[August 12, 2011] MDU COMMUNICATIONS INTERNATIONAL INC - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Tweet (Edgar Glimpses Via Acquire Media NewsEdge) The purpose of this discussion is to provide an understanding of the Company's financial results and condition by focusing on changes in certain key measures from year to year. Management's Discussion and Analysis is organized in the following sections: · Forward-Looking Statements · Overview · Summary of Results and Recent Events · Critical Accounting Policies and Estimates · Recently Issued and Not Yet Effective Accounting Pronouncements · Recently Adopted Accounting Pronouncements · Results of Operations - Nine and Three Months Ended June 30, 2011 Compared to Nine and Three Months Ended June 30, 2010 · Liquidity and Capital Resources - Nine Months Ended June 30, 2011 NOTE REGARDING FORWARD-LOOKING STATEMENTS The statements contained in this Management's Discussion and Analysis of Financial Condition and Results of Operations that are not historical in nature are forward-looking within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those indicated in the forward-looking statements. In some cases, you can identify forward-looking statements by our use of words such as "may," "will," "should," "could," "expect," "plan," "intend," "anticipate," "believe," "estimate," "potential" or "continue," or the negative, or other variations of these words, or other comparable words or phrases. Factors that could cause or contribute to such differences include, but are not limited to, the fact that we are dependent on our program providers for satellite signals and programming, our ability to successfully expand our sales force and marketing programs, changes in our suppliers' or competitors' pricing policies, the risks that competition, technological change or evolving customer preferences could adversely affect the sale of our products, the integration and performance of acquisitions, unexpected changes in regulatory requirements and other factors identified from time to time in the Company's reports filed with the Securities and Exchange Commission, including, but not limited to our Annual Report on Form 10-K filed on December 21, 2010 for the period ended September 30, 2010. Although we believe that the expectations reflected in our forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements or other future events. Moreover, neither we nor anyone else assumes responsibility for the accuracy and completeness of forward-looking statements. We are under no duty to update any of our forward-looking statements after the date of this report. You should not place undue reliance on forward-looking statements. In this discussion, the words "MDU Communications," "the Company," "we," "our," and "us" refer to MDU Communications International, Inc. together with its subsidiaries, where appropriate. OVERVIEW MDU Communications International, Inc. is a national provider of digital satellite television, high-speed Internet, voice over IP ("VoIP") and other information and communication services to residents living in the United States multi-dwelling unit ("MDU") market-estimated to include 26 million residences. MDUs include apartment buildings, condominiums, gated communities, universities and other properties having multiple units located within a defined area. The Company negotiates long-term access agreements with the owners and managers of MDU properties allowing it the right to design, install, own and operate the infrastructure and systems required to provide digital satellite television, high-speed Internet, VoIP, and potentially other services, to their residents. 13 -------------------------------------------------------------------------------- MDU properties present unique technological, management and marketing challenges to conventional providers of these services, as compared to single family homes. The Company's proprietary delivery and design solutions and access agreements differentiate it from other multi-family service providers through a unique strategy of balancing the information and communication needs of today's MDU residents with the technology concerns of property managers and owners and providing the best overall service to both. To accomplish this objective, the Company has partnered with DIRECTV, Inc. and has been working with large property owners and real estate investment trusts (REITs) such as AvalonBay Communities, Post Properties, Roseland Property Company, Related Companies, the U.S. Army, as well as many others, to understand and meet the technology and service needs of these groups. The Company derives revenue through the sale of subscription services to owners and residents of MDUs resulting in monthly annuity-like revenue streams. The Company offers two types of satellite television service, Direct to Home ("DTH") and Private Cable ("PC") programming. The DTH service uses a set-top digital receiver for residents to receive state-of-the-art digital satellite and local channel programming. For DTH, the Company exclusively offers DIRECTV® programming packages. From the DTH offerings the Company receives the following revenue, (i) an upfront subscriber commission from DIRECTV for each new subscriber, (ii) a percentage of the fees charged by DIRECTV to the subscriber each month for programming, (iii) a per subscriber monthly fee billed to subscribers for "protection plan" maintenance and services, and (iv) occasional other marketing incentives or subsidies from DIRECTV. Secondly, the Company offers a Private Cable video service where analog or digital satellite television programming can be tailored to the needs of an individual MDU property and received through normal cable-ready televisions. In Private Cable deployed properties, a bundle of programming services is delivered to the resident's cable-ready television without the requirement of a set-top digital receiver in the residence. Net revenues from Private Cable result from the difference between the wholesale prices charged by programming providers and the price charged by the Company to subscribers for the private cable programming package. The Company provides DTH, Private Cable, Internet services and VoIP on an individual subscriber basis, but in many properties it provides these services in bulk (100% of the units), directly to the property owner, resulting in one invoice and thus minimizing churn, collection and bad debt exposure. These subscribers are referred to in the Company's periodic filings as Bulk DTH or Bulk Choice Advantage ("BCA") type subscribers in DIRECTV deployed properties or Bulk PC type subscribers in Private Cable deployed properties. From subscribers to the Internet service, the Company earns a monthly Internet access service fee. Again, in many properties, this service is provided in bulk and is referred to as Bulk ISP. The Company's common stock trades under the symbol "MDTV" on the OTC Bulletin Board. Its principal executive offices are located at 60-D Commerce Way, Totowa, New Jersey 07512 and its telephone number is (973) 237-9499. The Company's website is located at www.mduc.com. SUMMARY OF RESULTS AND RECENT EVENTS Total revenue for the nine month period ended June 30, 2011 increased 5% over the same period in fiscal 2010 from $19,274,086 to $20,254,067. However, recurring revenue between the same periods increased by 9% due to $708,650 in non-recurring HD upgrade subsidy included in the nine months ended June 30, 2010 revenue and $0 in the nine months ended June 30, 2011. EBITDA (as adjusted) for the nine months ended June 30, 2011 also increased significantly over the same period in fiscal 2010 from $1,288,388 to $2,919,334. The Company expects EBITDA (as adjusted) to continue to improve during the remainder of fiscal 2011 as (i) it adds subscribers through organic growth and in recently acquired properties, (ii) direct costs from recent acquisitions continue to normalize and scale is maximized, and (iii) previous revenue generating and cost-saving measures continue to take hold. The Company also experienced a reduction (as a percent of revenue) in direct costs of 2%, in sales expenses of 3%, in customer service and operating expenses of just under 1%, and in general and administrative expense of 1% for the nine months ended June 30, 2011, compared to the nine months ended June 30, 2010. The fact that the Company's expenses were collectively lower as a percent of revenue, while servicing an increased subscriber base, is evidence of the incremental financial benefit realized from new subscriber growth and scale. 14 -------------------------------------------------------------------------------- On April 6, 2011, the Company entered into a new agreement with AT&T Video Services, Inc. to acquire 53 additional properties containing 12,528 units and 5,247 digital video subscribers. The acquisition and transition of these properties subscribers occurred late in the quarter ending June 30, 2011, and as a result, the positive impact on revenue and EBITDA (as adjusted) from these subscribers will not be realized until the Company's fourth fiscal quarter. The Company reports 79,825 subscribers to its services as of June 30, 2011, a 5% increase in its subscriber base from June 30, 2010, however, the Company experienced approximately 1,000 seasonal disconnects during the quarter, which, exclusive of such, would have increased subscriber growth by 6.5%. Additionally, during the quarter ended June 30, 2011, the Company had 20 properties and 6,197 units in work-in-process ("WIP") which will contribute to organic growth in the upcoming quarters. The Company's breakdown of total subscribers by type and kind is outlined below: Subscribers Subscribers Subscribers Subscribers Subscribers as of as of as of as of as of Service Type June 30, 2010 Sept. 30, 2010 Dec. 31, 2010 Mar. 31, 2011 June 30, 2011 Bulk DTH -DIRECTV 15,784 16,143 16,489 16,943 20,328 Bulk BCA -DIRECTV 10,319 10,339 10,418 10,621 10,403 DTH -DIRECTV Choice/Exclusive 17,032 17,477 21,323 21,246 22,577 Bulk Private Cable 17,824 16,112 15,166 13,174 13,125 Private Cable Choice/ Exclusive 3,141 3,010 4,081 3,665 2,669 Bulk ISP 6,102 6,121 5,508 5,887 5,887 ISP Choice or Exclusive 5,689 5,484 5,534 5,356 4,818 Voice 25 26 26 22 18 Total Subscribers 75,916 74,712 78,545 76,914 79,825 The Company's average revenue per unit ("ARPU") at June 30, 2011 was $29.04, a 3% decrease over the year ended September 30, 2010 of $29.82, due mainly to the difference in non-recurring HD upgrade subsidy included in the September 30, 2010 ARPU. ARPU is calculated by dividing average monthly revenues for the period (total revenues during the period divided by the number of months in the period) by average subscribers for the period. The average subscribers for the period is calculated by adding the number of subscribers as of the beginning of the period and for each quarter end in the current year or period and dividing by the sum of the number of quarters in the period plus one. The Company believes that its recurring revenue and ARPU will be positively impacted by (i) an increasing DIRECTV ARPU (the average revenue generated by a DIRECTV subscriber was up 3.9% for DIRECTV's first fiscal quarter to $88.79 (as disclosed in DIRECTV's public filings), (ii) a general increase in recurring revenue realized from price increases and the upgrade of properties to the new DIRECTV HD platform and the associated advanced services, and (iii) an increase in the total number of Choice and Exclusive video subscribers that produce a higher ARPU relative to certain other types of subscribers. DIRECTV currently offers over 160 national HD programming channels - the most full time HD channels of any provider, and its first fiscal quarter 2011 represented an 84% increase in net subscriber additions. The continued launch and advertising campaign for the new DIRECTV HD programming and associated services will continue to provide visibility, incremental revenue and improved penetration rates within Company properties. The Company continued in the third fiscal quarter of 2011 a number of previously announced initiatives which began in fiscal 2010 designed to improve EBITDA (as adjusted) and reduce reliance on debt financing. In particular, the Company (i) concluded the transition of the remaining ATTVS properties, (ii) initiated additional price increases and introduced new pricing bundles for video and broadband services, (iii) rolled out additional premium priced broadband services and tiers to several other of its high-speed Internet properties, (iv) negotiated direct cost reductions for broadband circuits, and (v) continued to push its "Customer Protection Plan" fee requiring annual pre-payment or monthly auto-payment (eliminating time and costs and reducing bad debt exposure). Due to these and prior initiatives, the Company has achieved continued significant growth in EBITDA (as adjusted). The Company continued to expand its relationship with DIRECTV in fiscal 2011. As previously announced, to reduce capital spending, but still concentrate on growth, the Company executed the DIRECTV CapEx Agreement, which will allow the Company to leverage its existing infrastructure to provide DIRECTV with deployment services to certain multi-family properties identified by the Company, but where DIRECTV becomes a party to the right of entry agreement. Once a property is identified by the Company, is under contract with DIRECTV and the satellite system constructed and activated, the Company earns fees from DIRECTV by providing certain services. The CapEx Agreement effectively reduces the Company's capital costs for subscriber growth. 15 -------------------------------------------------------------------------------- During the quarter ended June 30, 2011, the Company entered into a Construction Contractor Agreement with DIRECTV for it to be an authorized contractor to provide DIRECTV with system design and construction services to support DIRECTV's multi-family "Connected Properties" program. Additionally, the Company and DIRECTV have been in discussions that are expected to result in DIRECTV acquiring, for its DIRECTV "Connected Properties" program, a portion of the Company's business assets relating to the provisioning of DIRECTV satellite services to multi-family properties that the Company has previously wired and that are covered under a current "choice" or "competitive" right of entry (access) agreement. In return, the Company would receive an acquisition fee based on each wired unit in the properties, a sales commission (dependent on the type and length of the right of entry agreement and number of wired units in the property) and, in accordance with the Company's new Construction Contractor Agreement, system design and construction fees to upgrade the properties to deliver incremental advanced services. The first phase of this divestiture includes 17 properties comprising 4,000 residences and should conclude prior to September 30, 2011. A second phase involving the transfer of additional properties is currently being discussed. Such a divestiture, to which the Company makes no representation as to its likelihood, would facilitate the Company's ability to (i) concentrate on "exclusive" and "bulk" video and broadband service offerings, (ii) reduce expenses as servicing "choice" properties is less cost effective than servicing bulk and exclusive properties and subscribers, and (iii) launch a new sales, design and construction division to augment its existing business by leveraging the Company's expertise to sell and deploy "choice" properties for the DIRECTV "Connected Properties" program. In addition, the Company is still continuing negotiations with several companies that it deems significant strategic acquisition/merger prospects. Two of these companies have a significant presence in the multi-family space and collectively have in excess of 70,000 subscribers (in mostly bulk or exclusive properties) as well as strong broadband capabilities. The Company previously executed a term sheet for a combined debt and equity financing of up to $10.25 million with the net proceeds to be used for one of the above-mentioned acquisitions should terms be reached. Additionally, the Company has been in discussions with its existing lenders regarding an increase and term extension to its existing Credit Facility to accommodate asset acquisitions, should terms be reached. The Company makes no representations that these acquisition/merger and financing negotiations will result in any closed transactions. On July 14, 2011, the Company held its Annual General Meeting of Stockholders in Totowa, New Jersey. Three issues were put forth to the stockholders; (i) election of one director, (ii) approval of an amendment to increase the number of authorized shares in the 2009 Employee Stock Purchase Plan from 150,000 to 600,000, and (iii) ratification of appointment of independent registered public accountants for fiscal 2011. As a result of the meeting vote, J.E. "Ted" Boyle was not re-elected to the Board of Directors, the increase in authorized shares for the 2009 Employee Stock Purchase Plan was not approved and J.H. Cohn L.L.P. was ratified as the independent registered public accountants for fiscal 2011. The Company continues to assess its core and non-core service areas and has identified certain assets in non-core markets that are being considered for sale. To that end, the Company is engaged with several parties regarding interest for the sale of these assets at prices similar to what the Company has previously received. The Company makes no representations that these sale negotiations will result in any closed transactions. Use of Non-GAAP Financial Measures The Company uses the performance gauge of EBITDA (as adjusted by the Company) to evidence earnings exclusive of mainly noncash events, as is common in the technology, and particularly the cable and telecommunications, industries. EBITDA (as adjusted) is an important gauge because the Company, as well as investors who follow this industry frequently, use it as a measure of financial performance. The most comparable GAAP reference is simply the removal from net income or loss of - in the Company's case - interest, depreciation, amortization and noncash charges related to its shares, warrants and stock options. The Company adjusts EBITDA by then adding back any provision for bad debts and inventory reserves. EBITDA (as adjusted) is not, and should not be considered, an alternative to income from operations, net income, net cash provided by operating activities, or any other measure for determining our operating performance or liquidity, as determined under accounting principles generally accepted in the Unites States of America. EBITDA (as adjusted) also does not necessarily indicate whether cash flow will be sufficient to fund working capital, capital expenditures or to react to changes in our industry or the economy generally. For the nine months ended June 30, 2011 and 2010, the Company reported EBITDA (as adjusted) of $2,919,334 and $1,288,388, respectively. For the three months ended June 30, 2011 and 2010, the Company reported EBITDA (as adjusted) of $888,016 and $645,284, respectively. The nine and three months ended June 30, 2010 included $708,650 and $250,650, respectively, in non-recurring subsidy received from the HD upgrade program, whereas the nine and three months ended June 30, 2011 had $0. The following table reconciles the comparative EBITDA (as adjusted) of the Company to its consolidated net loss as computed under accounting principles generally accepted in the United States of America: 16-------------------------------------------------------------------------------- For The Nine Months For The Three Months Ended June 30, Ended June 30, 2011 2010 2011 2010 EBITDA $ 2,919,334 $ 1,288,388 $ 888,016 $ 645,284 Interest Expense (1,942,432 ) (1,567,163 ) (669,568 ) (578,405 ) Deferred finance costs and debt discount amortization (interest expense) (261,279 ) (236,280 ) (92,649 ) (84,317 ) Provision for doubtful accounts (349,934 ) (243,470 ) (140,975 ) (96,987 ) Depreciation and Amortization (5,665,545 ) (5,262,507 ) (1,923,371 ) (1,823,120 ) Share-based compensation expense - employees (38,784 ) (41,426 ) (16,097 ) (14,457 ) Compensation expense for issuance of common stock through employee stock purchase plan (28,930 ) (24,481 ) (10,608 ) (624 ) Compensation expense for issuance of common stock for employee bonuses (31,767 ) - (31,767 ) - Compensation expense for issuance of common stock for employee wages (59,790 ) - (28,970 ) - Compensation expense accrued to be settled through the issuance of common stock - - 60,737 - Compensation expense through the issuance of restricted common stock for services rendered (88,770 ) (28,000 ) (88,770 ) (4,000 ) Net Loss $ (5,547,897 ) $ (6,114,939 ) $ (2,054,022 ) $ (1,956,626 ) CRITICAL ACCOUNTING POLICIES AND ESTIMATES The condensed consolidated financial statements of the Company have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these condensed consolidated financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. Significant estimates are used for, but not limited to, revenue recognition with respect to a new subscriber activation subsidy, allowance for doubtful accounts, useful lives of property and equipment, fair value of equity instruments and valuation of deferred tax assets and long-lived assets. On an on-going basis, the Company evaluates its estimates. Estimates are based on historical experience and on other assumptions that are believed to be reasonable under the circumstances. Accordingly, actual results could differ from these estimates under different assumptions or conditions. During the nine months ended June 30, 2011, there were no material changes to accounting estimates or judgments. RECENTLY ISSUED AND NOT YET EFFECTIVE ACCOUNTING PRONOUNCEMENTS In April 2011, accounting standards update on "Reconsideration of Effective Control for Repurchase Agreements" was issued. The amendments in this update remove from the assessment of effective control (a) the criterion requiring the transferor to have the ability to repurchase or redeem the financial assets on substantially the agreed terms, even in the event of default by the transferee, and (b) the collateral maintenance implementation guidance related to that criterion. The guidance should be applied prospectively to transactions or modifications of existing transactions that occur on or after the effective date. The guidance is effective for the first interim or annual period beginning on or after December 15, 2011. Early adoption is not permitted. The Company does not believe that this update will have a material impact on its operations. In March 2011, accounting standards update on "Troubled Debt Restructuring" was issued. The update clarifies which loan modifications constitute troubled debt restructurings. It is intended to assist creditors in determining whether a modification of the terms of a receivable meets the criteria to be considered a troubled debt restructuring, both for purposes of recording an impairment loss and for disclosure of troubled debt restructurings. In evaluating whether a restructuring constitutes a troubled debt restructuring, a creditor must separately conclude that both of the following exist, (a) the restructuring constitutes a concession, and (b) the debtor is experiencing financial difficulties. For public companies, the new guidance is effective for interim and annual periods beginning on or after June 15, 2011. The Company does not believe that this new pronouncement will have a material impact on its operations. 17 --------------------------------------------------------------------------------RECENTLY ADOPTED ACCOUNTING PRONOUNCEMENTS In October 2009, "Multiple-Deliverable Revenue Arrangements" was issued. This update provides amendments to the criteria for revenue recognition for separating consideration in multiple-deliverable arrangements. The amendments to this update establish a selling price hierarchy for determining the selling price of a deliverable. Multiple-Deliverable Revenue Arrangements is effective for financial statements issued for years beginning on or after June 15, 2010. The Company evaluated the effect of the adoption of Multiple-Deliverable Revenue Arrangements will have on its consolidated results of operations, financial position and cash flows, and has determined the adoption had no material impact. RESULTS OF OPERATIONS The following discussion of results of operations and financial condition of the Company should be read in conjunction with the Company's Condensed Consolidated Financial Statements included elsewhere in this quarterly report on Form 10-Q. NINE MONTHS ENDED JUNE 30, 2011 COMPARED TO NINE MONTHS ENDED JUNE 30, 2010 The following table sets forth for the nine months ended June 30, 2011 and 2010 the percentages which selected items in the Statement of Operations bear to total revenue and dollar and percentage changes between the periods: Nine Months Nine Months Change Change Ended June 30, 2011 Ended June 30, 2010 ($) (%) REVENUE $ 20,254,067 100 % $ 19,274,086 100 % $ 979,981 5 % Direct costs 9,099,461 45 % 8,996,252 47 % 103,209 1 % Sales expenses 1,084,501 5 % 1,606,660 8 % (522,159 ) -32 % Customer service and operating expenses 4,432,407 22 % 4,327,791 22 % 104,616 2 % General and administrative expenses 3,376,774 17 % 3,392,712 18 % (15,938 ) 0 % Depreciation and amortization 5,665,545 28 % 5,262,507 27 % 403,038 8 % Gain on sale of customers and property and equipment (60,416 ) 0 % - 0 % (60,416 ) 100 % OPERATING LOSS (3,344,205 ) -17 % (4,311,836 ) -22 % 967,631 -22 %Total other expense (2,203,692 ) -10 % (1,803,103 ) -10 % (400,589 ) 22 % NET LOSS $ (5,547,897 ) -27 % $ (6,114,939 ) -32 % $ 567,042 -9 % Revenue. Revenue for the nine months ended June 30, 2011 increased 5% to $20,254,067, compared to revenue of $19,274,086 for the nine months ended June 30, 2010. The nine month revenue for June 30, 2010 included $708,650 in one-time installation revenue from the DIRECTV HD upgrade subsidy compared to $0 corresponding HD upgrade subsidy revenue in the nine month revenue for June 30, 2011. Adjusted for this difference in HD upgrade subsidy, the Company actually realized 9% growth in "recurring revenue" during the periods. This increase in recurring revenue is mainly attributable to the increase in billable (and higher ARPU) subscribers, instituted price increases and a higher percentage of customers subscribing to advanced services. The Company expects total revenue to increase during the remainder of fiscal 2011 as newly acquired subscribers and properties are fully transitioned and marketing programs get underway. Revenue (inclusive of the DIRECTV HD upgrade subsidy) has been derived, as a percent, from the following sources: Nine Months Nine Months Ended June 30, 2011 Ended June 30, 2010 Private cable programming revenue $ 3,125,207 15 % $ 3,445,436 18 % DTH programming revenue and subsidy 12,900,916 64 % 11,333,892 59 % Internet access fees 2,413,618 12 % 2,519,291 13 % Installation fees, wiring and other revenue 1,814,326 9 % 1,975,467 10 % Total Revenue $ 20,254,067 100 % $ 19,274,086 100 % The Company expects DTH programming revenue to continue to increase due to a larger subscriber base, an increase in revenue associated with advanced services, and the conversion of certain properties from low average revenue private cable subscribers to DIRECTV service subscribers, which conversely explains the decrease in private cable programming revenue. The decrease in installation fees, wiring and other revenue is due to the completion of the HD upgrade plan and loss of the subsidy referenced above. 18 -------------------------------------------------------------------------------- Direct Costs. Direct costs are comprised of programming costs, monthly recurring Internet broadband circuits and costs relating directly to installation services. Direct costs increased slightly to $9,099,461 for the nine months ended June 30, 2011, as compared to $8,996,252 for the nine months ended June 30, 2010, due to the 5% increase in subscriber base between the periods, however, as a percent of revenue, direct costs declined 2% between the periods. The Company expects a proportionate increase in direct costs as subscriber growth continues, however, direct costs are linked to the type of subscribers the Company adds. Choice and exclusive DTH DIRECTV subscribers have no associated programming cost and therefore little to no direct cost, while private cable and broadband subscribers have programming and circuit costs and therefore a higher direct cost. Even though direct costs are expected to increase during fiscal 2011 as subscribers are added, the Company expects that these costs will continue to decrease as a percent of revenue during the remainder of fiscal 2011 as lower direct cost subscribers are added and broadband circuits continue to decrease in price. Sales Expenses. Sales expenses were $1,084,501 for the nine months ended June 30, 2011, compared to $1,606,660 for the nine months ended June 30, 2010, a 3% decrease as a percent of revenue. The decrease is attributable to cost cutting measures and a concentration of sales and marketing efforts primarily on newly acquired properties. During the remainder of fiscal 2011, the Company expects sales expenses to remain constant or increase slightly as sales and marketing efforts remain strictly focused, but should continue to decline as a percent of revenue as additional revenue is generated from new subscribers with no corresponding increase in sales and marketing resources. Customer Service and Operating Expenses. Customer service and operating expenses are comprised of expenses related to the Company's call center, technical support, project management and general operations. Customer service and operating expenses were $4,432,407 and $4,327,791 for the nine months ended June 30, 2011 and 2010, respectively. These expenses remained fairly constant between the periods due to cost reductions and realization of efficiencies, despite an increase in the number of subscribers served between the periods. These expenses are generally expected to increase in dollars in relative proportion with any increase in billable subscribers or any increase in customer service quality levels, however, the Company anticipates these expenses to continue to decrease slightly as a percent of revenue during the remainder of fiscal 2011 as efficiencies and scale are further realized. A breakdown of customer service and operating expenses is as follows: Nine Months Ended Nine Months Ended June 30, 2011 June 30, 2010 Call center expenses $ 1,647,972 37 % $ 1,456,291 34 % General operation expenses 806,776 18 % 998,253 23 % Property system maintenance expenses 1,977,659 45 % 1,873,247 43 % Total customer service and operation expense $ 4,432,407 100 % $ 4,327,791 100 % Call center expenses are closely proportional to the number of subscribers the Company adds during any given period and increased relatively proportionally to subscriber growth between the two periods. General operations expenses decreased due to cost reductions and greater efficiencies between the periods. Property system maintenance is generally proportional to the number of properties the Company services (not necessarily the number of subscribers), so the increase between the periods was due to an increased number of actual properties, partially offset with some one-time cost reductions. General and Administrative Expenses. General and administrative expenses for the nine months ended June 30, 2011 and 2010, of $3,376,774 and $3,392,712, respectively, decreased 1% as a percent of revenue due mainly to cost reduction initiatives. Of the general and administrative expenses for the nine months ended June 30, 2011 and 2010, the Company had total noncash charges included of $583,833 and $337,377, respectively. These noncash charges are described below: 19 -------------------------------------------------------------------------------- Nine Months Ended June 30, 2011 2010 Total general and administrative expenses $ 3,376,774 $ 3,392,712 Noncash charges: Share based compensation - employees (1) 38,784 41,426 Compensation expense through the issuance of restricted common stock for services rendered 88,770 28,000 Excess discount for the issuance of stock under stock purchase plan 28,930 24,481 Issuance of common stock for bonuses 31,767 - Provision for compensation expense settled through the issuance of common stock 45,648 - Bad debt provision 349,934 243,470 Total noncash charges 583,833 337,377 Total general and administrative expense net of noncash charges $ 2,792,941 $ 3,055,335 Percent of revenue 14 % 16 % --------------------------------------------------------------------------------(1) The Company recognized noncash share-based compensation expense for employees based upon the fair value at the grant dates for awards to employees for the nine months ended June 30, 2011 and 2010 of $38,784 and $41,416, respectively, amortized over the requisite vesting period. The total stock-based compensation expense not yet recognized and expected to vest over the next 23 months is approximately $110,000. General and administrative expenses are fairly fixed and, therefore, the Company expects these expenses to decline as a percent of revenue during the remainder of fiscal 2011 as revenues increase. Other Noncash Charges. Depreciation and amortization expenses increased from $5,262,507 during the nine months ended June 30, 2010 to $5,665,545 during the nine months ended June 30, 2011, a 1% increase as a percent of revenue. The dollar increase in depreciation and amortization is associated with additional equipment being deployed, including HD upgrade equipment, and other intangible assets that were acquired over prior periods. Interest expense included noncash charges of $261,279 for the amortization of deferred finance costs and debt discount. Net Loss. Primarily as a result of the above, and total noncash charges of $6,524,799, the Company reported a net loss of $5,547,897 for the nine months ended June 30, 2011, compared to noncash charges of $5,836,164 and a reported net loss of $6,114,939 for the nine months ended June 30, 2010. THREE MONTHS ENDED JUNE 30, 2011 COMPARED TO THREE MONTHS ENDED JUNE 30, 2010 The following table sets forth for the three months ended June 30, 2011 and 2010 the percentages which selected items in the Statements of Operations bear to total revenue and dollar and percentage changes between the periods: Three Months Three Months Change Change Ended June 30, 2011 Ended June 30, 2010 ($) (%) REVENUE $ 6,815,207 100 % $ 6,664,388 100 % $ 150,819 2 % Direct costs 3,130,141 46 % 3,074,319 46 % 55,822 2 % Sales expenses 363,603 5 % 560,343 8 % (196,740 ) -35 % Customer service and operating expenses 1,479,022 22 % 1,349,047 20 % 129,975 10 % General and administrative expenses 1,210,875 18 % 1,151,598 17 % 59,277 5 % Depreciation and amortization 1,923,371 28 % 1,823,120 28 % 100,251 5 % OPERATING INCOME (LOSS) (1,291,805 ) -19 % (1,294,039 ) -19 % 2,234 0 % Total other loss (762,217 ) -11 % (662,587 ) -10 % (99,630 ) 15 % NET INCOME (LOSS) $ (2,054,022 ) -30 % $ (1,956,626 ) -29 % $ (97,396 ) 5 % 20-------------------------------------------------------------------------------- Revenue. Revenue for the three months ended June 30, 2011 increased 2% to $6,815,207, compared to revenue of $6,664,388 for the three months ended June 30, 2010. The three month revenue for June 30, 2010 included $250,650 in one-time installation revenue from the HD upgrade subsidy compared to $0 corresponding HD upgrade subsidy revenue in the three month revenue for June 30, 2011. Adjusted for this difference in HD upgrade subsidy, the Company actually realized 6% growth in "recurring revenue" during the periods. This increase in revenue is mainly attributable to an increase in billable (and higher ARPU) subscribers, price increases and a higher percentage of customers subscribing to advanced services. The Company expects total revenue to increase during the remainder of fiscal 2011 as newly acquired subscribers and properties are fully transitioned and marketing programs get underway. Revenue has been derived, as a percent, from the following sources: Three Months Three Months Ended June 30, 2011 Ended June 30, 2010 Private cable programming revenue $ 947,158 14 % $ 1,175,720 18 % DTH programming revenue and subsidy 4,536,816 67 % 4,002,924 60 % Internet access fees 774,847 11 % 840,456 12 % Installation fees, wiring and other revenue 556,386 8 % 645,288 10 % Total Revenue $ 6,815,207 100 % $ 6,664,388 100 % The Company expects DTH programming revenue to continue to increase due to a larger subscriber base, an increase in revenue associated with advanced services and the conversion of certain properties from low average revenue private cable subscribers to DIRECTV service subscribers, which conversely explains the decrease in private cable programming revenue. The decrease in installation fees, wiring and other revenue is due to the completion of the HD upgrade plan and loss of the subsidy referenced above. Direct Costs. Direct costs are comprised of programming costs, monthly recurring Internet broadband circuits and costs relating directly to installation services. Direct costs increased slightly to $3,130,141 for the three months ended June 30, 2011, as compared to $3,074,319 for the three months ended June 30, 2011, despite a 5% increase in subscribers and certain transition related costs on acquired properties. As a percent of revenue, direct costs remained unchanged between the periods. The Company expects a proportionate increase in direct costs as subscriber growth continues, however, direct costs are linked to the type of subscribers the Company adds. Choice and exclusive DTH DIRECTV subscribers have no associated programming cost and therefore little to no direct cost, while private cable and broadband subscribers have programming and circuit costs and therefore a higher direct cost. Even though direct costs are expected to increase during fiscal 2011 as subscribers are added, the Company expects that these costs will continue to decrease as a percent of revenue during the remainder of fiscal 2011 as lower direct cost subscribers are added and broadband circuits continue to decrease in price. Sales Expenses. Sales expenses were $363,603 for the three months ended June 30, 2011, compared to $560,343 for the three months ended June 30, 2010, a 3% decrease as a percent of revenue. The decrease is attributable to cost cutting measures and a concentration of sales and marketing efforts primarily on newly acquired properties. During the remainder of fiscal 2011, the Company expects these expenses to remain constant or increase only slightly as sales and marketing efforts remain strictly focused, but should continue to decline as a percent of revenue as additional revenue is generated from new subscribers with no corresponding increase in sales and marketing resources. Customer Service and Operating Expenses. Customer service and operating expenses are comprised of expenses related to the Company's call center, technical support, project management and general operations. Customer service and operating expenses were $1,479,022 and $1,349,047 for the three months ended June 30, 2011 and 2010, respectively. These expenses increased 2% as a percent of revenue, despite a 5% increase in the number of subscribers served between the periods and certain transition related costs on recently acquired properties. These expenses are generally expected to increase in dollars in relative proportion with any increase in billable subscribers or any increase in customer service quality levels, however, the Company anticipates these expenses to generally decrease slightly as a percent of revenue during the remainder of fiscal 2011 as efficiencies and scale are further realized. A breakdown of customer service and operating expenses is as follows: Three Months Ended Three Months Ended June 30, 2011 June 30, 2010 Call center expenses $ 553,715 37 % $ 469,179 35 % General operation expenses 275,010 19 % 308,094 23 % Property system maintenance expenses 650,297 44 % 571,774 42 % Total customer service and operation expense $ 1,479,022 100 % $ 1,349,047 100 % 21-------------------------------------------------------------------------------- Call center expenses are closely proportional to the number of subscribers the Company adds during any given period and increased proportionally to the subscriber increase between the two periods. General operations expenses decreased due to one-time cost reductions between the periods. Property system maintenance is generally proportional to the number of properties the Company services (not necessarily the number of subscribers), so the increase between the periods was due to an increased number of actual properties, partially offset with some one-time cost reductions. General and Administrative Expenses. General and administrative expenses for the three months ended June 30, 2011 and 2010 of $1,210,875 and $1,151,598, respectively, increased 1% as a percent of revenue, due mainly to increases in noncash charges. Of the general and administrative expenses for the three months ended June 30, 2011 and 2010, the Company had total noncash charges included of $256,450 and $116,068, respectively. These noncash charges are described below: Three Months Ended June 30, 2011 2010 Total general and administrative expenses $ 1,210,875 $ 1,151,598 Noncash charges: Share based compensation - employees (1) 16,097 14,457 Compensation expense through the issuance of restricted common stock for services rendered 88,770 4,000 Excess discount for the issuance of stock under stock purchase plan 10,608 624 Bad debt provision 140,975 96,987 Total noncash charges 256,450 116,068 Total general and administrative expense net of noncash charges $ 954,425 $ 1,035,530 Percent of revenue 14 % 16 % --------------------------------------------------------------------------------(1) The Company recognized noncash share-based compensation expense for employees based upon the fair value at the grant dates for awards to employees for the three months ended June 30, 2011 and 2010, amortized over the requisite vesting period, of $16,097 and $14,457, respectively. The total share-based compensation expense not yet recognized and expected to vest over the next 23 months is approximately $110,000. General and administrative expenses are fairly fixed and, therefore, the Company expects these expenses to decline as a percent of revenue during the remainder of fiscal 2011 as revenues increase. Other Noncash Charges. Depreciation and amortization expenses increased from $1,823,120 for the three months ended June 30, 2010 to $1,923,371 for the three months ended June 30, 2011. The increase in depreciation and amortization is associated with additional equipment being deployed, including HD upgrade equipment, and other intangible assets that were acquired over prior periods. Interest expense included noncash charges of $92,649 for the amortization of deferred finance costs and debt discount. Net Loss. Primarily as a result of the above, and total noncash charges of $2,272,470, the Company reported a net loss of $2,054,022 for the three months ended June 30, 2011, compared to noncash charges of $2,023,505 and a reported net loss of $1,956,626 for the three months ended June 30, 2010. LIQUIDITY AND CAPITAL RESOURCES On September 11, 2006, the Company entered into a Loan and Security Agreement with FCC, LLC, d/b/a First Capital, and Full Circle Funding, LP for a senior secured $20 million non-amortizing revolving five-year credit facility ("Credit Facility") to fund the Company's subscriber growth. The Credit Facility was specifically designed to provide a long-term funding solution to the Company's subscriber growth capital requirements. The size of the Credit Facility is ultimately determined by factors relating to the present value of the Company's future revenue as determined by its access agreements. Therefore, as the Company's subscriber base increases through the signing of new access agreements and renewal of existing access agreements, the Company's borrowing base potential increases concurrently to certain limits. Given the Company's focus on both EBITDA (as adjusted) and subscriber growth, an increasing percentage of future subscriber acquisition costs should be funded from net operations, despite the availability of more capital through an increasing borrowing base. On June 30, 2008, the Company entered into an Amended and Restated Loan and Security Agreement with the same parties for a $10 million increase to the Credit Facility and a new five-year term. The original material terms and conditions of the Credit Facility, previously negotiated and executed on September 11, 2006, have not changed. 22 -------------------------------------------------------------------------------- The Credit Facility requires interest payable monthly only on the principal outstanding and is specially tailored to the Company's needs by being divided into six $5 million increments. The Company is under no obligation to draw an entire increment at one time. The first $5 million increment carries an interest rate of prime plus 4.1%, the second $5 million at prime plus 3%, the third $5 million at prime plus 2%, the fourth $5 million at prime plus 1%, and the new $10 million in additional Credit Facility is also divided into two $5 million increments with the interest rate on these increments being prime plus 1% to 4%, depending on the Company's ratio of EBITDA to the total outstanding loan balance. As defined in the Credit Facility, "prime" shall be a minimum of 7.75%. The Company borrowed $1,316,437 on its Credit Facility during the quarter ended June 30, 2011, and as of that date, the Company has borrowed a total of $25,885,945, which is due on June 30, 2013. To access the Credit Facility above $20 million (which the Company has), the Company must have (i) positive EBITDA of $1 million, on either the higher of a trailing twelve (12) month basis or a six (6) month basis times two, and (ii) 60,000 subscribers. To access the Credit Facility above $25 million (which the Company has), the Company must have (i) positive EBITDA of $3 million on a trailing twelve (12) month basis, and (ii) 65,000 subscribers. EBITDA shall mean the Company's net income (excluding extraordinary gains and non-cash charges as defined in the Credit Facility) before provisions for interest expense, taxes, depreciation and amortization. As of June 30, 2011, $4,114,055 remains available for borrowing under the Credit Facility. The Credit Facility is secured by the Company's cash and temporary investments, accounts receivable, inventory, access agreements and certain property, plant and equipment. The Credit Facility contains covenants limiting the Company's ability to, without the prior written consent of FCC, LLC, d/b/a First Capital, and Full Circle Funding, LP, among other things: · incur other indebtedness; · incur other liens; · undergo any fundamental changes; · engage in transactions with affiliates; · issue certain equity, grant dividends or repurchase shares; · change our fiscal periods; · enter into mergers or consolidations; · sell assets; and · prepay other debt. The Credit Facility also includes certain events of default, including nonpayment of obligations, bankruptcy and change of control. Borrowings will generally be available subject to a borrowing base and to the accuracy of all representations and warranties, including the absence of a material adverse change and the absence of any default or event of default. The Company did not incur or record a provision for income tax for the nine months ended June 30, 2011 and 2010 due to the net loss. The net operating loss carry forward expires on various dates through 2029, therefore, the Company should not incur cash needs for income taxes for the foreseeable future. The Company believes, but cannot assure, that the combination of revenues, expected revenue increases, and the remaining available balance under the Credit Facility up to $30 million will provide it with the needed capital to maintain operations through June 30, 2012. Should the Company begin to accelerate subscriber growth, it may have to rely on the DIRECTV CapEx Program, sell assets, or find alternative sources of capital funding. NINE MONTHS ENDED JUNE 30, 2011 AND 2010 During the nine months ended June 30, 2011 and 2010, the Company recorded a net loss of $5,547,897 and $6,114,939, respectively. At June 30, 2011, the Company had an accumulated deficit of $66,499,101. 23-------------------------------------------------------------------------------- Cash Balance. At June 30, 2011, the Company had cash and cash equivalents of $120,309, compared to $324,524 at September 30, 2010. The Company maintains little cash, as revenues are deposited against the balance of the Credit Facility to reduce interest cost. During the nine months ended June 30, 2011, the Company increased the amount borrowed against the Credit Facility by $2,792,701. As of June 30, 2011, the Company believes, but cannot assure, that the combination of cash, revenues, expected revenue growth and the remaining available balance under the Credit Facility up to $30 million, will provide it with the needed funds to maintain operations at least through June 30, 2012. Operating Activities. Company operations provided net cash of $400,669 during the nine months ended June 30, 2011 and used net cash of $631,928 for the nine months ended June 30, 2010. Net cash provided by (used in) operating activities during the nine months ended June 30, 2011 and 2010 included a decrease of $122,188 and $210,871, respectively, in accounts payable and other accrued liabilities, an increase of $631,419 and a decrease of $128,554, respectively, in accounts and other receivables, and an increase in prepaid expenses and deposits of $33,114 and $92,077, respectively. During the nine months ended June 30, 2011 and 2010, deferred revenue increased $237,458 and decreased $177,873, respectively. Net loss for the nine months ended June 30, 2011 and 2010 was $5,547,897 and $6,114,939, respectively, inclusive of net noncash charges associated primarily with depreciation and amortization and stock options and warrants of $6,524,799 and $5,836,164, respectively. Investing Activities. During the nine months ended June 30, 2011 and 2010, the Company purchased $2,673,151 and $4,871,727, respectively, of equipment relating to subscriber additions and HD upgrades for the periods and for future periods. During the nine months ended June 30, 2011 and 2010, the Company paid $621,220 and $833,846, respectively, for the acquisition of intangible assets and related fees. During the nine months ended June 30, 2011, the Company received $89,651 in proceeds for the sale of subscribers and related property and equipment to Comcast and during the nine months ended June 30, 2010, the Company received $5,000 in proceeds for the disposal of equipment. Financing Activities. During the nine months ended June 30, 2011 and 2010, the Company incurred $200,000 and $150,000 in deferred financing costs, respectively, and increased by $2,792,701, and $6,095,229, the amount borrowed through the Credit Facility, respectively. Equity financing activity provided $7,135 from 2,785 shares of common stock and $8,575 from 2,719 shares of common stock purchased by employees through the 2009 Employee Stock Purchase Plan during the nine months ended June 30, 2011 and 2010, respectively. Working Capital. As at June 30, 2011, the Company had negative working capital of approximately $2,691,000, compared to negative working capital of approximately $2,714,000 as at September 30, 2010. To minimize the draw on the Credit Facility and the liability, the Company expects to be neutral or slightly negative working capital in fiscal 2011. The Company believes, but cannot assure, that it will have sufficient funds to meet current operating activity obligations through current revenue levels, expected revenue growth, cost cutting, and the funds available through the Credit Facility up to $30 million, to maintain operations through June 30, 2012. Should the Company accelerate growth beyond current levels, it may have to rely on the DIRECTV CapEx Program, sell assets, or find alternative sources of capital funding. Capital Commitments and Contingencies. The Company has access agreements with the owners of multiple dwelling unit properties to supply digital satellite programming and Internet systems and services to the residents of those properties; however, the Company has no obligation to build out those properties and no penalties will accrue if it elects not to do so. Future Commitments and Contingencies. The Company believes, but can not assure, that it has sufficient liquidity to fund operating expenses through June 30, 2012 and beyond. To fund future organic growth and acquisitions, the Company has been and will continue to (i) pursue opportunities to raise additional financing through private placements of both equity and debt securities, (ii) accelerate deployments and growth under the DIRECTV CapEx Program which does not require significant capital, and/or (iii) pursue negotiations with certain entities for the sale of Company non-core assets. There is no assurance that the Company will be successful in the financing of this or any of the other above directives. [ Back To TMCnet.com's Homepage ]