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EARTHLINK HOLDINGS CORP. - 10-K - Management's Discussion and Analysis of Financial Condition and Results of Operations.(Edgar Glimpses Via Acquire Media NewsEdge) Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") is intended to provide a reader of our financial statements with a narrative from the perspective of management. The following MD&A should be read in conjunction with audited Consolidated Financial Statements and notes thereto included elsewhere in this Annual Report on Form 10-K. Certain statements in this MD&A are forward-looking statements. Important factors that could cause actual results to differ from estimates or projections contained in the forward-looking statements are described under "Cautionary Note Concerning Factors That May Affect Future Results" in this Item 7. Change in Organization Structure On December 31, 2013, through the creation of a new holding company structure (the "Holding Company Reorganization"), EarthLink, Inc. merged into EarthLink, LLC, which became a wholly-owned subsidiary of a new publicly traded parent company, EarthLink Holdings Corp. We expect the new holding company design will enhance our corporate structure and provide greater flexibility and efficiency from a management, operations, customer, regulatory, accounting, financial and tax perspective. As the Holding Company Reorganization occurred at the parent company level, the remainder of our subsidiaries, operations and customers were not affected. Accordingly, the historical financial statements reflect the effect of the reorganization for all periods presented. Following the Holding Company Reorganization, EarthLink Holdings Corp. became the primary obligor on our outstanding debt obligations and EarthLink, LLC became a guarantor and a restricted subsidiary. The Holding Company Reorganization was effected under Section 251(g) of the Delaware General Corporation Law which provides for the formation of a holding company structure without a stockholder vote. Existing shares of EarthLink, Inc. common stock were converted into the same number of shares of common stock of EarthLink Holdings Corp. Overview EarthLink Holdings Corp. ("EarthLink" or the "Company"), together with its consolidated subsidiaries, is a leading communications and IT services provider, empowering businesses with a fully-managed, end-to-end communications, IT and virtualization portfolio including cloud computing, IT security, colocation, enterprise-class hosted applications, secure network connectivity and IT support services. We operate two reportable segments, Business Services and Consumer Services. Our Business Services segment provides a broad range of data, voice and IT services to retail and wholesale business customers. Our Consumer Services segment provides nationwide Internet access and related value-added services to residential customers. We operate an extensive network including more than 28,000 route miles of fiber, 90 metro fiber rings and eight secure enterprise-class data centers that provide data and voice IP service coverage across more than 90 percent of the United States. Business Strategy Our business strategy is to be the premier communications and IT services provider for mid-market and enterprise customers. We believe IT services is an emerging market with significant opportunity for growth. Our goal is to use our nationwide network and newly developed and acquired IT services to be a one-stop ubiquitous provider of these services to larger and multi-location enterprise customers. We are also focused on maximizing the cash flow generated by our traditional voice and data products. The key elements of our business strategy are as follows: • Offer a complete package of communications and IT services products. We provide a nationwide suite of business voice, data and IT services. We are focused on maintaining a broad suite of products and services and offering solutions to address the evolving business and infrastructure needs of our customers. In 2012 and 2013, we expanded our IT solutions footprint with four additional data centers and invested capital to extend our core fiber IP network. We also acquired CenterBeam in July 2013 to further grow our IT services portfolio, specifically around customer end-point management. We believe our broad suite of products allows us to compete for larger and more complex customers. • Increase revenues from growth products and services. Revenues from some of our products and services have been declining due to economic, competitive, technological and regulatory developments and we expect some of these revenues to continue to decline. We are attempting to manage this decline by working with our customers to replace or augment declining products with our growth products, where financially and technically feasible to do so. Our growth products are MultiProtocol Label Switching ("MPLS"), hosted voice and IT services such as virtualization and virtual tech care. We are also focused on growing revenues for these products by enhancing our sales force efforts and increasing brand awareness for our IT services. We also aim to grow our wholesale services as we capitalize on unique and new fiber routes within our footprint. 34-------------------------------------------------------------------------------- Table of Contents • Provide a superior customer experience. We are committed to providing high-quality customer service and continuing to monitor customer satisfaction in all facets of our business. We believe exceeding customers' expectations for service increases loyalty and reduces churn. We also believe that our broad communications and IT services portfolio and blend of access technologies for connectivity enable us to provide high-quality customer service by solving a wide range of issues faced by our customers and prospects. We are focused on creating a customer-focused organization that will provide a quality approach to offering and supporting EarthLink products and services. • Optimize our cost structure. We are currently focused on optimizing the cost structure of our business by reducing network costs, streamlining our internal processes and operations and maximizing the cash flows generated from traditional voice and data products. The success of our operating efficiency and cost reduction initiatives is necessary to align costs with declining revenues for some of our products as non-variable costs place further pressure on margins. • Opportunistically consider potential strategic acquisitions. We continue to evaluate acquisition opportunities as we become aware of them. We believe that targeted corporate acquisitions, when available at the right economics, can be an effective means to improve our product, network, and data center capabilities or to accelerate revenue growth. Our acquisition strategy may include investments or acquisitions of new product and services capabilities, network assets or business customers to achieve greater national scale. Challenges and Risks The primary challenge we face is executing on our business strategy to be the premier communications and IT services provider, and more specifically to continue to grow revenues from our growth products and services. Contributing to this challenge are the following: responding to competitive and economic pressures, reducing churn in our existing customer base, providing products and services that meet changing customer needs on a timely and cost-effective basis, and adapting to regulatory changes and initiatives. Another primary challenge is managing the rate of decline in revenues for our traditional products. To address these challenges, we are targeting larger customers who have lower churn profiles, focusing efforts on customer retention, upselling additional growth products and services to existing customers, implementing cost efficiencies in order to maximize cash flows and seeking to make costs more variable. Our future success for growth depends on the timing and market acceptance of our new products and services, our ability to market our services to new customers, our ability to differentiate our services from those of our competitors, our ability to maintain and expand our sales to existing customers, our ability to strengthen awareness of our brand, our ability to provide quality implementation and customer support for these products and the reliability and quality of our services. Revenue Sources Business Services. Our Business Services segment earns revenue by providing a broad range of data, voice and IT services to retail and wholesale business customers. We present our Business Services revenue in the following three categories: (1) retail services, which includes data, voice and IT services provided to business customers; (2) wholesale services, which includes the sale of transmission capacity to other telecommunications carriers and businesses; and (3) other services, which primarily consists of web hosting. Our IT services, which are included within our retail services, include data centers, virtualization, security, applications, premises-based solutions, managed solutions and support services. Revenues generally consist of recurring monthly charges for such services; usage fees; installation fees; termination fees; and administrative fees. Consumer Services. Our Consumer Services segment earns revenue by providing nationwide Internet access and related value-added services to residential customers. We present our Consumer Services in two categories: (1) access services, which includes narrowband access services and broadband access services; and (2) value-added services, which includes revenues from ancillary services sold as add-on features to EarthLink's Internet access services, such as security products, premium email only, home networking and email storage; search revenues; and advertising revenues. Revenues generally consist of recurring monthly charges for such services. 35-------------------------------------------------------------------------------- Table of Contents General Developments in our Business Key developments in our business during 2013 are described below: • Issued $300.0 million aggregate principal amount of 7.375% Senior Secured Notes due 2020 (the "Senior Secured Notes") in May 2013 and used the net proceeds, together with available cash, to fund a tender offer and redemption of our ITC^DeltaCom 10.5% Senior Secured Notes due April 2016 (the "ITC^DeltaCom Notes"), which had been assumed in connection with our acquisition of ITC^DeltaCom, Inc. ("ITC^DeltaCom"). The debt issuance and redemption will reduce the amount of interest we will pay going forward. • Acquired substantially all of the assets of CenterBeam, Inc. ("CenterBeam"), a privately-held information technology managed service provider delivering cloud computing and hosted IT services to mid-sized businesses, in July 2013 for a total consideration of approximately $23.5 million to further grow our IT services portfolio by adding IT services customer scale, expanded IT support center resources and complementary products and capabilities. • Sold our ITC^DeltaCom telecom systems business in August 2013, which was a low margin business that generated mostly non-recurring revenue streams. • Completed the roll out of four additional data centers, launched our next generation cloud hosting platform in five of our eight data centers and expanded our fiber network with additional unique routes. • Made progress in the integration of our operating support systems and began to leverage some of these new capabilities in pursuing our business strategy. • Generated revenues of $1.2 billion in 2013, a 7% decrease during the year consisting of a $53.2 million decrease in Business Services revenue and a $41.3 million decrease in Consumer Services revenue. The decreases were primarily driven by declines in traditional voice and data products. However, partially offsetting these declines was an increase in sales of growth products for our Business Services and a decrease in churn for our Consumer Services. • Generated a net loss of $538.8 million in 2013, which reflects a $255.6 million goodwill impairment and related tax impact, a $265.3 million increase to our income tax provision due to the recording of a full valuation allowance against our deferred tax assets, an increase in restructuring, acquisition and integration costs and a decrease in Adjusted EBITDA, as described below. • Generated Adjusted EBITDA (a non-GAAP measure, see "Non-GAAP Financial Measures" in this Item 7) of $227.1 million in 2013, a decrease from $283.9 million in the prior year primarily due to the decrease in revenues from traditional voice and data products, as well as increased costs to grow our business. • Made $20.8 million of dividend payments to shareholders and repurchased 1.2 million shares of common stock for $6.1 million during the year. Trends in our Business Our financial results are impacted by several significant trends, which are described below. Industry factors. We operate in the communications and IT services industry, which is characterized by intense competition, industry consolidation resulting in larger competitors, an evolving regulatory environment, changing technology and changes in customer needs. We expect these trends to continue. In addition, merger and acquisition transactions and other factors have reduced the number of vendors from which we may purchase network elements that we leverage to operate our business. Traditional business services revenues. Our traditional voice and data business service revenues, specifically traditional voice and lower-end, single site broadband services, have been declining due to competitive pressures and changes in the industry, and we expect this trend to continue. We have also experienced an increase in churn for these retail products, especially as customers come out of contract term. To counteract trends in our Business Services revenues, we are focused on building long-term customer relationships, offering customers a bundle that includes our growth services and focusing on larger, more complex customers who have a lower churn profile. As a result, sales in our growth products have increased and the mix of new sales is shifting towards our growth products. We are also taking steps to lower the cost structure of our Business Services operations. 36-------------------------------------------------------------------------------- Table of Contents IT services. The industry for cloud, managed security and IT services is relatively new and continues to evolve. The IT services market is growing as security needs, compliance requirements and IT costs increase. IT services currently represents the smallest proportion of our Business Services revenues. However, we believe this represents a significant growth area for our business and there is opportunity for EarthLink to address this market nationally. As a result, we have been taking steps to accelerate our transition into an IT services company. Specifically, we are focusing on larger geographic markets where there are more customers with a propensity to buy IT services, increasing our efforts in Search Engine Marketing to drive leads for our inside sales force, increasing brand awareness for our IT services and adding additional technical talent in the field to support our IT services sales efforts. Economic conditions. Many of our customers are small and medium-sized businesses. We believe these businesses are more likely to be affected by economic downturns than larger, more established businesses. We believe that the financial and economic pressures faced by our customers in this environment of diminished consumer spending, corporate downsizing and tightened credit have had, and may continue to have, an adverse effect on our results of operations, including longer sales cycles and increased customer demands for price reductions in connection with contract renewals. Additionally, our consumer access services are discretionary and dependent upon levels of consumer spending. Unfavorable economic conditions could cause customers to slow spending in the future, which could adversely affect our revenues and churn. Consumer access declines. Our consumer access subscriber base and revenues have been declining and are expected to continue to decline due to the continued maturation of the market for Internet access and competitive pressures in the industry. In addition, we have implemented, and expect to continue to implement, targeted price increases, which could negatively impact our churn rates. To counteract trends in our consumer revenues, we are focused on customer retention, operational efficiency and adding customers through marketing channels that we believe will produce an acceptable rate of return. Business Outlook We expect continued declines in Business Services revenues from traditional voice and data products. Revenues may also be adversely impacted by churn, competition, regulatory changes, timing and market acceptance of our newer products and services, shifting patterns of use, convergence of technology and general economic conditions. However, to counteract these pressures, we continue to emphasize our diverse portfolio of communications and IT services and are focused on growing our suite of growth and IT services. We are also focused on growing our wholesale services as we capitalize on new and unique fiber routes within our footprint. As a result, we expect the mix of our retail Business Service revenues to change over time, from traditional products to growth products and services. As our product mix shifts towards growth products, revenues may be impacted in the near term by longer sales cycles and installations and higher costs to deliver these services. We expect our consumer access subscriber base and revenues to continue to decrease due to limited sales and marketing activities, competition from cable, DSL and wireless providers, declines in gross broadband subscriber additions and the continued maturation of the market for narrowband Internet access. However, we expect the rate of churn and revenue decline to continue to decline as our customer base becomes longer tenured. 37-------------------------------------------------------------------------------- Table of Contents Consolidated Results of Operations The following comparison of statement of operations data is affected by our acquisition of One Communications on April 1, 2011. The results of operations of One Communications are included in our operating results beginning on the acquisition date. The following comparison of statement of operations data is also affected, to a lesser extent, by our other acquisitions and transactions completed during 2011 including STS Telecom, Logical Solutions and Business Vitals, LLC, among others, and our CenterBeam transaction completed during 2013. The following table sets forth statement of operations data for the years ended December 31, 2011, 2012 and 2013: Year Ended December 31, 2011 2012 2013 (in thousands) Revenues $ 1,300,543 $ 1,335,135 $ 1,240,606 Operating costs and expenses: Cost of revenues (exclusive of depreciation and amortization shown separately below) 581,264 632,616 600,742 Selling, general and administrative (exclusive of of depreciation and amortization shown separately below) 397,574 429,087 426,070 Depreciation and amortization 159,993 183,165 183,114 Impairment of goodwill - - 255,599 Restructuring, acquisition and integration-related costs 32,068 18,244 40,030 Total operating costs and expenses 1,170,899 1,263,112 1,505,555 Income (loss) from operations 129,644 72,023 (264,949 ) Interest expense and other, net (70,640 ) (63,416 ) (60,686 ) Income (loss) from continuing operations before income taxes 59,004 8,607 (325,635 ) Income tax (provision) benefit (21,731 ) 1,331 (211,231 ) Net income (loss) 37,273 9,938 (536,866 ) Loss from discontinued operations, net of tax (2,706 ) (2,418 ) (1,961 ) Net income (loss) $ 34,567 $ 7,520 $ (538,827 ) Revenues The following table presents our revenues for the years ended December 31, 2011, 2012 and 2013: Year Ended December 31, 2012 vs 2011 2013 vs 2012 2011 2012 2013 $ Change % Change $ Change % Change (dollars in thousands) Business Services Retail services $ 766,098 $ 845,664 $ 793,940 $ 79,566 10 % $ (51,724 ) (6 )% Wholesale services 136,224 151,910 151,071 15,686 12 % (839 ) (1 )% Other 22,376 19,851 19,216 (2,525 ) (11 )% (635 ) (3 )% Total revenues 924,698 1,017,425 964,227 92,727 10 % (53,198 ) (5 )% Consumer Services Access services 323,998 269,533 231,448 (54,465 ) (17 )% (38,085 ) (14 )% Value-added services 51,847 48,177 44,931 (3,670 ) (7 )% (3,246 ) (7 )% Total revenues 375,845 317,710 276,379 (58,135 ) (15 )% (41,331 ) (13 )% Total revenues $ 1,300,543 $ 1,335,135 $ 1,240,606 $ 34,592 3 % $ (94,529 ) (7 )% 38 -------------------------------------------------------------------------------- Table of Contents Business Services Retail Services. Retail services include data, voice and IT services (including data centers, virtualization, security, applications, premises-based solutions, managed solutions and support services) provided to business customers. The following table presents the primary reasons for the changes in Business Services retail revenues for the years ended December 31, 2012 and 2013 compared to the prior years: 2012 vs 2011 2013 vs 2012 (in millions) Due to acquisitions (a) $ 104.3 $ 8.6 Due to growth products (b) - 18.7 Due to IT services (c) 12.2 13.5 Due net favorable settlements and reserve adjustments (d) 9.4 (9.4 ) Due to decline in traditional voice and data products (e) (46.3 ) (83.1 ) Total change in Business Services retail revenues $ 79.6 $ (51.7 ) ______________ (a) Increase in 2012 due to the inclusion of revenues from One Communications for a full year in 2012 compared to a partial period in 2011, as the acquisition occurred on April 1, 2011. Increase in 2013 due to the inclusion of revenues from CenterBeam beginning in July 2013. (b) Increase in 2013 due to sales of growth products, including MPLS and hosted voice. During 2012, this amount was included in the decline in traditional voice and data products as we were still integrating our reporting systems and were not able to capture this detail separately. (c) Increase due to IT Services transactions entered into during 2011 and new product launches to expand our IT services portfolio. (d) Change due to net favorable settlements and reserve adjustments of $9.4 million during 2012. (e) Decrease due to decline in certain traditional voice and data products, including traditional voice, lower-end, single site broadband services and web hosting. Revenues for these traditional voice and data products have been decreasing due to competition in the industry, the migration of customers to more advanced services and a decreased emphasis on selling these services. The decrease in 2012 was partially offset by sales of growth products, including MPLS and hosted voice. Wholesale Services. Wholesale services includes the sale of transmission capacity to other telecommunications carriers and businesses. The increase in wholesale services revenues during the year ended December 31, 2012 compared to the prior year was primarily due to the inclusion of revenues from One Communications for a full year in 2012 compared to a partial period in 2011. The decrease in wholesale services revenues during the year ended December 31, 2013 compared to the prior year was primarily due to an increase in customer churn in the current year and a favorable settlement with a telecommunications carrier recorded during the prior year. This was partially offset by a $1.2 million favorable adjustment associated with the One Communications acquisition recognized during the year ended December 31, 2013 and an increase in transport and usage revenues as we capitalize on unique fiber routes. Other Services. Other services consists primarily of web hosting and certain equipment-related revenue. The decreases in other services revenues during the years ended December 31, 2012 and 2013 compared to the prior years were primarily due to a decrease in average web hosting accounts. Consumer Services Access services. Access services include narrowband access services (including traditional, fully-featured narrowband access and value-priced narrowband access) and broadband access services (including high-speed access via DSL and cable and VoIP). Access service revenues consist of recurring monthly charges for narrowband and broadband access services; usage fees; installation fees; termination fees; and fees for equipment. The decreases in consumer access revenues during the years ended December 31, 2012 and 2013 compared to the prior years were due to decreases in narrowband access and broadband access revenues. This was primarily due to a decrease in average consumer access subscribers, which were 1.5 million, 1.2 million and 1.1 million during the years ended December 31, 2011, 2012 and 2013, respectively. The decrease in average consumer access subscribers resulted from limited sales and marketing activities, the continued maturation of and competition in the market for Internet access and competitive pressures in the industry. However, we continue to focus on the retention of customers and on marketing channels that we believe will produce an acceptable rate of 39-------------------------------------------------------------------------------- Table of Contents return. Our monthly consumer subscriber churn rates were 2.6%, 2.4% and 2.1% during the years ended December 31, 2011, 2012 and 2013, respectively, which moderated the decline in average consumer subscribers. Churn rates decreased due to the increased tenure of our consumer subscriber base. Slightly offsetting the decreases in revenues during the years ended December 31, 2012 and 2013 compared to the prior years was an increase in average revenue per subscriber due to targeted price increases implemented over the past year and a change in mix of subscribers. Value-added services revenues. Value-added services revenues consist of revenues from ancillary services sold as add-on features to our Internet access services, such as security products, premium email only, home networking and email storage; search revenues; and advertising revenues. We derive these revenues from fees charged for ancillary services; fees generated through revenue sharing arrangements with online partners whose products and services can be accessed through our web properties, such as the Google™ search engine; and fees charged for advertising on our various web properties. The decreases in value-added services revenues during the years ended December 31, 2012 and 2013 compared to the prior years were due primarily to a decrease in revenues from our security and home networking services and a decrease in search and advertising revenues. These decreases were attributable to the overall decline in the average number of consumer subscribers. Cost of revenues The following table presents our cost of revenues for the years ended December 31, 2011, 2012 and 2013: Year Ended December 31, 2012 vs 2011 2013 vs 2012 2011 2012 2013 $ Change % Change $ Change % Change (dollars in thousands)Business Services $ 463,782 $ 527,514 $ 506,245 $ 63,732 14 % $ (21,269 ) (4 )% Consumer Services 117,482 105,102 94,497 (12,380 ) (11 )% (10,605 ) (10 )% Total cost of revenues $ 581,264 $ 632,616 $ 600,742 $ 51,352 9 % $ (31,874 ) (5 )% Business Services Cost of revenues for our Business Services segment primarily consists of the cost of connecting customers to our networks via leased facilities; the costs of leasing components of our network facilities; costs paid to third-party providers for interconnect access and transport services; the costs of providing IT services; and the cost of equipment sold to customers. The following table presents the primary reasons for the changes in Business Services cost of revenues for the years ended December 31, 2012 and 2013 compared to the prior years: 2012 vs 2011 2013 vs 2012 (in millions) Due to acquisitions (a) $ 58.0 $ 3.0 Due to IT services (b) 8.3 4.6 Due to change in reserves for regulatory audits (c) 8.3 (15.5 ) Due to favorable settlements (d) - (3.8 ) Due to decline in traditional voice and data products, offset by growth (e) (10.9 ) (9.6 ) Total change in Business Services cost of revenues $ 63.7 $ (21.3 ) ______________ (a) Increase in 2012 due to the inclusion of cost of revenues from One Communications for a full year in 2012 compared to a partial period in 2011. Increase in 2013 due to inclusion of CenterBeam cost of revenues beginning in July 2013. (b) Increase due to IT services transactions entered into during 2011 and new product launches to expand our IT services portfolio. (c) Increase in 2012 due to an $8.3 million charge recorded in the second quarter of 2012 to increase our reserves for regulatory audits, primarily an audit conducted by the Universal Service Administrative Company on previous ITC^DeltaCom Universal Service Fund assessments and payments. Decrease in 2013 due to the $8.3 million charge recorded in the prior year and a $7.2 million favorable adjustment recorded in the third quarter of 2013 to decrease our reserves for regulatory audits resulting from final interpretation and resolution of certain regulatory audits, primarily the audit by the Universal Service Administrative Company 40-------------------------------------------------------------------------------- Table of Contents (d) Decrease due to certain favorable settlements recognized during 2013, including: a $1.8 million favorable adjustment due to the renegotiation of an IRU agreement recorded as a liability in purchase accounting for ITC^DeltaCom; a $0.9 million favorable adjustment for an arbitrator's final decision with respect to post-closing working capital adjustments relating to the One Communications acquisition; and a $1.1 million favorable settlement with a telecommunication vendor. (e) Decrease due to decline in certain traditional voice and data products, including traditional voice, lower-end, single site broadband services and web hosting, partially offset by sales of growth products which include MPLS and hosted VoIP. Consumer Services Cost of revenues for our Consumer Services segment primarily consists of telecommunications fees and network operations costs incurred to provide our Internet access services; fees paid to suppliers of our value-added services; fees paid to content providers for information provided on our online properties; and the cost of equipment sold to customers for use with our services. Our principal providers for narrowband services are AT&T, GlobalPOPs and Windstream. We also purchase lesser amounts of narrowband services from certain regional and local providers. Our principal providers of broadband connectivity are AT&T Inc., Bright House Networks, CenturyLink, Inc., Comcast Corporation, Megapath, Time Warner Cable and Verizon Communications, Inc. Many of our agreements have a short term or operate on a month-to-month basis. We cannot be certain of renewal or non-termination of our contracts or that legislative or regulatory factors will not affect our contracts. The decreases in Consumer Services cost of revenues during the years ended December 31, 2012 and 2013 compared to the prior years were primarily due to the declines in the average number of consumer services subscribers. Partially offsetting this decrease was an increase in our average cost per subscriber. Our agreements with certain service providers generally have volume based tiered pricing which is leading to higher unit costs as we see a decline in subscribers over time. Also contributing to the increase was a shift in the mix to customers with higher costs associated with delivering services. Selling, general and administrative The following table presents our selling, general and administrative expenses for the years ended December 31, 2011, 2012 and 2013: Year Ended December 31, 2012 vs 2011 2013 vs 2012 2011 2012 2013 $ Change % Change $ Change % Change (dollars in thousands) Selling, general and administrative expenses $ 397,574 $ 429,087 $ 426,070 $ 31,513 8 % $ (3,017 ) (1 )% Selling, general and administrative expenses consist of expenses related to sales and marketing, customer service, network operations, information technology, regulatory, billing and collections, corporate administration, and legal and accounting. Such costs include salaries and related employee costs (including stock-based compensation), outsourced labor, professional fees, property taxes, travel, insurance, occupancy costs, advertising and other administrative expenses. The following table presents the primary reasons for the changes in selling, general and administrative expenses for the years ended December 31, 2012 and 2013 compared to the prior years: 2012 vs 2011 2013 vs 2012 (in millions) Due to acquisitions (a) $ 43.3 $ 3.6 Due to decrease in people-related costs (b) (8.3 ) (9.9 ) Due to change in stock-based compensation expense (c) (3.3 ) 2.8 Due to change in other selling, general and administrative (d) (0.2 ) 0.5 Total change in selling, general and administrative expenses $ 31.5 $ (3.0 ) ______________ 41-------------------------------------------------------------------------------- Table of Contents (a) Increase in 2012 due to the inclusion of selling, general and administrative expenses from One Communications and STS Telecom for a full year in 2012 compared to partial periods in 2011. Increase in 2013 due to the inclusion of CenterBeam selling, general and administrative expenses beginning in July 2013. (b) Decrease primarily due to cost savings realized from workforce reductions and other synergies from integrating our businesses. Also contributing was an increase in personnel costs being classified in capitalized labor and integration-related costs. (c) Decrease in 2012 due to lower headcount, which resulted in fewer grants. Increase in 2013 due to higher grants and stock-based compensation expense recognized for the acceleration of vesting in connection with certain employee terminations. (d) Change in other selling, general and administrative costs such as professional fees, property taxes, commissions, outsourced labor, travel, insurance, occupancy costs and advertising. Depreciation and amortization The following table presents our depreciation and amortization expense for the years ended December 31, 2011, 2012 and 2013: Year Ended December 31, 2012 vs 2011 2013 vs 2012 2011 2012 2013 $ Change % Change $ Change % Change (dollars in thousands) Depreciation expense $ 100,774 $ 112,489 $ 116,744 $ 11,715 12 % $ 4,255 4 % Amortization expense 59,219 70,676 66,370 11,457 19 % (4,306 ) (6 )% Total depreciation and amortization $ 159,993 $ 183,165 $ 183,114 $ 23,172 14 % $ (51 ) - % Depreciation and amortization includes depreciation of property and equipment and amortization of definite-lived intangible assets acquired in purchases of businesses and purchases of customer bases from other companies. Property and equipment is depreciated using the straight-line method over the estimated useful lives of the various asset classes. Customer installation and acquisition costs are amortized over the actual weighted average initial contract terms of contracts initiated each month, assuming a customer churn factor. Leasehold improvements are depreciated using the straight-line method over the shorter of the estimated useful life or the remaining term of the lease. Definite-lived intangible assets, which primarily consist of subscriber bases and customer relationships, acquired software and technology, trade names and other assets, are amortized on a straight-line basis over their estimated useful lives, which range from three to six years. The following table presents the primary reasons for the changes in depreciation and amortization expense for the years ended December 31, 2012 and 2013 compared to the prior years: 2012 vs 2011 2013 vs 2012 (in millions)Due to depreciation expense from acquisitions (a) $ 12.8 $ 0.2 Due to amortization expense from acquisitions (b) 10.9 0.8 Due to other changes in depreciation expense (c) (1.1 ) 4.0 Due to other changes in amortization expense (d) 0.6 (5.1 ) Total change in depreciation and amortization $ 23.2 $ (0.1 ) ______________ (a) Increase in 2012 due to depreciation expense resulting from property and equipment obtained in the acquisitions of One Communications on April 1, 2011 and STS Telecom on March 2, 2011. Increase in 2013 due to inclusion of CenterBeam depreciation expense beginning July 1, 2013. (b) Increase in 2012 due to amortization expense resulting from the definite-lived intangible assets obtained in the acquisitions of One Communications on April 1, 2011 and STS Telecom on March 2, 2011. Increase in 2013 due to amortization expense resulting from the definite-lived intangible assets obtained in the acquisition of CenterBeam on July 1, 2013. (c) Decrease in depreciation expense in 2012 primarily due to assets becoming fully depreciated during the year. Increase in depreciation expense in 2013 primarily due to an increase in capital expenditures, including customer acquisition costs, costs to maintain and enhance our network and costs for data center and fiber expansion. Also contributing to the increase in 2013 was accelerated depreciation expense on property and equipment that was disposed of during the year. (d) Increase in amortization expense in 2012 primarily due to a change in useful life for certain One Communications intangible assets, offset by definite-lived intangible assets becoming fully amortized during the year. Decrease in 42-------------------------------------------------------------------------------- Table of Contents amortization expense in 2013 primarily due to definite-lived intangible assets becoming fully amortized during the year. Impairment of goodwill Interim goodwill test. During the first quarter of 2013, we recognized a $256.7 million non-cash impairment charge to goodwill related to our Business Services reporting unit, of which $255.6 million is included in continuing operations and $1.1 million is reflected in discontinued operations. We test our goodwill annually during the fourth quarter of each fiscal year or when events or changes in circumstances indicate that goodwill might be impaired. Our stock price and market capitalization declined during the three months ended March 31, 2013 following the announcement in mid-February 2013 of our fourth quarter 2012 earnings and 2013 financial guidance. As a result of the sustained decrease in stock price and market capitalization, we performed an interim goodwill test in conjunction with the preparation of our financial statements for the three months ended March 31, 2013. The primary factor contributing to the impairment was a change in the discount rate and market multiples as a result of the change in these market conditions, both key assumptions used in the determination of fair value. Impairment testing of goodwill is required at the reporting unit level and involves a two-step process. We identified two reporting units, Business Services and Consumer Services, for evaluating goodwill. Each of these reporting units constitutes a business for which discrete financial information is available and segment management regularly reviews the operating results. The first step of the impairment test involves comparing the estimated fair values of our reporting units with the reporting units' carrying amounts, including goodwill. We estimated the fair values of our reporting units based on weighting of the income and market approaches. These models use significant unobservable inputs, or Level 3 inputs, as defined by the fair value hierarchy. Under the income approach, the fair value of the reporting unit was estimated based on the present value of estimated cash flows using a discounted cash flow method. The significant assumptions used in the discounted cash flow method included internal forecasts and projections developed by management for planning purposes, available industry/market data, strategic plans, discount rates and the growth rate to calculate the terminal value. Under the market approach, the fair value was estimated using the guideline company method. We selected guideline companies in the industry in which each reporting unit operates. Upon completion of the first step, we determined that the carrying value of our Business Services reporting unit exceeded its estimated fair value, so a second step was performed to compare the carrying amount of goodwill to the implied fair value of that goodwill. The implied fair value of goodwill for the Business Services reporting unit was determined in the same manner as utilized to recognize goodwill in a business combination. To determine the implied value of goodwill, fair values were allocated to the assets and liabilities of the Business Services reporting unit as of March 31, 2013. The implied fair value of goodwill was measured as the excess of the fair value of the Business Services reporting unit over the fair value of its assets and liabilities. The impairment loss of $256.7 million during the first quarter of 2013 was measured as the amount the carrying value of goodwill exceeded the implied fair value of the goodwill. Annual goodwill test. We did not record any impairment of goodwill during the years ended 2011 or 2012. In addition, our annual test of impairment for fiscal 2013 did not result in an impairment. However, approximately $50.3 million of goodwill attributable to our Business Services reporting unit and $88.9 million of goodwill attributable to our Consumer Services reporting unit remains as of December 31, 2013. Deterioration in market conditions or estimated future cash flows in our reporting units could result in future goodwill impairment. We continue to monitor events and circumstances which may affect the fair value of this reporting unit. Restructuring, acquisition and integration-related costs Restructuring, acquisition and integration-related costs consisted of the following during the years ended December 31, 2011, 2012 and 2013: Year Ended December 31, 2012 vs 2011 2013 vs 2012 2011 2012 2013 $ Change % Change $ Change % Change (dollars in thousands)Integration-related costs $ 4,044 $ 10,452 $ 21,622 $ 6,408 158 % $ 11,170 107 % Severance, retention and other employee costs 16,460 6,067 14,844 (10,393 ) (63 )% 8,777 145 % Transaction-related costs 5,756 1,399 1,021 (4,357 ) (76 )% (378 ) (27 )% Facility-related costs 5,530 479 2,328 (5,051 ) (91 )% 1,849 386 % Legacy plan restructuring costs 278 (153 ) 215 (431 ) (155 )% 368 241 % Restructuring, acquisition and integration-related costs $ 32,068 $ 18,244 $ 40,030 $ (13,824 ) (43 )% $ 21,786 119 % 43-------------------------------------------------------------------------------- Table of Contents Restructuring, acquisition and integration-related costs consist of costs related to EarthLink's restructuring, acquisition and integration-related activities. Such costs include: 1) integration-related costs, such as system conversion, rebranding costs and integration-related consulting and employee costs; 2) severance, retention and other employee termination costs associated with acquisition and integration activities and with certain voluntary employee separations; 3) transaction-related costs, which are direct costs incurred to effect a business combination, such as advisory, legal, accounting, valuation and other professional fees; and 4) facility-related costs, such as lease termination and asset impairments. Restructuring, acquisition and integration-related costs are expensed in the period in which the costs are incurred and the services are received and are included in restructuring, acquisition and integration-related costs in the Consolidated Statements of Comprehensive Income (Loss). The decrease in restructuring, acquisition and integration-related costs during the year ended December 31, 2012 compared to the prior year was primarily due to a decline in certain up-front costs related to our 2010 and 2011 acquisitions, such as severance costs incurred to eliminate duplicate positions, transaction costs incurred to effect the transactions and facility-related costs to exit duplicate facilities. Partially offsetting this decline was an increase in integration-related costs, as we incurred costs to integrate operating support systems and networks. The increase in restructuring, acquisition and integration-related costs during the year ended December 31, 2013 compared to the prior year was primarily due to an increase in costs to integrate operating support systems, networks and certain billing systems as we worked to complete several significant integration milestones during the year; costs related to our acquisition of CenterBeam; employee termination costs associated with certain voluntary employee separations; and costs to exit duplicate facilities. In addition, during the first quarter of 2013, we restructured our sales organization in order to better meet the needs of the IT services market, which resulted in a reduction in our sales workforce and some offices closing. We also decided to exit telecom systems sales early in 2013 to enable focus on our hosted VoIP platform for new voice customers, which resulted in a small number of position eliminations. Interest expense and other, net The following table presents our interest expense and other, net, for the years ended December 31, 2011, 2012 and 2013: Year Ended December 31, 2012 vs 2011 2013 vs 2012 2011 2012 2013 $ Change % Change $ Change % Change (dollars in thousands)Interest expense $ 74,949 $ 64,331 $ 60,495 $ (10,618 ) (14 )% $ (3,836 ) (6 )% Interest income (4,678 ) (2,076 ) (84 ) 2,602 (56 )% 1,992 (96 )% Other, net 369 1,161 275 792 215 % (886 ) (76 )% Total interest expense and other, net $ 70,640 $ 63,416 $ 60,686 $ (7,224 ) (10 )% $ (2,730 ) (4 )% Interest expense and other, net, is primarily comprised of interest expense incurred on our debt and capital leases, amortization of debt issuance costs, debt premiums, and debt discounts; interest earned on our cash, cash equivalents and marketable securities; and other miscellaneous income and expense items. The decrease in interest expense and other, net, during the year ended December 31, 2012 compared to the prior year was primarily due to the redemption and repayment of our outstanding $255.8 million principal amount of convertible senior notes due 2026 on November 15, 2011, as well as the redemption of $32.5 million aggregate principal amount of our 10.5% ITC^DeltaCom Notes on December 6, 2012. Partially offsetting this was a decrease in interest income due to lower investment yields and a decrease in our average cash and marketable securities. The decrease in interest expense and other, net, during the year ended December 31, 2013 compared to the prior year was primarily due to lower interest expense resulting from the issuance of 7.375% Senior Secured Notes and repayment of our remaining ITC^DeltaCom Notes in May 2013. In May 2013, we issued $300.0 million aggregate principal amount of 7.375% Senior Secured Notes. Also in May 2013, we completed a tender offer and redemption of all outstanding principal of our 10.5% ITC^DeltaCom Notes. Partially offsetting the decrease in interest expense was a $2.0 million loss on repayment of debt recorded in connection with the redemption of our ITC^DeltaCom Notes and a $2.0 million decrease in interest income due to lower cash and marketable securities. We recognized a net loss of $2.0 million as a result of $16.2 million of premiums paid for the acquisition of ITC^DeltaCom Notes, net of a $14.2 million write-off of the unamortized premium on debt. 44-------------------------------------------------------------------------------- Table of Contents Income tax (provision) benefit The following table presents the components of the income tax (provision) benefit for the years ended December 31, 2011, 2012 and 2013: Year Ended December 31, 2011 2012 2013 (in thousands)Current (provision) benefit $ (3,777 ) $ 1,224 $ 1,639 Deferred (provision ) benefit (17,954 ) 107 (212,870 ) Total income tax (provision) benefit $ (21,731 ) $ 1,331 $ (211,231 ) During the year ended December 31, 2011, the current tax provision was due to state income and federal and state alternative minimum tax ("AMT") amounts payable due to the net operating loss carryforward limitations associated with the AMT calculation and the non-cash deferred tax provision was due primarily to the utilization of net operating loss carryforwards. During the year ended December 31, 2012, the current and non-cash deferred benefits were primarily due to the tax impact of changes to our state deferred income tax rates and the resulting impact on the re-measurement of deferred tax assets and liabilities recorded on the balance sheet as of January 1, 2012; the release of valuation allowance related to specific state net operating losses; and the reversal of state related uncertain tax positions in the current year due to statute expirations. During the year ended December 31, 2013, the current tax benefit was primarily related to expense for Canadian tax amounts payable, prior year state tax items and penalties and interest related to uncertain tax positions, which is offset with benefit from the current release of uncertain tax positions related to prior years. During the year ended December 31, 2013, the non-cash deferred tax provision was due primarily to the recording of a valuation allowance against deferred tax assets (as further described below). The tax provision for the year ended December 31, 2013 includes a $266.3 million non-cash charge to record a valuation allowance against our deferred tax assets. During the three months ended December 31, 2013, we entered into a three-year cumulative loss position. For purposes of assessing the realization of the deferred tax assets, this cumulative loss position is considered significant negative evidence. Also during the three months ended December 31, 2013, management reassessed its projections of future taxable income. This change in projections, coupled with its cumulative loss position caused management to modify its assessment of the realizability of its deferred tax asset and conclude that a full valuation allowance, exclusive of our deferred tax liabilities with indefinite useful lives and our capital loss carryforward, was necessary. We will reassess the realization of the deferred tax assets each reporting period. To the extent that our financial results improve and the deferred tax assets becomes realizable, we will reduce the valuation allowance through earnings. Loss from discontinued operations, net of tax The operating results of the our telecom systems business acquired as part of ITC^DeltaCom have been separately presented as discontinued operations for all periods presented. On August 2, 2013, we sold our telecom systems business. We received $0.6 million of cash and recorded an $0.8 million receivable for contingent consideration expected to be received over the next four years. No gain or loss was recognized on the sale. We have no significant continuing involvement in the operations or significant continuing direct cash flows. The telecom systems results of operations were previously included in our Business Services segment. The following table presents summarized results of operations related to discontinued operations for the years ended December 31, 2011, 2012 and 2013: Year Ended December 31, 2011 2012 2013 (in thousands) Revenues $ 13,561 $ 13,842 $ 6,141 Operating costs and expenses (18,096 ) (17,860 ) (8,102 ) Income tax benefit 1,829 1,600 -Loss from discontinued operations, net of tax $ (2,706 ) $ (2,418 ) $ (1,961 ) 45 -------------------------------------------------------------------------------- Table of Contents Segment Results of Operations We operate two reportable segments, Business Services and Consumer Services. We present our segment information along the same lines that our chief executive reviews our operating results in assessing performance and allocating resources. Our Business Services segment earns revenue by providing a broad range of data, voice and IT services to businesses and communications carriers. Our Consumer Services segment provides nationwide Internet access and related value-added services to residential customers. We evaluate the performance of our operating segments based on segment operating income. Segment operating income includes revenues from external customers, related cost of revenues and operating expenses directly attributable to the segment, which include expenses over which segment managers have direct discretionary control, such as advertising and marketing programs, customer support expenses, operations expenses, product development expenses, certain technology and facilities expenses, billing operations and provisions for doubtful accounts. Segment operating income excludes other income and expense items and certain expenses over which segment managers do not have discretionary control. Costs excluded from segment operating income include various corporate expenses (consisting of certain costs such as corporate management, human resources, finance and legal), depreciation and amortization, impairment of goodwill and intangible assets, restructuring, acquisition and integration-related costs and stock-based compensation expense, as they are not considered in the measurement of segment performance. Business Services Segment The following table sets forth operating results for our Business Services segment for the years ended December 31, 2011, 2012 and 2013: Year Ended December 31, 2012 vs 2011 2013 vs 2012 2011 2012 2013 $ Change % Change $ Change % Change (dollars in thousands) Revenues $ 924,698 $ 1,017,425 $ 964,227 $ 92,727 10 % $ (53,198 ) (5 )% Cost of revenues 463,782 527,514 506,245 63,732 14 % (21,269 ) (4 )% Segment operating expenses 293,211 332,542 342,630 39,331 13 % 10,088 3 % Segment operating income $ 167,705 $ 157,369 $ 115,352 $ (10,336 ) (6 )% $ (42,017 ) (27 )% The increase in Business Services revenues during the year ended December 31, 2012 compared to the prior year was primarily due to a full year of One Communications revenues in 2012 compared to a partial period 2011; revenues from our IT services transactions entered into during 2011 and new product launches over the year; partially offset by continued declines in revenues for certain traditional voice and data products, including traditional voice, web hosting and lower-end, single site broadband services. The decrease in Business Services revenues during the year ended December 31, 2013 compared to the prior year was primarily due to continued declines in revenues for traditional voice and data products, partially offset by revenues from our growth products, including MPLS, hosted voice and IT services, and revenues from CenterBeam beginning in July 2013. For more detail, please see discussion under "Revenues" in "Consolidated Results of Operations" elsewhere in this section. The decrease in Business Services operating income during the year ended December 31, 2012 compared to the prior year was primarily due to the decline in traditional voice and data products. The decrease in Business Services operating income during the year ended December 31, 2013 compared to the prior year was primarily due to the continued decline in revenues for traditional voice and data products. In addition, costs increased due to investments in our growth products and due to the change in mix of products to growth products, which are more costly to deliver. 46-------------------------------------------------------------------------------- Table of Contents Consumer Services Segment Consumer Services Operating Metrics The following table sets forth subscriber and operating data for our Consumer Services segment for the years ended December 31, 2011, 2012 and 2013: Year Ended December 31, 2011 2012 2013 Consumer Subscriber Activity Subscribers at beginning of year 1,636,000 1,350,000 1,139,000 Gross organic subscriber additions 184,000 146,000 105,000 Churn (470,000) (357,000) (268,000) Subscribers at end of year (a) 1,350,000 1,139,000 976,000 Consumer Metrics Average narrowband subscribers (b) 830,000 678,000 582,000 Average broadband subscribers (b) 654,000 562,000 473,000 Average consumer subscribers (b) 1,484,000 1,240,000 1,055,000 ARPU (c) $ 21.10 $ 21.34 $ 21.83 Churn rate (d) 2.6 % 2.4 % 2.1 % (a) Subscriber counts do not include new nonpaying customers. Customers receiving service under promotional programs that include periods of free service at inception are not included in subscriber counts until they become paying customers. (b) Average subscribers is calculated by averaging the ending monthly subscribers or accounts for the thirteen months preceding and including the end of the year. (c) ARPU represents the average monthly revenue per user (subscriber). ARPU is computed by dividing average monthly revenue for the period by the average number of subscribers for the period. Average monthly revenue used to calculate ARPU includes recurring service revenue as well as nonrecurring revenues associated with equipment and other one-time charges associated with initiating or discontinuing services. (d) Churn rate is used to measure the rate at which subscribers discontinue service on a voluntary or involuntary basis. Churn rate is computed by dividing the average monthly number of subscribers that discontinued service during the period by the average subscribers for the period. 47-------------------------------------------------------------------------------- Table of Contents Consumer Services Operating Results The following table sets forth operating results for our Consumer Services segment for the years ended December 31, 2011, 2012 and 2013: Year Ended December 31, 2012 vs 2011 2013 vs 2012 2011 2012 2013 $ Change % Change $ Change % Change (dollars in thousands) Revenues $ 375,845 $ 317,710 $ 276,379 $ (58,135 ) (15 )% $ (41,331 ) (13 )% Cost of revenues 117,482 105,102 94,497 (12,380 ) (11 )% (10,605 ) (10 )% Segment operating expenses 73,293 67,526 50,623 (5,767 ) (8 )% (16,903 ) (25 )% Segment operating income $ 185,070 $ 145,082 $ 131,259 $ (39,988 ) (22 )% $ (13,823 ) (10 )% The decreases in Consumer Services revenues and operating income during the years ended December 31, 2012 and 2013 compared to the prior years were primarily due to the continued maturation of and competition in the market for consumer Internet access and competitive pressures in the industry. The decreases in revenue were partially offset by decreases in operating expenses as our consumer subscriber base has decreased and become longer-tenured. Our longer tenured customers require less customer service and technical support and have a lower frequency of non-payment. Liquidity and Capital Resources The following table sets forth summarized cash flow data for the years ended December 31, 2011, 2012 and 2013: Year Ended December 31, 2012 vs 2011 2013 vs 2012 2011 2012 2013 $ Change % Change $ Change % Change (dollars in thousands) Net cash provided by operating activities $ 146,234 $ 191,055 $ 124,156 $ 44,821 31 % $ (66,899 ) (35 )% Net cash provided by (used in) investing activities 141,594 (163,836 ) (112,500 ) (305,430 ) (216 )% 51,336 31 % Net cash used in financing activities (318,997 ) (81,381 ) (52,641 ) 237,616 74 % 28,740 35 % Net decrease in cash and cash equivalents $ (31,169 ) $ (54,162 ) $ (40,985 ) $ (22,993 ) (74 )% $ 13,177 24 % Operating activities The increase in cash provided by operating activities during the year ended December 31, 2012 compared to the prior year was primarily due to the inclusion of a full period of cash generated by One Communications in 2012 compared to a partial period in 2011. Also contributing to the increase was an increase in accounts payable and accrued liabilities, primarily related to timing of certain payments to network providers. This was partially offset by severance, transaction and other integration-related costs and an increase in interest payments. The decrease in cash provided by operating activities during the year ended December 31, 2013 compared to the prior year period was primarily due to the overall decrease in revenues as well as an increase in payments for acquisition, restructuring and integration-related activities. Investing activities The change in cash flows from investing activities during the year ended December 31, 2012 compared to the prior year was primarily due to $307.4 million change in cash associated with investments in marketable securities. During the year ended December 31, 2011, we received cash of $290.1 million for sales and maturities of investments in marketable securities, net of purchases. During the year ended December 31, 2012, we used cash of $17.2 million for purchases of marketable securities, net of sales and maturities. Also contributing to the decrease was a $45.4 million increase in capital expenditures, primarily due to a full year of One Communications of capital expenditures, network and technology center related projects and customer acquisition costs. The overall decrease in cash flows from investing activities was offset by a $43.1 million decrease in cash used for acquisitions, net of cash acquired. 48-------------------------------------------------------------------------------- Table of Contents The decrease in net cash used in investing activities during the year ended December 31, 2013 compared to the prior year period was primarily due to a $64.1 million change in net cash from purchases and sales of marketable securities. During the year ended December 31, 2012, we used $17.2 million of cash for purchases of marketable securities, net of sales and maturities. During the year ended December 31, 2013, we generated $46.9 million of cash from sales and maturities of marketable securities, net of purchases. Also contributing was a $3.7 million decrease in capital expenditures. Partially offsetting these decreases was $16.8 million of cash used for our acquisition of CenterBeam in July 2013. Financing activities The decrease in net cash used in financing activities during the year ended December 31, 2012 compared to the prior year was primarily due to a $215.0 million net change in cash flows from debt activities, a $21.6 million decrease in repurchases of common stock and a $1.8 million decrease in dividend payments. During the year ended December 31, 2011, we used $250.3 million for repayment of debt and capital lease obligations and during the year ended December 31, 2012, we used $35.3 million for repayment of debt and capital lease obligations. During the year ended December 31, 2011, we repurchased 6.3 million shares of our common stock for $47.0 million and during the year ended December 31, 2012, we repurchased 3.7 million shares of our common stock for $25.4 million. Dividend payments were $22.9 million and $21.1 million during the years ended December 31, 2011 and 2012, respectively, reflecting quarterly dividends of $0.05 per share. The decrease in net cash used in financing activities during the year ended December 31, 2013 compared to the prior year was primarily due to a $19.3 million decrease in repurchases of common stock, a $9.4 million decrease in net cash used for debt and capital lease transactions and a $0.3 million decrease in dividends paid. During the year ended December 31, 2012, we repurchased 3.7 million shares of our common stock for $25.4 million compared to 1.1 million shares of our common stock for $6.1 million during the year ended December 31, 2013. During the year ended December 31, 2012, we used $35.3 million for repayments of debt and capital lease obligations, compared to $25.8 million net cash used for debt transactions during the year ended December 31, 2013, which are more fully described below. Dividend payments were $21.1 million and $20.8 million during the years ended December 31, 2012 and 2013, respectively, reflecting quarterly dividends of $0.05 per share. In May 2013, we completed a private placement of $300.0 million aggregate principal amount of Senior Secured Notes, resulting in net proceeds of $292.6 million after deducting transaction fees of $7.4 million. We used proceeds from the private placement, together with available cash, to fund a tender offer and redemption of our ITC^DeltaCom Notes. We used approximately $314.8 million to repay the ITC^DeltaCom Notes, which consisted of $292.3 million of outstanding principal amount, $16.2 million of premiums and $6.3 million of accrued and unpaid interest. In May 2013, we also amended and restated our revolving credit facility and paid $1.9 million of transaction fees and expenses. Finally, in connection with our acquisition of CenterBeam in July 2013, we assumed and repaid $6.5 million of debt. Future uses of cash Our primary future cash requirements relate to outstanding indebtedness, capital expenditures and investments in our Business Services segment. In addition, we have historically used cash for dividends and we may use cash in the future to make strategic acquisitions or repurchase common stock or debt. Debt and interest. We expect to use cash to service our outstanding indebtedness, including our $300.0 million aggregate principal amount of Senior Notes due in May 2019, our $300.0 million aggregate principal amount of Senior Secured Notes due in June 2020 and any future borrowings under our $135.0 million revolving credit facility. Capital expenditures. We expect to incur capital expenditures of approximately $125.0 million to $135.0 million during 2014. The capital expenditures primarily relate to the acquisition of new customers and to maintain and upgrade our network and technology infrastructure. The actual amount of capital expenditures may fluctuate due to a number of factors which are difficult to predict and could change significantly over time. Additionally, technological advances may require us to make capital expenditures to develop or acquire new equipment or technology in order to replace aging or obsolete equipment. Investments in our Business Services segment. One of our key strategies is to grow our Business Services revenue. We are deploying a wide array of cloud, managed security and IT support services. We expect to invest cash in sales and marketing efforts and resources required to support our business services, including investments in search engine marketing campaigns and advertising to increase brand awareness. Dividends. During the years ended December 31, 2011, 2012 and 2013, cash dividends declared were $0.20 per common share. The decision to declare future dividends is made at the discretion of the Board of Directors and will depend on, among other 49-------------------------------------------------------------------------------- Table of Contents things, our results of operations, financial condition, cash requirements, investment opportunities, restrictions on dividends under the agreements governing our indebtedness and other factors the Board of Directors may deem relevant. Other. We may also use cash to invest in or acquire other companies, to repurchase common stock or to repurchase or redeem debt. We expect to continue to evaluate and consider potential strategic transactions that we believe may complement or grow our business. Although we continue to consider and evaluate potential strategic transactions, there can be no assurance that we will be able to consummate any such transaction. In addition, we continue to evaluate our business, including evaluating ways to reduce the cost structure of our business, and may incur costs for additional restructuring activities. Our cash requirements depend on numerous factors, including costs required to integrate our acquisitions, costs incurred to redeem or repurchase debt, the size and types of future acquisitions in which we may engage, the costs required to maintain our network infrastructure, the outcome of various telecommunications-related disputes and proceedings, the pricing of our services and the level of resources used for our sales and marketing activities, among others. In addition, our use of cash in connection with acquisitions may limit other potential uses of our cash, including stock repurchases, debt repayments or repurchases and dividend payments. Future sources of cash Our principal sources of liquidity are our cash, cash equivalents and marketable securities, as well as the cash flow we generate from our operations. During the years ended December 31, 2011, 2012 and 2013, we generated $146.2 million, $191.1 million and $124.2 million in cash from operations, respectively. As of December 31, 2013, we had $116.6 million in cash and cash equivalents. Our cash and cash equivalents are subject to general credit, liquidity, market, and interest rate risks, which may be exacerbated by unfavorable economic conditions. Another source of liquidity is our revolving credit facility. We have a credit agreement providing for a senior secured revolving credit facility with aggregate revolving commitments of $135.0 million. The senior secured revolving credit facility terminates in May 2017, and at that time any amounts outstanding thereunder shall be due and payable in full. As of December 31, 2013, no amounts had been drawn or were outstanding under the senior secured revolving credit facility. Our available cash and cash equivalents, together with our results of operations, are expected to be sufficient to meet our operating expenses, service outstanding indebtedness, capital requirements and investment and other obligations for at least the next 12 months. However, to increase available liquidity or to fund acquisitions or other strategic activities, we may seek additional financing. We have no commitments for any additional financing and have no lines of credit or similar sources of financing, other than the $135.0 million credit facility. We cannot be sure that we can obtain additional financing on favorable terms, if at all, through the issuance of equity securities or the incurrence of additional debt. Additional equity financing may dilute our stockholders, and debt financing, if available, may restrict our ability to repurchase common stock or debt, declare and pay dividends and raise future capital. If we are unable to obtain additional needed financing, it may prohibit us from refinancing existing indebtedness and making acquisitions, capital expenditures and/or investments, which could materially and adversely affect our business. 50-------------------------------------------------------------------------------- Table of Contents Contractual Obligations and Commitments The following table sets forth our contractual obligations and commercial commitments as of December 31, 2013: Payment Due by Period 2015- 2017- Total 2014 2016 2018 After 5 Years (in thousands)Long-term debt (1) $ 600,000 $ - $ - $ - $ 600,000 Interest payments on long-term debt (2) 285,078 48,750 97,500 97,500 41,328 Purchase commitments (3) 106,960 50,603 43,161 6,127 7,069 Operating leases (4) 181,717 40,436 51,934 47,106 42,241 Capital leases (5) 25,889 3,305 7,759 6,146 8,679 Total (6) $ 1,199,644 $ 143,094 $ 200,354 $ 156,879 $ 699,317 __________________________________________ (1) Long-term debt includes principal payments on outstanding debt obligations. Long-term debt excludes unamortized discounts and premiums. As of December 31, 2013, we had $600.0 million aggregate principal amount of debt outstanding, consisting of $300.0 million of 8.875% Senior Notes due May 15, 2019 and $300.0 million of 7.375% Senior Secured Notes due June 1, 2020. (2) Interest payments on long-term debt includes interest due on outstanding debt through maturity and commitment fees and borrowing costs under our senior secured revolving credit facility. (3) Purchase commitments represent non-cancellable contractual obligations for services and equipment; minimum commitments under network access agreements with several carriers; and certain commitments regarding employee agreements. (4) These amounts represent base rent payments under non-cancellable operating leases for facilities and equipment that expire in various years through 2018, as well as an allocation for operating expenses. Not included in these amounts is expected sublease income of $2.1 million, $1.1 million, $1.1 million, $1.1 million and $0.9 million during the years ended December 31, 2014, 2015, 2016, 2017 and 2018, respectively. (5) Represents remaining payments under capital leases, including interest. (6) The table does not include our reserve for uncertain tax positions, which as of December 31, 2013 total $21.6 million, as the specific timing of any cash payments relating to this obligation cannot be projected with reasonable certainty. Debt Covenants Under the indentures governing our debt agreements, acceleration on principal payments would occur upon payment default or violation of debt covenants. We were in compliance with all covenants under our debt agreements as of December 31, 2013. Off-Balance Sheet Arrangements As of December 31, 2013, we did not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to investors. Share Repurchase Program The Board of Directors has authorized a total of $750.0 million to repurchase our common stock under our share repurchase program. As of December 31, 2013, we had utilized approximately $682.1 million pursuant to the authorizations and had $67.9 million available under the current authorization. We may repurchase our common stock from time to time in compliance with the Securities and Exchange Commission's regulations and other legal requirements, and subject to market conditions and other factors. The share repurchase program does not require us to acquire any specific number of shares and may be terminated by the Board of Directors at any time. 51-------------------------------------------------------------------------------- Table of Contents Non-GAAP Financial Measures In addition to our financial information presented in accordance with U.S. generally accepted accounting principles ("GAAP"), management uses certain "non-GAAP financial measures" within the meaning of the SEC Regulation G, to clarify and enhance understanding of past performance and prospects for the future. Generally, a non-GAAP financial measure is a numerical measure of a company's operating performance, financial position or cash flows that excludes or includes amounts that are included in or excluded from the most directly comparable measure calculated and presented in accordance with GAAP. Set forth below is a discussion of the presentation and use of Adjusted EBITDA and Unlevered Free Cash Flow, the non-GAAP financial measures used by management. Adjusted EBITDA is defined as net income (loss) before interest expense and other, net, income tax provision (benefit), depreciation and amortization, stock-based compensation expense, impairment of goodwill and intangible assets, restructuring, acquisition and integration-related costs, and loss from discontinued operations, net of tax. Unlevered Free Cash Flow is defined as net income (loss) before interest expense and other, net, income tax provision (benefit), depreciation and amortization, stock-based compensation expense, impairment of goodwill and intangible assets, restructuring, acquisition and integration-related costs, and loss from discontinued operations, net of tax, less cash used for purchases of property and equipment. These non-GAAP financial measures are commonly used in the industry and are presented because management believes they provide relevant and useful information to investors. Management uses these non-GAAP financial measures to evaluate the performance of its business. Management also uses Unlevered Free Cash Flow to assess its ability to fund capital expenditures, fund growth and service debt. Management believes that excluding the effects of certain non-cash and non-operating items enables investors to better understand and analyze the current period's results and provides a better measure of comparability. There are limitations to using these non-GAAP financial measures. Adjusted EBITDA and Unlevered Free Cash Flow are not indicative of cash provided or used by operating activities and may differ from comparable information provided by other companies. Adjusted EBITDA and Unlevered Free Cash Flow should not be considered in isolation, as an alternative to, or more meaningful than measures of financial performance determined in accordance with U.S. GAAP. The following table presents a reconciliation of Adjusted EBITDA to the most closely related financial measure reported under GAAP for the years ended December 31, 2011, 2012 and 2013: Year Ended December 31, 2011 2012 2013 (in thousands) Net income (loss) $ 34,567 $ 7,520 $ (538,827 ) Interest expense and other, net 70,640 63,416 60,686 Income tax provision (benefit) 21,731 (1,331 ) 211,231 Depreciation and amortization 159,993 183,165 183,114 Stock-based compensation expense 13,466 10,462 13,275 Impairment of goodwill - - 255,599 Restructuring, acquisition and integration-related costs 32,068 18,244 40,030 Loss from discontinued operations, net of tax 2,706 2,418 1,961 Adjusted EBITDA $ 335,171 $ 283,894 $ 227,069 52-------------------------------------------------------------------------------- Table of Contents The following table presents a reconciliation of Unlevered Free Cash Flow to the most closely related financial measure reported under GAAP for the years ended December 31, 2011, 2012 and 2013: Year Ended December 31, 2011 2012 2013 (in thousands) Net income (loss) $ 34,567 $ 7,520 $ (538,827 ) Interest expense and other, net 70,640 63,416 60,686 Income tax provision (benefit) 21,731 (1,331 ) 211,231 Depreciation and amortization 159,993 183,165 183,114 Stock-based compensation expense 13,466 10,462 13,275 Impairment of goodwill - - 255,599 Restructuring, acquisition and integration-related costs 32,068 18,244 40,030 Loss from discontinued operations, net of tax 2,706 2,418 1,961 Purchases of property and equipment (101,967 ) (147,360 ) (143,614 ) Unlevered Free Cash Flow $ 233,204 $ 136,534 $ 83,455 The following table presents a reconciliation of Unlevered Free Cash Flow, as a liquidity measure, to net cash provided by operating activities for the years ended December 31, 2011, 2012 and 2013: Year Ended December 31, 2011 2012 2013 (in thousands)Net cash provided by operating activities $ 146,234 $ 191,055 $ 124,156 Income tax provision (benefit) 21,731 (1,331 ) 211,231 Non-cash income taxes (17,954 ) 107 (212,870 ) Interest expense and other, net 70,640 63,416 60,686 Amortization of debt discount, premium and issuance costs (11,136 ) 1,945 (2,061 ) Restructuring, acquisition and integration-related costs 32,068 18,244 40,030 Changes in operating assets and liabilities 91,301 7,930 5,662 Purchases of property and equipment (101,967 ) (147,360 ) (143,614 ) Other, net 2,287 2,528 235 Unlevered Free Cash Flow $ 233,204 $ 136,534 $ 83,455 Net cash provided by (used in) investing activities $ 141,594 $ (163,836 ) $ (112,500 ) Net cash used in financing activities $ (318,997 ) $ (81,381 ) $ (52,641 ) 53-------------------------------------------------------------------------------- Table of Contents Critical Accounting Policies and Estimates Set forth below is a discussion of the accounting policies and related estimates that we believe are the most critical to understanding our consolidated financial statements, financial condition and results of operations and which require complex management judgments, uncertainties and/or estimates. The preparation of financial statements in accordance with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities and the reported amounts of revenues and expenses during a reporting period; however, actual results could differ from those estimates. Management has discussed the development, selection and disclosure of the critical accounting policies and estimates with the Audit Committee of the Board of Directors. Information regarding our other accounting policies is included in the Notes to our Consolidated Financial Statements. Judgments and Effect if Actual Results Description Uncertainties Differ From Assumptions Revenue Recognition We offer certain services The determination of We have not made any that are provided by whether we meet many of material changes in the third-party vendors. When the attributes for gross accounting methodology we we are the primary obligor and net revenue use to recognize revenue in a transaction, have recognition is judgmental during the past three latitude in establishing in nature and is based on years. prices, are the party an evaluation of the terms determining the service of each arrangement. We do not believe there is specifications or have a reasonable likelihood several but not all of that there will be a these indicators, we record material change in the the revenue and cost of future estimates or revenue on a gross basis. assumptions used to If we are not the primary recognize revenue. obligor and/or a third-party vendor has A change in the latitude in establishing determination of gross prices, we record revenue versus net revenue associated with the related recognition would have an subscribers on a net basis, impact on the gross netting the cost of revenue amounts of revenues and associated with the service cost of revenues we against the gross amount recognize and the gross billed the customer and profit margin percentages recording the net amount as in the period in which revenue. such determination is made and in subsequent periods; however, such a change in determination of revenue recognition would not affect net income. Sales Credit Reserves We make estimates for The determination of our We have not made any potential future sales general sales credit and material changes in the credits to be issued customer dispute credit accounting methodology we related to billing errors, reserves contain use to record sales credit service interruptions and uncertainties because they reserves during the past customer disputes, which require management to make three years. are recorded as a reduction assumptions and apply in revenue. We analyze judgment about the amount We do not believe there is historical credit activity and timing of unknown a reasonable likelihood and changes in customer billing errors and that there will be a demands related to current disputes. material change in the billing and service future estimates or interruptions when assumptions used to record evaluating our credit sales credit reserves. reserve requirements. Invoices provided to other A 10% difference in our telecommunications sales credit reserves as providers are often subject of December 31, 2013 would to significant billing have affected net loss by disputes, and these approximately $4.9 million disputes may require a during the year ended significant amount of time December 31, 2013. to resolve given the complexities and regulatory issues surrounding the customer relationships. Allowance for Doubtful Accounts We maintain an allowance The determination of our We have not made any for accounts receivable allowance for doubtful material changes in the that may not be accounts contains accounting methodology we collectible. In assessing uncertainties because it use to record our the adequacy of the requires management to allowance for doubtful allowance for doubtful make assumptions and apply accounts during the past accounts, management judgment about future three years. considers a number of uncollectible accounts. factors, including the We do not believe there is aging of the accounts a reasonable likelihood receivable balances, that there will be a historical collection material change in the experience and a specific future estimates or customer's ability to meet assumptions used to record its financial obligations our allowance for doubtful to us. accounts. A 10% difference in our allowance for doubtful accounts as of December 31, 2013 would have affected net loss by approximately $0.9 million during the year ended December 31, 2013. 54-------------------------------------------------------------------------------- Table of Contents Judgments and Effect if Actual Results Description Uncertainties Differ From Assumptions Cost of Revenues We rely on other carriers Our cost of revenues We have not made any to provide services where methodology contains material changes in the we do not have facilities, uncertainties because it accounting methodology we and we use a number of requires management to use to estimate reserves different carriers to make assumptions and apply for billing disputes terminate our long distance judgment regarding the during the past three calls. These costs are amount of future billing years. expensed as incurred. The dispute resolutions. invoices received from We do not believe there is other telecommunications a reasonable likelihood providers are often subject that there will be a to significant billing material change in the disputes. These disputes future estimates or may require a significant assumptions we use for amount of time to resolve these reserves. given the complexities and regulatory issues surrounding the vendor relationships. We maintain reserves for any anticipated exposure associated with these billing disputes. The reserves are reviewed on a monthly basis, but are subject to changes in estimates and management judgment as new information becomes available. Income Taxes We recognize deferred tax We consider the During the three months assets and liabilities probability of future ended December 31, 2013, using tax rates in effect taxable income and our we recorded income tax for the years in which historical profitability, expense of $266.3 million temporary differences are among other factors, in to record a valuation expected to reverse, assessing the amount of allowance for deferred tax including net operating the valuation allowance. assets that we determined loss carryforwards. Significant judgment is are not Management assesses the involved in this "more-likely-than-not" realizability of deferred determination, including able to be realized. Any tax assets and records a projections of future future change in the valuation allowance if it taxable income. valuation allowance could is more-likely-than-not have an effect on that all or a portion of Our liability for stockholders' equity and the deferred tax assets unrecognized tax benefits the income tax provision will not be realized. contains uncertainties in the statement of because management is comprehensive income. We establish reserves for required to make tax-related uncertainties assumptions and to apply As of December 31, 2013, if it is judgment to estimate the we had unrecognized tax more-likely-than-not that exposures associated with benefits of $21.6 million. additional taxes will be our various filing Within the next twelve due. We adjust these positions. months, it is reasonably reserves in light of possible that changing facts and Our effective income tax approximately $5.5 million circumstances, such as the rate is also affected by of the total uncertain tax closing of a tax audit, new changes in tax law, our positions recorded will tax legislation or the level of earnings and the reverse, primarily due to change of an estimate. To results of tax audits. the expiration of statutes the extent that the final of limitation in various tax outcome of these jurisdictions. matters is different than Approximately $5.7 million the amounts recorded, such would impact the effective differences will affect the rate once settled. provision for income taxes in the period in which such Changes in these estimates determination is made. The and assumptions could provision for income taxes materially affect the includes the effect of amount or timing of reserve provisions and valuation allowance changes to reserves that releases. are considered appropriate, as well as the related net interest and penalties. 55-------------------------------------------------------------------------------- Table of Contents Judgments and Effect if Actual Results Description Uncertainties Differ From Assumptions Goodwill We perform an impairment Application of the We have not made any test of our goodwill goodwill impairment test material changes in the annually during the fourth requires judgment, accounting methodology quarter of our fiscal year including performing the used to evaluate (October 1) or when events qualitative assessment, impairment of goodwill and circumstances indicate the identification of during the last three goodwill might be impaired. reporting units, assigning years other than the Impairment testing of assets and liabilities to adoption of the new goodwill is required at the reporting units, assigning guidance in 2011 allowing reporting unit level and goodwill to reporting the option to first assess involves a two-step units, and determining the qualitative factors to process. However, we may fair value of each determine whether it is first assess the reporting unit. necessary to perform the qualitative factors to two-step quantitative determine whether it is We estimate the fair impairment test. necessary to perform the values of our reporting two-step quantitative units based on weighting During the first quarter goodwill impairment test. of the income and market of 2013, we performed an approaches. These models interim goodwill test and The first step of the use significant recognized a $256.7 impairment test involves unobservable inputs, or million non-cash comparing the estimated Level 3 inputs, as defined impairment charge to fair value of our reporting by the fair value goodwill related to our units with the reporting hierarchy. Under the Business Services unit's carrying amount, income approach, we reporting unit. The including goodwill. If we calculate the fair value impairment was based on an determine that the carrying of the reporting unit analysis of a number of value of a reporting unit based on the present value factors after a decline in exceeds its estimated fair of estimated cash flows our market capitalization value, we perform a second using a discounted cash following the announcement step to compare the flow method. The of our fourth quarter 2012 carrying amount of goodwill significant assumptions earnings and 2013 to the implied fair value used in the discounted financial guidance. The of that goodwill. The cash flow method include primary factor implied fair value of internal forecasts and contributing to the goodwill is determined in projections developed by impairment was a change in the same manner as utilized management for planning the discount rate and to recognize goodwill in a purposes, available market multiples as a business combination. If industry/market data, result of the change in the carrying amount of strategic plans, discount these market conditions, goodwill exceeds the rates and the growth rate both key assumptions used implied fair value of that to calculate the terminal in the determination of goodwill, an impairment value. Under the market fair value. We did not loss would be recognized in approach, we estimate the record any impairment of an amount equal to the fair value using the goodwill during the years excess. guideline company method. ended 2011 or 2012. We select guideline We evaluate our reporting companies in the industry As of December 31, 2013, units on an annual basis where each reporting unit we had approximately and allocate goodwill to operates. We primarily use $139.2 million of our reporting units based revenue and EBITDA goodwill. Of the total on the reporting units multiples based on the goodwill, $50.3 million expected to benefit from multiples of the selected was allocated to our the acquisition generating guideline companies. Business Services the goodwill. reporting unit and $88.9 The assumptions with the million was allocated to most significant impact on our Consumer Services the fair value of the reporting unit. Our fiscal reporting unit are those 2013 impairment test related to the discount indicated the estimated rate, the terminal value, fair value of our Consumer future operating cash Services reporting unit flows and the growth rate. substantially exceeded the carrying value and These types of analyses therefore was not at risk contain uncertainties of future impairment. The because they require estimated fair value of management to make our Business assumptions and to apply Services reporting unit judgment to estimate exceeded its carrying industry economic factors value by approximately and the profitability of 47%. Deterioration in future business estimated future cash strategies. flows in this reporting unit could result in future goodwill impairment. We continue to monitor events and circumstances which may affect the fair value of this reporting unit. Examples of events or circumstances that could have a negative effect on the estimated fair value of the Business Services reporting unit include (i) changes in technology or customer demands that were not anticipated; (ii) competition or regulatory developments in the industry that may adversely affect profitability; (iii) a prolonged weakness in general economic conditions; (iv) a sustained decrease in share price; (v) volatility in the equity and debt markets which could result in a higher discount rate; and (vi) the inability to execute our strategy to grow our IT services and other growth products. If the assumptions used in the impairment analysis are not met or materially change, we may be required to recognize an impairment loss. There have been no significant events since the timing of our impairment test that would have triggered additional impairment testing. 56-------------------------------------------------------------------------------- Table of Contents Judgments and Effect if Actual Results Description Uncertainties Differ From Assumptions Long-lived assets We depreciate property and Estimates of useful lives We have not made any equipment and amortize can differ from actual material changes in the intangible assets using the useful lives due to the accounting methodology we straight-line method over inherent uncertainty in use to account for the estimated useful lives making these estimates. long-lived assets during of the assets. Estimates of the past three years. We useful lives are based on Our impairment tests did not recognize any the nature of the contain uncertainties material impairment underlying assets as well because they require charges for our long-lived as our experience with management to make assets during the past similar assets and intended assumptions and apply three years. use. We periodically review judgment to estimate estimated useful lives for future cash flows and We do not believe there is reasonableness. asset fair values a reasonable likelihood including, subscriber that there will be a We evaluate recoverability additions, churn, prices, material change in the of long-lived assets, marketing spending, future estimates or including property and operating costs and assumptions used to equipment and capital spending. account for long-lived definite-lived intangible Significant judgment is assets. assets, when events or involved in estimating changes in circumstances these factors, and they indicate that the carrying include inherent amount may not be uncertainties. recoverable. Business Combinations We account for business Accounting for business Although we believe the combinations by recognizing combinations requires our assumptions and estimates all of the assets acquired management to make we have made in the past and liabilities assumed at significant estimates and have been reasonable and the acquisition date fair assumptions about appropriate, they are value. Goodwill as of the intangible assets, inherently uncertain. As a acquisition date is obligations assumed and result, actual results may measured as the excess of pre-acquisition differ from estimates. consideration transferred contingencies, including and the net of the uncertain tax positions acquisition date fair and tax-related valuation values of the assets allowances, reserves for acquired and the billing disputes and liabilities assumed. During revenue reserves. Critical the measurement period, estimates in valuing which may be up to one year certain of the intangible from the acquisition date, assets include, but are adjustments to the assets not limited to, future acquired and liabilities expected cash flows from assumed are recorded to customer relationships and goodwill. Upon the developed technologies; conclusion of the the acquired company's measurement period, any brand and competitive subsequent adjustments are position, as well as recorded to our assumptions about the Consolidated Statements of period of time the Comprehensive Income acquired brand will (Loss). continue to be used in the combined company's product portfolio; and discount rates. Loss Contingencies We are party to various Significant judgment is Until the final resolution legal proceedings and other required to determine both of such matters, there may disputes arising in the likelihood of there being be an exposure to loss in normal course of business, and the estimated amount excess of the amount including, but not limited of a loss related to such recorded, and such amounts to, regulatory audits, matters. In addition, we could be material. Should trademark and patent are subject to significant any of our estimates and infringement, billing regulation and regulatory assumptions change, it disputes, rights of access, matters are subject to could have a material tax, consumer protection, differing interpretations. impact on our business, employment and tort. We consolidated financial accrue for such matters position, results of when it is both probable operations or cash flows that a liability has been incurred and the amount of During the year ended the loss can be reasonably December 31, 2012, we estimated. Where it is recorded an $8.3 million probable that a liability charge to increase our has been incurred and there reserves for regulatory is a range of expected loss audits, primarily an audit for which no amount in the that was conducted by the range is more likely than Universal Service any other amount, we accrue Administrative Company on at the low end of the previous ITC^DeltaCom range. We review our Universal Service Fund accruals each reporting assessments and payments, period. because the amount became probable and estimable during the period. During the year ended December 31, 2013, we recorded a $7.2 million favorable adjustment to decrease our reserves for regulatory audits resulting from final interpretation and resolution of certain regulatory audits, primarily the audit by the Universal Service Administrative Company. We have not made any material changes in the accounting methodology used to accrue for loss contingencies during the last three years 57-------------------------------------------------------------------------------- Table of Contents Cautionary Note Concerning Factors That May Affect Future Results The Management's Discussion and Analysis and other portions of this Annual Report on Form 10-K include "forward-looking" statements (rather than historical facts) that are subject to risks and uncertainties that could cause actual results to differ materially from those described. Although we believe that the expectations expressed in these forward-looking statements are reasonable, we cannot promise that our expectations will turn out to be correct. Our actual results could be materially different from and worse than our expectations. With respect to such forward-looking statements, we seek the protections afforded by the Private Securities Litigation Reform Act of 1995. These risks include, without limitation (1) that we may not be able to execute our strategy to be a leading communications and IT services provider, which could adversely affect our results of operations and cash flows; (2) that we may not be able to grow revenues from our growth products and services to offset declining revenues from our traditional products and services, which could adversely affect our results of operations and cash flows; (3) that our failure to achieve operating efficiencies will adversely affect our results of operations; (4) that as a result of our continuing review of our business, we may have to undertake further restructuring plans that would require additional charges, including incurring facility exit and restructuring charges; (5) that we may be unsuccessful integrating acquisitions into our business, which could result in operating difficulties, losses and other adverse consequences; (6) that if we are unable to adapt to changes in technology and customer demands, we may not remain competitive, and our revenues and operating results could suffer; (7) that unfavorable general economic conditions could harm our business; (8) that we may be unable to successfully identify, manage and assimilate future acquisitions, which could adversely affect our results of operations; (9) that we face significant competition in the communications and IT services industry that could reduce our profitability; (10) that failure to retain existing customers could adversely affect our results of operations and cash flows; (11) that decisions by legislative or regulatory authorities, including the Federal Communications Commission relieving incumbent carriers of certain regulatory requirements, and possible further deregulation in the future, may restrict our ability to provide services and may increase the costs we incur to provide these services; (12) that if we are unable to interconnect with AT&T, Verizon and other incumbent carriers on acceptable terms, our ability to offer competitively priced local telephone services will be adversely affected; (13) that our operating performance will suffer if we are not offered competitive rates for the access services we need to provide our long distance services; (14) that we may experience reductions in switched access and reciprocal compensation revenue; (15) that failure to obtain and maintain necessary permits and rights-of-way could interfere with our network infrastructure and operations; (16) that we have substantial business relationships with several large telecommunications carriers, and some of our customer agreements may not continue due to financial difficulty, acquisitions, non-renewal or other factors, which could adversely affect our wholesale revenue and results of operations; (17) that we obtain a majority of our network equipment and software from a limited number of third-party suppliers; (18) that work stoppages experienced by other communications companies on whom we rely for service could adversely impact our ability to provision and service our customers; (19) that our commercial and alliance arrangements may not be renewed or may not generate expected benefits, which could adversely affect our results of operations; (20) our consumer business is dependent on the availability of third-party network service providers; (21) that we face significant competition in the Internet access industry that could reduce our profitability; (22) that the continued decline of our consumer access subscribers will adversely affect our results of operations; (23) that potential regulation of Internet service providers could adversely affect our operations; (24) that cyber security breaches could harm our business; (25) that privacy concerns relating to our business could damage our reputation and deter current and potential users from using our services; (26) that interruption or failure of our network, information systems or other technologies could impair our ability to provide our services, which could damage our reputation and harm our operating results; (27) that our business depends on effective business support systems and processes; (28) that if we, or other industry participants, are unable to successfully defend against disputes or legal actions, we could face substantial liabilities or suffer harm to our financial and operational prospects; (29) that we may be accused of infringing upon the intellectual property rights of third parties, which is costly to defend and could limit our ability to use certain technologies in the future; (30) that we may not be able to protect our intellectual property; (31) that we may be unable to hire and retain sufficient qualified personnel, and the loss of any of our key executive officers could adversely affect us; (32) that government regulations could adversely affect our business or force us to change our business practices; (33) that our business may suffer if third parties are unable to provide services or terminate their relationships with us; (34) that we may be required to recognize impairment charges on our goodwill and intangible assets, which would adversely affect our results of operations and financial position; (35) that we may not realize our deferred tax assets, we may have exposure to greater than anticipated tax liabilities and we may be limited in the use of our net operating losses and certain other tax attributes in the future; (36) that our indebtedness could adversely affect our financial health and limit our ability to react to changes in our industry; (37) that we may require substantial capital to support business growth, and this capital may not be available to us on acceptable terms, or at all; (38) that our debt agreements include restrictive covenants, and failure to comply with these covenants could trigger acceleration of payment of outstanding indebtedness; (39) that we may reduce, or cease payment of, quarterly cash dividends; (40) that our stock price may be volatile; (41) that provisions of our certificate of incorporation, bylaws and other elements of our capital structure could limit our share price and delay a change of control of the company; and (42) that our bylaws designate the Court of Chancery of the State of Delaware as the sole and exclusive forum for certain types of actions and proceedings that may be initiated by our stockholders, which could limit our stockholders' flexibility in obtaining a judicial forum for disputes with us or our directors, officers or employees. These risks and uncertainties are described in greater detail in Item 1A of Part I, "Risk Factors." 58-------------------------------------------------------------------------------- Table of Contents |