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ALTEVA, INC. - 10-Q - 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 Quarterly Report on Form 10-Q, including, without limitation, statements containing the words "believes," "anticipates," "intends," "expects" 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; 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; 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. For a further discussion of the matters described above, see Item 1A, "Risk Factors" in our Annual Report on Form 10-K for the year ended December 31, 2013. Overview Alteva, Inc. (we, our or us) 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 20-1,000 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 Condensed Consolidated Financial Statements and Notes thereto appearing elsewhere in this Quarterly Report on Form 10-Q. Executive Summary Three months ended March 31, 2014 Three months ended March 31, 2013 Change Segment % of Total Segment Segment % of Total Segment Segment Favorable Revenue Revenue Loss Margin Revenue Revenue Loss Margin Revenue (Unfavorable) Unified Communications $ 4,211 56 % $ (2,053 ) (49 )% $ 3,956 51 % $ (3,921 ) (99 )% $ 255 $ 1,868 Telephone 3,313 44 % (176 ) (5 )% 3,784 49 % (378 ) (10 )% (471 ) 202 Total $ 7,524 100 % $ (2,229 ) (30 )% $ 7,740 100 % $ (4,299 ) (56 )% $ (216 ) $ 2,070 Revenues decreased 2.8% to $7.5 million for the three months ended March 31, 2014, in comparison to $7.7 million for the three months ended March 31, 2013. The decrease is primarily from a $0.5 million decrease in revenue due to our sale of operations in Syracuse, New York in August 2013 and a $0.4 million decrease in our USF revenues in our Telephone segment, partially offset by a $0.7 million growth in our UC license and usage revenue. During the three months ended March 31, 2014, we had an operating loss of $2.2 million, compared to an operating loss of $4.3 million for the three months ended March 31, 2013. The decrease in operating loss was attributable to higher selling, general and administrative expenses incurred in 2013 to support the growth of the UC segment and severance costs related to management changes and staff rationalization. During the three months ended March 31, 2014, we had a net loss of $0.2 million, compared to a net loss of $0.7 million for the three months ended March 31, 2013. For the past several years, we have experienced declines in telephone access lines within our Telephone segment due to sustained competition and cellular substitution for landline telephone services in our regulated franchise area that has reduced revenue in this segment. We partially offset the decline in telephone access lines by focusing our efforts on identifying and pursuing growth opportunities to increase our ILEC broadband Internet business. 16 -------------------------------------------------------------------------------- Table of Contents Results of Operations for the three months ended March 31, 2014 and 2013 OPERATING REVENUES For the three months ended March 31, 2014 For the three months ended March 31, 2013 Change % of Total % of Total Revenue Revenue Revenue Revenue Revenue Unified Communications $ 4,211 56 % $ 3,956 51 % $ 255 Telephone 3,313 44 % 3,784 49 % (471 ) Total $ 7,524 100 % $ 7,740 100 % $ (216 ) Revenues for our UC segment increased 7% for the three months ended March 31, 2014 compared to the same period in 2013. This increase was primarily associated with a $0.7 million increase in license and usage revenue from the segment's organic growth. This increase was partially offset by a $0.5 million decrease due to our sale of operations in Syracuse, New York in August 2013. Revenues for our Telephone segment decreased 12% for the three months ended March 31, 2014 compared to the same period in 2013. The decrease was primarily driven by a $0.4 million decline in USF revenues, due to lower reimbursable costs. OPERATING EXPENSES Unified Communications Telephone Consolidated For the Three Month Ended March 31, For the Three Month Ended March 31, For the Three Month Ended March 31, in thousands 2014 2013 Change 2014 2013 Change 2014 2013 Change Cost of services and products $ 2,026 $ 2,570 $ (544 ) $ 1,026 $ 1,219 $ (193 ) $ 3,052 $ 3,789 $ (737 ) Selling, general and administrative 3,717 4,689 (972 ) 2,081 2,559 (478 ) 5,798 7,248 (1,450 ) Depreciation and amortization 521 618 (97 ) 382 384 (2 ) 903 1,002 (99 ) Total operating expenses $ 6,264 $ 7,877 $ (1,613 ) $ 3,489 $ 4,162 $ (673 ) $ 9,753 $ 12,039 $ (2,286 ) Operating expenses declined 19% for the three months ended March 31, 2014 compared to the three months ended March 31, 2013 primarily due to selling, general and administrative expenses decreasing 21% associated with our UC segment. In the first three months of 2013 we incurred $1.3 million in charges associated with the restructuring of management and staff rationalization, as well as $0.4 million in marketing expenses associated with the rebranding of the company, which were not incurred in 2014. Cost of Services and Products Cost of services and products for our UC segment decreased 21% for three months ended March 31, 2014 compared to the same period in 2013 and decreased as a percentage of revenue to 48% from 65% primarily due to leveraging the UC infrastructure over a larger revenue base. The decrease was primarily due to a combined $0.6 million decrease from lower third-party carrier costs as a part of our cost reduction initiatives and cost savings from the sale of our operations in Syracuse, New York. Cost of services and products for our Telephone segment decreased for three months ended March 31, 2014 compared to the same period in 2013 primarily due to a $0.2 million reduction in wages from the right sizing of the segment in 2013. Selling, General and Administrative Expenses Selling, general and administrative expenses decreased 20% for the three months ended March 31, 2014 compared to the same period primarily due to severance costs related to management changes and staff rationalization impacting both segments in 2013 of approximately $1.3 million. In addition, both marketing and legal expenses decreased each by $0.2 million which was primarily driven by higher costs in 2013 from the rebranding to the Alteva name. Depreciation and Amortization Expense Depreciation and amortization expense in the UC segment decreased 16% for the three months ended March 31, 2014 compared to the three months ended March 31, 2013 primarily due to a lower depreciable base due to the sale of our operations in Syracuse, New York in August 2013. 17 -------------------------------------------------------------------------------- Table of Contents TOTAL OTHER INCOME (EXPENSE) For the Three Month Ended March 31, in thousands 2014 2013 Change Interest expense, net $ (139 ) $ (236 ) $ 97 Income from equity method investment 2,040 3,250 (1,210 ) Other income, net 21 108 (87 ) Total other income $ 1,922 $ 3,122 $ (1,200 ) Total other income decreased 38% for the three months ended March 31, 2014 compared to same period in 2013 due to the decline in income from the O-P agreement. In 2013 we received guaranteed annual distributions of $13 million ($3.25 million each quarter). In 2014, in accordance with to the O-P agreement, our guaranteed distribution levels stopped and we will receive income from the equity investment only for our ownership share of 8.108% of the O-P's net income. INCOME TAXES For the three months ended March 31, 2014, we had an income tax benefit of $58,000, or 19% of loss before income taxes, as compared to an income tax benefit of $0.5 million, or 43% of loss before income taxes, for the three months ended March 31, 2013. The estimated effective tax rate for each period includes projections of tax expense on the expected change in our valuation allowance for deferred tax assets. The estimated annual effective tax rate for the year ended December 31, 2014 excludes the estimated tax effects of the O-P gain on the put exercise, which is being treated as a discrete item in the Company's second quarter of 2014. The decrease in the effective tax rate is due to the expected increase in the valuation allowance for deferred tax assets reducing the overall tax benefit recorded for the period ended March 31, 2014. LIQUIDITY AND CAPITAL RESOURCES We had $0.3 million of cash and cash equivalents at March 31, 2014 as compared with $1.6 million at December 31, 2013. Our source of cash flows continue to be primarily generated from cash distributions from the O-P and borrowing under our credit facilities. The O-P's cash distributions are made to us on a quarterly basis. We sold all of our ownership interest in the O-P on April 30, 2014 for gross proceeds of $50 million (see Note 5). We will not receive any income from the O-P after April 30, 2014. We used a portion of the proceeds to repay all of the outstanding borrowings under the TriState credit facility, allowing $17.0 million to remain available under the credit facility (see Note 6). We expect the remaining gross proceeds to be used to pay taxes on the related gain, fund working capital needs and support growth initiatives. 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, we entered into a new credit agreement with 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. 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 3.50% or 2.00%, respectively. For the three months ended March 31, 2014, the effective interest rate on the TriState credit facility was approximately 3.7%. As of March 31, 2014, the Company had $6.5 million available under the Credit Agreement. Under the terms of the TriState credit agreement, we are required to comply with certain loan covenants, which include, but are not limited to, the achievement of certain financial ratios as well as certain financial reporting requirements. We must maintain a Consolidated Liquidity Ratio, as defined in the TriState 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. We are required to obtain the consent of TriState prior to agreeing to any amendment to the agreements we have with the O-P. Our obligations under the TriState credit facility are secured by all of our assets and guaranteed by all of our wholly-owned subsidiaries except for the subsidiary that is operating as an ILEC. 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. On March 11, 2013, we borrowed $15.2 million to repay all borrowings outstanding under the CoBank, Provident and prior TriState credit facilities and retired those facilities. CASH FROM OPERATING ACTIVITIES The change from net cash provided by to cash used in operating activities from March 31, 2013 to March 31, 2014 was primarily due to the fact that although we recorded $2.0 million of income from O-P for the three months ended March 31, 2014, the distribution of this income is expected in May 2014. We did not receive cash from the O-P during the three months ended March 31, 2014. 18 -------------------------------------------------------------------------------- Table of Contents For the three months ended March 31, 2013, net cash provided by operating activities was $0.6 million. Operating cash flows included $1.8 million of distributions from the O-P that represented our share of the O-P's income. CASH FROM INVESTING ACTIVITIES Net cash provided by investing activities was nominal for the three months ended March 31, 2014. In the first quarter of 2014, we purchased $0.1 million of seat licenses; however, we still have a payable balance and therefore no cash outflows were incurred for the three months ended March 31, 2014. Net cash provided by investing activities of $1.0 million for the three months ended March 31, 2013 was primarily due to distributions of $1.4 million we received from the O-P in excess of our share of the O-P's income. CASH FROM FINANCING ACTIVITIES Net cash provided by financing activities during the three months ended March 31, 2014 was $0.2 million compared to cash used in financing activities of $1.4 million for the three months ended March 31, 2013. We had net borrowings of $0.6 million primarily from our TriState credit facility to fund working capital needs of the Company offset by $0.4 million in purchases of treasury shares from employee restricted stock vestings. Dividends declared on our common shares by the Board of Directors were $0.27 per share for the three months ended March 31, 2013. The total amount of dividends paid on our common shares by us for the three months ended March 31, 2013 was $1.7 million. The additional financing activities for the three months ended March 31, 2013 were attributed to the repayment of debt of $15.1 million offset by $15.5 million proceeds from our new debt with TriState. |