months ended September 30, 2018. During the three months ended September 30, 2018, the $0.1 million of conversion expenses associated with our new billing system had no comparable expense in the three months ended September 30, 2019. This decrease was offset by an increase of $0.1 million in legal expense and $0.1 million in senior management incentive compensation accrual reflecting a change from stock to cash incentive compensation for the 2019 performance year.

 

Depreciation and amortization. Depreciation and amortization increased 6.7% to $1.9 million in the three months ended September 30, 2019, from $1.8 million in the three months ended September 30, 2018. An increase in RLEC depreciation combined with depreciation of our new billing system accounted for the increase.

 

For the nine months ended September 30, 2019, and 2018

 

    Nine Months Ended September 30,     Change  
    2019     2018     Amount     Percent  
    (dollars in thousands)  
Cost of services   $ 22,630     $ 23,026     $ (396 )     (1.7 )%
Selling, general and administrative expenses     7,535       7,691       (156 )     (2.0 )%
Depreciation and amortization     5,698       5,382       316       5.9 %
Total   $ 35,863     $ 36,099     $ (236 )     (0.7 )%

 

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Cost of services. Cost of services decreased 1.7% to $22.6 million in the nine months ended September 30, 2019, from $23.0 million in the nine months ended September 30, 2018. Network access and toll expense decreased $0.1 million and network operations cost decreased by $0.3 million.

 

Selling, general and administrative expenses. Selling, general and administrative expenses decreased 2.0% to $7.5 million in the nine months ended September 30, 2019, from $7.7 million in the nine months ended September 30, 2018. During the nine months ended September 30, 2018, the $0.5 million of conversion expenses associated with our new billing system had no comparable expense in the nine months ended September 30, 2019. In addition, accounting, finance and human resources expense decreased $0.2 million and uncollectible expense decreased $0.1 million. The decreases were partially offset by an increase of $0.1 million in legal expense and $0.4 million in senior management incentive compensation accrual reflecting a change from stock to cash incentive compensation for the 2019 performance year.

 

Depreciation and amortization. Depreciation and amortization increased 5.9% to $5.7 million in the nine months ended September 30, 2019, from $5.4 million in the nine months ended September 30, 2018. Depreciation of our new billing system was $0.2 million with no comparable depreciation in 2018. RLEC depreciation increased $0.1 million.

 

For the three months ended September 30, 2019, and 2018

 

    Three Months Ended September 30,     Change  
    2019     2018     Amount     Percent  
    (dollars in thousands)  
Interest expense   $ (1,315 )   $ (1,459 )   $ (144 )     (9.9 )%
Other income     5       83       (78 )     (94.0 )
Income tax expense     (712 )     (834 )     (122 )     (14.6 )

 

Interest expense. Interest expense decreased 9.9% in the three months ended September 30, 2019, to $1.3 million from $1.5 million in the three months ended September 30, 2018. Lower outstanding principal balance and lower interest rates under our Credit Facility accounted for the decrease. Our Credit Facility matures in November 2022. See additional information in the “Liquidity and Capital Resources” section below.

 

Other income. Other income decreased 94.0% in the three months ended September 30, 2019, to less than $0.1 million from $0.1 million in the three months ended September 30, 2018, primarily related to the one-time CoBank dividend related to the impact of the Tax Act received in the third quarter of last year.

 

Income tax expense. The Tax Act enacted on December 22, 2017, reduced the maximum federal corporate tax rate from 35% to 21% which results in a lower effective income tax rate when compared to historical rates prior to 2018. For the three months ended September 30, 2019, our effective tax rate is 28.1%, as compared to 26.4% for the three months ended September 30, 2019. The effective income tax rate varies from the federal corporate tax rate of 21% largely due to state income taxes and other permanent differences.

 

For the nine months ended September 30, 2019 and 2018

 

    Nine Months Ended September 30,     Change  
    2019     2018     Amount     Percent  
    (dollars in thousands)  
Interest expense   $ (4,044 )   $ (4,384 )   $ (340 )     (7.8 )%
Other income     604       252       352       139.7  
Income tax expense     (2,056 )     (2,406 )     (350 )     (14.5 )

 

Interest expense. Interest expense decreased 7.8% in the nine months ended September 30, 2019, to $4.0 million from $4.4 million in the nine months ended September 30, 2018. Lower outstanding principal balance and lower interest rates under our Credit Facility accounted for the decrease. Our credit facility matures in November 2022. See additional information in the “Liquidity and Capital Resources” section below.

 

Other income. Other income increased 139.7% in the nine months ended September 30, 2019, to $0.6 million from $0.3 million in the nine months ended September 30, 2018, primarily related to the annual CoBank dividend received in the first quarter of each year and the special CoBank dividend related to the impact of the Tax Act received in the third quarter of last year.

 

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Income tax expense. The Tax Act enacted on December 22, 2017, reduced the maximum federal corporate tax rate from 35% to 21% which results in a lower effective income tax rate when compared to historical rates prior to 2018. For the nine months ended September 30, 2019, our effective tax rate is 26.1%, as compared to 25.0% for the nine months ended September 30, 2018. The effective income tax rate varies from the federal corporate tax rate of 21% largely due to state income taxes and other permanent differences.

 

Net income. As a result of the foregoing, there was net income of $1.8 million and $2.3 million in the three months ended September 30, 2019, and 2018, respectively. As a result of the foregoing, there was net income of $5.8 million and $7.2 million in the nine months ended September 30, 2019, and 2018, respectively.

 

Liquidity and Capital Resources

 

Our liquidity needs arise primarily from: (i) interest and principal payments related to our credit facility; (ii) capital expenditures for investment in our business, including A-CAM requirements; and (iii) working capital requirements.

 

For the nine months ended September 30, 2019, we generated cash from our business to invest in additional property and equipment of $7.6 million, pay loan principal of $3.3 million and pay scheduled interest on our debt of $3.7 million. After meeting all of these needs of our business, cash increased to $5.3 million as of September 30, 2019, from $4.7 million as of December 31, 2018.

 

Cash flows from operating activities for the nine months ended September 30, 2019, amounted to $11.7 million compared to $15.5 million for the nine months ended September 30, 2018, primarily reflecting lower net income, an increase in materials and supplies and accrued expenses associated with increased fiber builds and the change in prepaid expenses.

 

Cash flows used in investing activities for the nine months ended September 30, 2019, were $7.6 million compared to $5.7 million for the nine months ended September 30, 2018, primarily reflecting RLEC fiber installation, including investments associated with the FCC’s A-CAM program. Plans have been announced that will increase investment in our network to an estimated $11.5 million in 2019, as we improve our network with additional fiber deployment and move to a VDSL delivery platform in all RLEC territories.

 

Cash flows used in financing activities for the nine months ended September 30, 2019, were $3.5 million compared to $9.6 million in the nine months ended September 30, 2018, reflecting $6.0 million in voluntary principal payments for the nine months ended September 30, 2018 with no comparable payment for the same period in 2019. Our plans are to continue reducing our debt through our required quarterly payments while utilizing available cash for network improvements.

 

We do not invest in financial instruments as part of our business strategy. However, our Credit Facility required that we acquire an interest rate hedge on at least 50% of our outstanding notes payable balance for a period of at least two years. Accordingly, we purchased a two-year 3.0% interest rate cap on one-month LIBOR covering $45.0 million on February 26, 2018. The interest rate cap is accounted for as an asset and marked to market each quarter.

 

On November 2, 2017, we refinanced our prior credit facilities with a new $92.0 million, five-year credit facility from a consortium of banks led by CoBank, ACB. Our Credit Facility includes an $87.0 million term loan and a $5.0 million revolving loan, which is undrawn. Our Credit Facility also includes a $20.0 million accordion feature that could be used to increase the term-loan portion of the credit facility, subject to the satisfaction of certain conditions and lender participation. Proceeds from the term loan and cash on hand were used to pay all amounts due in respect of principal, interest, prepayment premiums and fees under our prior credit facilities, as well as fees associated with the transaction. Our Credit Facility requires annual principal reduction of $4.3 million paid equally on a quarterly basis and, beginning in 2019, an annual principal payment equal to 50% of our excess cash flow for the year. During the nine months ended September 30, 2019, we made our scheduled principal payment of $3.3 million. We made no voluntary principal prepayments. The 2018 voluntary principal prepayments were used to offset the required 2019 excess cash flow payment due in first quarter 2019. No annual excess cash flow payment for 2019 is projected to be due in the first quarter of 2020.

 

We anticipate that operating cash flow, together with borrowings under our Credit Facility, will be adequate to meet our currently anticipated operating and capital expenditure requirements for at least the next 12 months. Our cash position reflects the continuing strength of our operations.

 

We use consolidated earnings before interest, taxes, depreciation and amortization (“Consolidated EBITDA”) and the ratio of our debt, net of cash, to Consolidated EBITDA for the last twelve months (the “Leverage Ratio”) as operational performance measurements. Consolidated EBITDA, as presented in this Quarterly Report on Form 10-Q, corresponds to the definition of Consolidated EBITDA in our credit facility. Consolidated EBITDA and the Leverage Ratio, as presented in this Quarterly Report on Form 10-Q, are supplemental measures of our performance that are not required by, or presented in accordance with, accounting principles generally accepted in the United States (“U.S. GAAP”). The lenders under our credit facility use Consolidated EBITDA to determine compliance with credit facility requirements. We report Consolidated EBITDA and the Leverage Ratio in our quarterly earnings press release to allow current and potential investors to understand these performance metrics and because we believe that they provide current and potential investors with helpful information with respect to our operating performance, including our ability to generate earnings sufficient to service our debt, and enhance understanding of our financial performance and highlight operational trends. However, Consolidated EBITDA and the Leverage Ratio should not be considered as an alternative to net income or any other performance measures derived in accordance with U.S. GAAP. Our presentation of Consolidated EBITDA and the Leverage Ratio may not be comparable to similarly titled measures used by other companies. Consolidated EBITDA for the three months and nine months ended September 30, 2019, and 2018, and the twelve months ended September 30, 2019, and its reconciliation to net income, is reflected in the table below (dollar amounts in thousands):

 

24

 

 

    Three Months Ended
September 30, 		   

Nine Months Ended
September 30,

    Twelve
Months Ended
September 30,
 
    2019     2018     2019     2018     2019  
Net income   $ 1,819     $ 2,326     $ 5,816     $ 7,230     $ 8,054  
Add: Depreciation     1,798       1,677       5,465       5,135       7,236  
Interest expense less interest income     1,198       1,343       3,692       4,029       5,030  
Interest expense - amortized loan cost     112       116       342       354       464  
Income tax expense     712       834       2,056       2,407       2,395  
Amortization - intangibles     75       79       233       247       312  
Loan fees     17       19       52       56       69  
Stock-based compensation (senior management)     59       56       172       207       273  
Consolidated EBITDA   $ 5,790     $ 6,450     $ 17,828     $ 19,665     $ 23,833  

 

The table below provides the calculation of the Leverage Ratio as of September 30, 2019 (dollar amounts in thousands).

 

Notes payable   $ 70,079  
Debt issuance costs     1,221  
Notes outstanding   $ 71,300  
         
Less cash     (5,298 )
Notes outstanding, net of cash   $ 66,002  
Consolidated EBITDA for the last twelve months   $ 23,833  
         
Leverage Ratio     2.77  

 

As we reduce our debt, our Leverage Ratio will vary based on changes in Consolidated EBITDA.

 

Off-Balance Sheet Arrangements

 

We have no material off-balance sheet arrangements.

 

Recently Adopted Accounting Pronouncements

 

See Note 1, Organization and Basis of Financial Reporting, to our unaudited condensed consolidated financial statements included in this Quarterly Report on Form 10-Q for a description of the recently adopted accounting pronouncements that are applicable to us, including details relating to our adoption of ASU 2016-02, Leases (Topic 842), at the beginning of 2019, which adoption did not have a material impact on our unaudited condensed consolidated financial statements.

 

Recent Accounting Pronouncements

 

See Note 1, Organization and Basis of Financial Reporting, to our unaudited condensed consolidated financial statements included in this Quarterly Report on Form 10-Q for a description of the recent accounting pronouncements that are applicable to us.

 

Item 3. Quantitative and Qualitative Disclosures about Market Risk

 

Our short-term excess cash balance is invested in short-term commercial paper. We do not invest in any derivative or commodity type instruments. Accordingly, we are subject to minimal market risk on our investments.

 

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Interest rates applicable to the term loans (including any incremental term loans incurred under the accordion feature) and the revolving loans under our credit facility are set at a margin over an adjusted LIBOR rate (which is defined as the higher of (1) LIBOR multiplied by the statutory reserve rate and (2) 0.0% per annum) or a base rate (which is defined as the highest of (1) the prime rate, (2) the federal funds effective rate plus 0.50% per annum, (3) the adjusted LIBOR rate for an interest period of one month plus 1.0% per annum and (4) 0.0% per annum). Accordingly, we are exposed to interest rate risk. A one percentage point change in one-month LIBOR interest rates from the interest rates actually applicable to the loans under our credit facility during the period would have resulted in an increase of $0.6 million in our interest expense for the nine months ended September 30, 2019.

 

Item 4. Controls and Procedures

 

With the participation of the Chief Executive Officer and the Chief Financial Officer, management has evaluated the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934). Based on that evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that our disclosure controls and procedures were effective as of September 30, 2019.

 

There were no changes in our internal control over financial reporting during the three months ended September 30, 2019, that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

26

 

 

PART II OTHER INFORMATION

 

Item 6. Exhibits

 

EXHIBIT INDEX

 

Exhibit No.   Description
10.1   Confidential Separation Agreement and General Release, dated as of July 1, 2019, effective as of September 30, 2019, by and between Otelco Inc. and Dennis K. Andrews (incorporated by reference to Exhibit 10.1 of Otelco Inc.’s Current Report on Form 8-K (File No. 001-32362), filed with the Securities and Exchange Commission on July 8, 2019)
31.1   Certificate pursuant to Rule 13a-14(a) or Rule 15d-14(a) under the Securities Exchange Act of 1934 of the Chief Executive Officer
31.2   Certificate pursuant to Rule 13a-14(a) or Rule 15d-14(a) under the Securities Exchange Act of 1934 of the Chief Financial Officer
32.1   Certificate pursuant to 18 U.S.C. §1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, of the Chief Executive Officer
32.2   Certificate pursuant to 18 U.S.C. §1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, of the Chief Financial Officer
101   The following information from the Company’s Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2019, formatted in Extensible Business Reporting Language (XBRL): (i) Condensed Consolidated Balance Sheets; (ii) Condensed Consolidated Statements of Operations; (iii) Condensed Consolidated Statements of Cash Flows; and (iv) Notes to Condensed Consolidated Financial Statements

 

27

 

 

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

Date: November 5, 2019 OTELCO INC.
     
     
By:   /s/ Curtis L. Garner, Jr.
    Curtis L. Garner, Jr.
    Chief Financial Officer

 

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