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ENVENTIS CORP - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) Forward Looking Statements The Private Securities Litigation Reform Act of 1995 contains certain safe harbor provisions regarding forward-looking statements. This Quarterly Report on Form 10-Q may include forward-looking statements. These statements may include, without limitation, statements with respect to anticipated future operating and financial performance, growth opportunities and growth rates, acquisition and divestiture opportunities, business strategies, business and competitive outlook, and other similar forecasts and statements of expectation. Words such as "expects," "anticipates," "intends," "plans," "believes," "seeks," "estimates," "targets," "projects," "will," "may," "continues," and "should," and variations of these words and similar expressions, are intended to identify these forward-looking statements. Such forward-looking statements are subject to risks and uncertainties that could cause our actual results to differ materially from such statements. Factors that might cause such a difference include, but are not limited to, those contained in Item 1A of Part II, "Risk Factors" of this Quarterly Report on Form 10-Q and Item 1A of Part I, "Risk Factors" of our Annual Report on Form 10-K for the year ended December 31, 2013, which is incorporated herein by reference. 17 -------------------------------------------------------------------------------- Table of Contents Because of these risks, uncertainties, and assumptions and the fact that any forward-looking statements made by us and our management are based on estimates, projections, beliefs, and assumptions of management, they are not guarantees of future performance and you should not place undue reliance on them. In addition, forward-looking statements speak only as of the date they are made. With the exception of the requirements set forth in the federal securities laws or the rules and regulations of the Securities and Exchange Commission, we do not undertake any obligations to update any forward-looking information, whether as a result of new information, future events or otherwise. Critical Accounting Policies and Estimates The preparation of our financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, and the related disclosure of contingent assets and liabilities. A description of the accounting policies we consider particularly important for the portrayal of our results of operations and financial position, and which may require a higher level of judgment by our management, is contained under the caption, "Critical Accounting Policies and Estimates," in the Management's Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the year ended December 31, 2013. Significant Recent Development On June 29, 2014, Enventis Corporation, a Minnesota corporation ("Enventis"), entered into an Agreement and Plan of Merger (the "Merger Agreement"), by and among Enventis, Consolidated Communications Holdings, Inc., a Delaware corporation ("Consolidated"), and Sky Merger Sub Inc., a Minnesota corporation and wholly owned subsidiary of Consolidated ("Merger Sub"), pursuant to which Merger Sub will merge with and into Enventis (the "Merger"). See Note 15 "Pending Merger." Overview We are a leading provider of advanced communication solutions servicing business and residential customers primarily throughout the upper Midwest. Our multi-state fiber network spans more than 4,200 route miles across Minnesota and into Iowa, North Dakota, South Dakota and Wisconsin. Across this region we provide business customers with IP-based voice, cloud, data and network solutions, managed and hosted services, network integration and support services. We also specialize in unified communication solutions for businesses of all sizes by providing Cisco equipment solutions and support. We provide residential broadband Internet, digital TV and voice services. Results of Operations We report our operations in three segments: (i) Fiber and Data, (ii) Equipment and (iii) Telecom. An overall description of our business segments can be found in Note 14 "Quarterly Segment Financial Summary." Executive Summary Our overall focus remains on positioning ourselves as a leading business and broadband communications provider. We strive to provide exceptional customer service and deliver reliable products and services which meet the evolving needs and demands of our customers while maintaining our traditional telecom services. Our strategic revenue stream entails business and broadband revenue which accounted for approximately 81% of our total consolidated revenue in the second quarter of 2014 and 79% in the second quarter of 2013. This revenue is derived from the Fiber and Data Segment, Equipment Segment and broadband revenue from our Telecom Segment. Revenue growth in these strategic areas is anticipated to offset the revenue decline in our legacy telecom services and this revenue diversification has transformed our company into a regional communication solutions provider. We continue to invest in our network to provide high-quality and reliable service allowing us to expand and enhance our service offerings and increase speeds and capacity in our service areas. As we add fiber access networks within our core fiber footprint we are able to extend our network closer to the customer premises allowing us to service multiple customers in an efficient manner. We leverage our regional network and long-haul routes to provide transport service to wireless service providers and backhaul services to accommodate the growth in wireless data usage. In June 2014, we launched and expanded our business cloud services to businesses of all sizes. Leveraging our network, IP and Cisco expertise, we are able to offer complete network and cloud services as well as premise-based and fully managed and hosted solutions. 18 -------------------------------------------------------------------------------- Table of Contents Revenue diversification could result in a higher proportion of lower margin revenue. Therefore, we closely manage our costs through a disciplined approach to capital and expense management and plan to manage our costs through network grooming and other expense reductions driven by operational and system efficiencies. Highlights for the quarter ended June 30, 2014 include: · Made significant success-based capital investments in our fiber network, which support specific customer revenue-generating projects and accommodates network capacity and reliability requirements. · Consolidated second quarter revenue was $49.7 million, a 5% increase compared to 2013. We experienced growth in both our higher margin services revenue and equipment revenue. o We experienced growth in both our business and wholesale services revenue in our Fiber and Data Segment, which offset customer churn and price compression. o Within our Equipment Segment, our services revenue grew 52% and equipment revenue increased 9%. o Growth in our strategic broadband revenue helped to offset the ongoing decline in the legacy telecom services resulting in an overall Telecom Segment revenue decline of 2%. · Total costs and expenses increased $3.4 million due to higher equipment sales levels and costs associated with the announcement of the merger. We continue to focus our efforts on cost management. · Net income of $1.9 million is down $410,000 or 18% compared to 2013 and was negatively impacted by $911,000 of costs associated with the pending merger. · EBITDA of $11.7 million in 2014 is down $559,000 or 5% due to the costs associated with the pending merger. EBITDA per our credit agreement of $12.6M is up $347,000 or 3%. Management believes this is an important financial measure as it represents our ability to generate cash flow and is used internally in evaluating our performance. A reconciliation of net income to EBITDA can be found in the non-GAAP measures section. Growth in our business segments is offsetting the decline in our traditional telecom services. · Successfully launched a suite of new and expanded cloud services which include SingleLink®, Cloud Compute, Data Protection and Cloud Wifi. 19-------------------------------------------------------------------------------- Table of Contents Fiber and Data Segment The following table provides detail of the Fiber and Data Segment operating results. Three Months Ended Six Months Ended June 30 % June 30 % (Dollars in thousands) 2014 2013 Change 2014 2013 Change Operating revenue before intersegment eliminations: Business $ 9,811 $ 9,239 6 % $ 19,474 $ 18,064 8 % Wholesale 7,821 7,540 4 % 15,636 15,186 3 % Intersegment 211 213 -1 % 432 426 1 % Total operating revenue $ 17,843 $ 16,992 5 % $ 35,542 $ 33,676 6 % Cost of services (excluding depreciation and amortization) $ 8,865 $ 8,583 3 % $ 17,071 $ 16,840 1 % Selling, general and administrative expenses 3,494 3,233 8 % 6,850 6,593 4 % Asset impairment - 5 0 % - 638 0 % Depreciation and amortization 3,107 2,922 6 % 6,297 5,718 10 % Total costs and expenses 15,466 14,743 5 % 30,218 29,789 1 % Operating income $ 2,377 $ 2,249 6 % $ 5,324 $ 3,887 37 % Net income $ 1,415 $ 1,340 6 % $ 3,154 $ 2,301 37 % Capital expenditures (A) $ 3,180 $ 2,970 7 % $ 5,768 $ 5,913 -2 % (A) Does not include change in materials and supplies. Revenue The Fiber and Data Segment revenue streams are generally based on a monthly recurring revenue base, which to a large extent, includes multi-year contracts. Business. We provide enterprise and commercial business customers with a wide array of advanced data services such as Ethernet, Private Line, MPLS, Dedicated Internet, voice and VoIP services. We deliver cost-effective communication solutions to fit the needs of our customers. Fiber and Data business revenue grew $572,000 or 6% in the second quarter and $1,410,000 or 8% year-to-date compared to 2013. The growth can be attributed to rising customer demand and purchases of advanced communication services such as integrated voice and data services. The transition from traditional business voice and long-distance services to more advanced integrated voice and data services also favorably impact this revenue stream. To remain competitive, we continue to expand and enhance our capabilities and business service offerings to meet our customers' communication needs. Evidence of this commitment is our launch of a new and expanded suite of cloud services. Last-mile connections and our local networks are also driving the sale of data services, including Ethernet, MPLS, Dedicated Internet, Private Line and VoIP services. The growth in this revenue stream is tempered by customer churn and price compression. Wholesale. We provide fiber and data services to regional and national service providers including wireless carriers, telecom providers and other service providers. We provide fiber-based transport and access services through our extensive regional fiber network and community access rings, supported by a 24x7x365 Network Operations Center. Through agreements and interconnections with other carriers, our services can be extended beyond our regional network for end-to-end national connectivity. Our expertise allows us to deliver custom network solutions and leverage our capabilities to provide a high-bandwidth, self-healing platform to provide reliable service. Fiber and Data wholesale revenue grew $281,000 or 4% in the second quarter and $450,000 or 3% year-to-date compared to 2013. Bandwidth demands continue to rapidly accelerate to support traffic growth as voice-only wireless traffic has evolved into full multimedia content and applications. Wireless carriers' need for higher bandwidth connections such as Ethernet, DWDM and MPLS technologies is driving revenue growth in our wholesale services. The number of fiber-served cell sites we service increased from 57 at June 30, 2013 to 105 sites at June 30, 2014. We anticipate continued revenue growth by building to additional cell sites in specific targeted areas, upgrading bandwidth and services on existing towers and serving multiple tenants on a build-out. However, due to the 2014 expiration of certain wholesale contracts with large wireless carriers we anticipate a portion of these contracted services to migrate to customer networks which will temper wholesale revenue growth. Wholesale revenue also continues to be hampered by industry consolidation, technological changes, customer network grooming and price compression. 20 -------------------------------------------------------------------------------- Table of Contents Cost of Services (excluding Depreciation and Amortization) Cost of services increased $282,000 or 3% in the second quarter and $231,000 or 1% year-to-date compared to 2013. The main contributors include: · Universal Service Fund ("USF") charges increased $81,000 in the second quarter. · Leased fiber capacity costs increased $75,000 in the second quarter and $123,000 year-to-date related to the expansion of our fiber footprint. · Bad debt expense increased $64,000 in the second quarter and $63,000 year-to-date driven by the uncollectibility of specific customer accounts. · Maintenance contract expense increased $65,000 in the second quarter and $122,000 year-to-date related to the deployment of new infrastructure and customer premise equipment. · Wages, benefits and other compensation related expenses increased $42,000 in the second quarter and $160,000 year-to-date related to the necessary resources to support the growth initiatives in this segment. · A net increase of $67,000 in the second quarter and $62,000 year-to-date in other expenses offset by; · Circuit related expense declines of $112,000 in the second quarter and $299,000 year-to-date primarily related to our efforts of grooming circuits from off-net providers to our own network. Selling, General and Administrative Expenses We are investing in our business to support growth initiatives and provide exceptional service to our customers. We remain committed to scaling the business through process improvements and building system efficiencies. Selling, general and administrative expenses increased $261,000 or 8% in the second quarter and $257,000 or 4% year-to-date compared to 2013. Expenses to note include: · Corporate expenses increased $131,000 in the second quarter and $262,000 year-to-date compared to 2013 driven by the increased resources and attention focused on process and system efficiencies, and success and growth of this segment. · Wages, benefits and other compensation-related expenses increased $78,000 in the second quarter although decreased $123,000 on a year-to-date basis. · Other expenses increased $52,000 in the second quarter and $118,000 on a year-to-date basis. Asset Impairment There were no asset impairment charges in the first six months of 2014. We did recognize an asset impairment charge of $633,000 in the first quarter of 2013 related to assets supporting a service we elected to discontinue and minor adjustments in the second quarter of 2013 resulted in the addition of $5,000 bringing the 2013 year-to-date impairment charge to $638,000. Depreciation and Amortization Fiber and Data Segment depreciation and amortization increased $185,000 or 6% in the second quarter and $579,000 or 10% year-to-date compared to 2013. We continue to invest in network capacity, expansion and reliability along with investments to support our strategic initiatives. 21 -------------------------------------------------------------------------------- Table of Contents Equipment Segment The following table provides detail of the Equipment Segment operating results. Three Months Ended Six Months Ended June 30 % June 30 % (Dollars in thousands) 2014 2013 Change 2014 2013 Change Operating revenue before intersegment eliminations: Equipment $ 14,052 $ 12,910 9 % $ 24,079 $ 28,274 -15 % Services 3,355 2,206 52 % 5,576 4,079 37 % Total operating revenue $ 17,407 $ 15,116 15 % $ 29,655 $ 32,353 -8 % Cost of sales (excluding depreciation and amortization) $ 12,357 $ 10,860 14 % $ 20,901 $ 24,082 -13 % Cost of services (excluding depreciation and amortization) 1,737 1,808 -4 % 3,514 3,503 0 % Selling, general and administrative expenses 1,467 1,390 6 % 2,770 2,804 -1 % Depreciation and amortization 130 124 5 % 268 209 28 % Total costs and expenses 15,691 14,182 11 % 27,453 30,598 -10 % Operating income $ 1,716 $ 934 84 % $ 2,202 $ 1,755 25 % Net income $ 1,020 $ 555 84 % $ 1,307 $ 1,040 26 % Capital expenditures $ 28 $ 403 -93 % $ 137 $ 961 -86 % Revenue Equipment. We are a Master Unified Communications and Gold Certified Cisco distributor providing equipment solutions and support for a broad spectrum of business customers. As an equipment integrator, we design and implement networks utilizing emerging technological advancements including TelePresence Video, Unified Communications and Data Center solutions. We also utilize relationships with other industry-leading vendors to provide integrated communication solutions for our clients to meet their emerging networking needs. Equipment sales are non-recurring in nature making this revenue dependent upon attracting new sales from existing and new customers, as well as leveraging relationships with our current customer base by adding more value through enhanced product and service offerings. Equipment revenue increased $1,142,000 or 9% in the second quarter and declined $4,195,000 or 15% year-to-date compared to 2013. We continue to experience success in selling data and communications equipment as customers invest in technology and IT solutions such as unified communication products, data center products, cloud computing solutions, storage, data analysis and IT virtualization. This revenue stream is non-recurring and the fluctuation in revenue can be attributed to multiple element accounting and the timing of customer sales which vary from quarter to quarter. Services. We provide a comprehensive set of services to support equipment solutions, including: advisory, implementation, development and support. We have the expertise and experience to transform the available technology into solutions to solve business challenges and meet their objectives. Maintenance contracts ("Smartnet" contracts) are offered in collaboration with Cisco systems. Our Total Care support team provides a proactive approach to monitoring and supporting customer networks, unified communications environments and data centers as well as a single-point-of-contact for the support of applications, systems and infrastructure. Equipment services revenue increased $1,149,000 or 52% in the second quarter and $1,497,000 or 37% year-to-date compared to 2013. The growth is reflective of our focus on growing the higher margin service revenue in this segment. The increase in contract services revenue accounts for 52% of the quarterly increase and 55% of the year-to-date increase. The increase in maintenance contracts accounts for 43% and 40% of the quarterly and yearly increase, respectively. Maintenance revenue is largely tied to equipment installations, and Smartnet contracts are typically three to five years. This revenue stream is cyclical in nature and is subject to timing of projects and renewal opportunities. 22 -------------------------------------------------------------------------------- Table of Contents Cost of Sales (excluding Depreciation and Amortization) Cost of sales is composed of equipment material costs associated with equipment sales. Cost of sales increased $1,497,000 or 14% in the second quarter and declined $3,181,000 or 13% year-to-date when compared to 2013. The change is directly associated with equipment sales along with the timing associated with the receipt of vendor specific rebates which directly decrease cost of sales. Quarter-over-quarter equipment margins were compressed due to a transfer of revenues from Equipment to Services revenue related to multiple element accounting. Labor associated with installation of the equipment is included in cost of services (excluding depreciation and amortization) described below. Cost of Services (excluding Depreciation and Amortization) Cost of services declined $71,000 or 4% in the second quarter and remained relatively flat year-to-date compared to 2013. Selling, General and Administrative Expenses Selling, general and administrative expenses increased $77,000 or 6% in the second quarter and declined $34,000 or 1% year-to-date compared to 2013. The primary contributors include: · Commissions expense increased $68,000 in the second quarter and declined $54,000 year-to-date which is in direct correlation with revenue. · A net increase of $9,000 in the second quarter and $20,000 year-to-date in other expenses. Depreciation and Amortization Depreciation expense increased $6,000 or 5% in the second quarter and $59,000 or 28% year-to-date compared to 2013, driven by expansion of office space. 23 -------------------------------------------------------------------------------- Table of Contents Telecom Segment The following table provides detail of the Telecom Segment operating results. Three Months Ended Six Months Ended June 30 % June 30 % (Dollars in thousands) 2014 2013 Change 2014 2013 Change Operating revenue before intersegment eliminations: Local service $ 2,799 $ 2,885 -3 % $ 5,529 $ 5,848 -5 % Network access 4,220 4,482 -6 % 8,635 9,183 -6 % Broadband 5,455 5,241 4 % 10,731 10,246 5 % Other 1,486 1,598 -7 % 2,999 3,177 -6 % Intersegment 426 416 2 % 860 833 3 % Total Telecom operating revenue $ 14,386 $ 14,622 -2 % $ 28,754 $ 29,287 -2 % Total Telecom revenue before intersegment eliminations Unaffiliated customers $ 13,960 $ 14,206 $ 27,894 $ 28,454 Intersegment 426 416 860 833 14,386 14,622 28,754 29,287 Cost of services (excluding depreciation and amortization) 6,845 6,767 1 % 13,654 13,614 0 % Selling, general and administrative expenses 1,981 2,146 -8 % 3,967 4,391 -10 % Depreciation and amortization 3,708 3,756 -1 % 7,386 7,459 -1 % Total Telecom costs and expenses 12,534 12,669 -1 % 25,007 25,464 -2 % Operating income $ 1,852 $ 1,953 -5 % $ 3,747 $ 3,823 -2 % Net income $ 1,103 $ 1,163 -5 % $ 2,221 $ 2,267 -2 % Capital expenditures (A) $ 3,508 $ 2,622 34 % $ 5,312 $ 4,382 21 % Key metrics Business access lines 18,660 19,628 -5 % Residential access lines 19,914 21,496 -7 % Total access lines 38,574 41,124 -6 % High-speed Internet ("DSL") customers 21,185 20,538 3 % Digital TV customers 11,749 11,001 7 % (A) Does not include change in materials and supplies. Revenue Local Service. We provide voice services, enhanced calling features and miscellaneous local services for residential and business customers. We also receive reciprocal compensation revenue based on interconnection agreements with wireless carriers who use our network to terminate calls. Local service revenue declined $86,000 or 3% in the second quarter and $319,000 or 5% year-to-date compared to the same periods in 2013. This revenue stream continues to be adversely impacted by the industry-wide decline in access lines and price compression due to competition and alternative communication services. We expect continued declines as customers replace traditional voice services with enhanced VoIP and wireless service options and products, including our own competing VoIP product offered through our Fiber and Data Segment. To mitigate future declines in access lines, we continue to market competitive service bundles, which provide our customers flexible options and bundle discounts. Network Access. We provide access services to other communications carriers to terminate or originate long distance calls on our network. We also bill subscriber line charges to our customers for access to the public switched network. Network access revenue is derived from several federally administered pooling arrangements designed to provide support and distribute funding to Incumbent Local Exchange Carriers ("ILEC"). Special access circuits provide dedicated lines and trunks to businesses and interexchange carriers. All of these revenue sources are components of network access revenue. Network access revenue declined $262,000 or 6% in the second quarter and $548,000 or 6% year-to-date compared to 2013. The decline is a result of declining access lines and lower minutes of use driven by alternative communication options, competition and network grooming/optimization. This revenue stream was, and will continue to be, impacted by regulatory decisions, particularly FCC Order 11-161 which reformed the framework of the Universal Service Fund and intercarrier compensation. Provisions in FCC Order 11-161 call for reductions of interstate and intrastate access charges through gradual annual reductions in rates for certain access components. Introduced as a part of the FCC Order 11-161 to help mitigate the revenue decline, additional end-user charges and support from the Connect America Fund ("CAF"). As anticipated, we experienced a decline in minutes-of-use, end-user and special access revenue which was partially offset by higher support revenue. 24 -------------------------------------------------------------------------------- Table of Contents Broadband. We provide residential and business broadband services for monthly recurring revenue. Broadband services include high-speed Internet, digital TV services, and business Ethernet and data services. Broadband revenue increased $214,000 or 4% in the second quarter and $485,000 or 5% year-to-date compared to 2013. The success of our multi-service bundle offerings is reflected in the 7% and 3% growth in our digital TV and high-speed Internet ("DSL") customer subscribers, respectively. Broadband revenue comprised 11% of our consolidated revenue in 2014 and 2013. We anticipate our broadband revenue to grow but at tapered rates due to the competitive pricing we offer our customers and the competitive approach of our competitors. Providing the best service experiences for both our residential and business customers is our priority. To remain competitive, we continue to invest in our broadband network for the delivery of competitive broadband service offerings and reliable services. Our multi-service bundles offer our customers competitive and flexible options with pricing discounts when bundling digital TV, Internet and/or voice services. Additional discounts are offered if a customer opts into a six-month, one- or two-year agreement. We believe the bundles provide our customers valuable money-saving packages and positively impact our customer retention. Other Revenue. Other revenue consists primarily of directory publishing, long distance, sales of wholesale contract services, late fees applied to subscriber billings, and add, move, and change revenue on customer premise equipment. Other revenue decreased $112,000 or 7% in the second quarter and $178,000 or 6% year-to-date compared to 2013 primarily attributable to lower directory revenue as businesses elect online media platforms over traditional printed directories, lower customer premise equipment revenue and lower long distance revenue. Cost of Services (excluding Depreciation and Amortization) Cost of services (excluding depreciation and amortization) increased $78,000 or 1% in the second quarter and remained relatively flat year-to-date compared to 2013. The main contributors include: · Programming expense increased $266,000 in the second quarter and $525,000 year-to-date driven by higher programming network fees associated with providing our digital TV service and our growing subscriber base. Programming fees are expected to continue to increase throughout 2014. · Loss on disposal of assets associated with our digital TV service increased $76,000 in the second quarter and $212,000 year-to-date offset by; · Access expenses declined $70,000 in the second quarter and $154,000 year-to-date driven by lower long distance minutes on our network and the declining customer base due to competition and wireless alternatives. · Material and supplies write-offs declined $94,000 in the second quarter and $193,000 year-to-date driven by our focus on materials management. · Wages and benefits declined $126,000 year-to-date driven by a smaller workforce in the Telecom Segment and savings associated with our post-retirement benefits. · A net decrease of $100,000 in the second quarter and $224,000 year-to-date in other expenses, which include decreases in directory fees, USF fees and computer expenses. Selling, General and Administrative Expenses Selling, general and administrative expenses decreased $165,000 or 8% in the second quarter and $424,000 or 10% year-to-date compared to 2013 driven primarily by: · Corporate expense decreased $142,000 in the second quarter and $284,000 year-to-date driven by the shift of our focus and resources toward the growth in the Fiber and Data Segment. · Regulatory fees declined $122,000 year-to-date. · A net decline of $23,000 in the second quarter and $18,000 year-to-date in other expenses. Depreciation and Amortization Depreciation and amortization expense decreased $48,000 or 1% in the second quarter and $73,000 or 1% year-to-date compared to 2013. As we continue to manage the anticipated declines in profitability in this segment, we selectively choose to invest in our broadband network and other revenue-generating projects. 25 -------------------------------------------------------------------------------- Table of Contents Consolidated Results Corporate and Other Operating Income Corporate and other operating income declined $1,621,000 in the second quarter and $1,984,000 year-to-date compared to 2013. The primary contributors include: · Bill processing revenue which declined $316,000 or 30% in the second quarter and $549,000 or 30% year-to-date compared to 2013 due to the timing of performance on contract services including project integration services and license fees related to the sale of our SuiteSolution product and the strategic shift to internal projects in an effort to streamline and improve our processes. · Selling, general and administrative expenses were impacted by $911,000 of expenses associated with the pending merger. · Other expenses increased $279,000 in the second quarter and $260,000 year-to-date compared to 2013. Depreciation and amortization increased $115,000 or 26% in the second quarter and $264,000 or 30% year-to-date compared to 2013 driven by capital expenditures related to our systems and processes. Interest Expense Consolidated interest expense of $991,000 in the second quarter of 2014 is 12% lower compared to the same period in 2013 driven primarily by the refinancing of our credit facility in October 2013. The outstanding balance of our debt obligations (long-term and current portion) declined $1,537,000 from $135,979,000 at June 30, 2013 to $134,442,000 as of June 30, 2014. The June 30, 2014 debt balance decreased $765,000 since December 31, 2013. Income Taxes Our effective income tax rate for the second quarter of 2014 and 2013 was 40.5% and 40.3%, respectively. The effective tax rate from operations differs from the federal statutory rate primarily due to state income taxes. Liquidity and Capital Resources Working Capital Working capital (current assets minus current liabilities) was $14,737,000 as of June 30, 2014 compared to working capital of $12,893,000 as of December 31, 2013. The ratio of current assets to current liabilities was 1.4 as of June 30, 2014 and December 31, 2013. Capital Structure The total capital structure (long-term and current maturities of long-term debt obligations plus shareholders' equity) was $184,286,000 at June 30, 2014 reflecting 27% equity and 73% debt. This compares to a total capital structure of $184,517,000 at December 31, 2013, also reflecting 27% equity and 73% debt. In the communications industry, debt financing is most often based on multiples of operating cash flows. Specifically, our current use of the senior credit facility is in a leverage ratio of approximately 2.8 times debt to Earnings Before Interest, Tax, Depreciation and Amortization, ("EBITDA") as defined in our credit agreement; well within the acceptable limit for our agreement and our industry. Our leverage ratio of 2.8 times debt to EBITDA is well within our amended credit facility limit of 3.50 times, and is a source of capital as we consider future opportunities. We employ an extended term payable financing arrangement for the equipment provisioning portion of our Equipment Segment and view this arrangement as a structured accounts payable that is paid within 60 days with no separate interest charge. As such, the extended term payable financing amount of $13,068,000 and $8,879,000 as of June 30, 2014 and December 31, 2013, respectively, is not considered to be part of our capital structure and has been excluded from the references above regarding debt and total capital. See Note 7 "Extended Term Payable." 26 -------------------------------------------------------------------------------- Table of Contents Internal operations of our business continue to be our primary source of liquidity. We have invested in capital expenditures, paid interest, taxes and dividends while paying down our debt obligations. We have not changed our equity capitalization, and new equity was not a source of liquidity during the period. Our cash and cash equivalents balance decreased $482,000 from $7,960,000 at December 31, 2013 to $7,478,000 as of June 30, 2014 primarily due to consolidated operating results, timing of our capital expenditures, dividend payments to our shareholders and our working capital needs. Cash Flows We expect cash flows from operations, cash and cash equivalents, and borrowings available under our credit facility will be sufficient to meet our current and long-term liquidity and capital requirements. For temporary increases in cash demand, we utilize our cash inflow. For more significant fluctuations in liquidity, driven by growth initiatives, we rely on our senior credit facility. These sources coupled with our access to a $30,000,000 revolving credit facility (presently unused) provide further assurance against interruption in our business plans due to financing. Our expected primary cash outflows include funding ongoing working capital requirements, capital expenditures, scheduled principal and interest payments on our credit facility, temporary financing of trade accounts receivable and the payment of dividends as they are declared. While it is difficult for us to predict the impact general economic conditions may have on our business, we believe that we will be able to meet our current and long-term cash requirements through our operating cash flows. We are in full compliance with our debt covenants and anticipate that we will be able to plan for and match future liquidity needs with future internal and available external resources. We feel we can adjust the timing or the number of strategic and growth initiatives accordingly to correspond to any limitation we may face or be imposed by our capital structure or sources of financing. The following table details the cash flow changes for the six months ended June 30, 2014 and 2013: (Dollars in thousands) Six Months Ended June 30 2014 2013 % Change Net cash provided by (used in): Operating activities $ 12,121 $ 11,634 4 % Investing activities (12,263 ) (11,917 ) 3 % Financing activities (340 ) (2,825 ) -88 % Net change in cash and cash equivalents $ (482 ) $ (3,108 ) -84 % Cash from operations represents the amount of cash generated by our daily operations after the payment of operating obligations and is our most significant source of liquidity. In both years, cash generated from operations was primarily attributable to net income and non-cash expenses including depreciation and amortization. The modest increase in net cash for operating activities is primarily due to changes in operating assets and liabilities, specifically accounts payable and accrued expenses as a result of timing of payments to vendors. Capital expenditures are our primary recurring investing activity and were consistent when comparing 2014 to 2013. Our capital expenditures continue to be directed toward leveraging our statewide fiber network in success-based and network expansion projects, such as customer fiber builds, fiber to cell sites and expansion in key strategic locations. In the first six months of 2014, 58% of our capital expenditures were related to success-based capital projects for customer and strategic initiatives. Cash requirements for capital expenditures were funded using cash generated by our operations. Financing activities primarily consist of borrowings and payments on our extended term payable and credit facility and payment of dividends to our shareholders. The decrease in cash used in financing activities is primarily due to the timing and volume of equipment orders in our Equipment Segment resulting in a $4,189,000 increase in our extended term payable in the first six months of 2014 compared to an increase of $2,752,000 in 2013. Dividends during the first six months of 2014 and 2013 were $4,091,000 and $3,936,000, respectively, an increase of 3.9%. A dividend of $0.15 per share payable in the third quarter of 2014 was declared by our Board of Directors in July 2014. 27 -------------------------------------------------------------------------------- Table of Contents Our long-term obligations, including current maturities of debt and capital leases as of June 30, 2014 and December 31, 2013 were $134,442,000 and $135,207,000, respectively. Our credit facility requires us to comply with specified financial ratios and tests. The financial ratios required by our credit facility are not calculated in accordance with accounting principles generally accepted in the United States of America ("non-GAAP financial measures"). The non-GAAP financial measures are presented below for the purpose of demonstrating compliance with our debt covenants: (Dollars in thousands) Leverage Ratio: June 30, 2014 (A) Total debt (including outstanding letters of credit) $ 134,462 EBITDA per our credit agreement Three months ended 6-30-14 12,623 Three months ended 3-31-14 12,073 Three months ended 12-31-13 12,019 Three months ended 9-30-13 11,801 (B) Total EBITDA per our credit agreement $ 48,516 Total leverage ratio (A)/(B) 2.77 Maximum leverage ratio allowed 3.50 (Dollars in thousands) Debt Service Coverage Ratio: June 30, 2014 EBITDA per our credit agreement, minus $ 48,516 Income taxes (5,366 ) (A) $ 43,150 (B) the sum of (i) all scheduled principal payments to be made on debt and (ii) interest expense 5,931 Debt service coverage ratio (A)/(B) 7.3 Minimum debt service ratio allowed 2.5 New Accounting Pronouncements The financial statement impact relating to new accounting standards that have not yet been adopted by us can be found in Note 1 "Basis of Presentation and Consolidation." Reconciliation of Non-GAAP Financial Measures In addition to the results reported in accordance with accounting principles generally accepted in the United States of America ("GAAP"), we also use certain non-GAAP measures including EBITDA and EBITDA (as defined in our credit agreement) to evaluate operating performance and to facilitate the comparison of our historical results and trends. These non-GAAP measures are also used to manage and evaluate the operating performance of our reportable segments. These financial measures should not be considered in isolation or as a substitute for net income as a measure of performance and net cash flow provided by operating activities as a measure of liquidity. EBITDA is included as a supplemental disclosure because management believes that it provides (1) additional information with respect to our ability to service debt, fund capital expenditures and meet working capital requirements, (2) a helpful measure for comparing our operating performance with the performance of other companies with different capital structures or tax rates, (3) comparison of our business segments performance to other public companies and (4) is a leading component of incentive-based compensation for operating management. Reconciliations to the most directly comparable GAAP measure are provided below. 28 -------------------------------------------------------------------------------- Table of Contents (Dollars in thousands) Three Months Ended June 30 Six Months Ended June 30 2014 2013 2014 2013 Net income $ 1,911 $ 2,321 $ 3,984 $ 3,947 Add: Depreciation and amortization 7,510 7,252 15,090 14,261 Interest expense 991 1,131 1,970 2,270 Income taxes 1,300 1,567 2,741 2,661 EBITDA $ 11,712 $ 12,271 $ 23,785 $ 23,139 Adjustments allowed under our credit agreement: Asset impairment - 5 - 638 Merger costs 911 - 911 - EBITDA per our credit agreement $ 12,623 $ 12,276 $ 24,696 $ 23,777 Three Months Ended (Dollars in thousands) Jun-14 Mar-14 Dec-13 Sep-13 Reconciliation of net income to EBITDA: Net income $ 1,911 $ 2,073 $ 1,923 $ 1,862 Add: Depreciation and amortization 7,510 7,580 7,547 7,514 Interest expense 991 979 1,194 1,155 Income taxes 1,300 1,441 1,355 1,270 EBITDA $ 11,712 $ 12,073 $ 12,019 $ 11,801 Adjustments allowed under our credit agreement: Merger costs 911 - - - EBITDA per our credit agreement $ 12,623 $ 12,073 $ 12,019 $ 11,801 Debt to EBITDA ratio Total outstanding debt as of June, 2014 (including outstanding letters of credit) $ 134,462 EBITDA per our credit agreement for the last (4) consecutive fiscal quarters as presented above 48,516 Debt to EBITDA ratio as of June 30, 2014 2.77 |