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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. 16-------------------------------------------------------------------------------- TABLE OF CONTENTS 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. Proposed Merger As reported in our Current Report on Form 8-K filed with the SEC on October 21, 2013, on October 20, 2013, we entered into an Agreement and Plan of Merger (the "Merger Agreement") with T3 North Intermediate Holdings, LLC, a Nevada limited liability company ("Holdings") and North Merger Sub, Inc., a Nevada corporation and a wholly-owned subsidiary of Holdings ("Merger Sub"). Upon the terms and subject to the conditions set forth in the Merger Agreement, the Company will become a wholly-owned subsidiary of Holdings through a merger of Merger Sub with and into the Company, with the Company as the surviving corporation (the "Merger"). Holdings and Merger Sub are affiliates of Tower Three Partners LLC ("Tower Three"). Consummation of the Merger is subject to a number of closing conditions, including, among other things: (i) the adoption and approval of the Merger Agreement by the requisite vote of our stockholders; (ii) receipt of certain third party consents; (iii) the absence of any law or order prohibiting the Merger; (iv) the accuracy of the representations and warranties, subject to customary materiality qualifiers; and (v) the absence of a Material Adverse Effect (as defined in the Merger Agreement). Consummation of the Merger is not subject to a financing condition. Simultaneously with the execution of the Merger Agreement, Guy Nissenson, our Chairman, President and Chief Executive Officer, entered into a Voting Agreement with Holdings and us (the "Voting Agreement"). Pursuant to the Voting Agreement, Mr. Nissenson has agreed, among other things, to vote the shares of our common stock held by him: ? in favor of the Merger Agreement proposal; ? against alternative transactions; and ? in favor of any action in furtherance of the transactions contemplated by the Merger Agreement. The Voting Agreement generally prohibits Mr. Nissenson from transferring his shares of common stock prior to the consummation of the Merger. The Voting Agreement will automatically terminate upon the first to occur of (i) the consummation of the Merger, or (ii) the termination of the Merger Agreement in accordance with its terms. In addition, the sole member of Holdings and Mr. Nissenson have entered into a Rollover Agreement (the "Rollover Agreement"), whereby Mr. Nissenson has committed to contribute, immediately prior to the effective time of the Merger, an aggregate of 1,390,871 shares of our common stock to the sole member of Holdings in exchange for equity interests of such entity. Mr. Nissenson's commitments pursuant to such agreement are conditioned upon the satisfaction or waiver of the conditions to closing contained in the Merger Agreement and will take place immediately prior to the consummation of the Merger. In addition, it is expected that Mr. Nissenson will enter into an equityholders agreement that will, among other things, provide that Mr. Nissenson may serve on the board of directors of the sole member of Holdings for so long as he continues to own a specified amount of equity in such entity. The parties to the Merger Agreement intend to complete the Merger in the second quarter of 2014. However, the Merger is subject to approvals and other conditions, and it is possible that factors outside the control of the parties could result in the Merger being completed at a later time, or not at all. See also Note 22 - Merger Agreement. 17-------------------------------------------------------------------------------- TABLE OF CONTENTS RESULTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 2013 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. The company 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 NTSC, through its 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). 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, LLC received from the Rural Utilities Service ("RUS"), a division of the U.S. Department of Agriculture an $11.5 million debt facility 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's initial capital investment in the project was a $2.5 million equity contribution. NTSC provides voice, data, and video services for NTS Telephone Company and also provides billing, sales and marketing, back and front offices services to this subsidiary. NTSC receives a management fee from NTS Telephone Company equal to 15% of its revenues. NTSC began marketing its triple-play service in limited areas of Levelland in 2009 and construction was completed on April 8, 2010. NTSC intends to continue to work diligently to secure sales and complete installations in pursuit of its take rate goals. 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. 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 was 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 completed our FTTP PRIDE network in Lamesa, Littlefield, Plainview, Burkburnett, Iowa Park, Brownfield, Slaton, and Whitharral, Texas and in Hammond, Louisiana, and started to record revenues from these markets which are expected to increase during 2014. The fundings are contingent upon PRIDE Network meeting the terms of the loans, grants or loans/grants agreement. NTSC also commenced 3 metro build projects in Abilene, Amarillo, Wichita Falls, all located in Texas. The builds are focused primarily on business customers and should add more than 3,500 passings to our network by 2014. The builds are financed through a delayed draw down term loan with ICON Agent, LLC. 18-------------------------------------------------------------------------------- TABLE OF CONTENTS 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. COMPARISON FINANCIAL INFORMATION YEARS ENDED DECEMBER 31, 2013 AND 2012 - PERCENTAGE OF REVENUES: Year Ended December 31, 2013 2012 Revenues: Services on Fiber-To-The-Premise network 39.4 % 30.4 % Leased local loop services and other 60.6 % 69.6 % Total Revenues 100 % 100 % Expenses: Cost of services (excluding depreciation and amortization) 43.0 % 45.9 % Selling, general and administrative 37.3 % 34.8 % Depreciation and amortization 12.4 % 10.5 % Financing expenses, net 10.7 % 9.3 % Other expenses 1.4 % 1.1 % Total expenses 104.9 % 101.6 % Loss before taxes (4.9) % (1.6) % Income tax benefit 1.6 % 0.7 % Net loss (3.3) % (0.9) % COMPARISON OF THE YEARS ENDED DECEMBER 31, 2013 AND 2012 Revenues. Revenues for the year ended December 31, 2013 decreased 0.5% to $59,587,246 from $59,870,468 for the same period in 2012. Revenues from NTS' Fiber-To-The-Premise ("FTTP") network include revenues from the delivery of products and services via its fully owned FTTP network. These products and services include video, high speed Internet and voice as well as broadband connectivity for private network within the footprint of NTS' FTTP network. Revenues from our FTTP network in the year ended December 31, 2013 increased 28.7% to $23,454,091 from $18,219,615 in the same period in 2012. As percentage of total sales, FTTP revenues in the year ended December 31, 2013 increased to 39.4% from 30.4% for the year ended December 31, 2012. 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, a subsidiary of NTSC and other communities in the region of West Texas. 19-------------------------------------------------------------------------------- TABLE OF CONTENTS 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, 2013 decreased 13.2% to $36,133,155 from $41,650,853 for the same period in 2012. As a percentage of total sales, leased local loop revenues in the year ended December 31, 2013 decreased to 60.6% from 69.6% for the same period in 2012. The decrease in revenues was caused by the aggressive competition in NTS' non-FTTP markets. NTS expects that the decline in revenues from non-FTTP residential customers will continue in 2014, but will be offset by the increase in revenues in FTTP from business and residential customers. 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, 2013 decreased 6.7% to $25,643,381 from $27,489,743 for the same period in 2012. Cost of services, as a percentage of revenues in the year ended December 31, 2013, decreased to 43.0% from 45.9% in the same period in 2012. We expect that the trend of decline in cost of services, as a percentage of revenues, will continue 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, General and Administrative expenses consist primarily of compensation costs for our sales, administrative and management employees. Selling, general and administrative expenses for the year ended December 31, 2013, increased 6.9% to $22,246,333 from $20,802,001 for the same period in 2012. The increase was the result of the write-off of $519,435 of assets acquired during various acquisitions in which management had determined they would not be able to obtain successful resolution and the continued assessment by management of the allowance for doubtful accounts which resulted in an increase of bad debt expense of $921,379 during the second quarter of 2013. This was offset by a decrease in payroll expenses which 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 and an increase in compensation in connection with the issuance of options to NTS' directors and employees. As a percentage of revenues, selling, general and administrative expense increased by 2.6%. Depreciation and Amortization. Depreciation and amortization expense for the year ended December 31, 2013 increased 17.6% to $7,380,483 from $6,274,488 for the same period in 2012. 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, 2013, increased 15.1% to $6,388,327 from $5,551,080 for the same period in 2012. Financing expenses consist of interest payable on NTS' financial obligations, and the measurement of the Bonds, which are stated in NIS and linked to the Israeli Consumer Price Index (the "CPI"). The increase in financing expense is a result of the increase in outstanding loans from the United States Department of Agriculture and ICON Agent, LLC which was offset by a non-recurring amortization of deferred compensation related to the repayment of the term loan from Burlingame Equity Investors LP. Other Expenses. Other expenses for the year ended December 31, 2013 increased 23.1% to $845,035 from $686,519 for the same period in 2012. Other expenses consist of real estate taxes, which were offset in 2012 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. 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 expenses, non-deductible compensation related to stock options and non-deductible amortization of intangible assets, we had a tax benefit for the year ended December 31, 2013 and 2012 and our effective tax rate was 33.0% and 41.4% for the years ended December 2013 and 2012, respectively. Net Loss. As a result of the foregoing, net loss for the year ended December 31, 2013 increased 257.3% to $1,954,347 from $546,993 for the same period in 2012. LIQUIDITY AND CAPITAL RESOURCES Cash and cash equivalents as of December 31, 2013 amounted to $4,981,942 compared to $3,908,620 as of December 31, 2012, an increase of $1,073,322. Net cash provided by operating activities in the year ended December 31, 2013 was $7,425,690, an increase of $3,899,866 compared to $3,525,824 which was provided by operating activities in the year ended December 31, 2012. The increase in cash flow from operating activities is mostly related to the following changes: (1) an increase in accounts receivable of $762,351 during the year ended December 31, 2013, compared to an increase of $1,669,435 in the same period of 2012; (2) a decrease in prepaid expenses and other receivables of $750,248 in the year ended December 31, 2013, compared to an increase of $8,782 in the same period of 2012; (3) an increase in trade payables of $2,033,922 during the year ended December 31, 2013, compared to a decrease of $1,482,871 during the same period of 2012. Cash used in investing activities for the year ended December 31, 2013, was $17,111,832 compared to $20,413,286 for the same period of 2012. Of that amount, $8,553,249 is attributable to the build out of our PRIDE Network projects and FTTP projects in Levelland, TX in year ended December 31, 2013, compared to $17,187,267 for the same period of 2012 and $8,558,583 is attributable to the purchase of other equipment in year ended December 31, 2013, compared to $3,226,019 for the same period of 2012. Net cash provided by financing activities for the year ended December 31, 2013, was $10,759,464 compared to $14,232,568 for the same period of 2012 and 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. 20-------------------------------------------------------------------------------- TABLE OF CONTENTS Capital lease obligations: We are the lessee of switching, other telecom equipment and vehicles under capital leases expiring on various dates through 2018. As of December 31, 2013, we reported a working capital deficit of $15,480,918 compared to a working capital deficit of $6,774,208 on December 31, 2012. 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 and the delay of the amortization schedules of the previously drawn down loans by six months. As of December 31, 2013, we drew down the full amount of the term loan. We believe that increased revenues from our high margin Fiber-To-The-Premise network together with increasing operating efficiency will result in profitability and cash flows, which will lead to improvement in the working capital deficit 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. The following table represents our contractual obligations and commercial commitments, excluding interest expense, as of December 31, 2013: Payments Due by Period Less than More than Contractual Obligations Total 1 Year 1-3 Years 4-5 Years 5 Years Domestic Note Payable $ 20,749,346 $ 3,413,096 $ 6,030,000 $ 11,306,250 $ - Notes Payable from the United States Department of Agriculture 44,186,615 2,266,361 4,532,721 4,532,721 32,854,812 Bonds 7,725,559 4,197,510 3,528,049 - - Capital leases 746,827 261,894 292,614 192,319 - Operating leases 907,205 444,206 446,962 16,037 - Total contractual cash obligations $ 74,315,552 $ 10,583,067 $ 14,830,346 $ 16,047,327 $ 32,854,812 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 interest annually 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. 21-------------------------------------------------------------------------------- TABLE OF CONTENTS On November 4, 2008, we filed a public prospectus (the "Prospectus") with the Israel Securities Authority 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 in September 2012. The Series A Bonds may only be traded in Israel. On November 5, 2013, Midroog Limited, an Israeli rating company which is a subsidiary of Moody's Investor Services ("Midroog") filed with the TASE an annual monitoring report, reaffirming the Ba1 rating of the Series A Bonds, however, Midroog's rating committee decided on a developing outlook on the rating of the Series A Bonds in light of the recently announced Merger Agreement. 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) us, 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: (i) An additional secured term loan in the amount of $3,500,000, for the payment of all liabilities owed to Burlingame (the "Second ICON Loan"), (ii) A secured delayed draw 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 (iii) 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 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 ("Amendment No. 2"). 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 loan 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 (the "Fourth ICON Loan"), 22-------------------------------------------------------------------------------- TABLE OF CONTENTS (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. On March 28, 2013, we entered into Amendment No. 4 to the Original ICON Agreement which contains some definitional clarifications. On the same day, we drew down under the Fourth ICON Loan in the aggregate amount of $1,700,000 which was the first draw down under the Fourth ICON Loan. The principal amount of the first draw down under the Fourth ICON Loan is payable in 51 consecutive monthly installments with the first nine monthly payments being payments of accrued interest only. On June 27, 2013, we entered into Amendment No. 5 to the Original ICON Agreement which makes certain technical amendments to the Original ICON Loan Agreement and waives a certain condition for the availability of the Fourth ICON Loan. In addition, on June 27, 2013, we drew down on the Fourth ICON Loan in the aggregate amount of $4,300,000 which was the second draw down under the Fourth ICON Loan. The principal amount of the second draw down under the Fourth ICON Loan is payable in 48 consecutive monthly installments with the first six 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. Pursuant to the Original ICON Agreement (as amended), we are required to maintain a 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. In addition, 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, 2013, we complied with the foregoing financial covenants. The total outstanding amount of the loans as of December 31, 2013 is $20,100,000. As of December 31, 2013, there are no amounts available for future draws. US subsidiaries NTS Telephone Company, LLC, a wholly-owned subsidiary of NTSC, received from the Rural Utilities Service ("RUS"), a division of the United States Department of Agriculture, $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 $16.1 million at December 31, 2013. As of December 31, 2013, the annual average weighted interest rate on the outstanding advances was 3.52%. 23-------------------------------------------------------------------------------- TABLE OF CONTENTS The total outstanding amount of these loans as of December 31, 2013 and December 31, 2012 is $8,839,862 and $9,589,321, respectively. The loans are to be repaid in monthly installments until 2023. 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, 2013 is $37,861,612 and $31,871,189, 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 rollout of our FTTP infrastructure, known as the PRIDE Network, and bring broadband services to northwestern Texas and 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 $56.9 million at December 31, 2013. As of December 31, 2013, the annual average weighted interest rate on the outstanding advances was 2.69%. As of December 31, 2013, the total amount of loan and grant to be available in the future is $16,131,426 and $14,005,730, respectively. The loans are to be repaid in monthly installments until 2030. The total outstanding amounts of these loans as of December 31, 2013 and December 31, 2012 are $35,346,753 and $27,748,342, respectively. As of December 31, 2013 and 2012, we recorded grants receivable of $1,008,733 and $974,120, respectively. Accounts payable of $1,350,006 and $1,013,880 that was financed by a long-term loan received during 2014 and 2013, respectively, is included in long-term liabilities. 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, 2013 is $141,833. 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, 2013 is $168,941. 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, 2013, our outstanding liability was increased by 7.02% as a result of the devaluation of the NIS in relation with the USD and an increase of 1.9% adjustment to the Israeli CPI. We may use foreign currency exchange contracts and other derivative instruments to be the appropriate tool for managing such exposure. 24-------------------------------------------------------------------------------- TABLE OF CONTENTS 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. 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 ensure 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. |