0000766561-12-000083.txt : 20121109 0000766561-12-000083.hdr.sgml : 20121109 20121109162149 ACCESSION NUMBER: 0000766561-12-000083 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 12 CONFORMED PERIOD OF REPORT: 20120930 FILED AS OF DATE: 20121109 DATE AS OF CHANGE: 20121109 FILER: COMPANY DATA: COMPANY CONFORMED NAME: HICKORY TECH CORP CENTRAL INDEX KEY: 0000766561 STANDARD INDUSTRIAL CLASSIFICATION: TELEPHONE COMMUNICATIONS (NO RADIO TELEPHONE) [4813] IRS NUMBER: 411524393 STATE OF INCORPORATION: MN FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-13721 FILM NUMBER: 121193937 BUSINESS ADDRESS: STREET 1: 221 E HICKORY ST STREET 2: P O BOX 3248 CITY: MANKATO STATE: MN ZIP: 56002-3248 BUSINESS PHONE: 8003265789 MAIL ADDRESS: STREET 1: P.O. BOX 3248 STREET 2: 221 EAST HICKORY STREET CITY: MANKATO STATE: MN ZIP: 56002-3248 FORMER COMPANY: FORMER CONFORMED NAME: MANKATO CITIZENS CORP DATE OF NAME CHANGE: 19850508 10-Q 1 form10q.htm FORM 10Q form10q.htm
 



 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549

FORM 10-Q

(Mark One)
þ
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
 
EXCHANGE ACT OF 1934
 
For the quarterly period ended September 30, 2012

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   0-13721

 
HICKORY TECH CORPORATION
 
(Exact name of registrant as specified in its charter)

Minnesota
41-1524393
(State or other jurisdiction of
(I.R.S. Employer
incorporation or organization)
Identification No.)

 
221 East Hickory Street
 
Mankato, Minnesota  56002-3248
 
(Address of principal executive offices and zip code)

 
(800) 326-5789
 
(Registrant’s telephone number, including area code)

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   þNo   ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes   þ    No   ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definition of “large accelerated filer, accelerated filer, and smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer  ¨      Accelerated filer  þ      Non-accelerated filer  ¨      Smaller reporting company  ¨

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Act).  Yes  ¨   No  þ

The total number of shares of the Registrant’s common stock outstanding as of November 2, 2012: 13,527,537.

 
 

 


 




Part I  Financial Information

Item 1.  Financial Statements
 
HICKORY TECH CORPORATION
 
CONSOLIDATED STATEMENTS OF OPERATIONS
 
(Unaudited)
 
                         
   
Three Months Ended September 30
   
Nine Months Ended September 30
 
 
 
2012
   
2011
   
2012
   
2011
 
(Dollars in thousands, except share and per share amounts)
       
(Restated)
         
(Restated)
 
Operating revenue:
                       
   Equipment
  $ 12,915     $ 14,269     $ 38,954     $ 31,499  
   Services
    32,898       30,975       97,660       92,475  
      Total operating revenue
    45,813       45,244       136,614       123,974  
                                 
Costs and expenses:
                               
   Cost of sales, excluding depreciation and amortization
    10,906       12,223       33,664       27,146  
   Cost of services, excluding depreciation and amortization
    16,358       14,738       47,589       44,244  
   Selling, general and administrative expenses
    7,123       6,147       21,270       19,419  
   Depreciation and amortization
    6,869       5,794       19,795       17,155  
      Total costs and expenses
    41,256       38,902       122,318       107,964  
                                 
Operating income
    4,557       6,342       14,296       16,010  
                                 
Other income and expense:
                               
   Interest and other income
    3       26       37       50  
   Interest expense
    (1,625 )     (2,880 )     (4,635 )     (5,199 )
      Total other (expense)
    (1,622 )     (2,854 )     (4,598 )     (5,149 )
                                 
Income before income taxes
    2,935       3,488       9,698       10,861  
Income tax provision
    1,194       1,355       3,925       4,034  
                                 
Net income
  $ 1,741     $ 2,133     $ 5,773     $ 6,827  
                                 
                                 
Basic earnings per share
  $ 0.13     $ 0.16     $ 0.43     $ 0.51  
                                 
Weighted average common shares outstanding
    13,511,009       13,394,225       13,483,358       13,363,874  
                                 
                                 
Diluted earnings per share
  $ 0.13     $ 0.16     $ 0.43     $ 0.51  
                                 
Weighted average common and equivalent shares outstanding
    13,526,875       13,409,414       13,498,268       13,376,261  
                                 
Dividends per share
  $ 0.14     $ 0.135     $ 0.42     $ 0.405  
                                 
The accompanying notes are an integral part of the consolidated financial statements.
 



HICKORY TECH CORPORATION
 
STATEMENT OF COMPREHENSIVE INCOME
 
(Unaudited)
 
                         
   
Three Months Ended September 30
   
Nine Months Ended September 30
 
 
 
2012
   
2011
   
2012
   
2011
 
(Dollars in thousands)
       
(Restated)
         
(Restated)
 
Net Income
  $ 1,741     $ 2,133     $ 5,773     $ 6,827  
Other comprehensive income:
                               
     Post-retirement benefit plan:
                               
        Amounts included in net periodic benefit cost:
                               
           Net actuarial loss
    203       107       473       321  
           Prior service credit
    (19 )     (13 )     (57 )     (41 )
           Transition asset
    15       15       45       45  
        Adjustment to post-retirement benefit plan
    -       -       (1,034 )     -  
        Income tax expense
    (80 )     (45 )     228       (130 )
     Change in post-retirement benefit plan
    119       64       (345 )     195  
                                 
Comprehensive Income
  $ 1,860     $ 2,197     $ 5,428     $ 7,022  
                                 
The accompanying notes are an integral part of the consolidated financial statements.
 


HICKORY TECH CORPORATION
 
CONSOLIDATED BALANCE SHEETS
 
(Unaudited)
 
(Dollars in thousands except share and per share amounts)
 
September 30, 2012
   
December 31, 2011
 
         
(Restated)
 
ASSETS
 
Current assets:
           
   Cash and cash equivalents
  $ 10,051     $ 13,057  
   Receivables, net of allowance for doubtful accounts of $289 and $436
    27,493       25,317  
   Inventories
    7,294       9,297  
   Income taxes receivable
    1,027       498  
   Deferred income taxes, net
    1,559       1,559  
   Prepaid expenses
    2,612       1,801  
   Other
    1,085       964  
      Total current assets
    51,121       52,493  
                 
Investments
    3,210       4,277  
                 
Property, plant and equipment
    424,782       396,816  
   Accumulated depreciation
    (247,979 )     (242,886 )
      Property, plant and equipment, net
    176,803       153,930  
                 
Other assets:
               
   Goodwill
    29,028       27,303  
   Intangible assets, net
    5,034       2,314  
   Deferred costs and other
    3,554       3,669  
      Total other assets
    37,616       33,286  
                 
Total assets
  $ 268,750     $ 243,986  
                 
LIABILITIES & SHAREHOLDERS' EQUITY
 
Current liabilities:
               
   Accounts payable
  $ 4,952     $ 4,661  
   Extended term payable
    14,008       6,920  
   Deferred revenue
    4,832       6,251  
   Accrued expenses and other
    9,645       10,175  
   Current maturities of long-term obligations
    1,636       1,407  
      Total current liabilities
    35,073       29,414  
                 
Long-term liabilities:
               
   Debt obligations, net of current maturities
    135,519       118,828  
   Accrued income taxes
    142       154  
   Deferred revenue
    1,045       1,131  
   Financial derivative instruments
    2,764       2,469  
   Accrued employee benefits and deferred compensation
    19,968       18,166  
   Deferred income taxes
    30,281       30,627  
      Total long-term liabilities
    189,719       171,375  
                 
         Total liabilities
    224,792       200,789  
                 
Commitments and contingencies
               
                 
Shareholders' equity:
               
Common stock, no par value, $.10 stated value
               
   Shares authorized: 100,000,000
               
   Shares issued and outstanding: 13,527,537 in 2012 and 13,396,176 in 2011
    1,353       1,340  
Additional paid-in capital
    16,661       15,683  
Retained earnings
    30,424       30,309  
Accumulated other comprehensive (loss)
    (4,480 )     (4,135 )
         Total shareholders' equity
    43,958       43,197  
                 
Total liabilities and shareholders' equity
  $ 268,750     $ 243,986  
                 
The accompanying notes are an integral part of the consolidated financial statements.
 


 
CONSOLIDATED STATEMENTS OF CASH FLOWS
 
(Unaudited)
 
   
Nine Months Ended September 30
 
(Dollars in thousands)
 
2012
   
2011
 
         
(Restated)
 
OPERATING ACTIVITIES:
           
     Net income
  $ 5,773     $ 6,827  
     Adjustments to reconcile net income to net cash provided by operating activities:
               
         Depreciation and amortization
    19,795       17,155  
         Accrued patronage refunds
    (527 )     (389 )
         Stock based compensation
    555       725  
         Loss on financial derivative instruments
    295       1,629  
         Other
    1,410       743  
         Changes in operating assets and liabilities, net of effect from acquired net assets
         
             Receivables
    (2,130 )     (9,988 )
             Prepaid expenses
    (810 )     (480 )
             Inventories
    2,116       (719 )
             Accounts payable and accrued expenses
    (771 )     2,625  
             Deferred revenue, billings and deposits
    (1,511 )     774  
             Income taxes
    (643 )     6,498  
             Other
    1,745       (602 )
     Net cash provided by operating activities
    25,297       24,798  
                 
INVESTING ACTIVITIES:
               
     Additions to property, plant and equipment
    (21,761 )     (14,798 )
     Broadband stimulus grant received
    2,941       666  
     Acquisition of IdeaOne Telecom
    (28,180 )     -  
     Proceeds from sale of assets
    1       120  
     Net cash (used in) investing activities
    (46,999 )     (14,012 )
                 
FINANCING ACTIVITIES:
               
     Borrowings on extended term payable arrangement
    41,370       46,438  
     Payments on extended term payable arrangement
    (34,281 )     (42,061 )
     Borrowings on credit facility
    22,000       147,700  
     Payments on credit facility and capital lease obligations
    (5,170 )     (146,117 )
     Proceeds from issuance of common stock
    435       467  
     Change in cash overdraft
    -       (238 )
     Stock repurchase
    -       (325 )
     Dividends paid
    (5,658 )     (5,407 )
     Net cash provided by financing activities
    18,696       457  
                 
Net increase (decrease) in cash and cash equivalents
    (3,006 )     11,243  
Cash and cash equivalents at beginning of the period
    13,057       73  
Cash and cash equivalents at the end of the period
  $ 10,051     $ 11,316  
                 
Supplemental disclosure of cash flow information:
               
     Cash paid for interest
  $ 4,453     $ 3,273  
     Net cash paid (received) for income taxes
  $ 4,568     $ (2,464 )
Non-cash investing and financing activities:
               
     Property, plant and equipment acquired with capital leases
  $ 90     $ 64  
     Change in other comprehensive (loss) from post-retirement benefits
  $ (345 )   $ 195  
                 
The accompanying notes are an integral part of the consolidated financial statements.
 
 
 
 
HICKORY TECH CORPORATION
September 30, 2012

Item 1.   Condensed Notes to Consolidated Financial Statements (Unaudited)

Note 1.   Basis of Presentation and Consolidation

The accompanying unaudited condensed consolidated financial statements of HickoryTech Corporation and its subsidiaries have been prepared in accordance with accounting principles generally accepted in the United States (GAAP) for interim financial information and with the rules and regulations of the Securities and Exchange Commission (SEC). Certain information and disclosures normally included in annual financial statements prepared in accordance with GAAP have been omitted or condensed pursuant to such rules and regulations. In the opinion of management, the unaudited condensed consolidated financial statements reflect all adjustments (consisting only of normal and recurring accruals) considered necessary for the fair presentation of the financial statements and present fairly the results of operations, financial position and cash flows for the interim periods presented as required by Regulation S-X, Rule 10-01. These unaudited interim condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto, together with our audited consolidated financial statements and notes thereto contained in our Amendment No. 1 on Form 10-K/A for year ended December 31, 2011.

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, expenses and related disclosures at the date of the financial statements and during the reporting period. Actual results could differ from these estimates. The results of operations for the interim periods presented are not necessarily indicative of the results that may be expected for the fiscal year as a whole or any other interim period.

Our consolidated financial statements report the financial condition and results of operations for HickoryTech Corporation and its subsidiaries in three business segments: Fiber and Data, Equipment and Telecom. Inter-company transactions have been eliminated from the consolidated financial statements.

Cost of Sales (excluding depreciation and amortization)
Cost of sales for the Equipment Segment are primarily for equipment and materials associated with the installation of products for customers. Labor associated with installation work is not included in this category, but is included in cost of services (excluding depreciation and amortization) described below.

Cost of Services (excluding depreciation and amortization)
Cost of services includes all costs related to delivery of communication services and products for all segments. These operating costs include all costs of performing services and providing related products including engineering, customer service, billing and collections, network monitoring and transport costs.

Selling, General and Administrative Expenses
Selling, general and administrative expenses include direct and indirect selling expenses, advertising and all other general and administrative costs associated with the operations of the business.

Recent Accounting Developments

We reviewed all significant newly issued accounting pronouncements and determined they are either not applicable to our business or that no material effect is expected on our financial position, results of operations or disclosures.

Note 2.   Restatement

We are restating our previously reported financial information for the quarter and year-to-date periods ended September 30, 2011 to change our accounting for interest rate swap agreements under ASC 815, “Derivatives and Hedging.”

 

ASC 815 requires that all derivative instruments be recorded on the balance sheet as either an asset or a liability measured at its fair value, and that changes in the derivatives fair value be recognized in earnings unless specific hedge accounting criteria are met. We applied the method of cash flow hedge accounting under ASC 815 to account for the interest rate swap agreements that allowed us to record changes in the instruments’ fair value in other comprehensive income (the “cash flow” method). We recently concluded that the interest rate swap agreements did not qualify for the cash flow method because the documentation was not in place at the inception of the hedge as well as on an ongoing basis. This change reverses the fair value adjustments that were made in other comprehensive income to be recognized in earnings.

Although the swaps do not qualify for the cash flow method under ASC 815, there is no effect on cash flows from operating, investing, or financing activities for these changes. The change in the accounting treatment has not impacted the economics of the interest rate swap agreements.

The following table details the impact of the restatement on the Company’s Statement of Operations and Balance Sheets for the periods ended September 30, 2011.
 
(Dollars in thousands, except share data)
 
Three Months Ended September 30, 2011
   
Nine Months Ended September 30, 2011
 
Statement of Operations Data:
 
As Reported
   
Restatement
 
Restated
   
As Reported
   
Restatement
   
Restated
 
Operating income
  $ 6,342     $ -     $ 6,342     $ 16,010     $ -     $ 16,010  
Other income and expense:
                                               
Interest and other income
    26       -       26       50       -       50  
Interest expense
    (1,487 )     (1,393 )     (2,880 )     (3,570 )     (1,629 )     (5,199 )
Total other (expense)
    (1,461 )     (1,393 )     (2,854 )     (3,520 )     (1,629 )     (5,149 )
                                                 
Income before income taxes
    4,881       (1,393 )     3,488       12,490       (1,629 )     10,861  
Income tax provision
    1,910       (555 )     1,355       4,683       (649 )     4,034  
Net income
  $ 2,971     $ (838 )   $ 2,133     $ 7,807     $ (980 )   $ 6,827  
Other comprehensive income, net of taxes
  $ (774 )   $ 838     $ 64     $ (785 )   $ 980     $ 195  
Total comprehensive income
  $ 2,197     $ -     $ 2,197     $ 7,022     $ -     $ 7,022  
Basic earnings per share
  $ 0.22     $ (0.06 )   $ 0.16     $ 0.58     $ (0.07 )   $ 0.51  
Diluted earnings per share
  $ 0.22     $ (0.06 )   $ 0.16     $ 0.58     $ (0.07 )   $ 0.51  
                                                 
   
As of December 31, 2011
       
Balance Sheet Data:
 
As Reported
   
Restatement
 
Restated
                         
Shareholders' equity:
                                               
Common stock
  $ 1,340     $ -     $ 1,340                          
Additional paid-in capital
    15,683       -       15,683                          
Retained earnings
    31,797       (1,488 )     30,309                          
Accumulated other comprehensive income (loss)
    (5,623 )     1,488       (4,135 )                        
Total shareholders' equity
  $ 43,197     $ -     $ 43,197                          

Note 3.  Earnings and Cash Dividends per Common Share

Basic earnings per share (EPS) are computed by dividing net income by the weighted average number of shares of common stock outstanding during the applicable period. Shares used in the EPS dilution calculation are based on the weighted average number of shares of common stock outstanding during the period increased by potentially dilutive common shares. Potentially dilutive common shares include stock options and stock subscribed under the HickoryTech Corporation Amended and Restated Employee Stock Purchase Plan (ESPP). Dilution is determined using the treasury stock method.
 
 
     
Three Months Ended September 30
   
Nine Months Ended September 30
     
2012
   
2011
     2012    
2011
(Dollars in thousands, except share and earnings per share amounts)
         
(Restated)
         
(Restated)
Net Income
  $
1,741
 
 2,133
 
 5,773
 
6,827
                         
Weighted average shares outstanding
   
 13,511,009
   
 13,394,225
   
 13,483,358
   
 13,363,874
Stock options (dilutive only)
   
 15,316
   
 13,310
   
 14,628
   
 11,272
Stock subscribed (ESPP)
   
 550
   
 1,879
   
 282
   
 1,115
Total dilutive shares outstanding
   
 13,526,875
   
 13,409,414
   
 13,498,268
   
 13,376,261
                         
Earnings per share:
                       
    Basic and Diluted
  $
0.13
 
0.16
 
 0.43
 
0.51
                         
Dividends per share
  $
0.14
 
0.135
 
 0.42
 
 0.405

Options to purchase 78,900 and 179,250 shares for the three months ended September 30, 2012 and 2011, respectively and 78,900 and 195,250 shares for the nine months ended September 30, 2012 and 2011, respectively were not included in the computation of diluted EPS, because their effect on diluted EPS would have been anti-dilutive.

Cash dividends are based on the number of common shares outstanding at their respective record dates. The number of shares outstanding as of the record date for the first three quarters of 2012 and 2011, respectively, are as follows:
 
Shares outstanding on record date
 
2012
   
2011
 
First quarter (February 15)
    13,409,941       13,311,817  
Second quarter (May 15)
    13,479,677       13,358,971  
Third quarter (August 15)
    13,494,599       13,383,012  

Dividends per share are based on the quarterly dividend per share as declared by the HickoryTech Board of Directors. HickoryTech paid dividends of $0.14 and $0.135 per share in the third quarter of 2012 and 2011, respectively. During the first nine months of 2012 and 2011, shareholders have elected to reinvest $223,000 and $204,000, respectively, of dividends into HickoryTech common stock pursuant to the HickoryTech Corporation Dividend Reinvestment Plan.

Note 4. Acquisition

On March 1, 2012, we acquired all of the membership units of IdeaOne Telecom Group, LLC. for cash consideration of $28,180,000 expanding our business and broadband services in the Fargo, North Dakota market. The acquisition was funded with existing liquidity through cash reserves of $6,180,000 and $22,000,000 of term loan debt which is integrated with our senior credit facility.

The table below sets forth the provisional estimates of fair value of the assets acquired, liabilities assumed and goodwill. The difference between the fair value of the consideration transferred and net assets acquired resulted in goodwill of $1,725,000. The fair value of the property and equipment, intangible assets and other assets and liabilities was determined based on level 3 inputs.

 
 
(Dollars in thousands)
 
2012
 
Property and equipment
  $ 23,077  
Accounts receivable
    310  
Identifiable intangible assets:
       
 
Customer relationships and contracts
    3,200  
 
Trade name
    100  
Goodwill
    1,725  
Other assets
    273  
Liabilities
    (505 )
Total cash consideration
  $ 28,180  

Goodwill from our acquisition is a result of the value of acquired employees along with the expected synergies from the combination of IdeaOne Telecom and our operations. IdeaOne Telecom operations have been integrated with and goodwill is recorded within our Fiber and Data Segment. Goodwill resulting from this acquisition is deductible for tax purposes.

Of the identified intangible assets above, customer relationships and contracts have useful lives between four and seven years and the trade name has a useful life of two years. Useful lives for identifiable intangible assets were estimated at the time of the acquisition based on the period of time from which we expect to derive benefits from the identifiable intangible assets. The identifiable intangible assets are amortized using the straight-line method, which reflects the pattern in which the assets are consumed.

Acquisition related expenses of $510,000 were reflected in selling, general and administrative expenses in results for the fourth quarter ended December 31, 2011. In 2012, acquisition related expenses were insignificant and are reflected in selling, general and administrative expenses. The Company has expensed all acquisition related costs except those related to the incremental debt. The costs incurred related to the incremental term debt financing have been capitalized and are amortized over the life of the debt facility using the effective interest rate method.

The amount of IdeaOne revenue and net income included in our Consolidated Statements of Operations for the nine months ended September 30, 2012, and the following unaudited pro forma consolidated results of operations for the nine months ended September 30, 2012 and 2011, have been prepared as if the acquisition of IdeaOne had occurred at January 1, 2011:
 
(unaudited)
               Diluted Earnings  
(Dollars in thousands)
 
Revenue
   
Net Income
   
 Per Share
 
Actual from March 1, 2012 to September 30, 2012
  $ 7,441     $ 500     $ 0.04  
Supplemental pro forma for the nine months ended September 30, 2012
  $ 138,731     $ 5,860     $ 0.43  
Supplemental pro forma for the nine months ended September 30, 2011
  $ 132,876     $ 7,074     $ 0.53  
 
The proforma results are presented for illustrative purposes and are not intended to be indicative of the results that would have actually been obtained if the merger had occurred as of the date indicated, nor do the pro forma results intend to be a projection of future results that may be obtained.

Note 5.  Goodwill and Other Intangible Assets

The carrying value of our goodwill and intangible assets increased during the first quarter of 2012 due to our acquisition of IdeaOne Telecom which closed on March 1, 2012. Goodwill was $29,028,000 as of September 30, 2012 compared to $27,303,000 at December 31, 2011. We have goodwill in all three of our operating units: Fiber and Data Segment goodwill resulted from our acquisition of IdeaOne Telecom in 2012, CP Telecom in 2009 and Enventis Telecom in 2005. Equipment Segment goodwill also resulted from our acquisition of Enventis Telecom and Telecom Segment goodwill resulted from our acquisition of Heartland Telecommunications in 1997.

 
 
(Dollars in thousands)
 
September 30, 2012
   
December 31, 2011
 
Fiber and Data
  $ 5,384     $ 3,659  
Equipment
  $ 596     $ 596  
Telecom
  $ 23,048     $ 23,048  

The components of intangible assets are as follows:
 
 
     
As of September 30, 2012
   
As of December 31, 2011
 
       
Gross Carrying
   
Accumulated
   
Gross Carrying
   
Accumulated
 
(Dollars in thousands)
 
Useful Lives
 
Amount
   
Amortization
   
Amount
   
Amortization
 
Definite-Lived Intangible Assets
                           
Customer relationships
 
1 - 8 years
  $ 8,499     $ 5,192     $ 5,299     $ 4,746  
Other intangibles
 
1 - 5 years
    2,930       1,203       2,830       1,069  
Total
      $ 11,429     $ 6,395     $ 8,129     $ 5,815  

Amortization expense related to the definite-lived intangible assets was $580,000 and $265,000 for the nine months ended September 30, 2012 and 2011, respectively. Total estimated amortization expense for the remaining three months of 2012 and the five years subsequent to 2012 is as follows: 2012 (October 1 – December 31) – $223,000; 2013 - $893,000; 2014 - $762,000; 2015 - $629,000; 2016 - $567,000; 2017 - $554,000.

Note 6.   Fair Value of Financial Instruments

The fair value of cash and cash equivalents, net accounts receivables and payables, other short-term monetary assets and liabilities was estimated by management to approximate fair value due to the relatively short period of time to maturity for these instruments.

The fair value estimate for our long-term debt is based on the overall weighted average interest rates and maturity compared to rates and terms currently available in the long-term financing markets. The fair value estimate of our interest rate swaps represent the net present value of future cash flows based on projections of the three-month LIBOR rate over the life of each swap. Our interest rate swaps are recognized at fair value under the long-term liabilities on the Consolidated Balance Sheets as of September 30, 2012 and December 31, 2011.

The fair value and carrying value of our long-term debt, after deducting current maturities and our interest rate swaps are as follows at September 30, 2012 and December 31, 2011:

 
       
September 30, 2012
   
December 31, 2011
 
(Dollars in thousands)
 
Input Level
   
Carrying Amount
   
Fair Value
   
Carrying Amount
   
Fair Value
 
Long-term debt
    2     $ 135,519     $ 138,816     $ 118,828     $ 122,886  
Interest rate swaps
    2     $ 2,764     $ 2,764     $ 2,469     $ 2,469  

Note 7.   Debt and Other Obligations

Our long-term obligations as of September 30, 2012 were $135,519,000, excluding current maturities of $1,420,000 on debt and $216,000 on current maturities of capital leases. Long-term obligations as of December 31, 2011 were $118,828,000 excluding current maturities of $1,200,000 on debt and $207,000 of capital leases.

On August 11, 2011, we entered into a $150,000,000 credit agreement with a syndicate of nine banks that matures on December 31, 2016. The credit facility is comprised of a $30,000,000 revolving credit component ($29,965,000 available to borrow as of September 30, 2012; $35,000 is reserved for outstanding letters of credit) and a $120,000,000 term loan component. On March 1, 2012 we borrowed an additional $22,000,000 of incremental term loan debt under our existing credit facility to fund our acquisition of IdeaOne Telecom.
 

The term loans are structured in a Term Loan B facility. The outstanding principal balance of (the initial) Term Loan is $116,800,000 as of September 30, 2012 and requires us to make quarterly principal payments of $300,000. The outstanding principal balance of the Incremental Term is $19,890,000 as of September 30, 2012 and requires us to make quarterly principal payments of $55,000. There was no outstanding principal balance under the revolving credit component as of September 30, 2012 and the revolving credit component does not require quarterly principal payments. Any remaining amounts outstanding on the revolving credit component and Term Loans will be due at maturity on December 31, 2016.

The term loan component has a provision whereby we periodically receive patronage capital refunds. Patronage refunds are recorded as an offset to interest expense and amounted to $527,000 in the first nine months of 2012 compared to $389,000 in the first nine months of 2011.

At September 30, 2012 we are in full compliance with specified financial ratios and tests required by our credit facility. The credit facility includes allowances for continued payment of dividends and specific limits on common stock repurchases. The banks in our credit facility syndicate provided a waiver of our specific breaches in representations provided to them regarding GAAP related to the financial information restatement. For additional information refer to the November 6, 2012 8-K SEC filing.

Our obligations under the credit facility are secured by a first-priority lien on the property and assets, tangible and intangible, of HickoryTech and its current subsidiaries, which includes total assets except for the Equipment Segment accounts receivable and inventory. We have also given a first-priority pledge of the capital stock of our current subsidiaries to secure the credit facility. The credit facility contains certain restrictions that, among other things, limit or restrict our ability to create liens or encumbrances; incur additional debt; issue stock; make asset sales, transfers, or dispositions; and engage in mergers and acquisitions, pay dividends or purchase/redeem Company stock over specified maximum values.

The credit facility requires us to enter in or maintain effective interest rate protection agreements on at least 50% of the Term Loans outstanding balance for a period ending August 2013 to manage our exposure to interest rate fluctuations. We currently have interest rate swap agreements, effectively fixing the LIBOR rate portion of the interest rate on $72,000,000 of our variable interest debt. Additional information on our interest-rate swap agreements can be found under Note 8 “Financial Derivative Instruments.”

Note 8.  Financial Derivative Instruments

We utilize interest-rate swap agreements to manage our exposure to interest rate fluctuations on a portion of our variable-interest rate debt. Our interest-rate swaps increase or decrease the amount of cash paid for interest depending on the increase or decrease of interest required on the variable rate debt. We have effectively changed our exposure to varying cash flows on the variable-rate portion of our debt into fixed-rate cash flows. We do not enter into derivative instruments for any purpose other than to manage interest rate exposure. That is, we do not engage in interest rate speculation using derivative instruments.

We account for derivatives in accordance with FASB ASC Topic 815, “Derivatives and Hedging.” ASC 815 requires that all derivative instruments be recorded on the balance sheet as either an asset or a liability measured at its fair value, and that changes in the derivatives’ fair value be recognized in earnings unless specific hedge accounting criteria are met. Our financial derivative instruments are not designated as hedges as of the end of and during the periods presented.

The fair value of our interest rate swap agreements were determined based on Level 2 inputs. Listed below are the interest-rate swap agreements which lock in our interest rates on existing variable-interest rate debt.
 
Interest-Rate Swap Agreement Effective Dates
 
Coverage Amount
   
Rate
 
September 2011 - September 2014
  $ 24,000,000       1.66 %
September 2011 - March 2015
  $ 24,000,000       1.91 %
September 2011 - September 2015
  $ 24,000,000       2.14 %


The fair value of our derivatives at September 30, 2012 and December 31, 2011 are recorded as financial derivative instruments under the long-term liabilities section of our balance sheet. The fair value of our derivatives at September 30, 2012 and December 31, 2011 is a net liability of $2,764,000 and $2,469,000, respectively. The change in the fair value of financial derivative instruments is recognized in earnings in that period. The table below illustrates the effect of derivative instruments on consolidated operations for the periods ended September 30, 2012 and 2011, respectively.
 
(Dollars in thousands)
     
Increase/(Decrease) in Interest Expense
   
Increase/(Decrease) in Interest Expense
 
 
 
 
 
Three Months Ended September 30
   
Nine Months Ended September 30
 
Derivative Instruments Hedging Relationships
 
Location of Financial Impact of Derivatives into Income
 
2012
   
2011
   
2012
   
2011
 
             
(Restated)
         
(Restated)
 
Interest Rate Contracts
 
Interest Expense
  $ 131     $ 1,393     $ 295     $ 1,629  
 
Note 9.   Extended Term Payable

Enterprise Integration Services, Inc., a wholly owned subsidiary of HickoryTech, has an $18,000,000 wholesale financing agreement with a financing company to fund equipment purchases from certain approved vendors. Advances under this financing arrangement are collateralized by the assets of our Equipment Segment and a guaranty of an amount up to $2,500,000 by HickoryTech. The agreement requires Enterprise Integration Services to maintain specific levels of collateral relative to the outstanding balance due, provide selected monthly financial information, and make all payments when due or on demand in the event of a collateral shortfall, among other requirements. A default on the financing agreement by Enterprise Integration Services would require HickoryTech to perform under the guaranty. The financing agreement provides 60 day, interest-free payment terms for working capital and can be terminated at any time by either party. The balance outstanding under the financing arrangement was $14,008,000 and $6,920,000 at September 30, 2012 and December 31, 2011, respectively. The balance fluctuates quarter to quarter based on timing of customer orders. These balances are classified as current liabilities in the accompanying Balance Sheets and are excluded from our debt financing per our senior credit agreement.

Note 10.  Employee Post-Retirement Benefits

HickoryTech provides post-retirement health care and life insurance benefits for eligible employees. We are currently not funding these post-retirement benefits, but have accrued these liabilities. We are required to recognize the funded status of our post-retirement benefit plans on our consolidated balance sheet and recognize as a component of accumulated other comprehensive income (loss), net of tax, the gains and losses and prior service costs or credit that arise during the period but are not recognized as components of net periodic benefit cost. New employees are not eligible for post-retirement health care and life insurance benefits.

 
   
Three Months Ended September 30
   
Nine Months Ended September 30
 
(Dollars in thousands)
 
2012
   
2011
   
2012
   
2011
 
Components of net periodic benefit cost
                       
Service cost
  $ 150     $ 127     $ 450     $ 381  
Interest cost
    188       200       564       600  
Expected return on plan assets
    -       -       -       -  
Amortization of transition obligation
    15       15       45       45  
Amortization of prior service cost
    (19 )     (14 )     (57 )     (42 )
Recognized net actuarial loss
    135       107       405       321  
Net periodic benefit cost
  $ 469     $ 435     $ 1,407     $ 1,305  
                                 
                                 
Employer's contributions for current premiums:
                   
September 30, 2012
 
     Contributions made for the nine months ended September 30, 2012
                    $ 258  
Expected contributions for remainder of 2012
                            110  
Total estimated employer contributions for fiscal year 2012
                    $ 368  

Note 11.  Inventories

Inventory includes parts, materials and supplies stored in our warehouses to support basic levels of service and maintenance as well as scheduled capital projects and equipment awaiting configuration for customers. Inventory also includes parts and equipment shipped directly from vendors to customer locations while in transit and parts and equipment returned from customers which is being returned to vendors for credit, as well as maintenance contracts associated with customer sales which have not yet transferred to the customer. The inventory value in the Fiber and Data Segment and the Telecom Segment are comprised of raw materials. The inventory value in the Equipment Segment is primarily comprised of finished goods in transit to customers or at customers’ locations of which title has not yet transferred. The inventory level in the Equipment Segment is subject to the fluctuations in the equipment revenue and the timing of individual customer orders.
 
(Dollars in thousands)
 
September 30, 2012
   
December 31, 2011
 
Fiber and Data
  $ 1,686     $ 950  
Equipment
  $ 3,920     $ 6,631  
Telecom
  $ 1,688     $ 1,716  

We value inventory using the lower of cost (perpetual weighted average-cost or specific identification) or market method. We adjust our inventory carrying value for estimated obsolescence or unmarketable inventory to the estimated market value based upon assumptions about future demand and market conditions. As market and other conditions change, we may be required to record additional write-downs of the carrying value of inventories.

Note 12.  Accumulated Other Comprehensive Income (Loss)

In addition to net income, our comprehensive income includes unrecognized Net Periodic Benefit Cost related to our Post-Retirement Benefit Plans. In the second quarter of 2012 a valuation adjustment was recorded related to our post-retirement benefit plan increasing accumulated other comprehensive income by $622,000, net of tax. This adjustment was made to correct an immaterial valuation error made at December 31, 2011.

 Note 13.  Income Taxes

The effective income tax rate from operations for the third quarter of 2012 and 2011 was 40.7% and 38.9%. In 2011, the effective tax rate was impacted by the release of income tax reserves and associated interest. The effective tax rate from operations differs from the federal statutory rate primarily due to state income taxes.
 
 
As of September 30, 2012, we had unrecognized tax benefits totaling $137,000 excluding interest. The amount of the unrecognized tax benefits, if recognized, that would affect the effective income tax rates of future periods is $119,000. It is reasonably possible that the total amount of unrecognized tax benefits may decrease by approximately $9,000, including interest, during the next 12 months as a result of expirations of the statute of limitations.

We file consolidated income tax returns in the United States federal jurisdiction and combined or separate income tax returns in various state jurisdictions. In general, we are no longer subject to United States federal income tax examinations for the years prior to 2008 except to the extent of losses utilized in subsequent years.

Note 14.  Stock Compensation

Refer to our Annual Report on Form 10-K for the year ended December 31, 2011 and Amendment No. 1 on Form 10-K/A for a complete description of all stock-based compensation plans.

Our stock award plans provide for granting non-qualified stock options, stock awards and restricted stock awards to employees. We recognize stock compensation charges related to stock award plans when management concludes it is probable the participant will earn the award. Share-based compensation expense includes amounts recognized related to the Company Employee Stock Purchase Plan. This plan allows participating employees to acquire shares of common stock at 85% of fair market value on one specified date. Stock-based compensation expense was $555,000 and $725,000, respectively, in the nine months ended September 30, 2012 and 2011. This includes compensation expense for share-based payment awards granted prior to, but not vested as of September 30, 2012.

The fair value of each option award is estimated on the date of the grant using a Black-Scholes option valuation model. We use a seven-year period to calculate the historical volatility of our stock price for use in the valuation model. The dividend yield rate is based on our current dividend payout pattern and current market price. The risk-free rate for options is based on a U.S. Treasury rate commensurate with the expected terms. The expected term of options granted is derived from historical experience and represents the period of time that options granted are expected to be outstanding. Historical data is used to estimate pre-vesting forfeitures and are estimated at the time of the grant and revised, if necessary, in subsequent periods if actual forfeitures differ from the estimate.

In April 2011, 10,000 options were granted associated with the acceptance of the Chief Operating Officer position. Other than this stock award issued, options were last granted under the Company’s Stock Award Plan in September 2006. The weighted average grant date fair value of options issued was $0.80.

A summary of stock option activity is as follows:

         
Weighted Average
 
   
Options
   
Exercise Price
 
Outstanding at January 1, 2012
    247,650     $ 11.28  
    Granted
    -       -  
    Exercised
    (1,500 )     10.22  
    Forfeited
    (4,050 )     10.88  
    Expired
    (83,000 )     13.95  
Outstanding at September 30, 2012
    159,100     $ 9.90  
Exercisable at September 30, 2012
    152,433     $ 9.94  

 
 
The following table provides certain information with respect to stock options outstanding at September 30, 2012:
 
           
Weighted
   
Weighted
 
Range of
   
Stock Options
   
Average
   
Average Remaining
 
Exercise Prices
   
Outstanding
   
Exercise Price
   
Contractual Life
 
  $6.00 - $8.00       15,000     $ 6.95       3.92  
  $8.00 - $12.00       144,100       10.21       1.76  
          159,100     $ 9.90       1.96  
                             
Aggregate intrinsic value:
            $ 161,000          

The following table provides certain information with respect to stock options exercisable at September 30, 2012:
 
           
Weighted
   
Weighted
 
Range of
   
Stock Options
   
Average
   
Average Remaining
 
Exercise Prices
   
Exercisable
   
Exercise Price
   
Contractual Life
 
  $6.00 - $8.00       15,000     $ 6.95       3.92  
  $8.00 - $12.00       137,433       10.27       1.43  
          152,433     $ 9.94       1.67  
                             
Aggregate intrinsic value:
            $ 151,000          

Note 15.  Quarterly Segment Financial Summary

Our operations are conducted in three segments: (i) Fiber and Data, (ii) Equipment and (iii) Telecom.

Our Fiber and Data Segment serves wholesale, enterprise and commercial business customers with data and voice communications services supported by our extensive statewide fiber network and community access rings. With our communication expertise, we are able to provide standard and customized network solutions which can be extended beyond our network to provide end-to-end national connectivity. The Fiber and Data Segment also includes revenue from our SingleLink unified communication services and voice, data and Internet services sold to commercial business customers in several metropolitan markets.

Our Equipment Segment provides equipment solutions and support for a broad spectrum of business customers. Our equipment solutions team plans, designs and implements networks utilizing emerging technological advancements including TelePresence Video, Unified Communications and data center solutions. We provide a complete array of products and services to support the Cisco equipment sold to business customers including professional services, maintenance, total care support and security. Professional services include network assessments, planning, design, implementation and training. Our total care support team provides a single-point-of-contact for the support of applications, systems and infrastructure. We also offer security solutions combining leading network security products with our experience and expertise in integrated communications systems.

Our Telecom Segment provides bundled residential and business services including high-speed Internet, broadband services, digital TV, local voice and long distance services in our legacy telecom service area. Telecom is comprised of two markets. The first includes an incumbent local exchange carrier (“ILEC”) operating in 13 south central Minnesota communities and 13 rural northwest Iowa communities. The second market is a competitive local exchange carrier (“CLEC”) operation. We own our network in both the ILEC and CLEC communities. The Telecom Segment, through National Independent Billing, Inc., also provides data processing and related billing services to HickoryTech and external communication providers including wireline, wireless and entertainment providers.
 
Our presentation of segments has changed from our 10-Q filings prior to 2012 to better represent the organization as our chief operating decision-makers base their decisions. In 2011, as a result of changes to our organizational and management structure, as well as the formation of a separate entity to isolate our equipment distribution operation, we were able to more clearly and completely separate our Business Sector into two reportable segments for operating decision-making, giving us a total of three reporting segments overall. The segment information below has been reclassified to reflect these changes.

Segment information for the three and nine months ended September 30, 2012 and 2011 is as follows:
 
(Dollars in thousands)
                   
Corporate and
       
Three Months Ended September 30, 2012
 
Fiber and Data
   
Equipment
   
Telecom
   
Eliminations
   
Consolidated
 
Revenue from unaffiliated customers
  $ 15,528     $ 15,001     $ 15,284     $ -     $ 45,813  
Intersegment revenue
    215       -       465       (680 )     -  
   Total operating revenue
    15,743       15,001       15,749       (680 )     45,813  
                                         
Depreciation and amortization
    2,638       71       4,146       14       6,869  
Operating income (loss)
    2,445       890       1,377       (155 )     4,557  
Interest expense
    2       -       9       1,614       1,625  
Income tax provision (benefit)
    990       360       554       (710 )     1,194  
Net Income (loss)
    1,454       529       816       (1,058 )     1,741  
Total assets
    109,869       21,213       120,056       17,613       268,750  
Property, plant and equipment, net
    88,157       1,347       87,237       62       176,803  
Additions to property, plant and equipment
    6,390       (15 )     2,979       -       9,354  
                                         
                                         
                           
Corporate and
         
Three Months Ended September 30, 2011
 
Fiber and Data
   
Equipment
   
Telecom
   
Eliminations
   
Consolidated
 
                           
(Restated)
   
(Restated)
 
Revenue from unaffiliated customers
  $ 11,368     $ 16,416     $ 17,460     $ -     $ 45,244  
Intersegment revenue
    219       -       404       (623 )     -  
   Total operating revenue
    11,587       16,416       17,864       (623 )     45,244  
                                         
Depreciation and amortization
    1,597       74       4,101       22       5,794  
Operating income (loss)
    1,926       1,250       3,000       166       6,342  
Interest expense
    -       -       13       2,867       2,880  
Income tax provision (benefit)
    780       506       1,216       (1,147 )     1,355  
Net Income (loss)
    1,146       744       1,787       (1,544 )     2,133  
Total assets
    73,858       27,083       127,163       18,822       246,926  
Property, plant and equipment, net
    57,128       1,332       93,896       82       152,438  
Additions to property, plant and equipment
    2,988       213       2,440       -       5,641  
 
(Dollars in thousands)
                   
Corporate and
       
Nine Months Ended September 30, 2012
 
Fiber and Data
   
Equipment
   
Telecom
   
Eliminations
   
Consolidated
 
Revenue from unaffiliated customers
  $ 43,924     $ 45,286     $ 47,404     $ -     $ 136,614  
Intersegment revenue
    601       -       1,319       (1,920 )     -  
   Total operating revenue
    44,525       45,286       48,723       (1,920 )     136,614  
                                         
Depreciation and amortization
    7,155       213       12,364       63       19,795  
Operating income (loss)
    7,074       2,109       5,557       (444 )     14,296  
Interest expense
    2       -       31       4,602       4,635  
Income tax provision (benefit)
    2,865       854       2,246       (2,040 )     3,925  
Net Income (loss)
    4,208       1,254       3,301       (2,990 )     5,773  
Total assets
    109,869       21,213       120,056       17,613       268,750  
Property, plant and equipment, net
    88,157       1,347       87,237       62       176,803  
Additions to property, plant and equipment
    11,958       175       6,777       -       18,910  
                                         
                                         
                           
Corporate and
         
Nine Months Ended September 30, 2011
 
Fiber and Data
   
Equipment
   
Telecom
   
Eliminations
   
Consolidated
 
                           
(Restated)
   
(Restated)
 
Revenue from unaffiliated customers
  $ 33,296     $ 38,586     $ 52,092     $ -     $ 123,974  
Intersegment revenue
    566       -       1,220       (1,786 )     -  
   Total operating revenue
    33,862       38,586       53,312       (1,786 )     123,974  
                                         
Depreciation and amortization
    4,739       213       12,137       66       17,155  
Operating income (loss)
    5,333       2,454       8,600       (377 )     16,010  
Interest expense
    -       1       46       5,152       5,199  
Income tax provision (benefit)
    2,161       995       3,473       (2,595 )     4,034  
Net Income (loss)
    3,173       1,458       5,102       (2,906 )     6,827  
Total assets
    73,858       27,083       127,163       18,822       246,926  
Property, plant and equipment, net
    57,128       1,332       93,896       82       152,438  
Additions to property, plant and equipment
    7,211       306       6,615       -       14,132  

Note 16.  Commitments and Contingencies

We are involved in certain contractual disputes in the ordinary course of business. We do not believe the ultimate resolution of any of these existing matters will have a material adverse effect on our financial position, results of operations or cash flows.

In August 2010, we were awarded a National Telecommunications Information Administration (NTIA) Broadband Technology Opportunities Program (BTOP) grant to extend our middle mile fiber-optic network across greater Minnesota connecting health care facilities, schools, libraries, higher education institutions and public offices with an advanced high-capacity broadband network. This project involves approximately $24,000,000 of capital expenditures of which $16,800,000 is funded by the NTIA grant. We began capitalizing costs associated with this project in 2010 and began receiving grant funds in June 2011. The following table provides an overview of the capital expenditures incurred on or received from the program.

   
Project Activity
       
(Dollars in thousands)
 
YTD September 30, 2012
   
YTD December 31, 2011
   
Project Total
 
Capital Expenditures Incurred
  $ 5,521     $ 12,664     $ 18,185  
NTIA Reimbursements Received
  $ 2,941     $ 6,945     $ 9,886  

We anticipate the completion of this project by August 2013.

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

Forward Looking Statements

The Private Securities Litigation Reform Act of 1995 contains certain safe harbor provisions regarding forward-looking statements. This Quarterly Report on Form 10-Q may include forward-looking statements. These statements may include, without limitation, statements with respect to anticipated future operating and financial performance, growth opportunities and growth rates, acquisition and divestiture opportunities, business strategies, business and competitive outlook, and other similar forecasts and statements of expectation. Words such as “expects,” “anticipates,” “intends,” “plans,” “believes,” “seeks,” “estimates,” “targets,” “projects,” “will,” “may,” “continues,” and “should,” and variations of these words and similar expressions, are intended to identify these forward-looking statements. Such forward-looking statements are subject to risks and uncertainties that could cause our actual results to differ materially from such statements. Factors that might cause such a difference include, but are not limited to, those contained in Item 1A of Part II, “Risk Factors” of this quarterly report on Form 10-Q and Item 1A, “Risk Factors” of our Annual Report on Form 10-K for the year ended December 31, 2011, which is incorporated herein by reference.

Because of these risks, uncertainties, and assumptions and the fact that any forward-looking statements made by us and our management are based on estimates, projections, beliefs, and assumptions of management, they are not guarantees of future performance and you should not place undue reliance on them. In addition, forward-looking statements speak only as of the date they are made. With the exception of the requirements set forth in the federal securities laws or the rules and regulations of the Securities and Exchange Commission, we do not undertake any obligations to update any forward-looking information, whether as a result of new information, future events or otherwise.

Critical Accounting Policies

The preparation of our financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, and the related disclosure of contingent assets and liabilities. A description of the accounting policies that we consider particularly important for the portrayal of our results of operations and financial position, and which may require a higher level of judgment by our management, is contained under the caption, “Critical Accounting Policies,” in the Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the year ended December 31, 2011 and Amendment No. 1 on Form 10-K/A other than the following.

Acquisition/Business Combinations
We account for each business combination by applying the acquisition method, which requires (i) identifying the acquiree; (ii) determining the acquisition date; (iii) recognizing and measuring the identifiable assets acquired, the liabilities assumed, and any non-controlling interest we have in the acquiree at their acquisition date fair value; and (iv) recognizing and measuring goodwill.

To establish fair value we measure the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The measurement assumes the highest and best use of the asset by the market participants that would maximize the value of the asset or the group of assets within which the asset would be used at the measurement date, even if the intended use of the asset is different.

Goodwill is measured and recorded as the amount, by which the consideration transferred, generally at the acquisition date fair value, exceeds the acquisition date fair value of identifiable and intangible assets acquired, liabilities assumed, and any non-controlling interest we have in the acquiree.

We also estimate the value of amortizable intangible assets such as customer relationships. These estimates are based on acquiree historical data such as experience based sales and retention rate assumptions.

Acquisition costs are expensed as incurred.


Financial Derivative Instruments
We enter into fixed interest rate swap agreements (financial derivative instruments) to manage exposure to interest rate fluctuations on a portion of our variable-interest rate debt. Our interest rate swaps increase or decrease the amount of cash paid for interest depending on the increase or decrease of interest required on our variable rate debt.

We account for our financial derivative instruments in accordance with ASC 815, “Derivatives and Hedging.” ASC 815 requires that all derivative instruments be recorded on the balance sheet as either an asset or a liability measured at its fair value, and that changes in the derivatives’ fair value be recognized in earnings unless specific hedge accounting criteria are met. The fair value estimate of our interest rate swaps represent the net present value of future cash flows based on projections of the three month LIBOR rate over the life of each swap. Our financial derivative instruments are not designated as hedges and therefore are not accounted for using hedge accounting. The difference between interest paid and interest received, which may change as market interest rates change, is accrued and recognized as a component of interest expense.

Results of Operations

We conduct our operations in three business segments: (i) Fiber and Data, (ii) Equipment and (iii) Telecom. An overall description of our three business segments can be found in Note 15 to the Notes to the Consolidated Financial Statements.

Executive Summary

Third quarter 2012 revenue of $45.8 million represents an increase of 1% compared to the same period in 2011. Revenue increased by $4.2 million or 36% in our Fiber and Data Segment driven both by organic growth and the addition of IdeaOne. This growth was largely offset by a decline of $1.4 million or 9% from customer contracts and project completion within our Equipment Segment combined with a decline of $2.1 million or 12% of revenue in the Telecom Segment. On a year-to-date basis revenue has grown by 10% led by a 31% increase in our Fiber and Data Segment services revenue and a 24% increase in equipment revenue. Telecom services revenue has declined 9% year-to-date, a sharper decline than we have experienced in recent years due primarily to the impacts of FCC order 11-161, whose effects we felt on both a broad scale in its reform of intercarrier compensation and in a more direct way through the modification of a specific customer agreement. Telecom revenue has also been adversely impacted by the industry-wide trend of declining legacy telecommunication services.

Fiber and Data Segment revenue of $15.7M reflects growth of $4.2M or 36% in the third quarter of 2012 compared to 2011. We completed our acquisition of IdeaOne Telecom, a Fargo-based fiber and data service provider in March of 2012. IdeaOne contributed $3.3M or 78% of the revenue growth realized during the third quarter utilizing the deep metro-fiber network in Fargo, which also connects to our regional fiber network. In 2013, completion of our northern Minnesota broadband route, will add even more diversity between our networks and is expected to provide additional growth opportunities for our customers and continue sales momentum in wholesale transport and fiber-based special access services.

Equipment Segment revenue while recording a decline of $1.4M or 9% in revenue in the third quarter of 2012 compared to 2011 has realized revenue growth of $6.7M or 17% increase year-over-year. Driving this growth is sales of equipment, which has increased $7.5M in year-to-date 2012 compared to 2011 providing customers with solutions that fully integrate their information technology networks and provide cloud-based technology infrastructure components.

Telecom Segment revenue declined $2,115,000 or 12% in the third quarter of 2012 as compared to 2011 with the largest declines realized in revenue from network access, local service and bill processing. The network access decline of $835,000 or 15% in the third quarter and a portion of the local service decline of $410,000 or 12% have been impacted by the unique effects of the Federal Communication Commission’s (“FCC”) revision of Intercarrier Compensation and Federal Universal Service Support rules that significantly impact network access and reciprocal compensation revenue and required a modification of a contract with an external communications provider who aggregated high volume traffic on our network. Competition continues to intensify and has caused price compression in our Telecom markets. In response we began offering our customers new service combination bundles in July 2012, discounting rates for existing customers in an attempt to reduce churn and attract new customers.


Total costs and expenses increased 6% in the third quarter of 2012 as compared to 2011 due to continued investment in growing our Fiber and Data Segment offset by lower sales volumes in our Equipment Segment. Expenses include a full quarter of IdeaOne Telecom operations, which is incorporated into the Fiber and Data Segment. Depreciation and amortization increased $1.1 million in the third quarter of 2012 compared to 2011 and is directly related to our newly acquired IdeaOne plant and intangible assets. Interest expense decreased $1,255,000 in the third quarter of 2012 primarily due to the change in fair value on our interest rate swap agreements. Without the accounting for fair value changes on our interest rate swap agreements which increased interest expense by $131,000 in the third quarter of 2012 and $1,393,000 in the third quarter of 2011, interest expense would have shown an increase of $7,000 in the third quarter of 2012 compared to the third quarter of 2011. The third quarter of 2011 was impacted by an adjustment to record amortization expense of debt fees related to our previous credit facility which increased interest expense by $310,000.



Fiber and Data Segment
The following table provides a breakdown of the Fiber and Data Segment operating results.
 
Fiber and Data
 
                                     
   
Three Months Ended September 30
   
%
   
Nine Months Ended September 30
   
%
 
(Dollars in thousands)
 
2012
   
2011
   
Change
   
2012
   
2011
   
Change
 
Operating revenue before intersegment eliminations:
                                   
   Services
    15,528       11,368       37 %     43,924       33,296       32 %
   Intersegment
    215       219       -2 %     601       566       6 %
Total operating revenue
  $ 15,743     $ 11,587       36 %   $ 44,525     $ 33,862       31 %
                                                 
Cost of services  (excluding depreciation and amortization)
    7,735       5,834       33 %     21,819       17,335       26 %
Selling, general and administrative expenses
    2,925       2,230       31 %     8,477       6,455       31 %
Depreciation and amortization
    2,638       1,597       65 %     7,155       4,739       51 %
   Total costs and expenses
    13,298       9,661       38 %     37,451       28,529       31 %
                                                 
Operating income
  $ 2,445     $ 1,926       27 %   $ 7,074     $ 5,333       33 %
Net income
  $ 1,454     $ 1,146       27 %   $ 4,208     $ 3,173       33 %
                                                 
Capital expenditures
  $ 6,390     $ 2,988       114 %   $ 11,958     $ 7,211       66 %

Revenue

Fiber and Data. We serve wholesale, enterprise, and commercial business customers with high-speed communications products delivered through our extensive regional fiber network and community access rings supported by a 24x7x365 network operations center. This revenue stream is generally based on multi-year contracts with retail businesses, regional and national service providers, and wireless carriers, building a solid monthly recurring revenue base.

Fiber and Data services revenue increased $4,156,000 or 36% in the third quarter and grew by $10,663,000 or 31% in the year-to-date period as compared to the same periods in 2011. Organic growth in the third quarter and year-to-date period was $901,000 or 8% and $3,222,000 or 10%. IdeaOne contributed $3,255,000 and $7,441,000 to revenue in the third quarter and year-to-date periods of 2012, respectively. We continue to experience demand for our wholesale private line services and growth in our fiber-based special access services, including backhaul sales to wireless carriers. We are also focused on our commercial customer segment expanding our busin