OTELCO INC. Overview
General
Since 1999, we have acquired and operate eleven RLECs serving subscribers in north centralAlabama , centralMaine , westernMassachusetts , centralMissouri , westernVermont and southernWest Virginia . We also operate a CLEC serving subscribers inMaine ,Massachusetts andNew Hampshire . Our services include a broad suite of communications and information services including local and long distance telephone services; internet and broadband data services; network access to other wireline, long distance and wireless carriers for calls originated or terminated on our network; other telephone related services; cloud hosting and professional engineering services for small and mid-sized companies who rely on mission-critical software applications; 17
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digital high-speed transport services (in ourNew England market); and video and security (in some markets). We view, manage and evaluate the results of operations from the various telecommunications services as one company and therefore have identified one reporting segment as it relates to providing segment information. TheFCC released theFCC ICC Order inNovember 2011 . This order has made and continues to make substantial changes in the way telecommunication carriers are compensated for serving high cost areas and for completing traffic with other carriers. We began seeing the significant impact of theFCC ICC Order to our business inJuly 2012 , with additional impacts beginning inJuly 2013 andJuly 2014 . The initial consequence to our business was to reduce access revenue from intrastate calling inMaine and other states where intrastate rates were higher than interstate rates. A portion of this revenue loss for our RLEC properties is returned to us through the CAF. There is no recovery mechanism for the lost revenue in our CLEC. Support under the A-CAM model-based approach is higher than the estimated support which would have been received under legacy rate-of-return regulation. Without the A-CAM model-based support, in 2017 our RLECs would have seen a normal year-over-year funding decrease under USF HCL and theFCC 's Budget Control mechanism. A-CAM support requires additional investment in plant and equipment to reach target broadband speeds and covered locations. A-CAM support will decline through 2028 as the additional investment is completed. The Tax Cuts and Jobs Act (the "Tax Act") passed inDecember 2017 reduced our cash tax liability. Specifically, both the lower income tax rate and the extension of bonus depreciation under the Tax Act positively affect our federal tax requirements. The limitation on interest deductibility under the Tax Act is not expected to affect our tax liabilities. COVID-19 A novel strain of coronavirus (COVID-19) was first identified inDecember 2019 , and subsequently declared a global pandemic by theWorld Health Organization onMarch 11, 2020 . As a result of the outbreak, companies have experienced disruptions in their operations and in markets served. We instituted numerous precautionary measures intended to help ensure the well-being of our employees, to continue providing essential telecommunications services to our customers and minimize business disruption. As COVID-19 restrictions were eased in some states, our employees who had been working from home sinceMarch 2020 began returning to their normal work locations while we continue to empower our technicians to reschedule any in-person installation or repair if they determine that circumstances at the location present a health risk. As the virus infection rate began increasing, we provided flexibility for employees who could effectively work from home with the option to do so. During third quarter 2020, we saw customer calls for new and changed service, payment arrangements and service troubles begin to trend toward pre-COVID-19 levels. As a result of the measures implemented, no significant adverse impact on our results of operations through and financial position atDecember 31, 2020 , has occurred as a result of the pandemic. The full extent of the future impacts of the COVID-19 pandemic on our operations is uncertain. The continued increase of COVID-19 cases in our service areas could have a material adverse impact on our financial results and business, including our timing and ability to collect accounts receivable and procure materials and services from our suppliers. CARES Act The Coronavirus Aid, Relief and Economic Security Act (the "CARES Act") was enacted onMarch 27, 2020 . There are several different provisions with the CARES Act that affect income taxes for corporations. We have evaluated the tax implications and believe these provisions did not have a material impact on our financial statements. Additionally, we applied for and received funds under the Paycheck Protection Program (the "PPP Loan") in the amount of$2,975,000 . The receipt of these funds, and the forgiveness of the loan attendant to these funds, is dependent on the Company having initially qualified for the loan and qualifying for the forgiveness of such loan based on our adherence to the updated forgiveness criteria included in the Paycheck Protection Program Flexibility Act ("PPP Flexibility Act"). We submitted the application for loan forgiveness of the full 18
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loan amount onOctober 1, 2020 , and completed the additional information request form of theSmall Business Administration (the "SBA") onDecember 2, 2020 . Request for loan forgiveness from the SBA has been made, but approval has not been received. Our PPP Loan has a two-year term and bears interest at a rate of 1.0% per annum. Under the PPP Flexibility Act, monthly principal and interest payments are deferred until the date the lender receives the applicable forgiven amount from the SBA. The PPP Loan may be prepaid at any time prior to maturity with no prepayment penalties. The promissory note contains events of default and other provisions customary for a loan of this type. The PPP Loan was used to retain our employees and allow them to be able to continue to provide essential telecommunications and data services for our customers during the initial peak of the COVID-19 pandemic. These services were and remain critical to customers as they work and live under physical separation and quarantine requirements. Given direction from theFCC and state public utilities commissions, free or discounted services were made available to families who receive other governmental assistance and service disconnection for non-payment was delayed for four months where families and businesses were experiencing COVID-19 financial constraints. Consent of the agent and Required Lenders (as defined in the Credit Facility) under the Credit Facility was obtained in connection with the incurrence of the PPP Loan. We will continue to work with federal, state and local governmental bodies to be responsive to COVID-19 guidance and CARES Act requirements. The following discussion and analysis should be read in conjunction with our consolidated financial statements and the related notes included in Item 8, Financial Statements and Supplementary Data, and the other financial information appearing elsewhere in this report. The following discussion and analysis relates to our financial condition and results of operations on a consolidated basis. Revenue Sources We derive our revenues from six sources: • Local services. We receive revenues from providing local exchange telecommunication services in our eleven rural territories. In addition, we receive revenues on a competitive basis through both wholesale and retail channels throughoutMaine ,New Hampshire and westernMassachusetts . These revenues include monthly subscription charges for basic service, calling beyond the local territory on a fixed price and on a per minute basis, local private line services and enhanced calling features, such as voicemail, caller identification, call waiting and call forwarding. We also receive revenues from directory advertising. A significant portion of our rural subscribers take bundled service plans which include multiple services, including unlimited domestic calling, for a flat monthly fee.
•
Network access. We receive revenues from charges established to compensate us for the origination, transport and termination of calls of long distance, wireless and other interexchange carriers. These include subscriber line charges imposed on customers and switched and special access charges paid by carriers. Switched access charges for long distance services withinAlabama ,Maine ,Massachusetts ,Missouri ,New Hampshire ,Vermont andWest Virginia have historically been based on rates approved by the APSC, MPUC, MDTC, MPSC, NHPUC, VPUC and WVPSC, respectively, where appropriate. TheFCC ICC Order preempted the state commissions' authority to set terminating intrastate access service rates, and required companies with terminating access rates higher than interstate rates to reduce their terminating intrastate access rates to a rate equal to interstate access service rates byJuly 1, 2013 , and to move to a "bill and keep" arrangement byJuly 1, 2020 , which has eliminated access charges between carriers. TheFCC ICC Order prescribes a recovery mechanism for the recovery of any decrease in intrastate terminating access revenues through the CAF for RLEC companies. This recovery is limited to 95% of the previous year's revenue requirement. Interstate access revenue is based on anFCC -regulated rate-of-return on investment and recovery of expenses and taxes. From 1990 throughJune 2016 , the rate-of-return had been authorized up to 11.25%. InMarch 2016 , theFCC reduced the authorized rate-of-return to 9.75% effectiveJuly 1, 2021 , using a transitional approach to reduce the impact of an immediate reduction. Rate-of-return transition began onJuly 1, 2016 , with the authorized rate reduced to 11.0%, with further 25 basis points reductions eachJuly 1 thereafter until the authorized rate reaches 9.75% onJuly 1, 2021 . Switched and special access charges for interstate and international 19
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services are based on rates approved by theFCC . We also receive revenue from the USF for the deployment of voice and broadband services to end-user customers. SinceJanuary 1, 2017 , ten of our RLECs receive support payments through A-CAM. One RLEC received support payments through modified legacy rate-of-return support mechanisms for USF HCL and ICLS for 2017 and 2018 and A-CAM support payments for 2019 and 2020. • Internet. We receive revenues from monthly recurring charges for digital high-speed data lines and ancillary services, such as web hosting and computer virus protection. • Transport services. We receive monthly recurring revenues for the rental of fiber to transport data and other telecommunication services inAlabama ,Maine andNew Hampshire . •
Video and security. We offer basic, digital, high-definition, digital video
recording and pay-per-view cable television services to a portion of our
telephone service territory in
•
Managed services. We provide private/hybrid cloud hosting services, as well as consulting and professional IT engineering services, for mission-critical software applications for small and mid-sized North American companies. Revenues are generated from monthly recurring hosting IaaS fees, monthly maintenance fees, à la carte professional engineering services and pay-as-you-use SaaS fees. Services are domiciled in two diverse owned data centers. Customer Trends The number of voice and data customers we serve and the number of services provided to those customers have an impact on our revenue stability. Reflecting a general trend in the RLEC industry, the number of rural residential voice customers we serve has been decreasing each year, while residential data lines and business voice and data lines have been more stable. Data services in 2020 increased as a result of providing the availability of increased data speeds throughout the territory we serve and the increase in work/learn-from-home requirements associated with the pandemic. We expect that these trends will continue and may be further influenced by competition from cable and co-operative electric providers in our RLEC territories, the availability of alternative telecommunications products, such as cellular data and IP-based services, as well as demand associated with responses to the pandemic. The growth of data lines and the increase in data speed requirements of our customer base partially offsets the loss of residential voice lines. Our ability to grow CLEC and RLEC business voice and data lines will have an important impact on our future revenues. The expansion of fiber-to-the premise and increased data speeds in the last eighteen months has improved the customer attrition rate and generated an increase in data services provided to customers.Otelco Inc. - Key Operating Statistics Change from Change fromDecember 31 ,September 30 ,June 30 ,March 31 ,December 31 ,December 31 ,December 31 , December 31, 2020 2020 2020 2020 2019 2019 2018 2018 Customers served Business/ Enterprise 5,120 5,131 5,192 5,241 5,337 (217) (4.1)% 5,769 (432) (7.5)% Residential 27,495 27,604 27,901 27,363 26,917 578 2.1% 27,734 (817) (2.9)% Customers served 32,615 32,735 33,093 32,604 32,254 361 1.1% 33,503 (1,249) (3.7)% Services provided Hosted PBX 8,005 7,994 8,010 8,199 8,685 (680) (7.8)% 9,008 (323) (3.6)% Voice 30,602 31,957 32,997 33,456 34,038 (3,436) (10.1)% 36,899 (2,861) (7.8)% Data 23,392 23,258 23,373 22,710 22,242 1,150 5.2% 22,514 (272) (1.2)% Video 2,585 2,660 2,683 2,662 2,669 (84) (3.1)% 2,734 (65) (2.4)% Services provided 64,584 65,869 67,063 67,027 67,634 (3,050) (4.5)% 71,155 (3,521) (4.9)% The following is a discussion of the major factors affecting our customer and services operating statistics: Competition. We face competition from cable providers or electric co-operatives in the majority of our RLEC territories, which primarily affects our residential voice and data lines. We also experience residential 20
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voice line losses to wireless carrier substitution. We have responded to competition by offering bundled service packages, which include unlimited domestic calling; features like voice mail and caller identification; data lines; and, where possible, television services. These service bundles are designed to meet the broader communications needs of our customers at industry competitive prices. There are a number of established competitive providers in ourMaine ,Massachusetts and New Hampshire CLEC markets. The effectiveness of our sales force, the pricing of our products and the market perception of the quality of our service are critical to our success in these markets. Cyclical Economic and Industry Factors. We believe that changes in global economic conditions have and will continue to have an impact on our voice line count. The rural nature of much of the territory we serve delays both the negative and positive response to the economy's impact on our customer base. Our Rate and Pricing Structure Our CLEC enterprise pricing is based on market requirements. We combine varying services to meet individual customer requirements, including technical support, and provide multi-year contracts that are both market sensitive for the customer and profitable for us. The MPUC, MDTC and NHPUC impose minimum requirements on all CLECs operating in their markets for reporting and for interactions with the various incumbent local exchange and interexchange carriers. These requirements provide wide latitude in pricing and delivery of services. Our RLECs operate in six states and have limited regulation by the respective state regulatory authorities. The impact on pricing flexibility varies by state. InMaine andVermont , our regulated subsidiaries have obtained authority to implement pricing flexibility while remaining under rate-of-return regulation. Our rates for other services we provide, including cable, long-distance, data lines and high-speed internet access, are not price regulated. The market for competitive services, such as wireless, also affects the ability to adjust prices. With the increase of bundled services offerings, including unlimited long distance, pricing for individual services takes on reduced importance to revenue stability. We expect this trend to continue into the immediate future. Alabama RLECs have state service funds, which were implemented more than a decade ago as part of balancing local service pricing and long distance access rates. These funds were intended to neutralize the revenue impact on state RLECs from pricing shifts implemented to reduce access rates over time.The Alabama Transition Service Fund provided total compensation of$0.9 million for the year endedDecember 31, 2018 ,$0.8 million for the year endedDecember 31, 2019 , and$0.6 million for the year endedDecember 31, 2020 , representing approximately 1.4%, 1.2% and 1.0% of our total revenue for the years endedDecember 31, 2018 , 2019 and 2020, respectively. The revenue we receive from these funds is being phased out over a five-year period that began inJune 2016 , with no revenue received afterJune 2021 . Categories of Operating Expenses Our operating expenses are categorized as cost of services; selling, general and administrative expenses; and depreciation and amortization. Cost of services. This includes expenses for salaries, wages and benefits relating to plant operation, maintenance, sales and customer service; other plant operations, maintenance and administrative costs; network access costs; and costs of services for long distance, cable television, internet and directory services. Selling, general and administrative expenses. This includes expenses for salaries, wages and benefits and contract service payments (for example, legal fees) relating to engineering, financial, human resources and corporate operations; information management expenses, including billing; allowance for uncollectible revenue; expenses for travel, lodging and meals; internal and external communications costs; insurance premiums; stock exchange and banking fees; and postage. Depreciation and amortization. This includes depreciation of our telecommunications, cable and internet networks and equipment, and amortization of intangible assets. Certain of these amortization expenses continue to be deductible for tax purposes. 21
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Our Ability to Control Operating Expenses We strive to control expenses in order to maintain our operating margins. As our revenue continues to shift to non-regulated services and CLEC customers, and our access and residential RLEC revenues continue to decline, operating margins decrease due to the lower margins associated with non-regulated services. Reductions in USF and intercarrier compensation payments based onFCC action in 2011 are difficult to fully offset through expense control and pricing action. However, A-CAM began providing support funding to increase capital investment in broadband services in our RLECs in 2017, which will continue for twelve years. Results of Operations The following discussion and analysis of our Results of Operations includes comparisons of our results for the year endedDecember 31, 2020 with the year endedDecember 31, 2019 . For a similar discussion that compares our results for the year endedDecember 31, 2019 with the year endedDecember 31, 2018 , see Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations - Results of Operations in Part II of our 2019 Annual Report on Form 10-K. Year Ended December 31, 2020 2019 Revenues Local services 29.7% 30.8% Network access 32.1 33.8 Internet 25.5 23.3 Transport services 7.0 6.7 Video and security 4.6 4.4 Managed services 1.1 1.0 Total revenues 100.0% 100.0% Operating expenses Cost of services 48.8 47.9 Selling, general and administrative expenses 19.2 16.3 Depreciation and amortization 13.4 12.2 Total operating expenses 81.4 76.4 Income from operations 18.6 23.6 Other income (expense) Interest expense (6.5) (8.4) Other income 1.3 1.0 Total other expenses (5.2) (7.4) Income before income tax expense 13.4 16.2 Income tax expense (3.2) (3.8) Net income 10.2% 12.4% Year EndedDecember 31, 2020 , Compared to Year EndedDecember 31, 2019 Total Revenues. Total revenues decreased 1.3% in 2020 to$62.0 million from$62.8 million in 2019. The table below provides the components of our revenues for 2020 compared to 2019. 22
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Year Ended December 31, Change
2020 2019 Amount Percent
(Dollars in Thousands)
Local services $ 18,367 $ 19,313 $ (946) (4.9)%
Network access 19,881 21,210 (1,329) (6.3)
Internet 15,812 14,646 1,166 8.0
Transport services 4,363 4,236 127 3.0
Video and security 2,840 2,735 105 3.8
Managed services 708 626 82 13.1
Total $ 61,971 $ 62,766 $ (795) (1.3)
Local services. Local services revenue in 2020 decreased 4.9% to $18.4 million
from $19.3 million in 2019. Local and related service revenue, including long
distance and directory revenue, decreased $0.5 million in 2020 compared to 2019,
reflecting the decline in residential voice lines and the impact of the FCC ICC
Order. Fiber and ethernet revenue decreased $0.2 million and customer special
line fees decreased $0.2 million during the same period.
Network access. Network access revenue in 2020 decreased 6.3% to $19.9 million
from $21.2 million in 2019. A-CAM revenue increased $0.5 million while CAF
revenue decreased $0.2 million in 2020 compared to 2019. Switched and special
access revenue decreased $0.5 million and transition support payments decreased
$0.4 million during the same period as part of the FCC ICC Order. End-user based
charges, including USF fees, decreased $0.7 million during the same period from
lower residential voice customers.
Internet. Internet revenue in 2020 increased 8.0% to $15.8 million from
$14.6 million in 2019. Demand for broadband access and higher data speeds
increased as a result of work/school-from-home during the pandemic and
additional installed fiber and other network improvements.
Transport services. Transport services revenue in 2020 increased 3.0% to
$4.4 million from $4.2 million in 2019. The increase is associated with an
increase in wholesale transport services.
Video and security. Video and security revenue in 2020 increased 3.8% to
$2.8 million from $2.7 million in 2019, representing an increase in price to
cover higher content cost, partially offset by a small decline in cable
customers.
Managed services. Managed services revenue in 2020 increased 13.1% to
$0.7 million from $0.6 million in 2019, representing higher professional
services and cloud hosting revenue during the period.
Operating expenses. Operating expenses increased 5.2% in 2020 to $50.4 million
from $47.9 million in 2019. The table below provides the components of our
operating expenses for 2020 compared to 2019.
Year Ended December 31, Change
2020 2019 Amount Percent
(Dollars in Thousands)
Cost of services $ 30,251 $ 30,075 $ 176 0.6%
Selling, general and administrative expenses 11,869 10,204 1,665 16.3
Depreciation and amortization 8,309 7,643 666 8.7
Total $ 50,429 $ 47,922 $ 2,507 5.2
Cost of services. Cost of services increased 0.6% to $30.3 million in 2020
from $30.1 million in 2019. Cable and internet expense increased $0.3 million
and network operations expenses increased by $0.3 million . These increases were
partially offset by a decrease in cost of toll, access and circuit expense of
$0.4 million .
Selling, general and administrative expenses. Selling, general and
administrative expenses increased 16.3% to $11.9 million in 2020 from
$10.2 million in 2019. Board project expense, including legal work associated
with the Oak Hill transaction, increased $1.4 million . Human resources cost and
uncollectible
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expense associated with the pandemic increased$0.3 million . Insurance and property taxes increased$0.1 million . These increases were partially offset by decreases in executive compensation and interstate settlements of$0.2 million . Depreciation and amortization. Depreciation and amortization increased 8.7% to$8.3 million in 2020 from$7.6 million in 2019. RLEC regulated services depreciation increased$0.6 million and RLEC unregulated services depreciation increased$0.2 million , reflecting growth in fiber and internet investment. CLEC depreciation decreased$0.1 million . Year Ended December 31, Change 2020 2019 Amount Percent (Dollars in Thousands) Interest expense$ (4,025) $ (5,271) $ (1,246) (23.6)% Other income 820 616 204 33.1 Income tax expense (2,030) (2,393) (363) (15.2) Interest expense. Interest expense decreased 23.6% in 2020 to$4.0 million from$5.3 million in 2019. Lower interest rates and lower outstanding principal balance on our credit facility accounted for the decrease. Other income. Other income increased 33.1% in 2020 to$0.8 million from$0.6 million in 2019, relating to the one-time gains on the sale of a surplus vacant building and a parcel of property. The annual CoBank dividend represents the majority of other income and is received in first quarter of each year. Income tax expense. The provision for income tax decreased 15.2% to$2.0 million in 2020 from$2.4 million in 2019. The effective income tax rate was 24.3% and 23.5% for 2020 and 2019, respectively. Net income. As a result of the foregoing, there was net income of$6.3 million in 2020 compared to$7.8 million in 2019. Liquidity and Capital Resources The following discussion and analysis of our Liquidity and Capital Resources includes comparisons of our cash flows for the year endedDecember 31, 2020 with the year endedDecember 31, 2019 . For a similar discussion that compares our cash flows for the year endedDecember 31, 2019 with the year endedDecember 31, 2018 , see Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources in Part II of our 2019 Annual Report on Form 10-K. Our liquidity needs arise primarily from: (i) principal and interest payments related to our credit facility; (ii) capital expenditures for investment in our business, including A-CAM requirements; and (iii) working capital requirements. Historically, we have satisfied our operating cash requirements from the cash generated by our business and utilized borrowings under our credit facilities to support larger acquisitions. For the year endedDecember 31, 2020 , we generated cash from our business to invest in additional property and equipment; pay scheduled principal payments on our credit facility; and pay interest on our debt. Cash increased from$3.1 million atDecember 31, 2019 , to$8.4 million atDecember 31, 2020 . During 2020, we reduced the balance of our notes payable by$4.3 million from$70.2 million as ofDecember 31, 2019 , to$65.9 million as ofDecember 31, 2020 . Our credit facility requires annual principal reduction of$4.3 million paid equally on a quarterly basis and an annual principal payment equal to 50% of our excess cash flow for the year. No excess cash flow payment was made inMarch 2020 . An excess cash flow payment for 2020 of$3.1 million will be made onMarch 31, 2021 . InApril 2020 , we received a$2.975 million PPP Loan, for which we have filed the application to have the loan forgiven. The receipt of these funds, and the forgiveness of the loan attendant to these funds, is dependent on the Company having initially qualified for the loan and qualifying for the forgiveness of such loan based on our adherence to the updated forgiveness criteria included in the PPP Flexibility Act. The outcome of this forgiveness application is uncertain. In addition, the CARES Act allowed companies to delay payment of certain 2020 payroll taxes for two years. We have deferred$0.5 million in payroll taxes which will be paid in 2021 and 2022. Cash flows from operating activities for 2020 were$16.8 million compared to$15.5 million for 2019, primarily reflecting lower net income offset by a positive change in operating assets and liabilities. 24
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Cash flows used in investing activities for 2020 were$9.8 million compared to$12.4 million for 2019, reflecting a reduction in the acquisition and construction of property and equipment, including building fiber to support our A-CAM build requirements and customer demand for increased internet speeds. Cash flows used in financing activities for 2020 were$1.6 million compared to$4.6 million for 2019, primarily reflecting the PPP Loan proceeds in 2020. We do not use financial instruments as part of our business strategy. However, our new credit facility required that we maintain an interest rate hedge on at least 50% of our outstanding notes payable balance for a period of at least two years. Accordingly, we purchased a two-year 3.0% interest rate cap on one-month LIBOR covering$45.0 million onFebruary 26, 2018 . The interest rate cap was not treated under the hedge accounting option and expired onFebruary 25, 2020 . We also have received patronage shares, primarily from one of our bank lenders, over a period of years for which there is a limited market to determine value until the shares are redeemed by the issuing institution. Historically, these shares have been redeemed at a value similar to their issued value. No patronage shares were redeemed in 2019 or 2020. No patronage shares are expected to be redeemed until we reach the required holding level of patronage shares, which is likely to be several years in the future. OnNovember 2, 2017 , we entered into a five-year credit facility, providing for a term loan facility in the aggregate principal amount of$87.0 million , a$5.0 million revolving credit facility, and an incremental term loan facility in an aggregate principal amount of up to$20.0 million , subject to the satisfaction of certain conditions and lender participation. See Item 8, Financial Statements and Supplementary Data - Note 7, Notes Payable, for additional information about our credit facility with CoBank, ACB. We anticipate that operating cash flow, together with borrowings under our revolving credit facility, will be adequate to meet our currently anticipated operating and capital expenditure requirements for at least the next 12 months. Our indebtedness levels have been reduced each year and the related debt service requirements have been reduced with our current credit facility. These factors assist us in meeting our capital expenditure requirements under A-CAM. However, as a result of our capital expenditure requirements under A-CAM, we may not retain a sufficient amount of cash to finance growth opportunities or unanticipated capital expenditure needs or to fund our operations in the event of a significant business downturn. We may have to forego growth opportunities or capital expenditures that would otherwise be necessary or desirable if the proposed Merger approved by our stockholders does not close. If we do not have sufficient cash for these purposes, our financial condition and our business will suffer. We use consolidated earnings before interest, taxes, depreciation and amortization, which we refer to as Consolidated EBITDA, and the ratio of our debt, net of cash, to Consolidated EBITDA for the last twelve months, which we refer to as the Leverage Ratio, as operational performance measurements. Consolidated EBITDA, as presented in this report, corresponds to the definition of Consolidated EBITDA in our credit facility. Consolidated EBITDA and the Leverage Ratio, as presented in this report, are supplemental measures of our performance that are not required by, or presented in accordance with, accounting principles generally accepted inthe United States , which we refer to asU.S. GAAP. The lender under our credit facility uses Consolidated EBITDA to determine compliance with credit facility requirements. We report Consolidated EBITDA and the Leverage Ratio in our quarterly earnings press release to allow current and potential investors to understand these performance metrics and because we believe that they provide current and potential investors with helpful information with respect to our operating performance, including our ability to generate earnings sufficient to service our debt, and enhance understanding of our financial performance and highlight operational trends. However, Consolidated EBITDA and the Leverage Ratio should not be considered as an alternative to net income or any other performance measures derived in accordance withU.S. GAAP. Our presentation of Consolidated EBITDA and the Leverage Ratio may not be comparable to similarly titled measures used by other companies. Consolidated EBITDA for the years endedDecember 31, 2020 , and 2019, and its reconciliation to net income, is reflected in the table below: 25
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Year Ended December 31,
2020 2019
(Dollars in Thousands)
Net income $ 6,307 $ 7,796
Add: Depreciation 7,994 7,344
Interest expense less interest income 3,504 4,803
Interest expense - amortize loan cost 502 452 Income tax expense 2,030 2,393 Amortization - intangibles 315 299 Loan fees 72 69 Stock-based compensation (senior management) 208 254 Consolidated EBITDA$ 20,932 $ 23,410
The table below provides the calculation of the Leverage Ratio, net of cash, as
of
Notes payable$ 65,040 Debt issuance costs 822 Notes outstanding (excluding PPP Loan)$ 65,862 Less cash (excluding PPP Loan proceeds) (5,470) Notes outstanding, net of cash$ 60,392 Consolidated EBITDA for the last twelve months$ 20,932 Leverage Ratio 2.89 Off-Balance Sheet Arrangements We have no off-balance sheet arrangements. Critical Accounting Policies and Accounting Estimates The process of preparing consolidated financial statements requires us to use of estimates that affect the reported amounts of assets, liabilities, revenues and expenses. These estimates are based on our historical experience and current facts and circumstances, combined with various assumptions which we believe are reasonable in today's understanding of our business, the results of which form the basis for making estimates about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. Certain of our accounting policies are considered critical as they are both important to the portrayal of our financial statements and require significant or complex judgment on the part of management. See Item 8, Financial Statements and Supplementary Data - Note 2, Summary of Significant Accounting Policies, for a description of our critical accounting policies and estimates. We believe that the following accounting estimates are the most critical to understanding and evaluating our reported financial results. Intangible Assets andGoodwill Our intangible assets, other than goodwill, consist primarily of the fair value of customer related intangibles, non-compete agreements and long-term customer contracts acquired in connection with previous business combinations. The current value of these assets is$0.2 million , which will be fully amortized byDecember 31, 2021 , and therefore does not represent a material estimation risk. See Item 8, Financial Statements and Supplementary Data - Note 3,Goodwill and Intangibles Assets, for a description of our intangible assets.Goodwill is not amortized but instead evaluated for impairment annually or whenever an event occurs or circumstances change that would indicate potential impairment. The Company is evaluated as a single 26
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reporting unit. The carrying value of our goodwill atDecember 31, 2020 , was$45.0 million on our Consolidated Balance Sheet from acquisitions sinceOtelco's formation. The annual evaluation is conducted as ofOctober 1 of each year. Beginning in 2011, FASB allowed companies to first assess qualitative factors to determine whether there is more than a 50% likelihood that the fair value of a reporting unit is less than its carrying value (Step 0). The following categories of events and conditions were evaluated to determine their impact on goodwill, in light of the coronavirus pandemic, governmental responses to the pandemic and the changes in the Company's revenue and stock price: • General macroeconomic conditions
•
Industry and market conditions
•
Changes in cost factors
•
Overall financial performance
•
Entity- and reporting unit-specific events
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Sustained decrease in share price
After reviewing the company-specific and market factors, we confirm that, as ofOctober 1, 2020 , the Company's goodwill was not impaired. We determined that no events or circumstances fromOctober 1, 2020 , throughDecember 31, 2020 , indicated that a further assessment was necessary. Changes in the estimated trajectory of the performance of our business could materially impact the valuation of goodwill and potentially lower its value in the future, negatively impacting net income. Depreciation The calculation of depreciation expense is based upon the estimated useful lives of the underlying property and equipment. Depreciation expense of regulated property and equipment is computed principally using the straight-line method over the useful lives as determined by the relevant public utility commission in the state where the asset is place into service. Depreciation expense of unregulated property and equipment primarily employs the straight-line method utilizing industry standard estimated useful lives. A substantial portion of our assets have a useful life that exceeds ten years, Should the sources for our evaluation of the useful lives of plant and equipment change, we would adjust depreciation accordingly. A one year decrease in the estimated useful lives of our property and equipment would result in an increase of approximately$0.9 million in depreciation expense and a decrease of the same amount in net income. See Item 8, Financial Statements and Supplementary Data - Note 4, Property and Equipment for additional financial information. Recently Adopted Accounting Pronouncements See Item 8, Financial Statements and Supplementary Data - Note 2, Summary of Significant Accounting Policies- Recently Adopted Accounting Pronouncements, for a description of the recently adopted accounting pronouncements that are applicable to us. Recent Accounting Pronouncements See Item 8, Financial Statements and Supplementary Data - Note 2, Summary of Significant Accounting Policies- Recent Accounting Pronouncements, for a description of the recent accounting pronouncements that are applicable to us. Item 7A. Quantitative and Qualitative Disclosures about Market Risk Our short-term excess cash balance is invested in short-term commercial paper. We do not invest in any derivative or commodity type instruments. Accordingly, we are subject to minimal market risk on our investments. Interest rates applicable to the term loans (including any incremental term loans incurred under the accordion feature) and the revolving loans (other than the swing line loans) under our credit facility are set at a margin over an adjusted LIBOR rate (which is defined as the higher of (1) LIBOR multiplied by the statutory reserve rate and (2) 0.0% per annum) or a base rate (which is defined as the highest of (a) the prime rate, (b) the 27
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federal funds effective rate plus 0.50% per annum, (c) the adjusted LIBOR rate for an interest period of one month plus 1.00% per annum, and (d) 0.0% per annum), at our option. Interest rates applicable to the swing line loans under our credit facility are set at a margin over the above-mentioned base rate. Accordingly, we are exposed to interest rate risk. Based on the daily average amount of our outstanding variable rate debt during 2020, a one percentage point change in one-month LIBOR interest rates would have resulted in an increase of$0.7 million in our interest expense for the year endedDecember 31, 2020 . 28
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