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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; 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; 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 Communications ("UC") solutions, including enterprise hosted Voice-over-Internet Protocol ("VoIP") and operates as a regional Incumbent Local Exchange Carrier ("ILEC") in southern Orange County, New York and northern New Jersey. We deliver cloud-based UC solutions including BroadSoft-based VoIP integrated with Microsoft Lync, Microsoft Exchange, Google Apps for Business, leading customer relationship management (CRM) applications such as Salesforce.com and Bring-Your-Own-Device (BYOD) solutions for Mobility. Our ILEC operations consist of providing local and toll telephone service to residential and business customers, Internet high-speed broadband service, and satellite television services provided by DIRECTV. Our cloud-based Unified Communication as a Service ("UCaaS") solutions are focused on medium, large and enterprise markets. 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 Six months ended June 30, 2014 Six months ended June 30, 2013 Change Segment % of Total Segment Segment % of Total Segment Segment Favorable Revenue Revenue Loss Margin Revenue Revenue Loss Margin Revenue (Unfavorable) Unified Communications $ 8,445 56 % $ (3,598 ) (43 )% $ 7,876 52 % $ (6,391 ) (81 )% $ 569 $ 2,793 Telephone 6,683 44 % (75 ) (1 )% 7,311 48 % (863 ) (12 )% (628 ) 788 Total $ 15,128 100 % $ (3,673 ) (24 )% $ 15,187 100 % $ (7,254 ) (48 )% $ (59 ) $ 3,581 Overall revenues were relatively consistent at $15.1 million for the six months ended June 30, 2014 and $15.2 million for the six months ended June 30, 2013. We experienced a 7% increase in our UC revenues due to the organic growth of the segment, which was partially offset by a $1.1 million decrease in revenue from our Syracuse, New York operation that were sold in August 2013. The decrease in our Telephone segment for the six months ended June 30, 2014 was primarily due to a $0.5 million decrease in our USF revenues, due to the expected trend of lower 20 -------------------------------------------------------------------------------- Table of Contents reimbursable costs. In addition, 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 have reduced revenue in this segment. We partially offset the decline in telephone access lines by focusing our efforts on identifying and pursuing growth opportunities including fiber deals and expansion of our broadband Internet business. During the six months ended June 30, 2014, we had an operating loss of $3.7 million, compared to an operating loss of $7.3 million for the six months ended June 30, 2013. The decrease in operating loss was attributed to lower payroll and operating costs in 2014 due to cost saving initiatives implemented in 2013 and the first half of 2014, that included severance charges related to management changes and staff rationalization primarily in 2013 and due to the sale of the operations in Syracuse, New York, which had incurred higher operating costs than revenue. During the six months ended June 30, 2014, we had net income of $31.3 million, compared to a net loss of $0.7 million for the six months ended June 31, 2013, as a result of our exercise of the Orange County-Poughkeepsie Limited Partnership ("O-P") Put for $50 million and the decrease in operating costs discussed above. Results of Operations for the three and six months ended June 30, 2014 and 2013 OPERATING REVENUES For the three months ended June 30, 2014 For the three months ended June 30, 2013 Change % of Total % of Total Revenue Revenue Revenue Revenue Revenue Unified Communications $ 4,234 56 % $ 3,920 53 % $ 314 Telephone 3,370 44 % 3,527 47 % (157 ) Total $ 7,604 100 % $ 7,447 100 % $ 157 Revenues for our UC segment increased 8% for the three months ended June 30, 2014 compared to the same period in 2013. This increase was associated with the segment's organic growth primarily driven by a $0.7 million increase in license and usage revenue. This increase was partially offset by a $0.6 million decrease in revenue from previous customers within our Syracuse, New York operations that were sold in August 2013. Revenues for our Telephone segment decreased 5% for the three months ended June 30, 2014 compared to the same period in 2013. The decrease was driven by a $0.1 million decline in USF revenues and a decrease in access line revenue. For the six months ended June 30, 2014 For the six months ended June 30, 2013 Change % of Total % of Total Revenue Revenue Revenue Revenue Revenue Unified Communications $ 8,445 56 % $ 7,876 52 % $ 569 Telephone 6,683 44 % 7,311 48 % (628 ) Total $ 15,128 100 % $ 15,187 100 % $ (59 ) Revenues for our UC segment increased 7% for the six months ended June 30, 2014 compared to the same period in 2013. This increase was associated with the segment's organic growth primarily driven by a $1.5 million increase in license and usage revenue. This increase was partially offset by a $1.1 million decrease due to our sale of operations in Syracuse, New York in August 2013. Revenues for our Telephone segment decreased 9% for the six months ended June 30, 2014 compared to the same period in 2013. The decrease was driven by a $0.5 million decline in USF revenues and a decrease in access line revenue. 21 -------------------------------------------------------------------------------- Table of Contents OPERATING EXPENSES Unified Communications Telephone Consolidated For the Three Month Ended June 30, For the Three Month Ended June 30, For the Three Month Ended June 30, in thousands 2014 2013 Change 2014 2013 Change 2014 2013 Change Cost of services and products $ 1,889 $ 2,015 $ (126 ) $ 978 $ 1,200 $ (222 ) $ 2,867 $ 3,215 $ (348 ) Selling, general and administrative 3,351 3,811 (460 ) 1,911 2,415 (504 ) 5,262 6,226 (964 ) Depreciation and amortization 539 564 (25 ) 380 397 (17 ) 919 961 (42 ) Total operating expenses $ 5,779 $ 6,390 $ (611 ) $ 3,269 $ 4,012 $ (743 ) $ 9,048 $ 10,402 $ (1,354 ) Operating expenses declined 13% for the three months ended June 30, 2014 compared to the three months ended June 30, 2013 primarily due to selling, general and administrative expenses decreasing 16% across both of our operating segments. For the three months ended June 30, 2014, we realized cost savings from a reduction in headcount. Cost of Services and Products Cost of services and products for our UC segment decreased 6% for three months ended June 30, 2014 compared to the same period in 2013 and decreased as a percentage of revenue to 45% from 51%. The decrease was primarily due to leveraging the UC infrastructure over a larger revenue base and 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 and improved margins on our equipment sales. These decreases were partially offset by a $0.2 million increase in circuit and usage costs due to increases in customers. Cost of services and products for our Telephone segment decreased for three months ended June 30, 2014 compared to the same period in 2013 primarily due to a $0.2 million reduction in circuit costs as part of our cost reduction initiatives. Selling, General and Administrative Expenses Selling, general and administrative expenses decreased 16% for the three months ended June 30, 2014 compared to the same period in 2013 primarily due a $0.5 decrease in wages and associated benefits and $0.3 million lower equity compensation due to staff reductions over the last year across both segments. In addition, we realized a $0.1 million decrease in marketing expenses due to the 2013 rebranding. Depreciation and Amortization Expense Depreciation and amortization expense in the UC segment decreased 5% for the three months ended June 30, 2014 compared to the three months ended June 30, 2013 primarily due to a lower depreciable base due to the sale of our operations in Syracuse, New York in August 2013. Unified Communications Telephone Consolidated For the Six Month Ended June 30, For the Six Month Ended June 30, For the Six Month Ended June 30, in thousands 2014 2013 Change 2014 2013 Change 2014 2013 Change Cost of services and products $ 3,915 $ 4,585 $ (670 ) $ 2,004 $ 2,419 $ (415 ) $ 5,919 $ 7,004 $ (1,085 ) Selling, general and administrative 7,068 8,500 (1,432 ) 3,992 4,974 (982 ) 11,060 13,474 (2,414 ) Depreciation and amortization 1,060 1,182 (122 ) 762 781 (19 ) 1,822 1,963 (141 ) Total operating expenses $ 12,043 $ 14,267 $ (2,224 ) $ 6,758 $ 8,174 $ (1,416 ) $ 18,801 $ 22,441 $ (3,640 ) Operating expenses declined 16% for the six months ended June 30, 2014 compared to the six months ended June 30, 2013 primarily due to selling, general and administrative expenses decreasing 18% across both of our operating segments. During the first six months of 2014 we incurred $1.8 million less in charges associated with the restructuring of management and staff rationalization, compared to the same period in 2013. In the first six months of 2013 we incurred $0.4 million in marketing expenses associated with the rebranding of the company, which were not incurred in 2014, and cost reduction initiatives put in place. 22 -------------------------------------------------------------------------------- Table of Contents Cost of Services and Products Cost of services and products for our UC segment decreased 15% for the six months ended June 30, 2014 compared to the same period in 2013 and decreased as a percentage of revenue to 46% from 58% primarily due to a combined $0.8 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, the leveraging of the UC infrastructure over a larger revenue base and improved margins on our equipment sales. This was offset by a $0.3 million increase in internet access costs due to an increase in customers. Cost of services and products for our Telephone segment decreased for the three months ended June 30, 2014 compared to the same period in 2013 due to $0.3 million in lower wages from staff rationalizations over the last year and $0.2 million reduction in circuit costs as part of our cost reduction initiatives. Selling, General and Administrative Expenses Selling, general and administrative expenses decreased 18% for the six months ended June 30, 2014 compared to the same period primarily due to a $1.2 million decrease in wages and associated benefits and $0.2 million lower equity compensation from staff reductions over the last year across both segments and $0.5 million in severance charges incurred in 2013 related to the former CEO. In addition, marketing decreased by $0.4 million which was primarily driven by higher costs in 2013 from the rebranding to the Alteva name and cost reduction initiatives put in place in 2014. Depreciation and Amortization Expense Depreciation and amortization expense in the UC segment decreased 10% for the six months ended June 30, 2014 compared to the six months ended June 30, 2013 primarily due to a lower depreciable base due to the sale of our operations in Syracuse, New York in August 2013. TOTAL OTHER INCOME (EXPENSE) For the Three Month Ended June 30, in thousands 2014 2013 Change Interest expense, net $ (54 ) $ (178 ) $ 124 Income from equity method investment 50,333 3,250 47,083 Other income, net 6 29 (23 ) Total other income $ 50,285 $ 3,101 $ 47,184 Total other income increased 1,522% for the three months ended June 30, 2014 compared to same period in 2013 due the $49.8 million gain on the sale of the O-P investment from the exercise of the Put in accordance with the O-P agreement as well as equity method earnings of $0.6 million from the O-P before the Put was exercised. In 2013 we received guaranteed annual distributions of $13 million ($3.25 million each quarter). In 2014, in accordance with the O-P agreement, our guaranteed distribution levels stopped and we received income from the equity investment only for our ownership share of 8.108% of the O-P's net income. For the Six Month Ended June 30, in thousands 2014 2013 Change Interest expense, net $ (193 ) $ (414 ) $ 221 Income from equity method investment 52,373 6,500 45,873 Other income, net 27 137 (110 ) Total other income $ 52,207 $ 6,223 $ 45,984 Total other income increased 739% for the six months ended June 30, 2014 compared to same period in 2013 due to the $49.8 million gain on the sale of the O-P investment from the exercise of the Put in accordance with the O-P agreement. In 2013 we received guaranteed annual distributions of $13 million ($3.25 million each quarter). In 2014, in accordance with the O-P agreement, our guaranteed distribution levels stopped and we received income from the equity investment only for our ownership share of 8.108% of the O-P's net income, which was $2.6 million the four months ended April 30, 2014. 23 -------------------------------------------------------------------------------- Table of Contents INCOME TAXES For the three months ended June 30, 2014, we had income tax expense of $17.3 million or 35% of income before taxes as compared to income tax expense of $0.2 million, or 106% of income before taxes, for the three months ended June 30, 2013. For the six months ended June 30, 2014, we had an income tax expense of $17.2 million, or 36% of income before income taxes, as compared to income tax benefit of $0.4 million, or 34% of loss before income taxes, for the six months ended June 30, 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 was treated as a discrete item in the Company's second quarter of 2014. The increase in the effective tax rate is due to exercise of the Put being treated as a discrete item and is taxed at the full federal tax rate of 35% for period ended June 30, 2014. Due to the nature of the gain on the Put, we have nominal state taxes associated with the gain which minimally impacts our effective tax rate. LIQUIDITY AND CAPITAL RESOURCES We had $40.1 million of cash and cash equivalents at June 30, 2014 as compared with $1.6 million at December 31, 2013. Our increase in cash flows was primarily generated from cash proceeds from the exercise of the O-P Put. 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 have not and 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. 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 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. 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. On April 30, 2014, upon receiving proceeds for the exercise of the O-P Put, we repaid all $11.6 million of the then outstanding debt on the credit facility. On June 1, 2014, the credit agreement was amended to reduce the borrowing capacity from a ceiling of $17.0 million to a ceiling of $5.0 million. Pursuant to the Credit Agreement, the Company has a one-time ability to request a ceiling increase not to exceed $3.0 million. On June 30, 2014, the credit agreement was amended to extend the expiration of the Credit Agreement from June 30, 2014 to October 8, 2014 (see Note 6). 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. As of June 30, 2014, the Company had $5.0 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 have to maintain a Consolidated Liquidity Ratio, as defined in the TriState credit agreement, in excess of 1.0 to 1.0. 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. These terms did not change when the credit agreement was amended on June 30, 2014. We currently have an outstanding employment matter related to our former CEO's termination which we believe is for cause. We have accrued for $0.1 million at June 30, 2014, based upon the current facts and circumstances; however, the maximum cash severance payments called for under Mr. Cuthbert's employment agreement in the case of a termination not for cause total $0.8 million. Future updates in this matter could adversely affect us if there is a more unfavorable outcome. CASH FROM OPERATING ACTIVITIES Cash used in operating activities increased from $0.2 million for the six months ended June 30, 2013 to $0.7 million for the six months ended June 30, 2014. The change in cash used in operating activities from June 30, 2013 to June 30, 2014 was primarily due to increases in our accounts receivable balance from the growth of our customer base and timing of payments on our liabilities, primarily for taxes associated with the O-P Put gain. 24 -------------------------------------------------------------------------------- Table of Contents CASH FROM INVESTING ACTIVITIES Net cash provided by investing activities was $49.6 million for the six months ended June 30, 2014, primarily due to the $49.8 million proceeds from the exercise of the O-P Put that represented the return of our investment. Net cash provided by investing activities of $2.0 million for the six months ended June 30, 2013 was primarily due to distributions of $2.8 million we received from the O-P in excess of our share of the O-P's income. CASH FROM FINANCING ACTIVITIES Net cash used in financing activities during the six months ended June 30, 2014 was $10.4 million compared to $2.9 million for the six months ended June 30, 2013. We repaid our outstanding balance of $11.6 million on our TriState credit facility from the proceeds received for the exercise of the O-P Put. Dividends declared on our common shares by the Board of Directors were $0.54 per share for the six months ended June 30, 2013. The total amount of dividends paid on our common shares by us for the six months ended June 30, 2013 was $3.3 million. The additional financing activities for the six months ended June 30, 2013 were attributed to the repayment of debt of $16.9 million offset by $17.6 million proceeds from our debt with TriState. |