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ALTEVA, INC. - 10-K - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) CAUTIONARY LANGUAGE CONCERNING FORWARD-LOOKING STATEMENTS Certain statements contained in this Form 10-K, including, without limitation, statements containing the words "believes," "anticipates," "intends," "expects," "will" and words of similar import, constitute "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. Such factors include, among others, the following: general economic and business conditions, both nationally and in the geographic regions in which we operate; industry capacity; goodwill and long-lived asset impairment; changes in the Orange County-Poughkeepsie Limited Partnership ("O-P") distributions; risks associated with the exercise of our option to sell our O-P interest back to Verizon; demographic changes; management turnover; technological changes and changes in consumer demand; existing governmental regulations and changes in or our failure to comply with, governmental regulations; current and potential restatements of our financial statements and associated material weaknesses, legislative proposals relating to the businesses in which we operate; changes to the USF; risks associated with our unfunded pension liability; competition; the loss of any significant ability to attract and retain highly skilled personnel and any other factors that are described in "Risk Factors." Given these uncertainties, current and prospective investors should be cautioned regarding reliance on such forward-looking statements. Except as required by law, we disclaim any obligation to update any such factors or to publicly announce the results of any revision to any of the forward-looking statements contained herein to reflect future events or developments. Restatement of Consolidated Financial Statements On March 14, 2014, the Audit Committee of our Board of Directors (the "Audit Committee"), in consultation with management, determined that, due to an error in the application of U.S. generally accepted accounting principles ("GAAP") for income taxes related to the determination of the valuation allowance needed to reflect our deferred tax assets at the amount that is more than likely than not realizable, our previously filed consolidated financial statements and related financial statement schedules as of and for the year ended December 31, 2012, contained in our Annual Report on Form 10-K/A for the year ended December 31, 2012, should be restated. In addition, the Audit Committee concluded that, due to similar errors in income tax accounting, the condensed interim financial statements as of March 31, 2013, June 30, 2013 and September 30, 2013 included in our Quarterly Reports on Forms 10-Q for the respective fiscal quarters then ended should be restated. (See Note 1 and Note 18 in our Notes to Consolidated Financial Statements). Effects of the Restatement The following tables provide a summary of selected line items from our consolidated statement of operations, consolidated statement of comprehensive income (loss), consolidated statement of cash flows and consolidated statement of shareholders' equity for the year ended December 31, 2012 and consolidated balance sheet as of December 31, 2012 affected by this restatement. The restatement impacted the consolidated statement of operations for the three months ended December 31, 2012, and, therefore, no restatement was required for any interim periods prior to the three month period ended December 31, 2012. The restatement impacted the condensed consolidated statements of operations and statements of comprehensive income (loss) for the three months ended March 31, 2013, for the three and six months ended June 30, 2013, and for the three and nine months ended September 30, 2013, and the condensed consolidated statements of cash flows for the three, six and nine months ended March 31, 2013, June 30, 2013 and September 30, 2013, respectively, and the condensed consolidated balance sheets as of March 31, 2013, June 30, 2013, and September 30, 2013. See Note 1 and Note 18 in our Notes to Consolidated Financial Statements. CONSOLIDATED STATEMENT OF OPERATIONS For the Year Ended December 31, 2012 ($ in thousands, except per share amounts) Correction of As previously reported Income Taxes As restated Income tax expense (benefit) $ (4,481 ) $ 1,437 $ (3,044 ) Net loss (9,452 ) (1,437 ) (10,889 ) Net loss applicable to common stock (9,477 ) (1,437 ) (10,914 ) Basic loss per common share (1.66 ) (0.25 ) (1.91 ) Diluted loss per common share (1.66 ) (0.25 ) (1.91 ) CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME (LOSS) For the Year Ended December 31, 2012 ($ in thousands) Correction of As Previously Reported Income Taxes As Restated Net loss $ (9,452 ) $ (1,437 ) $ (10,889 ) Comprehensive loss (8,472 ) (1,437 ) (9,909 ) 22 -------------------------------------------------------------------------------- Table of Contents CONSOLIDATED BALANCE SHEET As of December 31, 2012 ($ in thousands) Correction of As Previously Reported Deferred Taxes As Restated Current assets: Prepaid income taxes $ 1,222 $ (298 ) $ 924 Deferred income taxes 268 (151 ) 117 Total current assets 8,453 (449 ) 8,004 Long-term assets: Deferred income taxes 874 (874 ) - Total assets 43,445 (1,323 ) 42,122 Long-term liabilities: Deferred income taxes - 114 114 Total liabilities 28,910 114 29,024 Retained earnings 13,628 (1,437 ) 12,191 Total shareholders' equity 14,535 (1,437 ) 13,098 Total liabilities and shareholders' equity 43,445 (1,323 ) 42,122 CONSOLIDATED STATEMENT OF CASH FLOWS For the Year Ended December 31, 2012 ($ in thousands) Correction of As previously reported Income Taxes As restated Net loss $ (9,452 ) $ (1,437 ) $ (10,889 ) Deferred income taxes (3,949 ) 1,139 (2,810 ) Prepaid income taxes 1,493 298 1,791 Net cash used in operating activities (2,583 ) - (2,583 ) CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY As previously reported Correction of income taxes As restated Total Total Total Retained Shareholders' Retained Shareholders' Retained Shareholders' Earnings Equity Earnings Equity Earnings Equity ($ in thousands) Balance, December 31, 2011 $ 29,364 $ 24,876 $ - $ - $ 29,364 $ 24,876 Net loss for the year (9,452 ) (9,452 ) (1,437 ) (1,437 ) (10,889 ) (10,889 ) Balance, December 31, 2012 13,628 14,535 (1,437 ) (1,437 ) 12,191 13,098 23 -------------------------------------------------------------------------------- Table of Contents OVERVIEW Alteva, Inc. (we, our or us), formerly known as Warwick Valley Telephone Company, is a cloud-based communications company that provides Unified Communication ("UC") solutions that unify an organization's communications systems; enterprise hosted VoIP and we operate a regional Incumbent Local Exchange Carrier ("ILEC") in southern Orange County, New York and northern New Jersey. Our UC segment delivers cloud-based UC solutions including enterprise hosted VoIP, hosted Microsoft Communication Services, fixed mobile convergence and advanced voice applications for the desktop. By combining voice service with Microsoft Communications Services products, our customers receive a voice-enabled UC solution that integrates with existing business applications. Our Telephone segment consists of our ILEC operations that provide local and toll telephone service to residential and business customers, internet high-speed broadband service, and DIRECTV. Our cloud-based Unified Communication as a Service ("UCaaS") solutions are focused on medium, large and enterprise markets, which are defined as 20-500 users per location. We meet our customers' unique needs for a business communications solution that integrates multi-location, mobility, business productivity and analytics, into a single seamless experience. This discussion and analysis provides information about the important aspects of our operations and investments, both at the consolidated and segment levels, and includes discussions of our results of operations, financial position and sources and uses of cash. This discussion and analysis should be read in conjunction with the accompanying Consolidated Financial Statements and Notes thereto appearing elsewhere in this Annual Report on Form 10-K. CRITICAL ACCOUNTING POLICIES AND ESTIMATES General We prepare our consolidated financial statements in accordance with accounting principles generally accepted in the United States of America. Certain of these accounting policies require management to make estimates and assumptions about future events that could materially affect the reported amounts of assets, liabilities, revenues and expenses and any disclosure of contingent assets and liabilities. Significant estimates include, but are not limited to, depreciation expense, allowance for doubtful accounts, long-lived assets, goodwill, pension and postretirement expenses and income taxes. Actual results could differ from those estimates. The consolidated financial statements include our accounts and the accounts of our wholly-owned subsidiaries. All intercompany transactions and balances have been eliminated in the consolidated financial statements. Equity Method Accounting Our interest in the O-P is accounted for under the equity method of accounting. Pursuant to the equity method accounting, we record our proportionate share of the O-P's net income as an increase to our investment account. We apply the cash payments up to our proportionate share of the O-P's net income made under the 4G Agreement as a return on our investment when received. As a result of receiving the fixed guaranteed cash distributions from the O-P in excess of our proportionate share of the O-P income, the investment account was reduced to zero within the first six months of 2012. Thereafter, we recorded the fixed guaranteed cash distributions that were received from the O-P in excess of the proportionate share of the O-P income directly to our statement of operations as other income. Revenue Recognition We derive our revenue from the sale of UC services as well as traditional telephone service. We recognize revenue when (i) persuasive evidence of an arrangement between us and the customer exists, (ii) the delivery of the product to the customer has occurred or service has been provided to the customer, (iii) the price to the customer is fixed or determinable, and (iv) collectability of the sales or service price is assured. UC Services The Company's UC services and solutions consist primarily of its hosted VoIP UC system, certain UC applications, and other professional services associated with the installation and activation. Additionally, the Company offers customers the ability to purchase telephone equipment from the Company directly or independently from external vendors. Multiple element arrangements primarily include the sale of telephone equipment, along with professional services associated with installation, activation and implementation services, as well as follow on hosting services. The Company has concluded that the separate units of accounting in these arrangements consist of (i) the telephone equipment sale and (ii) the professional services provided combined with the follow on hosting services. The professional services provided do not constitute a separate unit of accounting as they do not have value to the customer on a stand-alone basis. Arrangement consideration is allocated to the separate units of accounting based on the relative selling price. The selling price for telephone equipment is based on third-party evidence representing list prices for similar equipment when sold a stand-alone basis. The selling price for professional and hosting services is based on the Company's best estimate of selling price (BESP). We develop our BESP by considering pricing practices, margin, competition and overall market trends. 24 -------------------------------------------------------------------------------- Table of Contents The Company bills a portion of its monthly recurring hosted service revenue a month in advance. Any amounts billed and collected, but for which the service is not yet delivered, are included in deferred revenue. These amounts are recognized as revenues only when the service is delivered. Equipment sales associated with the sale of telephone equipment is recognized upon delivery to the customer, as it is considered to be a separate earnings process. The sales are recognized on a gross basis, as the Company is considered the principal obligor in customer transactions among other considerations. Other upfront fees, excluding equipment, along with associated costs, up to but not exceeding these fees, are deferred and recognized over the estimated life of the customer relationship. The Company has estimated its customer relationship life at eight years and evaluates it periodically for continued appropriateness. Telephone Revenue is earned from monthly billings to customers for local voice services, long distance, DSL, Internet services, hardware and other services. Revenue is also derived from charges for network access to the local exchange telephone network from subscriber line charges and from contractual arrangements for services such as billing and collection and directory advertising. Revenue is recognized in the period in which service is provided to the customer. Directory advertising revenue is recorded ratably over the life of the directory. With multiple billing cycles, the Company accrues revenue earned but not yet billed at the end of a quarter. The Company also defers services billed in advance and recognizes them as income when earned. The Telephone Segment markets competitive service bundles which may include multiple deliverables. The base bundles consist of voice services (including a business or residential phone line), calling features and long distance services and customers may choose to add internet services to a base bundle package. Separate units of accounting within the bundled packages include voice services, long distance and Internet services. Revenue for all services included in bundles are recognized over the same service period, which is the time period in which the service is provided to the customer. Certain revenue is realized under pooling arrangements with other service providers and is divided among the companies based on respective costs and investments to provide the services. The companies that take part in pooling arrangements may adjust their costs and investments for a period of two years, which causes the dollars distributed by the pool to be adjusted retroactively. The Company believes that recorded amounts represent reasonable estimates of the final distribution from these pools. However, to the extent that the companies participating in these pools make adjustments, there will be corresponding adjustments to the Company's recorded revenue in future periods. Certain revenue from these pooling arrangements which includes Universal Service Funds ("USF") and National Exchange Carrier Association ("NECA") pool settlements, accounted for 3% and 9% of the Company's consolidated revenues for the three months ended December 31, 2013 and 2012, respectively, and 5% and 8% of the Company's consolidated revenues for the years ended December 31, 2013 and 2012, respectively. It is our policy to classify sales taxes collected from our customers and remitted to the government as netted through revenue. Income Taxes We record deferred taxes that arise from temporary differences between the financial statement and the tax basis of assets and liabilities. Deferred taxes are classified as current or non-current, depending on the classification of the assets and liabilities to which they relate. Deferred tax assets and deferred tax liabilities are adjusted for the effect of changes in tax laws and rates on the date of enactment. Our deferred taxes result principally from differences in the timing of depreciation and in the accounting for pensions and other postretirement benefits. The process of providing for income taxes and determining the related balance sheet accounts requires management to assess uncertainties, make judgments regarding outcomes and utilize estimates. Management must make judgments currently about such uncertainties and determine estimates of our tax assets and liabilities. To the extent the final outcome differs, future adjustments to our tax assets and liabilities may be necessary. In assessing the realizability of deferred tax assets, we consider whether it is more-likely-than-not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible and the tax credits and loss carryforwards are available to reduce taxable income. In making its assessment, we considered all sources of taxable income including carryback potential, future reversals of existing deferred tax liabilities, prudent and feasible tax planning strategies, and lastly, objectively verifiable projections of future taxable income exclusive of reversing temporary differences and carryforwards. Based on this assessment, we must evaluate the need for, and the amount of, valuation allowances against our deferred tax assets. To the extent facts and circumstances change in the future, adjustments to the valuation allowances may be required. Accounting for uncertainty in income taxes requires uncertain tax positions to be classified as non-current income tax liabilities unless they are expected to be paid within one year. We have adopted the accounting guidance for uncertain tax positions and have concluded that there are no uncertain tax positions requiring recognition in our consolidated financial statements as of December 31, 2013 and 2012. We recognize interest accrued related to unrecognized tax benefits in interest income (expense). Goodwill and Other Intangible Assets Assets acquired and liabilities assumed must be recorded at their fair value at the date of acquisition. Our balance sheet includes amounts designated as goodwill and other intangible assets. Goodwill represents the excess of the purchase price over the fair value of the net assets of acquired businesses. Other intangible assets primarily represent the Alteva trade name, customer relationships, and seat licenses. Goodwill is not amortized, rather tested for impairment at least annually. Our impairment testing for goodwill is performed annually on December 31, or whenever events or circumstances indicate that there may be impairment. For the purpose of the goodwill impairment test, the Company can elect to perform a qualitative analysis to determine if it is more likely than not that the fair values of its reporting units are less than the respective carrying values of those reporting units. We elected to bypass performing the qualitative screen and went directly to performing the first step quantitative analysis of the goodwill impairment test in the current year, primarily due to the UC segment's historical operating losses that have been generated since the goodwill was acquired in August 2011. Management believes that these operating losses were a result of the investments made to support the future growth of the UC segment and are not indicative of the future operating performance of the UC segment. We may elect to perform the qualitative analysis in future periods. The first step in the quantitative process is to compare the carrying amount of the reporting unit's net assets to the fair value of the reporting unit. If the fair value exceeds the carrying value, no further evaluation is required and no impairment loss is recognized. If the carrying amount exceeds the fair value, then the second step must be completed, which involves allocating the fair value of the reporting unit to each asset and liability, with the excess being implied goodwill. An impairment loss occurs if the amount of the recorded goodwill exceeds the implied goodwill. We would be required to record any such impairment losses. 25 -------------------------------------------------------------------------------- Table of Contents We have determined that our operating segments are the applicable reporting units because they are the lowest level at which discrete, reliable financial and cash flow information is regularly reviewed by segment management. The estimated fair value of the UC reporting unit is based on a weighting of the income and market approach, with significant weighting given to the income approach. We principally rely on a discounted cash flow analysis to determine the fair value of the UC reporting unit, which considers forecasted cash flows discounted at an appropriate discount rate. We believe that market participants would use a discounted cash flow analysis to determine the fair value of our reporting units in a sale transaction. The annual goodwill impairment test requires us to make a number of assumptions and estimates concerning future levels of revenue growth, operating margins, depreciation, amortization and working capital requirements, which are based upon our long-range plan. Our long-range plan is updated as part of our annual planning process and is reviewed and approved by management. The growth rates are based upon the UC segment's historical performance and the future expectations of the unified communications industry. The future profitability is based upon our estimated expenses required to obtain and support the estimated revenue growth, and the UC segment's ability to leverage its current infrastructure. The UC segment and unified communications industry have experienced strong growth in recent years. The discount rate is an estimate of the overall after-tax rate of return required by a market participant, whose weighted average cost of capital includes both equity and debt, including a risk premium. While we use the best available information to prepare our cash flow and discount rate assumptions, actual future cash flows or market conditions could differ significantly resulting in future impairment charges related to recorded goodwill balances. In order to evaluate the sensitivity of the goodwill impairment test to changes in the fair value calculations, we applied a hypothetical 20% decrease in the fair value of the UC reporting unit. The 2013 results (expressed as a percentage of carrying value for the unit) showed that, despite the hypothetical 20% decrease in fair value, the fair value of our UC reporting unit still exceeded the carrying value by over 10%. At December 31, 2013, goodwill of $9.0 million which was solely in our UC reporting unit, represented 24% of total assets. We performed our required annual impairment test in the fourth quarter of 2013 and determined that our goodwill was not impaired. There can be no assurance that goodwill impairment will not occur in the future. Intangible assets that have finite useful lives are amortized by the straight-line method over their useful lives ranging from 3 to 15 years. Other intangible assets with finite lives are evaluated for impairment when events or changes in circumstances indicate the carrying value may not be recoverable. The carrying value of other intangible assets with finite lives is considered impaired when the total projected undiscounted cash flows from those assets are less than the carrying value. In that event, a loss is recognized based on the amount by which the carrying value exceeds the fair market value of those assets. Fair market value is determined primarily using present value techniques based on projected cash flows from the asset group. As of December 31, 2013, our balance sheet included other intangibles that represented 20% of total assets. Property, Plant and Equipment We record property, plant and equipment at cost. Construction costs, labor and applicable overhead related to installations and interest during construction are capitalized. Costs of maintenance and repairs of property, plant and equipment are charged to operating expense. The estimated useful life of support equipment (vehicles, computers, etc.) ranges from 3 to 19 years. The estimated useful life of Internet equipment ranges from 3 to 5 years. The estimated useful life of communication and network equipment ranges from 10 to 15 years. The estimated useful life of buildings and other equipment ranges from 14 to 50 years. Depreciation expense is computed using the straight-line method. We review the recoverability of our long-lived assets, including buildings, equipment, internal-use software and other intangible assets, when events or changes in circumstances occur that indicate that the carrying value of the asset may not be recoverable. The assessment of possible impairment is based on our ability to recover the carrying value of the asset from the expected future cash flows (undiscounted and without interest charges) of the related operations. If these cash flows are less than the carrying value of such asset, an impairment loss is recognized for the difference between estimated fair value and carrying value. The primary measure of fair value is based on discounted cash flows. For the year ended December 31, 2012, we determined that the continuing revenue decline in the Telephone segment due to access line decline was an indicator of impairment for us to test for recoverability of the net realizable value of the segment assets. Accordingly, we performed an undiscounted cash flow analysis on our Telephone assets. Because we did not pass the recoverability test, we proceeded to perform a discounted cash flow to measure the assets fair value. We compared the assets fair value to their recorded book value and noted that the book value exceeded the fair value of our Telephone assets. As a result, we recorded an asset impairment charge of $8.9 million in the Telephone segment. We did not record an asset impairment charge for the year ended December 31, 2013. Pension and Postretirement Benefit Plans We have two defined benefit pension plans and one postretirement medical benefit plan. The most significant elements in determining our pension and postretirement income or expense are the assumed pension liability discount rate and the expected return on plan assets. The pension discount rate reflects the current interest rate at which the pension liabilities could be settled at the valuation date. At the end of each year, we determine the assumed discount rate to be used to discount plan liabilities. In estimating this rate for 2013, we considered rates of return on high-quality, fixed-income investments that have maturities consistent with the anticipated funding requirements of the plan. The discount rates used in determining the 2013 pension cost were 3.7% to 3.9% for the defined benefit pension plans and 3.6% for the postretirement medical benefit plan. The discount rate used for determining the funded status of the plans at December 31, 2013 and determining the 2014 defined benefit pension cost was 4.5% to 4.7% for the pension plans and 4.5% for the postretirement medical plan. In estimating the discount rates, our actuaries developed a customized discount rate appropriate to the 26 -------------------------------------------------------------------------------- Table of Contents plans' projected benefit cash flow based on yields derived from a database of long-term bonds at consistent maturity dates. We used an expected long-term rate of return on plan assets for 2013 of 8% for the pension and postretirement plans. In 2014, the Company will use 7% for the plans. We determine the expected long-term rate of return based primarily on its expectation of future returns for the plans' investments. Additionally, we consider historical returns on comparable fixed-income and equity investments, and adjust our estimate as deemed appropriate. All unrecognized prior service costs, remaining transition obligations or assets and actuarial gains and losses have been recognized, net of tax effects, as a charge to accumulated other comprehensive income in stockholders' equity and will be amortized as a component of net periodic pension cost. We use a December 31 measurement date (the date at which plan assets and benefit obligations are measured) for our defined benefit plans. To fund the plans, we made cash contributions to its defined benefit plans in 2013, which totaled $0.7 million, compared with $0.6 million in 2012. The Company anticipates making approximately $0.3 million in cash contributions to its defined benefit pension plans in 2014. New Accounting Pronouncements In December 2011, an ASU regarding balance sheet disclosures of offsetting assets and liabilities was issued and the scope was clarified in January 2013. This update requires disclosure on information about offsetting and related arrangements to enable users of an entity's financial statements to understand the effect of those arrangements on its financial position. This applies to derivatives accounted for in accordance with Topic 815, including bifurcated embedded instruments, repurchase agreements and reverse repurchase agreements and securities borrowings and securities lending transactions. We adopted this update effective January 1, 2013 and it did not have a material impact on our disclosures or consolidated financial statements. In February 2013, an accounting standards update regarding the reporting of amounts reclassified out of accumulated other comprehensive income was issued. This update requires an entity to report the effect of significant reclassifications out of accumulated other comprehensive income on the respective line items in net income if the amount being reclassified is required under U.S. GAAP. An entity is required to apply the update prospectively for reporting periods beginning after December 15, 2012. We adopted this update effective January 1, 2013. CONSOLIDATED RESULTS OF OPERATIONS A discussion of the factors that affected our overall financial results for the past two years is presented below. We also discuss our expected revenue and expense trends in "Operating Environment and Business Trends" below. OPERATING REVENUES 2013 Compared to 2012 (as restated) Operating revenues for the year ended December 31, 2013 increased $2.2 million, or 8%, to $30.1 million from $27.9 million in the same period in 2012. This increase was due primarily to a 17% increase in revenues from our UC segment resulting from organic growth, partially offset by a decrease of 1% in revenue from our Telephone segment. As part of our efforts to further improve performance of the UC segment, we restructured its NCI platform business by exiting, effective September 1, 2013, our Syracuse, New York operations. The annual revenue associated with these operations was $2.2 million for the year ended December 31, 2012. Revenues for our UC segment increased $2.2 million, or 16%, to $15.8 million for the year ended December 31, 2013 from $13.6 million for the same period in 2012. This increase was primarily due to a $3.1 million increase in hosted recurring license and usage revenue, and a $0.8 million increase in equipment revenue, which was primarily from new customers. These increases were partially offset by a $0.6 million decrease in wholesale carrier services resulting from our decision during 2012 to move away from this line of business, and $0.8 million decrease from the sale of our operations in Syracuse, New York. See Note 3 to our Consolidated Financial Statements contained in Item 8 herein. Revenues for our Telephone segment decreased $0.1 million, or 1%, to $14.3 million for the year ended December 31, 2013 from $14.4 million for the same period in 2012. This decrease was primarily attributable to a $0.9 million decrease in network access services revenue, mainly due to a decrease in access line revenues and a 34% decline in USF revenues, due to recent FCC reforms of USF funding and lower billing to carriers. These decreases were partially offset by increases in Broadband and rate changes. 2012 (as restated) Compared to 2011 Operating revenues for the year ended December 31, 2012 increased $2.0 million, or 8% to $27.9 million from $25.9 million in the same period in 2011. This increase was due primarily to a 62% increase in revenues from our UC segment resulting from the operations associated with our acquisition of substantially all of the assets of Alteva, LLC in August 2011 (the "Alteva acquisition"), partially offset by a decrease of 18% in revenue from our Telephone segment. Revenues for our UC segment increased $5.2 million, or 62% from $8.4 million from the year ended December 31, 2011 to $13.6 million for the year ended December 31, 2012. This increase was primarily due to an increase in hosted services revenue of $6.4 million, which includes VoIP usage, data and equipment. The increase in hosted services revenue was primarily the result of a full year of operations in 2012 associated with the Alteva acquisition as compared to a partial year in 2011. This increase was partially offset by the decrease in 27 -------------------------------------------------------------------------------- Table of Contents wholesale carrier services of $1.3 million, or 66%, resulting from our decision during 2012 to move away from this line of business due to lower margins, which led to lower usage from wholesale customers. Revenues for our Telephone segment decreased $3.2 million, or 18%, from $17.6 million for the year ended December 31, 2011 to $14.4 million for the year ended December 31, 2012. This decrease was partially attributable to lower network access services revenue of $1.1 million, or 14%, mainly due to lower USF revenues of $0.6 million or 23%, due to recent FCC reforms of USF funding and lower billing to carriers. This decrease was also attributable to lower DIRECTV revenues of $0.6 million, resulting from the termination of the National Rural Telecommunications Cooperative ("NRTC") as of August 15, 2011. We no longer bill and collect for the monthly recurring revenue for NRTC and instead we now only receive a commission on DIRECTV sales and reimbursement for installations costs. Also contributing to this decrease was reductions in long distance revenue of $0.8 million, or 41% primarily associated with customers switching to our promotional prices and lower usage and a decrease in video revenue of $0.4 million, or 92% resulting from our exit of landline video services. OPERATING EXPENSES Operating expenses for year ended December 31, 2013 decreased $10.5 million, or 20%, to $41.7 million from $52.2 million for the same period in 2012. This decrease was primarily due to an $8.9 million impairment of fixed assets in the Telephone segment in 2012, which lowered the depreciable basis for the year ended December 31, 2013. Also contributing to the decrease were the cost saving initiatives undertaken during 2013, including the restructuring of the Telephone segment, lower circuit costs, and the sale of our operations in Syracuse, New York. See Note 3 to our Consolidated Financial Statements contained in Item 8 herein. 2013 Compared to 2012 (as restated) Cost of Services and Products The cost of services and products decreased $0.6 million, or 4%, to $13.5 million for the year ended December 31, 2013, from $14.1 for the same period in 2012. Cost of services and products for our UC segment decreased $0.2 million, or 2%, to $8.8 million for the year ended December 31, 2013 from $9.0 million for the year ended December 31, 2012, and decreased as a percentage of revenue to 56% from 66%. The decrease as a percentage of revenue was due to leveraging the UC infrastructure over a larger revenue base. The dollar decrease was primarily due to lower third-party carrier costs as part of our cost reduction initiatives and cost savings from the sale of our operations in Syracuse, New York. See Note 3 to our Consolidated Financial Statements contained in Item 8 herein. Cost of services and products for our Telephone segment decreased $0.4 million, or 8%, to $4.7 million for the year ended December 31, 2013 from $5.1 million for the same period in 2012. This decrease was primarily attributable to the restructuring of our Telephone segment in 2013, which included headcount reductions. Selling, General and Administrative Expenses Selling, general and administrative expenses for the year ended December 31, 2013 increased $0.3 million, or 1%, to $24.0 from $23.7 million for the same period in 2012. The increase was primarily attributable to increases in direct UC costs offset by decreases in direct Telephone costs and corporate costs that are allocated to the segments. Selling, general and administrative expenses for our UC segment increased $0.5 million, or 3%, to $15.6 million from $15.1 million for the same period in 2012. The increase was primarily attributable to increases in the salesforce and marketing initiatives to support the growth initiatives, and increases in sales commissions as a result of the growth in revenue. These increases were partially offset by a decrease in the allocated corporate expenses due to cost saving initiatives completed during 2013. Selling, general and administrative expenses for our Telephone segment decreased $0.2 million, or 2%, to $8.4 million for the year ended December 31, 2013 from $8.6 million for the same period in 2012. The decrease was attributable to the restructuring of our Telephone segment in 2013, which included headcount reductions, and a decrease in allocated corporate expenses due to cost saving initiatives completed during 2013. Impairment of Fixed Assets At December 31, 2012, we determined that the carrying value of long-lived assets in the Telephone segment exceeded their fair value. As a result, we incurred a fixed asset impairment charge of $8.9 million in our Telephone segment. The fair value of long-lived assets in the Telephone segment was impacted by the continuing declines in revenues in our Telephone segment. See Note 8 to our Consolidated Financial Statements contained in Item 8 herein. Depreciation and Amortization Expense Depreciation and amortization expense for the year ended December 31, 2013 decreased $1.7 million, or 31%, to $3.8 million from $5.5 million for the same period in 2012. This decrease was primarily due to the lower depreciable basis on our Telephone segment assets as a result of the $8.9 million write-down of property, plant and equipment during the year ended December 31, 2012. 28 -------------------------------------------------------------------------------- Table of Contents 2012 (as restated) Compared to 2011 Cost of Services and Products The cost of services and products decreased $0.6 million, or 4%, to $14.1 million for the year ended December 31, 2012, from $14.7 for the same period in 2011. Cost of services and products for our UC segment increased $2.4 million, or 36% from $6.6 million for the year ended December 31, 2011 to $9.0 million for the year ended December 31, 2012. This increase was primarily from the operations of Alteva since its acquisition in August of 2011 and the repurposing of employees from the Telephone segment. Cost of services and products for our Telephone segment decreased $3.0 million, or 37% from $8.1 million for the year ended December 31, 2011 to $5.1 million for the year ended December 31, 2012. This decrease was primarily attributable to decreases in content costs for landline video due to the elimination of channel offerings resulting from exiting our landline video service on December 31, 2012, as well as repurposing employees into the UC segment. Selling, General and Administrative Expenses Selling, general and administrative expenses for the year ended December 31, 2012 increased $6.2 million, or 35%, to $23.7 million for the year ended December 31, 2012, from $17.5 million for the same period in 2011. This increase was primarily from the integration of operations associated with the Alteva acquisition. Selling, general and administrative expenses for our UC segment increased $5.3 million, or 54% from $9.8 million for the year ended December 31, 2011 to $15.1 million for the year ended December 31, 2012. This increase was primarily due to a full year of costs associated with the integration of operations with the Alteva acquisition. Selling, general and administrative expenses for our Telephone segment increased $0.8 million, or 10% from $7.8 million for the year ended December 31, 2011 to $8.6 million for the year ended December 31, 2012. We incurred higher professional fees associated with (i) the dispute with a local exchange carrier and (ii) our corporate restructuring that will allow us to operate as an unregulated holding company. Also contributing to the increase was the increases in compensation expenses associated with our growth initiatives, business plan and the transition of our business. Impairment of Fixed Assets At December 31, 2012, we determined that the carrying value of long-lived assets in the Telephone segment exceeded their fair value. As a result, we incurred a fixed asset impairment charge of $8.9 million in our Telephone segment. The fair value of long-lived assets in the Telephone segment was impacted by the continuing declines in revenues in our Telephone segment. See Note 8 to our Consolidated Financial Statements contained in Item 8 herein. Depreciation and Amortization Expense Depreciation and amortization expense for the year ended December 31, 2012 increased $0.2 million, or 4%, to $5.5 million from $5.3 million for the same period in 2011. This was associated with a decrease of $0.7 million in our Telephone segment primarily due to the full depreciation of central office switches, computer equipment and leasehold improvements, offset by an increase of $0.9 million of primarily amortization of the intangible trade name and customer lists associated with Alteva in our UC segment. OTHER INCOME (EXPENSE) 2013 Compared to 2012 (as restated) Total other income (expense) for the year ended December 31, 2013 increased $2.1 million, or 20%, to $12.4 million from $10.3 million in the same period 2012. This increase was primarily due to O-P distributions in excess of our proportionate share of the O-P's income being recorded as other income as opposed to be being applied to our investment. The excess of guaranteed distributions over our proportionate share of the O-P's income under the 4G Agreement were first recorded as a return of capital and were not recorded on our statement of operations until all of our capital was returned and our O-P partnership capital account was at zero, which occurred during the quarter ended June 30, 2012. All distributions we received from the O-P after June 30, 2012 were recorded as income. For more information on the 4G Agreement and the accounting treatment of the distributions we received from the O-P, see Note 10 to our consolidated financial statements contained in Item 8 herein. 2012 (as restated) Compared to 2011 Total other income (expense) for the year ended December 31, 2012 increased $2.5 million or 32% to $10.3 million from $7.8 million in the same period 2011. This is due to O-P distributions in excess of our proportionate share of the O-P's income being recorded as other income as opposed to be being applied to our investment. The excess of guaranteed distributions over our proportionate share of the O-P's income under the 4G Agreement were first recorded as a return of capital and were not recorded on our statement of operations until 29 -------------------------------------------------------------------------------- Table of Contents all of our capital was returned and our O-P partnership capital account was at zero, which occurred during the quarter ended June 30, 2012. All distributions we received from the O-P after June 30, 2012 were recorded as income. For more information on the 4G Agreement and the accounting treatment of the distributions we received from the O-P, see Note 10 to our consolidated financial statements contained in Item 8 herein. This increase was partially offset by the payment to certain members of Alteva LLC., which was recorded as an expense of $0.5 million. INCOME TAXES - ANNUAL PERIODS 2013 Compared to 2012 (as restated) For the year ended December 31, 2013 we had income tax expense of $1.4 million, or 181% of income before income taxes, as compared to an income tax benefit of $3.0 million, or 22% of loss before income taxes for the year ended December 31, 2012. The difference between our effective tax rate and the statutory federal rate of 34% is primarily due to increases in our valuation allowance by $0.9 million and $2.5 million for the years end December 31, 2013 and 2012, respectively, since we were unable to conclude that it was more likely than not that we would realize our deferred income tax assets prior to their expiration (see Note 12). The income tax benefit for the year ended December 31, 2012 was primarily attributable to the benefit recognized on current year losses, offset by the increase in our valuation allowance by $2.5 million. 2012 (as restated) Compared to 2011 For the year ended December 31, 2012 we had an income tax benefit of $3.0 million, or 22% of loss before income taxes, as compared to an income tax benefit of $0.9 million, or 23% of loss before income taxes for the year ended December 31, 2011. During the years ended December 31, 2012 and 2011, we increased our valuation allowance by $2.5 million and $0.6 million, respectively, since we were unable to conclude that it was more likely than not that we would realize our deferred income tax assets prior to their expiration (see Note 12). The income tax benefit for the year ended December 31, 2012 was primarily attributable to the benefit recognized on current year losses, offset by the increase in our valuation allowance by $2.5 million. INCOME TAXES - INTERIM PERIODS During our interim periods in 2012, we were recognizing an income tax benefit at 30% to 32% of our pre-tax loss through the nine months ended September 30, 2012, however, during the three months ended December 31, 2012, we concluded that a valuation allowance for substantially all of our net deferred tax assets was necessary to properly state our deferred tax assets at the amount that is more likely than not realizable. We determined our interim tax provisions in 2013 by developing an estimate of the annual effective tax rate and applying such rate to interim pre-tax results. The estimated rate includes projections of tax expense on the expected increase in our valuation allowance for deferred tax assets at December 31, 2013. During 2013, our estimate of the annual effective tax rate changed primarily due to changes in our projections of full year taxable income during the year, while the projected increase in our valuation allowance remained relatively stable. Three and Nine Months Ended September 30, 2013 (as restated) Compared to the Three and Nine Months Ended September 30, 2012 For the three months ended September 30, 2013 we had an income tax expense of $0.7 million, or 66% of income before income taxes, as compared to an income tax benefit of $0.4 million, or 32% of loss before income taxes, for the three months ended September 30, 2012. The increase in the effective tax rate for the three months ended September 30, 2013 was principally due to the estimated effects on income tax expense of the expected increase in the valuation allowance for deferred tax assets at December 31, 2013. For the nine months ended September 30, 2013 we had an income tax expense of $0.3 million, or 891% of loss before income taxes, as compared to an income tax benefit of $1.1 million, or 31% of loss before income taxes for the nine months ended September 30, 2012. We had income tax expense despite generating a loss before income taxes, for the nine months ended September 30, 2013 principally due to the estimated effects on income tax expense of the expected increase in the valuation allowance for deferred tax assets at December 31, 2013 and an increase in the valuation allowance due to a change in judgment pertaining to estimates of future taxable income available to realize deferred tax assets. Three and Six Months Ended June 30, 2013 (as restated) Compared to the Three and Six Months Ended June 30, 2012 For the three months ended June 30, 2013 we had an income tax expense of $0.2 million, or 106% of income before income taxes, as compared to an income tax benefit of $0.1 million, or 30% of loss before income taxes, for the three months ended June 30, 2012. The increase in the effective tax rate for the three months ended June 30, 2013 was principally due to the estimated effects on income tax expense of the expected increase in the valuation allowance for deferred tax assets at December 31, 2013, and an increase in the valuation allowance due to a change in judgment pertaining to estimates of future taxable income available to realize deferred tax assets. For the six months ended June 30, 2013 we had an income tax benefit of $0.4 million, or 34% of loss before income taxes, as compared to an income tax benefit of $0.7 million, or 31% of loss before income taxes, for the six months ended June 30, 2012. The increase in the effective tax rate for the six months ended June 30, 2013 was principally due to the estimated effects on income tax expense of the expected increase in the valuation allowance for deferred tax assets at December 31, 2013 and an increase in the valuation allowance due to a change in judgment pertaining to estimates of future taxable income available to realize deferred tax assets Three Months Ended March 31, 2013 (as restated) Compared to the Three Months Ended March 31, 2012 For the three months ended March 31, 2013 we had an income tax benefit of $0.5 million, or 43% of loss before income taxes, as compared to an income tax benefit of $0.6 million, or 31% of loss before income taxes, for the three months ended March 31, 2012. The increase in the effective tax rate for the three months ended March 31, 2013 was principally due to the estimated affects on income tax expense of the expected increase in the valuation allowance for deferred tax assets at December 31, 2013. SEGMENT RESULTS OVERVIEW Our Unified Communications ("UC") segment accounted for approximately 53% and 49% of our consolidated segment operating revenues in 2013 and 2012, respectively. Growth in revenue was a result of organic growth in the UC segment. We expect this upward trend in UC revenue to continue in the future. This segment provides enterprise hosted VoIP, hosted Microsoft Communication Services, mobile convergence and advanced voice applications for the desktop. Our Telephone segment, which operates as a retail and wholesale seller of communications services, accounted for approximately 47% and 51% of our consolidated segment operating revenues in 2013 and 2012, respectively. This segment provides telecommunications services, including local networks, network access, long distance voice, customer premise equipment, PBX equipment, high speed (broadband Internet) and dial-up Internet access services, wireless and directory advertising services (yellow and white pages advertising and electronic publishing). In 2011, our UC segment accounted for approximately 32% and our Telephone segment accounted for 68% of our consolidated operating revenue. For further segment information, see Note 17 to the Consolidated Financial Statements contained in Item 8 herein. Orange County-Poughkeepsie Limited Partnership We currently own an 8.108% limited partnership interest in the Orange County-Poughkeepsie Limited Partnership (the "O-P"). Verizon Wireless of the East, L.P. ("Verizon") is the general partner and currently has a 91.892% ownership interest in the O-P. The O-P provides cellular telephone service throughout the Orange County-Poughkeepsie Metropolitan Service Area. Our income from the O-P that we record as income from equity method investment was $13.0 million, $11.0 million and 7.9 million for the years ended December 31, 2013, 2012 and 2011, respectively. For more information on our O-P interest, see Note 10 to the Consolidated Financial Statements contained in Item 8 herein. On May 26, 2011, we entered into an agreement with Verizon, the general partner and a limited partner of the O-P, and Cellco Partnership, the other limited partner in the O-P, to make certain changes to the O-P partnership agreement which, among other things, specifies that the O-P will provide 4G cellular services (the "4G Agreement") and that the O-P will be converted from a wholesale business to a retail business. The conversion of the O-P from a wholesale business to a retail business increased the cellular service costs and sales and marketing expenses incurred by the O-P, which caused a subsequent reduction in the O-P's net income. Regardless of the O-P's net income, pursuant to the 4G Agreement, we received an annual cash distribution of $13.0 million, $13.0 million and $13.6 million for the years ended December 31, 2013, 2012 and 2011, respectively. Under equity method accounting, we currently report as income our proportionate share of the O-P income that is less than the guaranteed cash distributions that we receive from the O-P. The cash distributions we receive from the O-P that are in excess of our proportionate share of the O-P income are applied to our investment account. As a result of receiving the fixed cash distributions from the O-P in excess of our proportionate share of the O-P income, our investment account was reduced to zero during the quarter ended June 30, 2012. Once the investment account was reduced to zero, we recorded the fixed cash distributions that we received from the O-P directly to our statement of operations as other income. As discussed below in "Liquidity and Capital Resources," the 4G Agreement also gives us the right to require one of the O- 30 -------------------------------------------------------------------------------- Table of Contents P's limited partners to purchase all of our ownership interest, which we currently intend to exercise in April 2014. LIQUIDITY AND CAPITAL RESOURCES We had $1.6 million of cash and cash equivalents available at December 31, 2013, as compared to $1.8 million at December 31, 2012. Our primary source of liquidity continues to be our payments from the O-P pursuant to the 4G Agreement and borrowings under our credit facility. Pursuant to the terms of the 4G Agreement, we received cash distributions of $13.0 million, $13.0 million and $13.6 million 2013, 2012 and 2011, respectively. The O-P's cash distributions are made to us on a quarterly basis. The distributions in excess of our proportionate share of O-P income are considered a return of our investment until such time as our investment is reduced to zero. The 4G Agreement also gives us the right to require one of the O-P's limited partners to purchase all our ownership interest in the O-P during April 2014 for an amount equal to the greater of (a) $50 million or (b) the product of five (5) times 0.081081 times the O-P's 2013 EBITDA, as defined in the 4G Agreement. The Company currently intends to exercise the Put option in April 2014 (see Note 10 to our Consolidated Financial Statements contained in Item 8 herein), and expects the gross proceeds to be $50.0 million. A portion of the gross proceeds of the Put will be used repay the outstanding debt under the TriState credit facility. Following the exercise of the Put option, we will no longer be entitled to distributions from the O-P. In August 2013, we announced the discontinuation of dividends on our common stock to support future growth initiatives and strengthen our financial position. On March 11, 2013, the Company entered into a credit agreement with TriState Capital Bank ("TriState") to provide for borrowings up to $17.0 million with the ability to increase the facility for borrowings up to $20.0 million with the participation of another lender (the "Credit Agreement"). All borrowings become due and payable on June 30, 2014. The TriState borrowings incur interest at a variable rate based on either LIBOR or a Base Rate, as defined in the Credit Agreement, plus an applicable margin of 3.50% or 2.00%, respectively. For the year ended December 31, 2013, the effective interest rate on the TriState credit facility was approximately 3.7%. As of December 31, 2013, the Company had $7.3 million available under the Credit Agreement. Under the terms of the Credit Agreement, the Company is required to comply with certain loan covenants, which include, but are not limited to, the achievement of certain financial ratios and certain financial reporting requirements. The Company must maintain a consolidated liquidity ratio, as defined in the Credit Agreement, in excess of 1.0 to 1.0, including the value of the Put calculated in accordance with the 4G Agreement, until April 30, 2014. The Company is required to obtain the consent of TriState prior to agreeing to any amendment to the agreements the Company has with the O-P. The Company's obligations under the TriState credit facility are secured by all of the Company's assets and guaranteed by all of the Company's wholly-owned subsidiaries except for the Company's ILEC subsidiary. The ILEC subsidiary entered into a negative pledge agreement with TriState whereby the ILEC subsidiary agreed not to pledge any of its assets as collateral or lien to be placed on any of its assets. As of December 31, 2012, the Company had three debt facilities. The Company had a revolving loan facility with CoBank, ACB ("CoBank") for $10.0 million with an interest rate (payable quarterly in arrears) at LIBOR plus 4.50%. The interest rate on the outstanding balance under the revolving loan facility with CoBank as of December 31, 2012 was 4.71%. The Company had an unsecured line of credit with Provident Bank ("Provident") of $4.0 million of which the entire amount had been drawn down at December 31, 2012. The interest rate (payable monthly in arrears) on the Provident unsecured line of credit was fixed at 2.50%. The Company had a prior credit agreement with TriState that provided for borrowings up to $2.5 million, with a variable interest rate based on either LIBOR or a Base Rate, as defined in the Company's credit agreement with TriState, plus an applicable margin 4.0% or 3.0%, respectively, with a maturity date of April 30, 2013. On March 11, 2013, the Company borrowed $15.2 million to repay all borrowings outstanding under the CoBank, Provident and prior TriState credit facilities and retired those facilities. As of December 31, 2013, we had a working capital deficit of $11.2 million, which was primarily due to borrowings of $9.7 million under the TriState credit facility that matures on June 30, 2014. This debt was primarily incurred to fund the purchase of Alteva, LLC in 2011. Our 2014 capital plan includes $1.2 million in expenditures, excluding seat licenses, primarily relating to the expansion of our UC and broadband products. We expect that we will have sufficient availability to fund these purchases using the O-P distributions or proceeds from the O-P Put, and debt financing, including equipment financing facilities. CASH FROM OPERATING ACTIVITIES Pursuant to the 4G Agreement, we received cash distributions from the O-P of $13.0 million during the years ended December 31, 2013 and 2012. The amount of the cash distributions we received from the O-P in excess of our proportionate share of the O-P's income for the years ended December 31, 2013 and 2012 are included in cash from investing activities, as described in greater detail below. During the year ended December 31, 2013, we had $2.2 million of cash provided by operating activities as compared with $2.6 million of cash used in operating activities during the year ended December 31, 2012. The increase in operating cash flow was primarily attributable to a decrease in operating losses due to the growth in UC and cost cutting initiatives implemented during 2013. Cash flows from operations included $7.3 million and $6.3 million of distributions from the O-P that represented our proportionate share of the O-P's income for the years ended December 31, 2013 and 2012, respectively. 31 -------------------------------------------------------------------------------- Table of Contents CASH FROM INVESTING ACTIVITIES Cash flows from investing activities included $5.7 million and $6.7 million of distributions we received from the O-P in excess of our proportionate share of the O-P's income for the years ended December 31, 2013 and 2012, respectively. Capital expenditures totaled $0.5 million during the year December 31, 2013, as compared to $4.0 million for the corresponding period in 2012. The decrease in capital expenditures was primarily a result of $1.5 million capital expenditures related to the build out of Alteva's innovation center and the UC headquarters in Philadelphia, Pennsylvania, as well as $1.0 million in capital expenditures related to expanding our VoIP and circuit equipment during 2012. Seat license purchases totaled $0.8 million during the years ended December 31, 2013, and 2012. In 2013, $0.4 million of the seat license purchases were done through capital leases resulting in cash outlay of $0.4 million. During the year ended December 31, 2013, we received $0.6 million for the sale of our operations in Syracuse, New York. See Note 3 to our Consolidated Financial Statements contained in Item 8 herein. CASH FROM FINANCING ACTIVITIES We used $7.7 million in financing activities during the year ended December 31, 2013, as compared to $2.4 million for the corresponding period in 2012. Dividends declared on our common shares by the Board of Directors were $0.54 per share for the year ended December 31, 2013 and were $1.08 per share for the year ended December 31, 2012. The total amount of dividends paid on our common shares by us for each of the years ended December 31, 2013 and 2012 was $3.3 million and $6.3 million, respectively. We repaid the outstanding balances on our lines of credit with Provident Bank, CoBank and TriState during the year ended December 31, 2013 by borrowing funds under our credit facility with TriState that matures on June 30, 2014. We made net repayments of $6.0 million against our credit facilities during the year ended December 31, 2013. OFF-BALANCE SHEET ARRANGEMENTS As of December 31, 2013, we did not have any off-balance sheet arrangements. CONTRACTUAL OBLIGATIONS AND COMMITMENTS A summary of our material contractual obligations and commitments as of December 31, 2013 is presented below: Payments Due by Period Less More than 1 - 3 3 - 5 than (n thousands) 1 Year Years Years 5 Years Total Debt obligations $ 9,698 $ - $ - $ - $ 9,698 Capital leases and other financing obligations 428 297 - - 725 Interest expense (a) 219 23 - - 242 Operating lease obligations (b) 348 712 489 1,200 2,749 Access line and license agreements obligations 1,798 3,178 396 - 5,372 Pension and postretirement benefit obligations (c) 267 - - 6,007 6,274 Total contractual obligations and commitments $ 12,758 $ 4,210 $ 885 $ 7,207 $ 25,060 -------------------------------------------------------------------------------- (a) Interest expense is derived from capital leases and short and long term debt arrangements. Debt under our TriState agreement is at a variable rate. Interest payments are calculated based upon a current interest rate. As of December 31, 2013, our interest rates was 3.7%. This rate and future borrowings are subject to fluctuation in the future. (b) We lease office space and office equipment. (c) Minimum contributions may vary due to performance of plan assets and are not fully estimable. Accordingly, we have classified the remaining liability in the more than 5 years category. OPERATING ENVIRONMENT AND BUSINESS TRENDS 2014 Revenue Trends In 2014, we expect the UC industry to continue to grow as industry experts have indicated. Accordingly, we expect our UC revenues will continue to grow. It is anticipated that we will continue to face the challenges found throughout the telecommunications industry, namely continued declines associated with our traditional service offerings and a reduction in USF revenue as a result of the FCC order dated November 28, 2011. 2014 Expense Trends Expense trends in dollars related to variable component of cost of services and products will increase in tandem with our increases in 32 -------------------------------------------------------------------------------- Table of Contents expected revenues for the UC business. We will continue to leverage or decrease the fixed components of our cost of services and products, and selling, general and administrative expenses. |