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NTS, INC. - 10-K - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) FORWARD-LOOKING STATEMENTS The information set forth in this Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") contains certain "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, Section 21E of the Securities Exchange Act of 1934, as amended, and the Private Securities Litigation Reform Act of 1995, including, among others (i) expected changes in NTS, Inc.'s (referred to herein as the "Company", or "NTSI", "we", "our", "ours" and "us") revenues and profitability, (ii) prospective business opportunities and (iii) our strategy for financing our business. Forward-looking statements are statements other than historical information or statements of current condition. Some forward-looking statements may be identified by use of terms such as "believes", "anticipates", "intends" or "expects". These forward-looking statements relate to our plans, objectives and expectations for future operations. Although we believe that our expectations with respect to the forward-looking statements are based upon reasonable assumptions within the bounds of our knowledge of our business and operations, in light of the risks and uncertainties inherent in all future projections, the inclusion of forward-looking statements in this Annual Report should not be regarded as a representation by us or any other person that our objectives or plans will be achieved. You should read the following discussion and analysis in conjunction with the Financial Statements and Notes under Item 8 herein, and the other financial data appearing elsewhere in this Annual Report. Our revenues and results of operations could differ materially from those projected in the forward-looking statements as a result of numerous factors, including, but not limited to, the following: negative changes in the credit rating of customers, the risk of significant natural disaster, the inability of the Company to insure against certain risks, inflationary and deflationary conditions and cycles, currency exchange rates, and changing government regulations domestically and internationally affecting our businesses. US Dollars are denoted herein by "USD" and New Israeli Shekels are denoted herein by "NIS". OVERVIEW NTSI was incorporated in the State of Nevada, U.S.A. in September 2000 under the name Xfone, Inc. We provide, through our subsidiaries, integrated communications services which include voice, video and data over our Fiber-To-The-Premise ("FTTP") and other networks. We currently have operations in Texas, Mississippi and Louisiana. Effective as of February 1, 2012, we changed our name to "NTS, Inc." and as of February 2, 2012 our shares of common stock are traded on the NYSE MKT and the TASE under the new ticker symbol "NTS". The name change is a reflection of our refined and enhanced business strategy which began with our acquisition of NTSC in 2008 and our focus on the build out of our high-speed, FTTP network. Purchase of assets and liabilities of CoBridge Telecom, LLC On April 25, 2011, NTSC entered into an Asset Purchase Agreement with CoBridge Telecom, LLC, ("CoBridge"), to acquire CoBridge's assets in and around the communities of Colorado City, Levelland, Littlefield, Morton, and Slaton Texas. CoBridge provided cable television service in those communities via coaxial cable facilities and we acquired these assets to accelerate our penetration in these markets. The sale and purchase closed on July 1, 2011 but the purchase price was adjusted in November 2011 based on the number of CoBridge's customers who failed to pay their accounts or cancelled service (offset by customers who converted to NTSC's service in relevant markets). This adjustment was made final by agreement of the parties in July 2012. 18 -------------------------------------------------------------------------------- Back to Table of Contents Purchase of assets and liabilities of Reach Broadband On September 16, 2011, NTSC entered into an Asset Purchase Agreement with RB3, LLC, and Arklaoktex, LLC, each doing business as Reach Broadband ("Reach"), to acquire Reach's assets in and around the communities of Abernathy, Anton, Brownfield, Hale Center, Idalou, Levelland, Littlefield, Meadow, New Deal, O'Donnell, Olton, Reese, Ropesville, Shallowater, Smyer, Tahoka, and Wollforth Texas. Reach provided those communities with cable television service via coaxial cable facilities and Internet service via a wireless network and we acquired these assets to accelerate our penetration in these markets. The sale and purchase closed on December 1, 2011. RESULTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 2012 NTS Communications, Inc. Our Texas based subsidiary, NTSC, is an integrated telecommunications service provider that owns and operates its own fiber optic and leased facilities-based, long haul and metropolitan telecommunications networks. NTSC provides, including through its subsidiaries, business and residential customers with high quality broadband, managed data, video, local, and long distance services within its service areas. NTSC also provides long distance, data, and private line services to numerous communications carriers. NTSC is currently authorized to provide interexchange service in Arizona, Colorado, Kansas, Louisiana, New Mexico, Oklahoma, and Texas. NTSC is also authorized to provide local service in Louisiana, New Mexico and Texas, and video service only in Louisiana and Texas. NTSC operates in a highly competitive environment which is generally characterized by the dominance of the Incumbent Local Exchange Carrier ("ILEC"). With respect to its primary Texas markets, the dominant ILEC is either AT&T (formerly Southwestern Bell Telephone Company) or Windstream Communications. NTSC also competes with the Incumbent Cable TV Provider ("ICTVP") in markets where that carrier provides voice, data and/or video services. In its core Texas markets, the ICTVP is SuddenLink Communications, Time Warner Communications, or other smaller operators. Within these same core markets, NTSC also competes with a variety of widely dispersed smaller Competitive Local Exchange Carriers ("CLEC"). With respect to its data and long distance products, the company competes with various national and regional players including AT&T, Verizon, Suddenlink Qwest, Level 3 and others. Levelland/Smyer, Texas Our wholly owned subsidiary, NTS Telephone Company, LLC (d/b/a NTS of Levelland), has extended its FTTP network to the nearby communities of Levelland (located approximately 30 miles west of Lubbock) and Smyer (approximately 15 miles west of Lubbock). These communities have added approximately 6,000 FTTP passings to the NTSC FTTP footprint bringing total FTTP passings to approximately 21,000. An "FTTP passing" represents the number of premises capable of being served by the Company's deployed fiber optic distribution plant, with or without the addition of a fiber optic drop cable from the closest network access point to the premises. NTS Telephone Company received from the Rural Utilities Service ("RUS") a long-term financing of $11.5 million to complete this build-out. The RUS loan is non-recourse to NTSC and all other NTSC subsidiaries and interest is charged at the average rate of U.S. government obligations. NTSC began marketing its triple-play service to limited areas of Levelland in 2009 and construction was completed on April 8, 2010. Texas South Plains; Burkburnett and Iowa Park, Texas; St. Helena, Washington, and Tangipahoa Parishes in Southern Louisiana In March 2010, we were notified that the applications of our wholly owned subsidiary, PRIDE Network, Inc. ("PRIDE Network"), for RUS funding from the U.S. Department of Agriculture under the Broadband Initiative Program for the FTTP build out of PRIDE Network's projects in Texas, had been approved. PRIDE Network was selected to receive approximately $63.7 million in RUS funding for these projects, which will be split between loans of approximately $35.53 million and grants of approximately $28.14 million. 19 -------------------------------------------------------------------------------- Back to Table of Contents In September 2010, we were notified that another application of PRIDE Network for additional funding under the Broadband Initiative Program for the FTTP build out of its project in Louisiana had been approved. PRIDE Network was selected to receive approximately $36.2 million in additional RUS funding which will be split between a loan of approximately $18.46 million and a grant of approximately $17.74 million. This funding is a significant milestone in our strategy to grow the FTTP business. The grants and loans created an opportunity for us to expand the rollout of our state-of-the-art FTTP infrastructure to bring broadband services to the Texas south plains, to the communities of Burkburnett and Iowa Park, Texas, and to St. Helena, Washington, and Tangipahoa Parishes in Southern Louisiana. Additionally, it is anticipated that these projects will help stimulate the economic growth of these communities by creating hundreds of new jobs associated with the network build out. When completed, the PRIDE Network is expected to add 30,000 FTTP passings to the NTSC network bringing company-wide FTTP passings to over 50,000. To date, we have completed our FTTP network in Lamesa, Littlefield, Plainview, Burkburnett, Iowa Park, Brownfield, Slaton, and Whitharral, Texas, and started to record minimal revenues from these markets which will increase during 2013. The fundings are contingent upon PRIDE Network meeting the terms of the loans, grants or loans/grants agreement. Xfone USA, Inc. Our Mississippi based subsidiary, Xfone USA, Inc. (d/b/a/ NTS Communications), is an integrated telecommunications service provider that owns and operates its own facilities-based, telecommunications switching system and network. Xfone USA provides residential and business customers with high quality local, long distance and high-speed broadband Internet services. Xfone USA utilizes integrated multi-media offerings - combining digital voice and data services over broadband technologies to deliver services to customers throughout its service areas. Xfone USA is currently licensed to provide telecommunications services in Louisiana and Mississippi. Like NTSC, Xfone USA also operates in highly competitive markets. In these markets Xfone USA competes against the dominate ILEC, AT&T (formerly BellSouth Telecommunications), as well as many smaller CLECs. With continued cross-selling to existing Xfone USA customers, augmented by the soon to be constructed PRIDE Louisiana FTTP network, our goal is to continue revenue growth and increase market share. Our markets continue to show strong interest in faster broadband and competition from facilities based providers continues to be the dominant theme. We compete favorably with the Regional Bell Carriers and incumbent cable providers using an approach that is flexible and customer focused. Broadband services are expected to continue to grow due to an ongoing need for faster broadband services by both business and residential customers. Our business plan in 2013 also includes growth through potential bolt-on acquisitions, which make sense for several reasons: (i) faster results in achieving large top line revenue performance; (ii) significant synergies from consolidating corporate functions; and (iii) relatively easy integration of acquired companies because of our existing facilities and network architecture. 20 -------------------------------------------------------------------------------- Back to Table of Contents COMPARISON FINANCIAL INFORMATION YEARS ENDED DECEMBER 31, 2012 AND 2011 - PERCENTAGE OF REVENUES: Year Ended December 31, 2012 2011 Revenues: Services on Fiber-To-The-Premise network 30.4 % 22.6 % Leased local loop services and other 69.6 % 77.4 % Total Revenues 100 % 100 % Expenses: Cost of services (excluding depreciation and amortization) 45.9 % 48.6 % Selling, general and administrative 34.8 % 36.5 % Depreciation and amortization 10.5 % 9.3 % Financing expenses, net 9.3 % 5.9 % Other expenses 1.1 % 1.2 % Acquisition costs - 0.3 % Total expenses 101.6 % 101.8 % Loss from continued operations before taxes (1.6) % (1.8) % Income tax benefit (expense) 0.7 % - % Loss from continued operations (0.9) % (1.8) % Net loss (0.9) % (2.0) % COMPARISON OF THE YEARS ENDED DECEMBER 31, 2012 AND 2011 Revenues. Revenues for the year ended December 31, 2012 increased 3.8% to $59,870,468 from $57,657,834 for the same period in 2011. Revenues from our FTTP network in the year ended December 31, 2012 increased 39.9% to $18,219,615 from $13,022,548 in the same period in 2011. As percentage of total sales, FTTP revenues in the year ended December 31, 2012 increased to 30.4% from 22.6% for the year ended December 31, 2011. The growth of FTTP revenues is expected to continue due to the progress in the build out of our FTTP network in the communities which are located in the areas of the PRIDE Network projects in Texas and Louisiana. Revenues from our leased local loop include revenues from wholesale, other carriers and other non-FTTP customers. Revenues from leased local loop in the year ended December 31, 2012 decreased 6.7% to $41,650,853 from $44,635,286 for the same period in 2011. As percentage of total sales, leased local loop revenues in the year ended December 31, 2012 decreased to 69.6% from 77.4% for the same period in 2011. The decrease in revenues was caused by the aggressive promotional packages and incentives launched by competitors and were partially offset with revenues from assets that were purchased from CoBridge and Reach. The transactions with CoBridge and Reach were closed in July 1, 2011 and December 1, 2011, respectively, and revenues from these assets were recorded from the closing date as non-FTTP revenues. We generated cable television services revenue from the acquisition of Cobridge and Reach's assets in the West Texas area of $2,150,945 for the year ended December 31, 2012 compared to $895,019 for the same period in 2011. We expect that the decline in revenues from non-FTTP residential customer will continue in 2013, but will be offset by the increase in revenues in FTTP from business and residential customers. 21 -------------------------------------------------------------------------------- Back to Table of Contents Cost of Services (excluding depreciation and amortization). Cost of services consists primarily of facilities and traffic time purchased from other telephone companies and content for our video services. Cost of services for the year ended December 31, 2012 decreased 1.9% to $27,489,743 from $28,025,723 for the same period in 2011. Cost of services, as a percentage of revenues in the year ended December 31, 2012, decreased to 45.9% from 48.6% in the same period in 2011. We expect that the cost of services, as a percentage of revenues, will decline as we increase the portion of revenues generated from our high-margin FTTP services. FTTP services are provided over our fully owned fiber network and therefore we do not incur third party costs for leased network lines. As the revenue mix changes towards greater percentage of the high-margin FTTP revenues, and a lesser percentage of the low-margin revenues from non-FTTP residential customers and wholesale, the cost of services, as a percentage of revenues, is expected to decline. Selling, General and Administrative Expenses. Selling expenses consist primarily of compensation costs for our sales, administrative and management employees. Selling, general and administrative expenses for the year ended December 31, 2012, decreased 1.1% to $20,802,001 from $21,040,426 for the same period in 2011. The decrease in the expenses resulted mainly from outsourcing most of our installation and maintenance work in the FTTP markets to subcontractors, which was offset by an increase in sales commission related to the increase in new FTTP revenues. As a percentage of revenues, selling, general and administrative expenses decreased by 1.7%. We expect that these changes will allow us to be more efficient on the construction work and reduce the payroll and payroll-related expenses in 2013. Depreciation and Amortization. Depreciation and amortization expense for the year ended December 31, 2012 increased 17.3% to $6,274,488 from $5,350,973 for the same period in 2011. The increase was due to the large investments in the development of the FTTP networks. Financing Expenses. Financing expenses, net, for the year ended December 31, 2012, increased 64.2% to $5,551,080 from $3,380,320 for the same period in 2011. Financing expenses consist of interest payable on our financial obligations, and the measurement of our Bonds, which are stated in NIS and linked to the Israeli Consumer Price Index ("CPI"). The increase in financing expenses is mainly a result of additional advances from the United States Department of Agriculture in the amount of $16,477,528 during the year ended December 31, 2012 compared to $13,215,852 in the same period in 2011, additional loans from ICON of $6,600,000 during the year ended December 31, 2012, and the devaluation of 2.3% in the USD against the NIS and adjustment to inflation of 1.5% during the year ended December 31, 2012, versus the evaluation of 7.7% in the USD against the NIS and adjustment to inflation of 2.6% in the same period in 2011. Financing expenses in the year ended December 31, 2012 also include expenses of $252,796 related to warrants that were issued to Burlingame Equity Investors, LP ("Burlingame") during March 2010, and the difference between the allocated relative fair value and the principal amount of the March 2010 loan from Burlingame. Other Expenses. Other expenses for the year ended December 31, 2012 increased 3.3% to $686,519 from $664,790 for the same period in 2011. Other expenses consist of real estate taxes, which were offset with the gain of $221,643 from the purchase of our Bonds by NTSC and expense of $88,400 due to adjustment of the final purchase price of Cobridge. We expect that real estate taxes will increase as we continue to expand our operations in the PRIDE Network markets. Acquisition Costs. Acquisition costs for the year ended December 31, 2011 of $205,047 were related to the acquisition of CoBridge. There were no acquisition costs for the year ended December 31, 2012. Income taxes. We conduct our business in several states in the US. Therefore, our operating income is subject to varying rates of state tax in the US. Consequently, our effective tax rate is dependent upon the geographic distribution of our earnings or losses. However, we expect that our income taxes will not materially vary in relation to the geographic distribution of our profits inside the US. Due to non-deductible compensation related to stock options and non-deductible amortization of intangible assets, our effective tax rate was 41.4% (including gain from the purchase of our Bonds) and 0.7% for the year ended December 31, 2012 and 2011, respectively. Net Loss. As a result of the foregoing, net loss for the year ended December 31, 2012 decreased 53.1% to $546,993 from $1,167,409 for the same period in 2011. 22-------------------------------------------------------------------------------- Back to Table of Contents LIQUIDITY AND CAPITAL RESOURCES Cash and cash equivalents as of December 31, 2012 amounted to $3,908,620 compared to $6,563,514 as of December 31, 2011, a decrease of $2,654,894. Net cash provided by operating activities in the year ended December 31, 2012 was $3,525,824, an increase of $1,112,621 compared to $2,413,203 which was provided by operating activities in the year ended December 31, 2011. The increase in cash flow from operating activities is mostly related to the following changes: (1) an increase in accounts receivable of $1,669,435 during the year ended December 31, 2012, compared to a decrease of $106,954 in the same period of 2011; (2) an increase in prepaid expenses and other receivables of $257,241 in the year ended December 31, 2012, compared to an increase of $766,092 in the same period of 2011; (3) an increase in the provision for bad debt of $275,087 during the year ended December 31, 2012, compared to an increase of $492,833 in the same period of 2011; (4) an increase in other liabilities and accrued expenses of $446,777 in the year ended December 31, 2012, compared to a decrease of $495,459 during the same period of 2011; (5) a decrease in trade payables of $1,482,871 during the year ended December 31, 2012, compared to a decrease of 963,834 during the same period of 2011 and (6) an increase in other long-term liabilities of $593,035 during year ended December 31, 2012 compared to a decrease in other long-term liabilities of $55,856 during the same period of 2011. Net cash used by investing activities in the year ended December 31, 2012 was $20,413,286 compared to $16,070,143 in the same period of 2011. Of that amount, $17,187,267 is attributable to the build out of our FTTP projects in Levelland, Texas and the PRIDE Network projects and $3,226,019 to the purchase of other equipment. Net cash provided by financing activities for the year ended December 31, 2012 was $14,232,568 compared to $19,003,027 in the same period of 2011. Net cash provided by financing activities in 2012 is primarily attributable to proceeds from long-term loans from the United States Department of Agriculture, and the Loan Agreement with ICON, which are offset by repayment of the long-term loans from the United States Department of Agriculture, capital lease obligations and a loan from Burlingame. Capital lease obligations: We are the lessee of switching and other telecom equipment under capital leases expiring on various dates through 2016. As of December 31, 2012, we reported a working capital deficit of $6,248,721 compared to a working capital deficit of $3,596,693 on December 31, 2011. On June 22, 2012 we entered into Amendment No. 1 to the Original ICON Agreement providing for an additional secured term loan in the amount of $3,500,000 and a secured delayed draw term loan in the amount of $3,100,000. We used the proceeds of the additional term loan solely for the payment and satisfaction in full of all liabilities owed to Burlingame, including but not limited to the Burlingame Note. On September 27, 2012, we drew down the delayed draw term loan in the amount of $3,100,000. We are using the proceeds of the delayed draw term loan for the purchase of equipment in connection with our project to construct a fiber network in Wichita Falls, Texas. On February 12, 2013, we entered into a further amendment to the Original ICON Agreement providing for an additional secured delayed draw term loan in the amount of $6,000,000 for the purchase of equipment in connection with our project to expand our fiber network in the region of West Texas. We believe that increased revenues from our higher margin Fiber-To-The-Premise network together with cost saving activities and a reduction in the number of our employees is expected to result in increased profitability and cash flows, which will lead to improvement in the working capital deficit in order to meet our anticipated cash requirements for at least the next 12 months. If, however, we do not generate sufficient cash from operations, or if we incur additional unanticipated liabilities or we are unable to renew and/or extend a portion of our short-term liabilities, we may be required to seek additional financing or sell equity or debt on terms which may not be as favorable as we could have otherwise obtained. No assurance can be given that any refinancing, additional borrowing or sale of equity or debt will be possible when needed or that we will be able to negotiate acceptable terms. In addition, our access to capital is affected by prevailing conditions in the financial and equity capital markets, as well as our own financial condition. While management believes that we will be able to meet our liquidity needs for at least the next 12 months, no assurance can be given that we will be able to do so. 23 -------------------------------------------------------------------------------- Back to Table of Contents The following table represents our contractual obligations and commercial commitments, excluding interest expense, as of December 31, 2012: Payments Due by Period Less than More than Contractual Obligations Total 1 Year 1-3 Years 4-5 Years 5 Years Domestic Note Payable $ 15,134,661 $ 723,887 $ 4,364,524 $ 10,046,250 $ - Notes Payable from the United States Department of Agriculture 37,337,663 1,817,816 3,635,632 3,635,632 28,248,583 Bonds 10,653,728 3,627,205 7,026,523 - - Capital leases 632,602 424,719 193,877 14,005 - Operating leases 1,358,248 859,223 451,362 47,664 - Total contractual cash obligations $ 65,116,902 $ 7,452,850 $ 15,671,918 $ 13,743,551 $ 28,248,583 NTS, Inc. The Series A Bonds On December 13, 2007 (the "Date of Issuance"), we issued non-convertible bonds to Israeli institutional investors, for total gross proceeds of NIS 100,382,100 (approximately $25,562,032, based on the exchange rate as of December 13, 2007) (the "Series A Bonds"). The Series A Bonds were issued for an amount equal to their par value. The Series A Bonds accrue annual interest that is paid semi-annually on the 1st of June and on the 1st of December of every year from 2008 until 2015 (inclusive). The principal of the Series A Bonds is repaid in eight equal annual payments on the 1st of December of every year from 2008 until 2015 (inclusive). The principal and interest of the Series A Bonds are linked to the Israeli CPI. On November 4, 2008, we filed a public prospectus (the "Prospectus") with the Israel Securities Authority (the "ISA") and the TASE for listing of the Series A Bonds for trading on the TASE. On November 11, 2008 (the "Date of Listing"), the Series A Bonds commenced trading on the TASE. From the Date of Issuance until the Date of Listing, the Series A Bonds accrued annual interest at a rate of 9%. As of the Date of Listing, the interest rate for the unpaid balance of the Series A Bonds was reduced by 1% to an annual interest rate of 8%. On March 25, 2008, we issued the holders of the Series A Bonds, for no additional consideration, 956,020 (non-tradable) warrants, each exercisable at an exercise price of $2.04 (as adjusted in November 2011) with a term of 4 years, commencing on September 2, 2008. These warrants expired unexercised in September 2012. The Series A Bonds may only be traded in Israel. As of August 6, 2012, the Series A Bonds are rated Ba1 with a stable outlook by Midroog Limited, an Israeli rating company which is a subsidiary of Moody's Investor Services. 24 -------------------------------------------------------------------------------- Back to Table of Contents Loan agreement with ICON Agent, LLC On October 6, 2011, we entered into a term loan, guarantee and security agreement (the "Original ICON Agreement"), as amended by the Amended & Restated Consent, Waiver & Amendment Agreement dated November 1, 2011 by and between the following: (1) ICON Agent, LLC (the "Agent"), acting as agent for the Lenders signatory thereto; (2) we, as Guarantor; (3) Xfone USA, Inc., NTS Communications, Inc., Gulf Coast Utilities, Inc., eXpeTel Communications, Inc., NTS Construction Company, Garey M. Wallace Company, Inc., Midcom of Arizona, Inc., Communications Brokers, Inc., and NTS Management Company, LLC, acting as Borrowers and Guarantors; and (4) PRIDE Network, Inc., and NTS Telephone Company, LLC (together with the Borrowers and Guarantors acting as Credit Parties) that provided for a secured term loan in the amount of $7,500,000 (the "First ICON Loan"). On June 22, 2012, we entered into Amendment No. 1 to the Original ICON Agreement ("Amendment No. 1") providing for an additional secured term loan in the amount of $3,500,000, for the payment of all liabilities owed by us to Burlingame Equity Investors, LP (the "Second ICON Loan"); a secured delayed draw term loan in the amount of $3,100,000, for the purchase of equipment in connection with our project to construct a fiber network in Wichita Falls, Texas (the "Third ICON Loan"); and certain other amendments to the Original ICON Agreement and the First ICON Loan, as described in Amendment No. 1. Each of the First ICON Loan, Second ICON Loan and Third ICON Loan bear interest at 12.75% per annum. The fundings of the First ICON Loan and the Second ICON Loan were made on October 27, 2011 and June 22, 2012, respectively. On August 9, 2012, we entered into Amendment No. 2 to the Original ICON Agreement providing for revised amortization schedules of the First ICON Loan and the Second ICON Loan. On September 27, 2012, we drew down the Third ICON Loan in the amount of $3,100,000. On February 12, 2013, we entered into Amendment No. 3 to the Original ICON Agreement ("Amendment No. 3") providing for (i) an additional secured delayed draw term loans in the aggregate amount of $6,000,000, bearing interest of 12.75% per annum for the purchase of equipment in connection with our project to expand our fiber network in the region of West Texas, (ii) revised amortization schedules of the First ICON Loan, Second ICON Loan and Third ICON Loan (as described below), and (iii) certain other amendments to the Original ICON Agreement (as amended by Amendment No. 1 and Amendment No. 2), described in Amendment No. 3. Pursuant to Amendment No. 3, the principal amount of the First ICON Loan is payable in 69 consecutive monthly installments with the first 27 monthly payments being payments of accrued interest only. The principal amount of the Second ICON Loan is payable in 61 consecutive monthly installments with the first 19 monthly payments being payments of accrued interest only. The principal amount of the Third ICON Loan is payable in 58 consecutive monthly installments with the first 16 monthly payments being payments of accrued interest only. Each of the foregoing loans are secured by a lien against all of each Borrower's and Guarantor's property and assets, whether real or personal, tangible or intangible, and whether now owned or hereafter acquired, or in which it now has or at any time in the future may acquire any right, title, or interest; provided, however, that none of the assets of PRIDE Network and NTS Telephone Company are being used as collateral for the loans and are specifically excluded. We are required maintain fixed charge coverage ratio of not less than 1.15 to 1.00 for the trailing four fiscal quarter period most recently ended if at any time cash was less than $3,000,000 as of the last day of any fiscal quarter. Pursuant to Amendment No. 3, senior leverage ratio should not exceed 2.25 to 1.00 from June 30, 2012 through March 31, 2013, 2.00 to 1.00 from June 30, 2013 through December 31, 2013, and 1.75 to 1.00 from March 31, 2014 and thereafter. As of December 31, 2012, we complied with the foregoing financial covenants. The total outstanding amount of the loans as of December 31, 2012 is $14,100,000. 25 -------------------------------------------------------------------------------- Back to Table of Contents Rights Offering On July 6, 2011 our Board approved a rights offering (the "Rights Offering") in which our stockholders received non-transferable and non-tradable rights to purchase one additional share of our common stock, par value $0.001 for each share owned as of the record date, for a subscription price of $0.30 per share (each, a "Right"). Our stockholders who exercised their Rights in full were also eligible to exercise an oversubscription privilege to purchase, on a pro rata basis, a portion of the unsubscribed shares, at the same price of $0.30 per share, subject to certain limitations. The record date for the Rights Offering was September 22, 2011 and the Rights Offering expired on October 26, 2011. On November 2, 2011, we completed the Rights Offering and raised $6,020,132 from our shareholders for 20,067,108 shares of our common stock. Taking into account the oversubscription rights, there was a demand for 95% of the offered shares. Because the Rights Offering was at a price per share which was lower than the market price at the time of announcement, we authorized a reduction of the exercise price of our outstanding warrants by an average of 41.4% and approved the issuance of additional 3,728,775 options to our directors and employees at an exercise price of $1.10 per share. The adjustment of the exercise price of the warrants and the issuance of additional options was made to maintain the same value of the warrants and options prior to the announcement of the Rights Offering based on the Black-Scholes model. Securities Purchase Agreement On March 23, 2010, we entered into a Securities Purchase Agreement (the "Purchase Agreement") with an existing shareholder, Burlingame. As part of the Purchase Agreement, we issued a senior promissory note in the aggregate principal amount of $3,500,000, with an initial maturity date of March 22, 2012. Interest accrued at an annual rate of 10% and was payable quarterly. The note was unsecured and had equal liquidation rights with our Series A Bonds issued in Israel on December 13, 2007. We evaluated the fair value of each of the three securities that were issued under the Purchase Agreement (i.e., the promissory note, 2,173,913 shares of our common stock, and a warrant to purchase 950,000 shares of our common stock) and recorded the promissory note at its fair value of $2,556,240. The difference between the fair value and the principal amount was expensed ratably over the life of the promissory note. On May 2, 2011, we entered into a First Amendment to the promissory note, pursuant to which we and Burlingame agreed to extend the maturity date of the promissory note from March 22, 2012 to March 22, 2013. The effective interest rate of the promissory note was calculated at 22.1%. The total amount of discount recognized was $252,796. The outstanding principal amount of the promissory note of $3,500,000 (plus accrued interest) was repaid on June 22, 2012. 26-------------------------------------------------------------------------------- Back to Table of Contents Buy-back plan Our Board adopted a buy-back plan (the "Plan"), effective as of February 13, 2012, according to which we were allowed, from time to time, to repurchase our Series A Bonds which are traded on the TASE. Under the Plan we were authorized to repurchase Series A Bonds for up to a total amount of NIS 5 million (approximately USD 1.35 million) in transactions on the TASE or outside the TASE, until December 31, 2012. Any repurchases of the Series A Bonds were financed from our internal sources. The Board authorized our management to manage the performance of repurchases according to the Plan, including the conduct of negotiations, at such times, scopes, prices and other terms as management deems fit. The timing, amounts and terms of any Series A Bonds repurchased by us were determined, at the discretion of management, based on market conditions, opportunities, economic advisability and other customary criteria and factors. Repurchases of the Bonds were carried out by us and/or our subsidiaries, either directly and/or through a third party. Bonds repurchased by us would have been cancelled and removed from trading on the TASE without permission to be reissued. The Board's resolution was not a commitment to repurchase any Bonds under the Plan. On July 4, 2012, NTSC, our wholly-owned subsidiary, purchased pursuant to the Plan, in a single transaction outside the TASE, NIS 1,339,310 in par value of Bonds at an aggregate purchase price of NIS 1,091,538 (approximately $278,596). On September 23, 2012, NTSC, our wholly-owned subsidiary, purchased pursuant to the Plan, in several transactions on the TASE, additional NIS 1,062,528 in par value of Bonds at an aggregate purchase price of NIS 838,228 (approximately $215,649). Pursuant to the indenture governing the Bonds, any Bonds purchased by our subsidiary (as opposed to Bonds repurchased by us) are not canceled or removed from trading on the TASE. The gain on the bonds purchased by NTSC, our wholly-owned subsidiary, is $221,643. The Plan expired on December 31, 2012. US subsidiaries NTS Telephone Company, LLC (d/b/a NTS of Levelland), a wholly owned subsidiary of NTSC, received from the Rural Utilities Service ("RUS"), a division of the United States Department of Agriculture, an $11.5 million debt facility to complete a telecommunications overbuild project in Levelland, Texas. The principal of the RUS loan is repaid monthly starting one year from the initial advance date until full repayment after 17 years. Each advance bears interest that will become fixed at the date of the advance at the average yield on outstanding marketable obligations of the United States having the final maturity comparable to the final maturity of the advance. The loans are non-recourse to NTSC and all other NTSC subsidiaries and are secured by NTS Telephone's assets which were $14.1 million at December 31, 2012. As of December 31, 2012, the annual average weighted interest rate on the outstanding advances was 3.65%. The total outstanding amount of these loans as of December 31, 2012 is $9,589,321. The loans are to be repaid in monthly installments until 2024. PRIDE Network, Inc., a wholly owned subsidiary of NTSC, has received approval from the Broadband Initiative Program of the American Recovery and Reinvestment Act, for a total $99.9 million funding in the form of $45.9 million in grants and $54 million in 19 to 20-year loans. The aggregate amount of these loans and grants received by the Company as of December 31, 2012 is $28,694,825 and $23,162,853, respectively. Each advance bears interest that will become fixed at the date of the advance at the average yield on outstanding marketable obligations of the United States having the final maturity comparable to the final maturity of the advance. The funding created an opportunity for us to expand the roll out of our FTTP infrastructure, known as the PRIDE Network projects, in northwestern Texas and in southern Louisiana. Construction work of PRIDE Network's FTTP infrastructure started in October 2010. The loans are non-recourse to NTSC and all other NTSC subsidiaries and are secured by PRIDE Network's assets which were $39.1 million at December 31, 2012. As of December 31, 2012, the annual average weighted interest rate on the outstanding advances was 2.97%. As of December 31, 2012, the total amount of loans and grants available in the future is $25,298,214 and $22,714,069, respectively. The loans are to be repaid in monthly installments until 2030. The total outstanding amount of these loans as of December 31, 2012 and December 31, 2011 are $27,748,342 and $12,126,052, respectively. As of December 31, 2012, the Company recorded grants receivable at the amount of $974,120. Accounts payable in the amount of $1,013,880 that was financed by long term loan received during 2013 is included in long term liabilities. 27-------------------------------------------------------------------------------- Back to Table of Contents On April 25, 2011, NTSC, our wholly-owned subsidiary, entered into an Asset Purchase Agreement with CoBridge Telecom, LLC, ("CoBridge"), pursuant to which CoBridge agreed to sell NTSC all of CoBridge's assets in and around the communities of Colorado City, Levelland, Littlefield, Morton, and Slaton Texas pursuant to the terms of the agreement. As part of the agreement, a note for $1,010,101 was issued on July 1, 2011 at an interest rate of 6% per annum and is payable in 36 equal monthly installments of $20,626. The total outstanding amount of the note as of December 31, 2012 is $373,244. On September 16, 2011, NTSC, our wholly-owned subsidiary, entered into an Asset Purchase Agreement with RB3, LLC, and Arklaoktex, LLC, each doing business as Reach Broadband ("Reach"), pursuant to which Reach agreed to sell NTSC all of Reach's assets in and around the communities of Abernathy, Anton, Brownfield, Hale Center, Idalou, Levelland, Littlefield, Meadow, New Deal, O'Donnell, Olton, Reese, Ropesville, Shallowater, Smyer, Tahoka, and Wolfforth Texas pursuant to the terms of the agreement. As part of the agreement, a note for $475,093 was issued on December 1, 2011 at an interest rate of 7% per annum and is payable in 36 equal monthly installments of $14,693. The total outstanding amount of the note as of December 31, 2012 is $327,357. IMPACT OF INFLATION AND CURRENCY FLUCTUATIONS All of our assets, liabilities (except the Series A Bonds and other insignificant costs), revenues and expenditures are in USD. Notwithstanding having our Series A Bonds stated in NIS and linked to the Israeli Consumer Price Index, during the year ended December 31, 2012, our outstanding liability was increased by $434,367 as a result of the adjustment to the Israeli CPI and revaluation of the NIS in relation with the USD. We may use foreign currency exchange contracts and other derivatives instruments to be the appropriate tool for managing such exposure. Related Party Transactions See "Related Party Transactions" set forth in Note 16 of the Notes to the Consolidated Financial Statements under Item 8 of this Annual Report. New Accounting Pronouncements See "New Accounting Pronouncements" set forth in Note 2 of the Notes to the Consolidated Financial Statements under Item 8 of this Annual Report, for information pertaining to recently adopted accounting standards or accounting standards to be adopted in the future. Critical Accounting Policies and Estimates The significant accounting policies of the Company are described in Note 2 to the consolidated financial statements and have been reviewed with the Audit Committee of our Board. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expense during the reporting period. Certain accounting estimates and assumptions are particularly sensitive because of their importance to the consolidated financial statements and possibility that future events affecting them may differ markedly. The accounting policies of the Company with significant estimates and assumptions are described below. Revenue Recognition Revenues derived from local telephone, long-distance, data and video services are recognized when services are provided. This is based upon either usage (e.g., minutes of traffic/bytes of data processed), period of time (e.g., monthly service fees) or other established fee schedules. 28-------------------------------------------------------------------------------- Back to Table of Contents Service revenues also include billings to our customers for various regulatory fees imposed on us by governmental authorities. Cash incentives given to customers are recorded as a reduction of revenue. For contracts that involve the bundling of services, revenue is allocated to the services based on their relative fair value. We record the resale of third-party services and the sale of equipment to customers as gross revenue when we are the primary obligor in the arrangement. Payments received in advance are deferred until the service is provided. We believe that the accounting estimates related to deferred services are "critical accounting estimates" because of their importance to the consolidated financial statements. Accounts Receivable Reserves This reserve is an estimate of the amount of accounts receivable that are uncollectible. The reserve is based on a combination of specific customer knowledge, general economic conditions and historical trends. Management believes the results could be materially different if economic conditions change for our customers. Long-lived Assets The carrying value of long-lived assets is periodically assessed to insure their carrying value does not exceed their estimated net realizable future value. This assessment includes certain assumptions related to future needs for the asset to help generate future cash flow. Changes in those assessments, future economic conditions or technological changes could have a material adverse impact on the carrying value of these assets. Deferred Taxes The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities and projected future taxable income in making this assessment. Actual future operating results, as well as changes in our future performance, could have a material adverse impact on the valuation reserves. |