Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") is intended to provide a reader of our financial statements with a narrative from the perspective of management. The following MD&A should be read in conjunction with audited Consolidated Financial Statements and notes thereto included elsewhere in this Annual Report on Form 10-K. Certain statements in this MD&A are forward-looking statements. Important factors that could cause actual results to differ from estimates or projections contained in the forward-looking statements are described under “Cautionary Note Concerning Factors That May Affect Future Results” in this Item 7.
Overview
EarthLink Holdings Corp. (“EarthLink” or the “Company”), together with our consolidated subsidiaries, is a leading managed network, security and cloud services provider to business and residential customers in the United States. We provide a broad range of data, voice and managed network services to retail and wholesale business customers. We also provide nationwide Internet access and related value-added services to residential customers. We operate an extensive network including more than 29,000 route miles of fiber and 90 metro fiber rings that provide data and voice IP service coverage across more than 90 percent of the United States. We operate four reportable segments aligned around distinct customer categories: Enterprise/Mid-Market, Small Business, Carrier/Transport and Consumer. For further information concerning the Company’s reportable segments, see Note 18 to our Consolidated Financial Statements and see "Segment Results of Operations" later in this MD&A.
2016 Highlights
Key developments in our business during 2016 are described below:
|
|
|
|
•
|
Generated revenues of
$1.0 billion
in 2016, a
13%
decrease during the year primarily driven by declines in traditional voice and data products and the sale of our IT services business, as further discussed below. These declines were partially offset by targeted price increases, increased sales of our growth products, successful efforts to renew customers coming out of contract and our acquisition of Boston Retail Partners.
|
|
|
|
|
•
|
Reduced cost of revenues
12%
during 2016, primarily due to the decline in revenues noted above as well as a concentrated effort to manage cost of revenues through network grooming, auditing telecommunications vendor invoices and other cost saving initiatives.
|
|
|
|
|
•
|
Generated net income of
$7.7 million
in 2016, compared to a net loss of
$43.2 million
in the prior year, primarily due to a decrease in depreciation and amortization expense, a decrease in interest expense due to lower outstanding debt, a decrease in loss on extinguishment of debt due to fewer debt repurchases and a $9.1 million pretax gain recognized on our sale of businesses. Partially offsetting these declines was a decrease in Adjusted EBITDA as described below.
|
|
|
|
|
•
|
Generated Adjusted EBITDA (a non-GAAP measure, see “Non-GAAP Financial Measures” in this Item 7) of
$214.2 million
in 2016, a decrease from
$242.5 million
in the prior year, primarily due to the decrease in revenues from traditional voice and data products, offset by improvements in our cost of revenues and operating expenses. The decrease in cost of revenues and operating expenses was driven by cost savings initiatives, including reductions in workforce, implemented over the past year.
|
|
|
|
|
•
|
Made capital expenditures of
$84.1 million
in 2016, a
4%
reduction from the prior year, primarily due to improving our processes and being more efficient, as well as a decrease in customer additions.
|
|
|
|
|
•
|
Reduced gross outstanding debt by $73.6 million during 2016.
|
|
|
|
|
•
|
Made
$22.0 million
million of dividend payments to shareholders in 2016.
|
Windstream Merger Transaction
In November 2016, we entered into a definitive merger agreement with Windstream Holdings, Inc. (“Windstream”) under which EarthLink and Windstream will merge in an all-stock transaction valued at approximately $1.1 billion. Under the terms of the merger agreement, EarthLink’s stockholders will receive 0.818 shares of Windstream common stock for each EarthLink share owned. Upon closing of the transaction, Windstream stockholders will own approximately 51% and EarthLink stockholders will own approximately 49% of the combined company. The transaction was approved by the EarthLink and Windstream shareholders on February 24, 2017. The transaction remains subject to customary closing conditions and is expected to close in the first quarter of 2017.
Sale of IT Services Business
In February 2016, we sold certain assets related to our IT services product offerings in connection with our strategy to simplify our operations and provide more flexibility to invest in new capabilities and services to drive growth in our core business. The purchase price in the transaction was $29.6 million, subject to post-closing contingencies that could increase or decrease the purchase price by up to $5.0 million. We received $26.6 million of cash. The other $3.0 million of consideration was deposited into an escrow account to fund potential indemnification obligations. We recognized a pretax gain of $6.3 million and recorded a $2.0 million deferred gain for contingent consideration. The loss of revenues related to our IT services product offerings has contributed and will continue to contribute to our anticipated revenue declines in 2016.
Acquisition of Boston Retail Partners
In July 2016, we acquired Boston Retail Partners LLC (“BRP”), a privately-held management consulting firm focused on the retail industry, for initial consideration of approximately $11.2 million, plus possible earn-out payments which could increase the purchase price by up to $5.6 million. The primary purpose of the transaction was to provide additional professional services capabilities in connection with our strategy to be a leading managed network, security and cloud services provider for multi-location retail and service businesses. We believe the acquisition of BRP will provide a growth opportunity for us by enabling us to enhance our support of retailers in creating and implementing customized strategies using our professional services.
Credit Facility Refinancing and Partial Debt Redemption
In June 2016, we amended and restated our existing revolving credit facility, which reduced the capacity from $135.0 million to $125.0 million, provided for an up to $50.0 million delayed draw senior secured term loan and extended the term to June 2021 (except that if our 7.375% Senior Secured Notes due 2020 have not been repaid in full by February 2020, the term will be February 2020). In August 2016, we redeemed $90.0 million aggregate principal amount of our 8.875% Senior Notes due 2019 at a redemption price equal to 102.219% of the principal amount thereof, plus accrued and unpaid interest. We used approximately $34.0 million of existing cash, $50.0 million under our term loan and $10.0 million of our revolving credit facility to fund the redemption, call premium and accrued interest.
Business Strategy
Our business strategy is to be a leading managed network, security and cloud services provider for multi-location retail and service businesses. We believe there is a significant market opportunity for managed network, security and cloud services due to the changing technological and business landscape, which is experiencing increased demand for data, evolving security threats, a shift towards more software based solutions, increased use of outsourcing and tightening budgets. We are positioning our company to focus on this opportunity. The key elements of our business strategy and transformation are as follows:
|
|
|
|
•
|
Operate each of our business units with focused, value-optimizing strategies.
Our organization is aligned around four distinct business units, which are Enterprise/Mid-Market, Small Business, Carrier/Transport and Consumer. We believe this concentrates our resources and investments into areas that will drive growth and deliver improved performance, enable each business to compete more successfully in the market and provide strategic optionality. We are focused on operating each business unit with value-optimizing strategies, which are managing the decline in our Small Business and Consumer Services business units and investing the cash flow to grow our Enterprise/Mid-Market and Carrier/Transport business units.
|
|
|
|
|
•
|
Optimize our cost structure and cash flows.
We are focused on optimizing our cost structure and maximizing our cash flows. This includes managing our cost of revenues and operating expenses, streamlining our internal processes and aligning our workforce to current revenue trends. It also includes the repayment and/or refinancing of debt in order to
|
reduce our interest expense. We plan to use the cash flow generated from our improvement efforts to continue to optimize our balance sheet and invest in growth.
|
|
|
|
•
|
Invest in growth business products, marketing and sales.
Our growth business products are MultiProtocol Label Switching ("MPLS"), hosted voice and other UCaaS products, software-defined wide area network ("SD-WAN"), hybrid WAN and managed network, security and cloud services for multi-location businesses and transport services for other communications carriers and enterprises. We are focused on investing in product and service capabilities and sales and marketing initiatives to support these growth products.
|
|
|
|
|
•
|
Evaluate potential strategic transactions.
We believe that targeted acquisitions, when available at the right economics, can be an effective means for growth and targeted capability building. In addition, we continue to evaluate our business, which could lead us to discontinue or divest non-strategic products, assets or customers based on management's assessment of their strategic value to our business.
|
Challenges and Risks
The primary challenges we face in executing on our business strategy are growing revenues from our growth products and services; reducing churn in our existing customer base; responding to competition; aligning costs with trends in our revenues; and ensuring adequate resources to invest in growth. To address these challenges we are taking the following actions:
|
|
|
|
•
|
Targeting larger multi-location retail and service businesses which have lower churn profiles, as well as a need for our product and services
|
|
|
|
|
•
|
Investing in new products and service capabilities to create value for our customers, in particular our cloud-based offerings and SD-WAN
|
|
|
|
|
•
|
Focusing on customer contract re-term efforts, retention offers, targeted price increases and opportunities to upsell products and services
|
|
|
|
|
•
|
Improving the customer experience to increase customer satisfaction and further enhance customer retention
|
|
|
|
|
•
|
Continuing to refine and narrow our product portfolio
|
|
|
|
|
•
|
Implementing cost efficiencies, such as network grooming, workforce alignment and facility closings, and seeking to make costs more variable
|
|
|
|
|
•
|
Repaying and/or refinancing outstanding indebtedness in order to reduce interest expense
|
|
|
|
|
•
|
Considering further divestitures of non-strategic products, assets or customers in order to continue to simplify our operations and generate cash to reduce debt or to use for other strategic needs
|
|
|
|
|
•
|
Evaluating potential strategic transactions to add products and services
|
Trends in our Business
Our financial results are impacted by several significant trends, which are described below.
|
|
|
|
•
|
Industry factors
. The communications industry is characterized by intense competition, changing technology and changes in customer needs, an evolving regulatory environment and industry consolidation resulting in larger competitors and fewer suppliers. We expect these trends to continue. More recently, trends in the industry have included increased demand for data, evolving security threats, the adoption of cloud computing and the increased use of outsourcing. We are trying to capitalize on these changes by focusing on our managed network, security and cloud services and transport services.
|
|
|
|
|
•
|
Traditional business voice and data products
.
Our traditional business voice and data revenues have been declining due to competition, migration to more advanced integrated voice and data services and mandated rate reductions. We expect this trend to continue. We have also experienced an increase in churn for these products. However, we are focused on decelerating these declines through customer retention efforts, contract renewals, upselling products and services and offering new services.
|
|
|
|
|
•
|
Consumer access declines
. Our consumer access subscriber base and revenues have been declining and are expected to continue to decline due to the continued maturation of the market for Internet access, competition from cable, DSL and wireless providers and limited sales and marketing activities. In addition, we have implemented, and expect to continue to implement, targeted price increases, which could negatively impact our churn rates. In July 2016, we sold approximately 12,000 customer relationships to one of our network providers, which will also cause our consumer access subscriber base and revenues to decrease. However, we are focused on customer retention and, as a result, we expect the rate of churn to continue to generally decline as our customer base becomes longer tenured. In 2016, we also launched Hyperlink high-speed Internet service that offers service at faster speeds than traditional DSL.
|
|
|
|
|
•
|
Operating costs and expenses
. We have experienced declines in cost of revenues and operating expense due to various cost saving initiatives and lower sales of traditional voice and data products. We are focused on continuing to optimize our cost structure to offset pressures on revenue. However, we may not be able to continue to achieve the level of cost savings we have been experiencing and there will be decreasing opportunities for cost savings in the future.
|
|
|
|
|
•
|
Dispute settlements.
Due to the nature of our industry, we are regularly involved in disputes related to our billings to other carriers for access to our network and network access charges that we are assessed by other companies. The disputes often take significant time to resolve, and they may be resolved or require adjustment in future periods although they relate to costs and revenues in prior periods. We have experienced an increase in dispute settlements impacting revenues and cost of revenues over the past few years. However, this trend may not continue at the rate it has historically.
|
Consolidated Results of Operations
The following table presents statement of operations data for the years ended
December 31, 2014, 2015 and 2016
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
2014
|
|
2015
|
|
2016
|
|
|
(in thousands)
|
|
Revenues
|
$
|
1,176,895
|
|
|
$
|
1,097,252
|
|
|
$
|
959,874
|
|
|
Operating costs and expenses:
|
|
|
|
|
|
|
|
|
Cost of revenues (exclusive of depreciation and amortization shown separately below)
|
557,436
|
|
|
500,628
|
|
|
442,608
|
|
|
Selling, general and administrative (exclusive of of depreciation and amortization shown separately below)
|
419,019
|
|
|
368,763
|
|
|
319,231
|
|
|
Depreciation and amortization
|
186,872
|
|
|
188,315
|
|
|
135,248
|
|
|
Impairment of long-lived assets
|
14,334
|
|
|
—
|
|
|
—
|
|
|
Restructuring, acquisition and integration-related costs
|
20,088
|
|
|
19,320
|
|
|
17,807
|
|
|
Total operating costs and expenses
|
1,197,749
|
|
|
1,077,026
|
|
|
914,894
|
|
|
Income (loss) from operations
|
(20,854
|
)
|
|
20,226
|
|
|
44,980
|
|
|
Gain on sale of businesses
|
—
|
|
|
—
|
|
|
9,128
|
|
|
Interest expense and other, net
|
(56,261
|
)
|
|
(50,972
|
)
|
|
(40,660
|
)
|
|
Loss on extinguishment of debt
|
—
|
|
|
(9,734
|
)
|
|
(4,823
|
)
|
|
Income (loss) from continuing operations before income taxes
|
(77,115
|
)
|
|
(40,480
|
)
|
|
8,625
|
|
|
Income tax benefit (provision)
|
4,744
|
|
|
(2,730
|
)
|
|
(945
|
)
|
|
Income (loss) from continuing operations
|
(72,371
|
)
|
|
(43,210
|
)
|
|
7,680
|
|
|
Loss from discontinued operations, net of tax
|
(381
|
)
|
|
—
|
|
|
—
|
|
|
Net income (loss)
|
$
|
(72,752
|
)
|
|
$
|
(43,210
|
)
|
|
$
|
7,680
|
|
Revenues
We generate revenues by providing a broad range of data, voice and managed network services to business and residential customers.
Our revenues primarily consist of the following:
|
|
|
|
•
|
Monthly recurring charges for providing data, voice and managed network services; transmission capacity; and Internet access and related value-added services;
|
|
|
|
|
•
|
Equipment revenues; and
|
|
|
|
|
•
|
Non-recurring and other revenues, such as installation fees, termination fees and administrative fees.
|
The following table presents our revenues for the years ended
December 31, 2014, 2015 and 2016
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
2015 vs 2014
|
|
2016 vs 2015
|
|
|
2014
|
|
2015
|
|
2016
|
|
$ Change
|
|
% Change
|
|
$ Change
|
|
% Change
|
|
|
(dollars in thousands)
|
|
Monthly recurring revenues
|
$
|
1,021,931
|
|
|
$
|
970,731
|
|
|
$
|
841,989
|
|
|
$
|
(51,200
|
)
|
|
(5)%
|
|
$
|
(128,742
|
)
|
|
(13
|
)%
|
|
Usage revenues
|
124,266
|
|
|
99,227
|
|
|
82,513
|
|
|
(25,039
|
)
|
|
(20)%
|
|
(16,714
|
)
|
|
(17
|
)%
|
|
Equipment revenues
|
14,731
|
|
|
15,201
|
|
|
15,920
|
|
|
470
|
|
|
3%
|
|
719
|
|
|
5
|
%
|
|
Non-recurring and other revenues
|
15,967
|
|
|
12,093
|
|
|
19,452
|
|
|
(3,874
|
)
|
|
(24)%
|
|
7,359
|
|
|
61
|
%
|
|
Total revenues
|
$
|
1,176,895
|
|
|
$
|
1,097,252
|
|
|
$
|
959,874
|
|
|
$
|
(79,643
|
)
|
|
(7)%
|
|
$
|
(137,378
|
)
|
|
(13
|
)%
|
The following table presents the primary reasons for the change in revenues for the year ended December 31, 2016 compared to the prior year:
|
|
|
|
|
|
|
|
|
2016 vs 2015
|
|
|
(in millions)
|
|
Due to decrease in Small Business revenues (a)
|
$
|
(60.0
|
)
|
|
Due to decrease in IT services revenues (b)
|
(41.7
|
)
|
|
Due to decrease in Enterprise/Mid-Market revenues (c)
|
(24.0
|
)
|
|
Due to decrease in Consumer revenues (d)
|
(22.6
|
)
|
|
Due to increase in Carrier/Transport (e)
|
6.2
|
|
|
Due to increase in BRP revenues (f)
|
4.7
|
|
|
Total change in revenues
|
$
|
(137.4
|
)
|
______________
|
|
|
|
(a)
|
Decrease primarily due to decline in traditional voice and data products, including traditional voice, lower-end, single site broadband services and web hosting. Revenues for these voice and data products have been decreasing due to an increase in customer churn, competition and a deemphasis on certain traditional products. Partially offsetting the decline in revenues for our traditional voice and data products were efforts to protect our revenue base, such as targeted price increases and re-terms of customers coming out of contract.
|
|
|
|
|
(b)
|
Decrease in IT services revenues primarily due to the sale of certain assets related to our IT services product offerings on February 1, 2016. Also contributing to the decrease prior to the sale in February 2016 was the discontinuance of certain products that were low margin revenue streams or that were not consistent with our more focused business strategy.
|
|
|
|
|
(c)
|
Decrease primarily due to decline in traditional voice and data products due to an increase in customer churn, competition and a deemphasis on certain traditional products. Over the past year we deemphasized and discontinued certain products that were low margin revenue streams or that were not consistent with our more focused business strategy. Partially offsetting the decline in revenues for our traditional voice and data products were price increases implemented during the year and an increase in sales of growth products, including MPLS, hosted voice and managed network services due to an increased emphasis on selling these products and services.
|
|
|
|
|
(d)
|
Decrease primarily due to the continued maturation of the market for Internet access, competitive pressures in the industry and limited sales and marketing activities. Also contributing to the decrease was the sale of approximately 12,000 customer relationships to one of our network providers in July 2016. Partially offsetting theses decrease was the launch of our Hyperlink high-speed Internet service in 2016, which offers service at faster speeds than traditional DSL.
|
|
|
|
|
(e)
|
Increase primarily due to an increase in transport revenues as we capitalize on unique fiber routes. Also contributing to the increase was a change in settlements and disputes related to billings to other carriers, as we recognized net unfavorable settlements during the year ended December 31, 2015 and favorable settlements during the year ended December 31, 2016.
|
|
|
|
|
(f)
|
Increase due to the inclusion of revenues from our acquisition of BRP in July 2016. The revenues are included within non-recurring and other revenues in our Enterprise/Mid-Market segment.
|
The following table presents the primary reasons for the change in revenues for the year ended December 31, 2015 compared to the prior year:
|
|
|
|
|
|
|
|
|
2015 vs 2014
|
|
|
(in millions)
|
|
Due to decrease in traditional voice and data products (a)
|
$
|
(66.1
|
)
|
|
Due to decrease in Consumer revenues (b)
|
(26.6
|
)
|
|
Due to net favorable settlements and reserve adjustments (c)
|
(5.5
|
)
|
|
Due to increase in growth products (d)
|
18.6
|
|
|
Total change in revenues
|
$
|
(79.6
|
)
|
______________
|
|
|
|
(a)
|
Decrease due to decline in traditional voice and data products, including traditional voice, lower-end, single site broadband services, usage and web hosting. Revenues for these voice and data products have been decreasing due to competition, migration to more advanced integrated voice and data services, customer churn and continued rate reductions as a result of FCC rules regarding intercarrier compensation. In addition, during 2015 we deemphasized and discontinued certain products that were low margin revenue streams or that were not in line with our more focused business strategy. Partially offsetting the decline in revenues was price increases implemented during 2015.
|
|
|
|
|
(b)
|
Decrease primarily due to the continued maturation of the market for Internet access, competitive pressures in the industry and limited sales and marketing activities, partially offset by targeted price increases.
|
|
|
|
|
(c)
|
Decrease due to change in favorable settlements and reserve adjustments, primarily related to our billings to other carriers for access to our network, for which revenue had not been previously recognized.
|
|
|
|
|
(d)
|
Increase due to sales of growth products, including MPLS, hosted voice and managed network services due to an increased emphasis on selling these products and services.
|
Cost of revenues
Cost of revenues primarily consists of the cost of connecting customers to our networks via leased facilities; the costs of leasing components of our network facilities; costs paid to third-party providers for interconnect access and transport services; fees paid to suppliers of our value-added services; fees paid to content providers for information provided on our online properties; and the cost of equipment sold to customers.
The following table presents our cost of revenues for the years ended
December 31, 2014, 2015 and 2016
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
2015 vs 2014
|
|
2016 vs 2015
|
|
|
2014
|
|
2015
|
|
2016
|
|
$ Change
|
|
% Change
|
|
$ Change
|
|
% Change
|
|
|
(dollars in thousands)
|
|
Cost of revenues
|
$
|
557,436
|
|
|
$
|
500,628
|
|
|
$
|
442,608
|
|
|
$
|
(56,808
|
)
|
|
(10)%
|
|
$
|
(58,020
|
)
|
|
(12
|
)%
|
The following table presents the primary reasons for the changes in cost of revenues for the years ended
December 31, 2015 and 2016
compared to the prior years:
|
|
|
|
|
|
|
|
|
|
|
|
|
2015 vs 2014
|
|
2016 vs 2015
|
|
|
(in millions)
|
|
Due to decrease in interconnection expenses (a)
|
$
|
(34.4
|
)
|
|
$
|
(31.5
|
)
|
|
Due to decrease in network expenses (b)
|
(9.5
|
)
|
|
(8.6
|
)
|
|
Due to decrease in usage (c)
|
(11.1
|
)
|
|
(6.0
|
)
|
|
Due to sale of IT services business (d)
|
(1.1
|
)
|
|
(19.2
|
)
|
|
Due to change in non-recurring charges and other expenses (e)
|
(0.7
|
)
|
|
4.8
|
|
|
Due to increase in BRP cost of revenues (f)
|
—
|
|
|
2.5
|
|
|
Total change in business services cost of revenues
|
$
|
(56.8
|
)
|
|
$
|
(58.0
|
)
|
______________
|
|
|
|
(a)
|
Decrease due to decline in revenues and a concentrated effort to manage cost of revenues through auditing telecommunications vendor invoices and other cost saving initiatives and declines in traditional voice and data products. Partially offsetting these declines were increased sales of growth products.
|
|
|
|
|
(b)
|
Decrease due to a concentrated effort to manage cost of revenues through network grooming and other cost saving initiatives and declines in traditional voice and data products. Partially offsetting these declines were increased sales of growth products.
|
|
|
|
|
(c)
|
Decrease due to declines in traditional voice and data products and a decreased emphasis on selling certain lower margin products and services.
|
|
|
|
|
(d)
|
Decrease in IT services cost of revenues primarily due to the sale of certain assets related to our IT services product offerings on February 1, 2016. Also contributing to the decrease prior to the sale in February 2016 was the discontinuance of certain products that had low margins or that were not consistent with our more focused business strategy.
|
|
|
|
|
(e)
|
Increase primarily due to fewer favorable adjustments and settlements during the year ended December 31, 2016 compared to the year ended December 31, 2015.
|
|
|
|
|
(f)
|
Increase due to the inclusion of cost of revenues from our acquisition of BRP in July 2016.
|
Selling, general and administrative
Selling, general and administrative expenses consist of expenses related to sales and marketing, customer service, network operations, information technology, regulatory, billing and collections, corporate administration, and legal and accounting. Such costs include salaries and related employee costs (including stock-based compensation), outsourced labor, professional fees, property taxes, travel, insurance, occupancy costs, advertising and other administrative expenses.
The following table presents our selling, general and administrative expenses for the years ended
December 31, 2014, 2015 and 2016
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
2015 vs 2014
|
|
2016 vs 2015
|
|
|
2014
|
|
2015
|
|
2016
|
|
$ Change
|
|
% Change
|
|
$ Change
|
|
% Change
|
|
|
(dollars in thousands)
|
|
Selling, general and administrative expenses
|
$
|
419,019
|
|
|
$
|
368,763
|
|
|
$
|
319,231
|
|
|
$
|
(50,256
|
)
|
|
(12)%
|
|
$
|
(49,532
|
)
|
|
(13
|
)%
|
The following table presents the primary reasons for the changes in selling, general and administrative expenses for the years ended
December 31, 2015 and 2016
compared to the prior years:
|
|
|
|
|
|
|
|
|
|
|
|
|
2015 vs 2014
|
|
2016 vs 2015
|
|
|
(in millions)
|
|
Due to decrease in people costs (a)
|
$
|
(35.7
|
)
|
|
$
|
(39.6
|
)
|
|
Due to decrease in rent and occupancy costs (b)
|
(4.5
|
)
|
|
(3.5
|
)
|
|
Due to decrease in outside sales commissions (c)
|
(3.1
|
)
|
|
(1.7
|
)
|
|
Due to decrease in bad debt expense (d)
|
(2.5
|
)
|
|
(1.0
|
)
|
|
Due to decrease in loss contingencies (e)
|
(2.2
|
)
|
|
—
|
|
|
Due to decrease in other selling, general and administrative costs (f)
|
(2.3
|
)
|
|
(5.5
|
)
|
|
Due to increase in BRP selling, general and administrative (g)
|
—
|
|
|
1.8
|
|
|
Total change in selling, general and administrative expenses
|
$
|
(50.3
|
)
|
|
$
|
(49.5
|
)
|
______________
|
|
|
|
(a)
|
Decrease in people costs primarily due headcount declines, as full-time equivalents were 2,659, 2,138 and 1,890 as of December 31, 2014, 2015 and 2016, respectively. The decrease in 2015 was primarily due to reductions in workforce driven by changes in our business strategy, including a reduction in workforce implemented during the fourth quarter of 2014 that eliminated approximately 450 positions. The decrease in 2016 was primarily due to reductions in workforce driven by additional changes in our business strategy and the transfer of employees in connection with the sale of IT services business on February 1, 2016.
|
|
|
|
|
(b)
|
Decrease in rent and occupancy costs primarily due to cost savings from the closing of several sales offices and other properties over the past two years in connection with changes to our business strategy and from moving our corporate headquarters location in September 2014.
|
|
|
|
|
(c)
|
Decrease in outside sales commissions primarily due to lower sales volume.
|
|
|
|
|
(d)
|
Decrease in bad debt expense due to more effective collection efforts and the overall decrease in revenues.
|
|
|
|
|
(e)
|
Decrease in loss contingencies due to $2.2 million of reserves recorded during year ended December 31, 2014, which was settled and paid during the year ended December 31, 2015.
|
|
|
|
|
(f)
|
Decrease in other selling, general and administrative costs such as advertising and marketing, outsourced labor, professional fees, payment processing, travel and insurance due to increased focus on optimizing our cost structure.
|
|
|
|
|
(g)
|
Increase due to the inclusion of selling, general and administrative expenses from our acquisition of BRP beginning in July 2016.
|
Depreciation and amortization
Depreciation and amortization includes depreciation of property and equipment and amortization of definite-lived intangible assets acquired in purchases of businesses and purchases of customer bases from other companies.
The following table presents our depreciation and amortization expense for the years ended
December 31, 2014, 2015 and 2016
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
2015 vs 2014
|
|
2016 vs 2015
|
|
|
2014
|
|
2015
|
|
2016
|
|
$ Change
|
|
% Change
|
|
$ Change
|
|
% Change
|
|
|
(dollars in thousands)
|
|
Depreciation expense
|
$
|
123,695
|
|
|
$
|
122,151
|
|
|
$
|
112,424
|
|
|
$
|
(1,544
|
)
|
|
(1)%
|
|
$
|
(9,727
|
)
|
|
(8)%
|
|
Amortization expense
|
63,177
|
|
|
66,164
|
|
|
22,824
|
|
|
2,987
|
|
|
5%
|
|
(43,340
|
)
|
|
(66)%
|
|
Total depreciation and amortization
|
$
|
186,872
|
|
|
$
|
188,315
|
|
|
$
|
135,248
|
|
|
$
|
1,443
|
|
|
1%
|
|
$
|
(53,067
|
)
|
|
(28)%
|
The decrease in depreciation expense during the year ended December 31, 2015 compared to the prior year was primarily due to a decrease in capital expenditures and assets becoming fully depreciated over the past year, offset by accelerated depreciation on retirements of property and equipment. The increase in amortization expense during the year ended December 31, 2015 compared to the prior year was primarily due to the shortening of useful lives for certain customer base intangible assets, which increased amortization expense by $5.7 million during the year ended December 31, 2015, partially offset by definite-lived intangible assets becoming fully amortized over the year.
The decrease in depreciation expense during the year ended December 31, 2016 compared to the prior year was primarily due to a decrease in capital expenditures, the sale of property and equipment related to our IT services business on February 1, 2016 and assets becoming fully amortized over the year. The decrease in amortization expense during the year ended December 31, 2016 compared to the prior year was primarily due to definite-lived intangible assets becoming fully amortized over the year and the sale of customer relationships and developed technology related to our IT services business on February 1, 2016, partially offset by amortization expense resulting from the definite-lived intangible assets obtained in our acquisition of BRP on July 13, 2016.
Impairment of long-lived assets
During the year ended December 31, 2014, we recorded $14.3 million for impairment of long-lived assets, consisting of impairment of work in progress for information technology projects not expected to be used, impairment of software licenses not expected to be used and impairment of certain assets held for sale. The impairments were classified within impairment of long-lived assets in the Consolidated Statement of Comprehensive Loss for the year ended December 31, 2014. We did not record any impairment of long-lived during the years ended December 31, 2015 or 2016.
Restructuring, acquisition and integration-related costs
Restructuring, acquisition and integration-related costs consist of costs related to our restructuring, acquisition and integration-related activities. Restructuring, acquisition and integration-related costs are expensed in the period in which the costs are incurred and the services are received and are included in restructuring, acquisition and integration-related costs in the Consolidated Statements of Comprehensive Income (Loss). We plan to continue to evaluate our business, which may result in additional restructuring activities. For more information regarding our restructuring, acquisition and integration-related costs, refer to Note 13 to our Consolidated Financial Statements. Such costs include the following:
|
|
|
|
•
|
Integration-related costs, such as system conversion and integration-related consulting and employee costs. We are also undertaking a long-term network optimization project designed to consolidate traffic onto network facilities operated by us and reduce the usage of other carriers’ networks. Integration-related costs associated with this initiative include costs to migrate traffic to lower cost circuits and to terminate existing contracts prior to their expiration;
|
|
|
|
|
•
|
Severance, retention and other employee termination costs associated with acquisition and integration activities and with certain voluntary employee separations; and
|
|
|
|
|
•
|
Facility-related costs, such as lease termination and asset impairments; and
|
|
|
|
|
•
|
Transaction-related costs, which are direct costs incurred to effect a business combination, such as advisory, legal, accounting, valuation and other professional fees.
|
The following table presents our restructuring, acquisition and integration-related costs for the years ended
December 31, 2014, 2015 and 2016
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
2015 vs 2014
|
|
2016 vs 2015
|
|
|
2014
|
|
2015
|
|
2016
|
|
$ Change
|
|
% Change
|
|
$ Change
|
|
% Change
|
|
|
(dollars in thousands)
|
|
Integration-related costs
|
$
|
9,043
|
|
|
$
|
5,924
|
|
|
$
|
8,135
|
|
|
$
|
(3,119
|
)
|
|
(34)%
|
|
$
|
2,211
|
|
|
37
|
%
|
|
Severance, retention and other employee costs
|
9,297
|
|
|
9,798
|
|
|
3,753
|
|
|
501
|
|
|
5%
|
|
(6,045
|
)
|
|
(62
|
)%
|
|
Facility-related costs
|
1,744
|
|
|
3,598
|
|
|
669
|
|
|
1,854
|
|
|
106%
|
|
(2,929
|
)
|
|
(81
|
)%
|
|
Transaction-related costs
|
4
|
|
|
—
|
|
|
5,250
|
|
|
(4
|
)
|
|
(100)%
|
|
5,250
|
|
|
100
|
%
|
|
Restructuring, acquisition and integration-related costs
|
$
|
20,088
|
|
|
$
|
19,320
|
|
|
$
|
17,807
|
|
|
$
|
(768
|
)
|
|
(4)%
|
|
$
|
(1,513
|
)
|
|
(8
|
)%
|
The decrease in restructuring, acquisition and integration-related costs during the year ended December 31, 2015 compared to the prior year was primarily due to the following:
|
|
|
|
•
|
the completion of integration projects during the year;
|
|
|
|
|
•
|
partially offset by an increase is restructuring costs. During the year ended December 31, 2015, we recorded $13.4 million of restructuring costs in connection with changes in our business strategy, consisting of $9.8 million of severance and other employee costs due to reductions in workforce and $3.6 million of facilities-related costs due to the closing of certain sales offices.
|
The increase in restructuring, acquisition and integration-related costs during the year ended December 31, 2016 compared to the prior year was primarily due to the following:
|
|
|
|
•
|
transaction-related costs incurred in connection with our pending merger with Windstream;
|
|
|
|
|
•
|
an increase in integration-related costs related to our network optimization projects;
|
|
|
|
|
•
|
partially offset by a decrease is restructuring costs. During the year ended December 31, 2016, we recored $4.4 million of restructuring costs in connection with changes in our business strategy, consisting of $3.7 million of severance and other employee costs due to reductions in workforce and $0.7 million of facilities-related costs due to the closing of certain sales offices.
|
Interest expense and other, net
Interest expense and other, net, is primarily comprised of interest expense incurred on our debt and capital leases, amortization of debt issuance costs and debt discounts and other miscellaneous income and expense items.
The following table presents our interest expense and other, net, for the years ended
December 31, 2014, 2015 and 2016
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
2015 vs 2014
|
|
2016 vs 2015
|
|
|
2014
|
|
2015
|
|
2016
|
|
$ Change
|
|
% Change
|
|
$ Change
|
|
% Change
|
|
|
(dollars in thousands)
|
|
Interest expense
|
$
|
56,382
|
|
|
$
|
49,979
|
|
|
$
|
40,711
|
|
|
$
|
(6,403
|
)
|
|
(11)%
|
|
$
|
(9,268
|
)
|
|
(19
|
)%
|
|
Other, net
|
(121
|
)
|
|
993
|
|
|
(51
|
)
|
|
1,114
|
|
|
*
|
|
(1,044
|
)
|
|
(105
|
)%
|
|
Total interest expense and other, net
|
$
|
56,261
|
|
|
$
|
50,972
|
|
|
$
|
40,660
|
|
|
$
|
(5,289
|
)
|
|
(9)%
|
|
$
|
(10,312
|
)
|
|
(20
|
)%
|
________
* Percentage is not meaningful
The decrease in interest expense and other, net, during the year ended December 31, 2015 compared to the prior year was primarily due to lower outstanding debt resulting from redemptions and repurchases during the year. As of December 31, 2014 and 2015, we had $600.0 million and $508.9 million, respectively, of gross amount of debt outstanding (excluding capital leases). For more information about our debt transactions, refer to Note 9 to our Consolidated Financial Statements.
The decrease in interest expense and other, net, during the year ended December 31, 2016 compared to the prior year was primarily due to lower outstanding debt resulting from redemptions and repurchases during the year. As of December 31, 2015 and 2016, we had $508.9 million and $435.3 million, respectively, of gross amount of debt outstanding (excluding capital leases). For more information about our debt transactions, refer to Note 9 to our Consolidated Financial Statements.
Loss on extinguishment of debt
During the years ended December 31, 2015 and 2016, we redeemed and repurchased $126.1 million and $97.4 million, respectively, outstanding principal of our 8.875% Senior Notes due 2019 and recorded $9.7 million and
$4.8 million
, respectively, for losses on extinguishment of debt. The losses consisted of premiums paid on our repurchases and redemptions, the write-off of unamortized discount on debt and the write-off of unamortized debt issuance costs. No loss on extinguishment of debt was recorded during the year ended December 31, 2014. For more information about our debt transactions, refer to Note 9 to our Consolidated Financial Statements.
Income tax
benefit
(provision)
The following table presents the components of our income tax
benefit
(provision) for the years ended
December 31, 2014, 2015 and 2016
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
2014
|
|
2015
|
|
2016
|
|
|
(in thousands)
|
|
Current benefit (provision)
|
$
|
5,335
|
|
|
$
|
(2,053
|
)
|
|
$
|
(375
|
)
|
|
Deferred provision
|
(591
|
)
|
|
(677
|
)
|
|
(570
|
)
|
|
Total income tax benefit (provision)
|
$
|
4,744
|
|
|
$
|
(2,730
|
)
|
|
$
|
(945
|
)
|
During the year ended December 31, 2014, the current tax benefit was primarily related to the release of uncertain tax positions related to prior years, partially offset by expense for Canadian tax amounts payable, current year state taxes and penalties and interest related to uncertain tax positions. The non-cash deferred tax expense was due primarily to the amortization of deferred tax liabilities with indefinite useful lives. During the year ended December 31, 2015, the current tax provision was primarily related to the recording of an uncertain tax position, including applicable interest, related to certain tax positions that the Company has taken during prior years, expense for Canadian tax amounts payable and current year state taxes. The non-cash deferred tax expense for the year ended December 31, 2015 was due primarily to the amortization of deferred tax liabilities with indefinite useful lives. During the year ended December 31, 2016, the current tax provision was primarily related to state taxes. The non-cash deferred tax expense for the year ended December 31, 2016 was due primarily to the amortization of deferred tax liabilities with indefinite useful lives.
We assess the realization of the deferred tax assets each reporting period. To the extent that our financial results improve and the deferred tax assets becomes realizable, we will reduce the valuation allowance through earnings. For more information about our income taxes, refer to Note 14 to our Consolidated Financial Statements.
Loss from discontinued operations, net of tax
The operating results of the our telecom systems business acquired as part of ITC^DeltaCom have been separately presented as discontinued operations for all periods presented. On August 2, 2013, we sold our telecom systems business. We have no significant continuing involvement in the operations or significant continuing direct cash flows. The telecom systems results of operations were previously included in our legacy Business Services segment.
Segment Results of Operations
Our reportable segments are strategic business units aligned around distinct customer categories to optimize operations. We believe this structure allows for better management accountability and decision making while providing greater visibility to our Chief Operating Decision Maker. We operate the following four reportable segments:
|
|
|
|
•
|
Enterprise/Mid-Market
. Our Enterprise/Mid-Market segment provides a broad range of data, voice and managed network services to distributed multi-site business customers.
|
|
|
|
|
•
|
Small Business
. Our Small Business segment provides a broad range of data, voice and managed network services to small, often single-site business customers.
|
|
|
|
|
•
|
Carrier/Transport
. Our Carrier/Transport segment provides transmission capacity and other data, voice and managed network services to telecommunications carriers and large enterprises.
|
|
|
|
|
•
|
Consumer
. Our Consumer segment provides nationwide Internet access and related value-added services to residential customers.
|
We evaluate performance of our segments based on segment gross margin. Segment gross margin includes revenues from external customers and related cost of revenues. Costs excluded from segment gross margin include selling, general and administrative expenses, depreciation and amortization, impairment of goodwill and intangible assets, restructuring, acquisition and integration-related costs, and stock-based compensation expense, as they are not considered in the measurement of segment performance. Management continues to evaluate the segmentation of customers within the distinct customer categories, which may result in changes to segment information in the future.
Prior to 2015, we operated two reportable segments, Business Services and Consumer Services. Our Business Services segment provided a broad range of data, voice and managed network services to retail and wholesale business customers. Our Consumer
Services segment provided nationwide Internet access and related value-added services to residential customers. During 2015, we implemented certain organizational, operational and reporting changes that resulted in the disaggregation of our Business Services segment into three separate reportable segments: Enterprise/Mid-Market, Small Business and Carrier/Transport. Our Consumer Services segment was not impacted.
We began recording revenue and cost of revenue transactions in our new segment structure during 2015. Management determined that it was impracticable to restate financial information prior to 2015 to conform to the new reportable segment structure due to the level of effort required to segment customers that terminated service prior to 2015 and identify the related cost of revenue associated with those customers, as this information was not available. The following discussion contains 2015 and 2016 segment operating results under the new segment reporting structure and for comparability purposes, contains 2014, 2015 and 2016 segment operating results under the previous segment reporting structure. For more information regarding our segment reporting, refer to Note 18 to our Consolidated Financial Statements.
Enterprise/Mid-Market Segment Results
The following table sets forth operating results for our Enterprise/Mid-Market segment for the years ended December 31, 2015 and 2016:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
Change
|
|
|
2015
|
|
2016
|
|
Dollars
|
|
Percent
|
|
|
(dollars in thousands)
|
|
Revenues
|
$
|
444,968
|
|
|
$
|
397,676
|
|
|
$
|
(47,292
|
)
|
|
(11)%
|
|
Cost of revenues
|
221,347
|
|
|
203,928
|
|
|
(17,419
|
)
|
|
(8)%
|
|
Gross margin
|
$
|
223,621
|
|
|
$
|
193,748
|
|
|
$
|
(29,873
|
)
|
|
(13)%
|
The decrease in Enterprise/Mid-Market revenues during the year ended December 31, 2016 compared to the prior year was primarily due to the following:
|
|
|
|
•
|
Decrease of $28.0 million in IT services revenues during the year ended December 31, 2016 compared to the prior year primarily due to the sale of certain assets related to our IT services product offerings on February 1, 2016, as well as the discontinuance of certain products that had low margins or that were not consistent with our more focused business strategy.
|
|
|
|
|
•
|
Decrease in traditional voice and data products. Revenues for traditional voice and data products have been decreasing due to an increase in customer churn, competition and a deemphasis on certain traditional products.
|
|
|
|
|
•
|
Partially offset by targeted price increases implemented during the year ended December 31, 2016 and increased sales of our growth products, including MPLS, hosted voice and managed network services.
|
|
|
|
|
•
|
Partially offset by an increase of $4.7 million during the year ended December 31, 2016 for the inclusion of revenues from our acquisition of BRP in July 2016.
|
The decrease in Enterprise/Mid-Market cost of revenues during the year ended December 31, 2016 compared to the prior year was primarily due to the decline in revenues noted above related to IT services and traditional voice and data products, as well as successful efforts to manage cost of revenues through network grooming, auditing telecommunications vendor invoices and other cost saving initiatives. This was partially offset by an increase due to the inclusion of cost of revenues from our acquisition of BRP in July 2016.
Small Business Segment Results
The following table sets forth operating results for our Small Business segment for the years ended December 31, 2015 and 2016:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
Change
|
|
|
2015
|
|
2016
|
|
Dollars
|
|
Percent
|
|
|
(dollars in thousands)
|
|
Revenues
|
$
|
297,039
|
|
|
$
|
223,776
|
|
|
$
|
(73,263
|
)
|
|
(25)%
|
|
Cost of revenues
|
139,440
|
|
|
107,662
|
|
|
(31,778
|
)
|
|
(23)%
|
|
Gross margin
|
$
|
157,599
|
|
|
$
|
116,114
|
|
|
$
|
(41,485
|
)
|
|
(26)%
|
The decrease in Small Business revenues during the year ended December 31, 2016 compared to the prior year was primarily due to the following:
|
|
|
|
•
|
Decrease in traditional voice and data products. Revenues for traditional voice and data products have been decreasing due to an increase in customer churn, competition and a deemphasis on certain traditional products.
|
|
|
|
|
•
|
Decrease of $13.6 million in IT services revenues during the year ended December 31, 2016 compared to the prior year primarily due to the sale of certain assets related to our IT services product offerings on February 1, 2016, as well as the discontinuance of certain products that had low margins or that were not consistent with our more focused business strategy.
|
|
|
|
|
•
|
Partially offset by efforts to protect our revenue base, such as targeted price increases and re-terms of customers coming out of contract.
|
The decrease in Small Business cost of revenues during the year ended December 31, 2016 compared to the prior year was primarily due to the decline in revenues noted above as well as successful efforts to manage cost of revenues through network grooming, auditing telecommunications vendor invoices and other cost saving initiatives.
Carrier/Transport Segment Results
The following table sets forth operating results for our Carrier/Transport segment for the years ended December 31, 2015 and 2016:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
Change
|
|
|
2015
|
|
2016
|
|
Dollars
|
|
Percent
|
|
|
(dollars in thousands)
|
|
Revenues
|
$
|
135,905
|
|
|
$
|
141,709
|
|
|
$
|
5,804
|
|
|
4%
|
|
Cost of revenues
|
61,979
|
|
|
63,158
|
|
|
1,179
|
|
|
2%
|
|
Gross margin
|
$
|
73,926
|
|
|
$
|
78,551
|
|
|
$
|
4,625
|
|
|
6%
|
The increase in Carrier/Transport revenues during the the year ended December 31, 2016 compared to the prior year was primarily due to an increase in transport revenues as we capitalize on unique fiber routes. Also contributing to the increase was a change in settlements and disputes related to billings to other carriers, as we recognized net unfavorable settlements during the year ended December 31, 2015 and favorable settlements during the year ended December 31, 2016. Partially offsetting the increase was a decrease in legacy products and services.
The increase in Carrier/Transport cost of revenues during the the year ended December 31, 2016 compared to the prior year was primarily due to an increase in usage volume and the increase in transport revenues.
Legacy Business Services Segment Results
The following table presents operating results for our legacy Business Services segment for the years ended
December 31, 2014, 2015 and 2016
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
2015 vs 2014
|
|
2016 vs 2015
|
|
|
2014
|
|
2015
|
|
2016
|
|
$ Change
|
|
% Change
|
|
$ Change
|
|
% Change
|
|
|
(dollars in thousands)
|
|
Revenues
|
$
|
930,931
|
|
|
$
|
877,912
|
|
|
$
|
763,161
|
|
|
$
|
(53,019
|
)
|
|
(6)%
|
|
$
|
(114,751
|
)
|
|
(13
|
)%
|
|
Cost of revenues
|
469,523
|
|
|
422,766
|
|
|
374,748
|
|
|
(46,757
|
)
|
|
(10)%
|
|
(48,018
|
)
|
|
(11
|
)%
|
|
Gross margin
|
$
|
461,408
|
|
|
$
|
455,146
|
|
|
$
|
388,413
|
|
|
$
|
(6,262
|
)
|
|
(1)%
|
|
$
|
(66,733
|
)
|
|
(15
|
)%
|
The decrease in Business Services revenues during the year ended December 31, 2015 compared to the prior year was primarily due to the following:
|
|
|
|
•
|
Decrease in traditional voice and data products. Revenues for traditional voice and data products have been decreasing due to an increase in customer churn, competition and a deemphasis on certain traditional products.
|
|
|
|
|
•
|
Partially offset by targeted price increases and increased sales of our growth products, including MPLS, hosted voice and managed network services.
|
The decrease in Business Services revenues during the year ended December 31, 2016 compared to the prior year was primarily due to the following:
|
|
|
|
•
|
Decrease in traditional voice and data products. Revenues for traditional voice and data products have been decreasing due to an increase in customer churn, competition and a deemphasis on certain traditional products.
|
|
|
|
|
•
|
Decrease of $41.7 million in IT services revenues due to the sale of certain assets related to our IT services product offerings on February 1, 2016, as well as the discontinuance of certain products that had low margins or that were not consistent with our more focused business strategy.
|
|
|
|
|
•
|
Partially offset by targeted price increases and increased sales of our growth products, including MPLS, hosted voice and managed network services.
|
|
|
|
|
•
|
Partially offset by the inclusion of $4.7 million of revenues from our acquisition of BRP in July 2016.
|
The decreases in Business Services cost of revenues during the years ended December 31, 2015 and 2016 compared to the prior years were primarily due to the declines in revenues noted above as well as successful efforts to manage cost of revenues through network grooming, auditing telecommunications vendor invoices and other cost saving initiatives. Partially offsetting the decrease during the year ended December 31, 2016 was the inclusion of cost of revenues from our acquisition of BRP beginning in July 2016.
Consumer Segment Results
Consumer Operating Results
The following table presents operating results for our Consumer segment for the years ended
December 31, 2014, 2015 and 2016
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
2015 vs 2014
|
|
2016 vs 2015
|
|
|
2014
|
|
2015
|
|
2016
|
|
$ Change
|
|
% Change
|
|
$ Change
|
|
% Change
|
|
|
(dollars in thousands)
|
|
Revenues
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Access services
|
$
|
202,008
|
|
|
$
|
173,389
|
|
|
$
|
151,909
|
|
|
$
|
(28,619
|
)
|
|
(14)%
|
|
$
|
(21,480
|
)
|
|
(12
|
)%
|
|
Value-added services
|
43,956
|
|
|
45,951
|
|
|
44,804
|
|
|
1,995
|
|
|
5%
|
|
(1,147
|
)
|
|
(2
|
)%
|
|
Total revenues
|
245,964
|
|
|
219,340
|
|
|
196,713
|
|
|
(26,624
|
)
|
|
(11)%
|
|
(22,627
|
)
|
|
(10
|
)%
|
|
Cost of revenues
|
87,913
|
|
|
77,862
|
|
|
67,860
|
|
|
(10,051
|
)
|
|
(11)%
|
|
(10,002
|
)
|
|
(13
|
)%
|
|
Gross margin
|
$
|
158,051
|
|
|
$
|
141,478
|
|
|
$
|
128,853
|
|
|
$
|
(16,573
|
)
|
|
(10)%
|
|
$
|
(12,625
|
)
|
|
(9
|
)%
|
We classify our Consumer segment revenue in two categories: (1) access services, which includes dial-up and high-speed Internet access services; and (2) value-added services, which includes revenues from ancillary services sold as add-on features to our Internet access services, such as security products, premium email, home networking and email storage; search revenues; and advertising revenues.
Consumer revenues decreased during the years ended December 31, 2015 and 2016 compared to the prior years primarily due to the following:
|
|
|
|
•
|
Decreases in average consumer access subscribers, which were
0.9 million
,
0.8 million
and
0.7 million
during the years ended
December 31, 2014, 2015 and 2016
, respectively. The decreases resulted from limited sales and marketing activities, the continued maturation of the market for Internet access and competitive pressures in the industry. However, as we continue to focus on the retention of customers, our monthly consumer subscriber churn rates were
2.1%
,
1.9%
and
1.6%
during the years ended
December 31, 2014, 2015 and 2016
, respectively, which moderated the decline in average consumer subscribers. During 2016, we also launched Hyperlink high speed Internet service that offers service at faster speeds than traditional DSL, which offset some of the decline.
|
|
|
|
|
•
|
Partially offset by increases in our average revenue per subscriber, which were
$22.89
,
$23.57
and
$23.92
during the years ended
December 31, 2014, 2015 and 2016
, respectively. The increases were due to targeted price increases and a change in mix of subscribers to those with hight price points, including subscribers for our recently launched Hyperlink service.
|
Consumer cost of revenues decreased during the years ended December 31, 2015 and 2016 compared to the prior years primarily due to the following:
|
|
|
|
•
|
The decreases in average consumer subscribers noted above.
|
|
|
|
|
•
|
Partially offset by increases in our average cost per subscriber. This was due to a shift in the mix to customers with higher costs associated with delivering services and higher unit costs as our agreements with certain service providers generally have volume based tiered pricing which is leading to higher unit costs as our subscriber base decreases.
|
Consumer Operating Metrics
The following table presents subscriber and operating data for our Consumer segment for the years ended
December 31, 2014, 2015 and 2016
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
2014
|
|
2015
|
|
2016
|
|
Consumer Subscriber Activity
|
|
|
|
|
|
|
|
Subscribers at beginning of year
|
976,000
|
|
|
821,000
|
|
|
729,000
|
|
|
Gross organic subscriber additions
|
75,000
|
|
|
62,000
|
|
|
57,000
|
|
|
Adjustment (a)
|
—
|
|
|
19,000
|
|
|
6,000
|
|
|
Sale of subscribers (b)
|
—
|
|
|
—
|
|
|
(12,000
|
)
|
|
Churn
|
(230,000
|
)
|
|
(173,000
|
)
|
|
(132,000
|
)
|
|
Subscribers at end of year (c)
|
821,000
|
|
|
729,000
|
|
|
648,000
|
|
|
|
|
|
|
|
|
|
Consumer Metrics
|
|
|
|
|
|
|
|
Average dial-up subscribers (d)
|
511,000
|
|
|
466,000
|
|
|
430,000
|
|
|
Average high-speed subscribers (d)
|
385,000
|
|
|
307,000
|
|
|
255,000
|
|
|
Average consumer subscribers (d)
|
896,000
|
|
|
773,000
|
|
|
685,000
|
|
|
|
|
|
|
|
|
|
ARPU (e)
|
$
|
22.89
|
|
|
$
|
23.57
|
|
|
$
|
23.92
|
|
|
Churn rate (f)
|
2.1
|
%
|
|
1.9
|
%
|
|
1.6
|
%
|
(a) During the years ended December 31, 2015 and 2016, we began reporting approximately 19,000 and 6,000 subscribers, respectively, in our paying subscriber count as a result of price increases implemented during the period. These subscribers were previously counted as non-paying subscribers because their monthly fee was below a certain threshold.
(b) During the year ended December 31, 2016, we sold approximately 12,000 customer relationships to one of our network providers.
(c) Subscriber counts do not include new non-paying customers. Customers receiving service under promotional programs that include periods of free service at inception are not included in subscriber counts until they become paying customers.
(d) Average subscribers is calculated by averaging the ending monthly subscribers or accounts for the
thirteen
months preceding and including the end of the year.
(e) ARPU represents the average monthly revenue per user (subscriber). ARPU is computed by dividing average monthly revenue for the period by the average number of subscribers for the period. Average monthly revenue used to calculate ARPU includes recurring service revenue as well as nonrecurring revenues associated with equipment and other one-time charges associated with initiating or discontinuing services.
(f) Churn rate is used to measure the rate at which subscribers discontinue service on a voluntary or involuntary basis. Churn rate is computed by dividing the average monthly number of subscribers that discontinued service during the period by the average subscribers for the period.
Liquidity and Capital Resources
The following table presents summarized cash flow data for the years ended
December 31, 2014, 2015 and 2016
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
2015 vs 2014
|
|
2016 vs 2015
|
|
|
2014
|
|
2015
|
|
2016
|
|
$ Change
|
|
% Change
|
|
$ Change
|
|
% Change
|
|
|
(dollars in thousands)
|
|
Net cash provided by operating activities
|
$
|
139,995
|
|
|
$
|
167,448
|
|
|
$
|
125,965
|
|
|
$
|
27,453
|
|
|
20%
|
|
$
|
(41,483
|
)
|
|
(25)%
|
|
Net cash used in investing activities
|
(102,777
|
)
|
|
(87,468
|
)
|
|
(64,003
|
)
|
|
15,309
|
|
|
15%
|
|
23,465
|
|
|
27%
|
|
Net cash used in financing activities
|
(19,721
|
)
|
|
(122,817
|
)
|
|
(101,729
|
)
|
|
(103,096
|
)
|
|
*
|
|
21,088
|
|
|
17%
|
|
Net increase (decrease) in cash and cash equivalents
|
$
|
17,497
|
|
|
$
|
(42,837
|
)
|
|
$
|
(39,767
|
)
|
|
$
|
(60,334
|
)
|
|
*
|
|
$
|
(3,070
|
)
|
|
(7)%
|
________
* Percentage is not meaningful
Operating activities
The increase in cash provided by operating activities during the year ended December 31, 2015 compared to the prior year was primarily due to lower operating costs and expenses and lower interest payments during the year ended December 31, 2015 compared to the prior year due to operating efficiencies and cost savings initiatives and lower outstanding debt, offset by lower revenues.The decrease in cash provided by operating activities during the year ended December 31, 2016 compared to the prior year was primarily due to lower revenue, partially offset by decreases in operating expense and interest payments during the year ended December 31, 2016 compared to the prior year.
Investing activities
The decrease in net cash used in investing activities during the year ended December 31, 2015 compared to the prior year was primarily due to a $15.4 million decrease in capital expenditures. The decrease was primarily driven by an increased focus on managing our cash flows by improving our processes and being more efficient, more scrutiny of capital projects, a decrease in customer additions and timing of certain projects. Capital expenditures for the year ended December 31, 2015 primarily related to enhancing our network and technology infrastructure and the acquisition of new customers.
The decrease in net cash used in investing activities during the year ended December 31, 2016 compared to the prior year was primarily due to the following:
|
|
|
|
•
|
$26.6 million of cash received from the sale of our IT services business.
|
|
|
|
|
•
|
$3.8 million of cash received from the sale of certain Consumer customer relationships.
|
|
|
|
|
•
|
a $3.4 million decrease in capital expenditures. Capital expenditures for the year ended December 31, 2016 primarily related to enhancing our network and technology infrastructure and the acquisition of new customers.
|
|
|
|
|
•
|
partially offset by $10.4 million net cash used for our acquisition of BRP.
|
Financing activities
The increase in net cash used in financing activities during the year ended December 31, 2015 compared to the prior year was primarily due to the following:
|
|
|
|
•
|
$131.3 million used for the redemption and repurchase of $126.1 million outstanding principal of our Senior Notes during the year ended December 31, 2015. For more information about these transactions, refer to Note 9 to our Consolidated Financial Statements.
|
|
|
|
|
•
|
a $10.4 million increase in dividends paid due to the timing of the funding of our quarterly dividend payment. During the the years ended December 31, 2014 and 2015, we declared cash dividends of $0.20 per share. However, we funded three quarterly payments during the year ended December 31, 2014 compared to five quarterly payments during the year ended December 31, 2015.
|
|
|
|
|
•
|
partially offset by $35.0 million drawn down under our senior secured revolving credit facility, net of repayments.
|
|
|
|
|
•
|
partially offset by a $2.2 million decrease in repurchases of common stock and $1.7 million of proceeds received for stock option exercises during the year ended December 31, 2015.
|
The decrease in net cash used in financing activities during the year ended December 31, 2016 compared to the prior year was primarily due the following:
|
|
|
|
•
|
a $31.9 million decrease in repayment of our Senior Notes. During the year ended December 31, 2015, we used $131.3 million to repurchase and redeem our Senior Notes and during the year ended December 31, 2016, we used $99.4 million to repurchase and redeem our Senior Notes. For more information about our debt transactions, refer to Note 9 to our Consolidated Financial Statements.
|
|
|
|
|
•
|
$48.7 million of proceeds (less quarterly principal payments) received from our term loan.
|
|
|
|
|
•
|
a $4.4 million decrease in dividends paid primarily due to the timing of the funding of our quarterly dividend payment. During the years ended December 31, 2015 and 2016, we declared cash dividends of $0.20 per share; however, we funded five quarterly payments during the year ended December 31, 2015 compared to four payments during the year ended December 31, 2016.
|
|
|
|
|
•
|
partially offset by a change in senior secured revolving credit facility proceeds. During the year ended December 31, 2015, we drew $35.0 million under our senior secured revolving credit facility, net of repayments, and during the year ended December 31, 2016, we paid $25.0 million under our senior secured revolving credit facility, net of draw downs.
|
|
|
|
|
•
|
partially offset by a $1.5 million decrease in proceeds received for stock option exercises.
|
Future uses of cash
Our cash requirements depend on numerous factors, including the costs required to maintain our network infrastructure, the outcome of various telecommunications-related disputes and proceedings, our product and service capabilities, the level of resources used for our sales and marketing activities, the level of restructuring activities, interest payments on outstanding debt, the costs incurred to redeem or repurchase debt and the size and types of acquisitions in which we may engage, among others. The following is a summary of our primary future cash requirements:
|
|
|
|
•
|
Debt and interest.
We expect to use cash to service our outstanding indebtedness, including $300.0 million aggregate principal amount of our Senior Secured Notes due in June 2020, $76.6 million aggregate principal amount of our Senior Notes due in May 2019, $48.8 million principal amount of our term loan and borrowings under our $125.0 million revolving credit facility. We may also use cash to repay outstanding indebtedness. During the year ended December 31, 2016, we redeemed and repurchased $97.4 million outstanding principal of our Senior Notes and made $1.3 million of quarterly principal payments on our term loan. We may repurchase or redeem additional debt.
|
|
|
|
|
•
|
Capital expenditures
. We incurred capital expenditures of
$84.1 million
in 2016 and expect to continue to incur capital expenditures in 2017. The capital expenditures primarily relate to the acquisition of new customers and to maintain and upgrade our network and technology infrastructure. The actual amount of capital expenditures may fluctuate due to a number of factors which are difficult to predict and could change significantly over time. Additionally, technological advances may require us to make capital expenditures to develop or acquire new equipment or technology in order to replace aging or obsolete equipment.
|
|
|
|
|
•
|
Investments in our growth products and services.
We expect to invest cash in sales and marketing efforts and other resources required to support our strategy related to our growth products and services, including our recently launched SD-WAN product.
|
|
|
|
|
•
|
Dividends
. We have historically used cash for dividends. The decision to declare future dividends is made at the discretion of the Board of Directors and will depend on, among other things, our results of operations, financial condition, cash requirements, investment opportunities, restrictions on dividends under the agreements governing our indebtedness and other factors the Board of Directors may deem relevant.
|
|
|
|
|
•
|
Other
. We may also use cash to acquire or invest in other companies or to repurchase common stock. We also expect to use cash for current restructuring liabilities. Payments for restructuring liabilities incurred to date will be funded through operating cash flows. We continue to evaluate our business, including evaluating ways to reduce the cost structure of our business, and may use cash for additional restructuring activities.
|
Future sources of cash
Our principal sources of liquidity are our cash and cash equivalents, as well as the cash flow we generate from our operations. During the years ended
December 31, 2014, 2015 and 2016
, we generated
$140.0 million
,
$167.4 million
and
$126.0 million
in cash from operations, respectively. As of
December 31, 2016
, we had
$51.5 million
in cash and cash equivalents. Our cash and cash equivalents are subject to general credit, liquidity, market, and interest rate risks, which may be exacerbated by unfavorable economic conditions.
We also have a credit agreement providing for a senior secured revolving credit facility with aggregate revolving commitments of $125.0 million. Our senior secured revolving credit facility terminates in June 2021, and at that time any amounts outstanding thereunder shall be due and payable in full, except that if our Senior Secured Notes have not been repaid in full by February 29, 2020, the maturity date will be February 29, 2020. As of
December 31, 2016
, $10.0 million was outstanding under our senior secured revolving credit facility.
Our available cash and cash equivalents, together with our results of operations, are expected to be sufficient to meet our operating expenses, debt service payments, capital requirements and other obligations for at least the next 12 months. However, to increase available liquidity or to fund acquisitions or other strategic activities, we may seek additional financing. We have no commitments for any additional financing and have no lines of credit or similar sources of financing, other than the borrowings available under our credit facility. We cannot be sure that we can obtain additional financing on favorable terms, if at all, through the issuance of equity securities or the incurrence of additional debt. Additional equity financing may dilute our stockholders, and debt financing, if available, may restrict our ability to repurchase common stock or debt, declare and pay dividends, raise future capital and make acquisitions. If we are unable to obtain additional needed financing, it may prohibit us from refinancing existing indebtedness and making acquisitions, capital expenditures and/or investments, which could materially and adversely affect our business.
Contractual Obligations and Commitments
The following table presents our contractual obligations and commercial commitments as of
December 31, 2016
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Payment Due by Period
|
|
|
|
Total
|
|
2017
|
|
2018-
2019
|
|
2020-
2021
|
|
After 5 Years
|
|
|
|
(in thousands)
|
|
Long-term debt (1)
|
|
$
|
435,307
|
|
|
$
|
2,500
|
|
|
$
|
83,432
|
|
|
$
|
349,375
|
|
|
$
|
—
|
|
|
Interest payments on long-term debt (2)
|
|
101,271
|
|
|
31,268
|
|
|
57,937
|
|
|
12,066
|
|
|
—
|
|
|
Purchase commitments (3)
|
|
117,191
|
|
|
49,908
|
|
|
52,638
|
|
|
9,935
|
|
|
4,710
|
|
|
Operating leases (4)
|
|
111,885
|
|
|
31,533
|
|
|
46,867
|
|
|
21,793
|
|
|
11,692
|
|
|
Capital leases (5)
|
|
16,678
|
|
|
3,427
|
|
|
6,920
|
|
|
5,420
|
|
|
911
|
|
|
Total (6)
|
|
$
|
782,332
|
|
|
$
|
118,636
|
|
|
$
|
247,794
|
|
|
$
|
398,589
|
|
|
$
|
17,313
|
|
__________________________________________
|
|
|
|
(1)
|
Long-term debt includes principal payments on outstanding debt obligations. Long-term debt excludes unamortized discounts and unamortized issuance costs. As of
December 31, 2016
, we had $435.3 million aggregate principal amount of debt outstanding, consisting of $300.0 million of 7.375% Senior Secured Notes due June 1, 2020, $76.6 million of 8.875% Senior Notes due May 15, 2019, $48.7 million outstanding under our term loan and $10.0 million outstanding under our senior secured revolving credit facility. For more information regarding our outstanding indebtedness, refer to Note 9 to our Consolidated Financial Statements.
|
|
|
|
|
(2)
|
Interest payments on long-term debt includes interest due on outstanding debt through maturity and commitment fees and borrowing costs under our senior secured revolving credit facility.
|
|
|
|
|
(3)
|
Purchase commitments represent non-cancellable contractual obligations for services and equipment; minimum commitments under network access agreements with several carriers.
|
|
|
|
|
(4)
|
These amounts represent base rent payments under non-cancellable operating leases for facilities and equipment that expire in various years through 2023, as well as an allocation for operating expenses. Not included in these amounts is expected sublease income of
$2.2 million
,
$2.2 million
and
$1.9 million
during the years ended December 31, 2017, 2018 and 2019, respectively.
|
|
|
|
|
(5)
|
Represents remaining payments under capital leases, including interest.
|
|
|
|
|
(6)
|
The table does not include our reserve for uncertain tax positions, as the specific timing of any cash payments relating to this obligation cannot be projected with reasonable certainty. Of our total
$18.1 million
total gross uncertain tax positions as of December 31, 2016, $1.5 million would impact the effective tax rate once settled.
|
Debt Covenants
The credit agreement for our senior secured credit facility requires us to maintain a consolidated net leverage ratio of not greater than 3.5 to 1.0 (with restrictions on cash netting) and a consolidated interest coverage ratio of not less than 2.5 to 1.0 in order to borrow under the agreement. We were in compliance with all covenants as of
December 31, 2016
. We expect to be in compliance with the maintenance covenants in our credit agreement for the next 12 months.
Off-Balance Sheet Arrangements
As of
December 31, 2016
, we did not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to investors.
Share Repurchase Program
The Board of Directors has authorized a total of
$750.0 million
to repurchase our common stock under our share repurchase program. As of
December 31, 2016
, we had utilized approximately
$684.3 million
pursuant to the authorizations and had
$65.7 million
available under the current authorization. We may repurchase our common stock from time to time in compliance with the Securities and Exchange Commission’s regulations and other legal requirements, and subject to market conditions and other factors. The share repurchase program does not require us to acquire any specific number of shares and may be terminated by the Board of Directors at any time. In addition, the agreements governing our Senior Secured Notes, Senior Notes and senior secured revolving credit facility contain restrictions on our ability to repurchase common stock.
Non-GAAP Financial Measures
In addition to our financial information presented in accordance with U.S. generally accepted accounting principles (“GAAP”), management uses certain “non-GAAP financial measures” within the meaning of the SEC Regulation G, to clarify and enhance understanding of past performance and prospects for the future. Generally, a non-GAAP financial measure is a numerical measure of a company’s operating performance, financial position or cash flows that excludes or includes amounts that are included in or excluded from the most directly comparable measure calculated and presented in accordance with GAAP. The non-GAAP financial performance measures used by management are Adjusted EBITDA and Unlevered Free Cash Flow, as discussed below.
Management believes that these non-GAAP financial performance measures reflect our ongoing business in a manner that allows for meaningful comparisons and analysis of trends in our business, as they exclude the effect of non-operational items, such as restructuring, acquisition and integration-related costs, gain on sale of business and loss on extinguishment of debt and non-cash items, such as depreciation and amortization and stock-based compensation expense. Management believes that excluding the effects of certain non-operational and non-cash items enables investors to better understand and analyze the current period’s results and provides a better measure of comparability. Management also believes that these non-GAAP financial measures enable investors to evaluate our operating results and future prospects in the same manner as management. These non-GAAP financial measures may also facilitate comparing financial results across accounting periods and to those of peer companies.
There are limitations to using these non-GAAP financial performance measures. Adjusted EBITDA and Unlevered Free Cash Flow are not indicative of cash provided by or used in operating activities and may differ from comparable information provided by other companies. Adjusted EBITDA and Unlevered Free Cash Flow should not be considered in isolation, as an alternative to, or more meaningful than measures of financial performance determined in accordance with U.S. GAAP.
Adjusted EBITDA is defined as net income (loss) before interest expense and other, net, income tax provision (benefit), depreciation and amortization, stock-based compensation expense, impairment of goodwill and long-lived assets, restructuring, acquisition and integration-related costs, gain on sale of business and loss on extinguishment of debt. Management uses Adjusted EBITDA to evaluate the performance of our business and for strategic planning and forecasting. Adjusted EBITDA is also used in incentive compensation arrangements and is a factor in calculating debt covenants.
Unlevered Free Cash Flow is defined as net income (loss) before interest expense and other, net, income tax provision (benefit), depreciation and amortization, stock-based compensation expense, impairment of goodwill and long-lived assets, restructuring, acquisition and integration-related costs, gain on sale of business and loss on extinguishment of debt, less cash used for purchases of property and equipment. Management uses Unlevered Free Cash Flow to evaluate the performance of our business and to assess our ability to fund capital expenditures, make strategic acquisitions, service and repay debt and pay dividends.
The following table presents a reconciliation of Adjusted EBITDA, as a performance measure, to the most closely related financial measure reported under GAAP for the years ended
December 31, 2014, 2015 and 2016
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
2014
|
|
2015
|
|
2016
|
|
|
(in thousands)
|
|
Net income (loss)
|
$
|
(72,752
|
)
|
|
$
|
(43,210
|
)
|
|
$
|
7,680
|
|
|
Interest expense and other, net
|
56,261
|
|
|
50,972
|
|
|
40,660
|
|
|
Income tax (benefit) provision
|
(4,744
|
)
|
|
2,730
|
|
|
945
|
|
|
Depreciation and amortization
|
186,872
|
|
|
188,315
|
|
|
135,248
|
|
|
Stock-based compensation expense
|
12,600
|
|
|
14,594
|
|
|
16,192
|
|
|
Impairment of long-lived assets
|
14,334
|
|
|
—
|
|
|
—
|
|
|
Restructuring, acquisition and integration-related costs
|
20,088
|
|
|
19,320
|
|
|
17,807
|
|
|
Gain on sale of businesses
|
—
|
|
|
—
|
|
|
(9,128
|
)
|
|
Loss on extinguishment of debt
|
—
|
|
|
9,734
|
|
|
4,823
|
|
|
Loss from discontinued operations, net of tax
|
381
|
|
|
—
|
|
|
—
|
|
|
Adjusted EBITDA
|
$
|
213,040
|
|
|
$
|
242,455
|
|
|
$
|
214,227
|
|
The following table presents a reconciliation of Unlevered Free Cash Flow, as a performance measure, to the most closely related financial measure reported under GAAP for the years ended
December 31, 2014, 2015 and 2016
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
2014
|
|
2015
|
|
2016
|
|
|
(in thousands)
|
|
Net income (loss)
|
$
|
(72,752
|
)
|
|
$
|
(43,210
|
)
|
|
$
|
7,680
|
|
|
Interest expense and other, net
|
56,261
|
|
|
50,972
|
|
|
40,660
|
|
|
Income tax (benefit) provision
|
(4,744
|
)
|
|
2,730
|
|
|
945
|
|
|
Depreciation and amortization
|
186,872
|
|
|
188,315
|
|
|
135,248
|
|
|
Stock-based compensation expense
|
12,600
|
|
|
14,594
|
|
|
16,192
|
|
|
Impairment of long-lived assets
|
14,334
|
|
|
—
|
|
|
—
|
|
|
Restructuring, acquisition and integration-related costs
|
20,088
|
|
|
19,320
|
|
|
17,807
|
|
|
Gain on sale of businesses
|
—
|
|
|
—
|
|
|
(9,128
|
)
|
|
Loss on extinguishment of debt
|
—
|
|
|
9,734
|
|
|
4,823
|
|
|
Loss from discontinued operations, net of tax
|
381
|
|
|
—
|
|
|
—
|
|
|
Purchases of property and equipment
|
(102,863
|
)
|
|
(87,468
|
)
|
|
(84,071
|
)
|
|
Unlevered Free Cash Flow
|
$
|
110,177
|
|
|
$
|
154,987
|
|
|
$
|
130,156
|
|
The following table presents a reconciliation of Unlevered Free Cash Flow, as a liquidity measure, to net cash provided by operating activities for the years ended
December 31, 2014, 2015 and 2016
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
2014
|
|
2015
|
|
2016
|
|
|
(in thousands)
|
|
Net cash provided by operating activities
|
$
|
139,995
|
|
|
$
|
167,448
|
|
|
$
|
125,965
|
|
|
Income tax provision (benefit)
|
(4,744
|
)
|
|
2,730
|
|
|
945
|
|
|
Non-cash income taxes
|
(591
|
)
|
|
(677
|
)
|
|
(570
|
)
|
|
Interest expense and other, net
|
56,261
|
|
|
50,972
|
|
|
40,660
|
|
|
Amortization of debt discount, premium and issuance costs
|
(4,104
|
)
|
|
(3,703
|
)
|
|
(3,091
|
)
|
|
Restructuring, acquisition and integration-related costs
|
20,088
|
|
|
19,320
|
|
|
17,807
|
|
|
Changes in operating assets and liabilities
|
5,673
|
|
|
6,721
|
|
|
31,828
|
|
|
Purchases of property and equipment
|
(102,863
|
)
|
|
(87,468
|
)
|
|
(84,071
|
)
|
|
Other, net
|
462
|
|
|
(356
|
)
|
|
683
|
|
|
Unlevered Free Cash Flow
|
$
|
110,177
|
|
|
$
|
154,987
|
|
|
$
|
130,156
|
|
|
|
|
|
|
|
|
|
|
Net cash used in investing activities
|
$
|
(102,777
|
)
|
|
$
|
(87,468
|
)
|
|
$
|
(64,003
|
)
|
|
Net cash used in financing activities
|
$
|
(19,721
|
)
|
|
$
|
(122,817
|
)
|
|
$
|
(101,729
|
)
|
Recently Issued Accounting Pronouncements
For information about recently issued accounting pronouncements, refer to Note 2 to our Consolidated Financial Statements.
Critical Accounting Policies and Estimates
Set forth below is a discussion of the accounting policies and related estimates that we believe are the most critical to understanding our consolidated financial statements, financial condition and results of operations and which require complex management judgments, uncertainties and/or estimates. The preparation of financial statements in accordance with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities and the reported amounts of revenues and expenses during a reporting period; however, actual results could differ from those estimates. Management has discussed the development, selection and disclosure of the critical accounting policies and estimates with the Audit Committee of the Board of Directors. Information regarding our other accounting policies is included in the Notes to our Consolidated Financial Statements.
|
|
|
|
|
|
|
Description
|
Judgments and Uncertainties
|
Effect if Actual Results Differ From Assumptions
|
|
Revenue Recognition
|
|
|
|
We offer certain services that are provided by third-party vendors. When we are the primary obligor in a transaction, have latitude in establishing prices, are the party determining the service specifications or have several but not all of these indicators, we record the revenue and cost of revenue on a gross basis. If we are not the primary obligor and/or a third-party vendor has latitude in establishing prices, we record revenue associated with the related subscribers on a net basis, netting the cost of revenue associated with the service against the gross amount billed to the customer and recording the net amount as revenue.
|
The determination of whether we meet many of the attributes for gross and net revenue recognition is judgmental in nature and is based on an evaluation of the terms of each arrangement.
|
We have not made any material changes in the accounting methodology we use to recognize revenue during the past three years.
We do not believe there is a reasonable likelihood that there will be a material change in the future estimates or assumptions used to recognize revenue.
A change in the determination of gross versus net revenue recognition would have an impact on the gross amounts of revenues and cost of revenues we recognize and the gross profit margin percentages in the period in which such determination is made and in subsequent periods; however, such a change in determination of revenue recognition would not affect net loss.
|
|
|
|
|
|
|
|
Sales Credit Reserves
|
|
|
|
We make estimates for potential future sales credits to be issued related to billing errors, service interruptions and customer disputes, which are recorded as a reduction in revenue. We analyze historical credit activity and changes in customer demands related to current billing and service interruptions when evaluating our credit reserve requirements. Invoices provided to other telecommunications providers are often subject to significant billing disputes, and these disputes may require a significant amount of time to resolve given the complexities and regulatory issues surrounding the customer relationships.
|
The determination of our general sales credit and customer dispute credit reserves contain uncertainties because they require management to make assumptions and apply judgment about the amount and timing of unknown billing errors and disputes.
|
We have not made any material changes in the accounting methodology we use to record sales credit reserves during the past three years.
We do not believe there is a reasonable likelihood that there will be a material change in the future estimates or assumptions used to record sales credit reserves.
A 10% difference in our sales credit reserves as of December 31, 2016 would have affected net loss by approximately $0.7 million during the year ended December 31, 2016.
|
|
|
|
|
|
|
|
Allowance for Doubtful Accounts
|
|
|
|
We maintain an allowance for accounts receivable that may not be collectible. In assessing the adequacy of the allowance for doubtful accounts, management considers a number of factors, including the aging of the accounts receivable balances, historical collection experience and a specific customer's ability to meet its financial obligations to us.
|
The determination of our allowance for doubtful accounts contains uncertainties because it requires management to make assumptions and apply judgment about future uncollectible accounts.
|
We have not made any material changes in the accounting methodology we use to record our allowance for doubtful accounts during the past three years.
We do not believe there is a reasonable likelihood that there will be a material change in the future estimates or assumptions used to record our allowance for doubtful accounts.
A 10% difference in our allowance for doubtful accounts as of December 31, 2016 would have affected net loss by approximately $0.3 million as of December 31, 2016.
|
|
|
|
|
|
|
|
Description
|
Judgments and Uncertainties
|
Effect if Actual Results Differ From Assumptions
|
|
Cost of Revenues
|
|
|
|
We rely on other carriers to provide services where we do not have facilities, and we use a number of different carriers to terminate our long distance calls. These costs are expensed as incurred. The invoices received from other telecommunications providers are often subject to significant billing disputes. These disputes may require a significant amount of time to resolve given the complexities and regulatory issues surrounding the vendor relationships.
We maintain reserves for any anticipated exposure associated with these billing disputes. The reserves are reviewed on a monthly basis, but are subject to changes in estimates and management judgment as new information becomes available.
|
Our cost of revenues methodology contains uncertainties because it requires management to make assumptions and apply judgment regarding the amount of future billing dispute resolutions.
|
We have not made any material changes in the accounting methodology we use to estimate reserves for billing disputes during the past three years.
While we believe our reserves for billing disputes are adequate, it is reasonably possible that we could record additional expense of up to $12.4 million for unrecorded disputed amounts.
We do not believe there is a reasonable likelihood that there will be a material change in the future estimates or assumptions we use for these reserves.
|
|
|
|
|
|
|
|
Income Taxes
|
|
|
|
We recognize deferred tax assets and liabilities using tax rates in effect for the years in which temporary differences are expected to reverse, including net operating loss carryforwards. Management assesses the realizability of deferred tax assets and records a valuation allowance if it is more-likely-than-not that all or a portion of the deferred tax assets will not be realized.
We establish reserves for tax-related uncertainties if it is more-likely-than-not that additional taxes will be due. We adjust these reserves in light of changing facts and circumstances, such as the closing of a tax audit, new tax legislation or the change of an estimate. To the extent that the final tax outcome of these matters is different than the amounts recorded, such differences will affect the provision for income taxes in the period in which such determination is made. The provision for income taxes includes the effect of reserve provisions and changes to reserves that are considered appropriate, as well as the related net interest and penalties.
|
We consider the probability of future taxable income and our historical profitability, among other factors, in assessing the amount of the valuation allowance. Significant judgment is involved in this determination, including projections of future taxable income.
Our liability for unrecognized tax benefits contains uncertainties because management is required to make assumptions and to apply judgment to estimate the exposures associated with our various filing positions.
Our effective income tax rate is also affected by changes in tax law, our level of earnings and the results of tax audits.
|
As of December 31, 2016, we had a valuation allowance for deferred tax assets that we determined are not "more likely than not" able to be realized. Any future change in the valuation allowance could have an effect on stockholders' equity and the income tax benefit (provision) in the Statement of Comprehensive Income (Loss).
As of December 31, 2016, we had unrecognized tax positions of $18.1 million. Within the next twelve months, it is reasonably possible that approximately $2.1 million of the total uncertain tax positions recorded will reverse, primarily due to the expiration of statutes of limitation in various jurisdictions. Approximately $1.5 million would impact the effective rate once settled.
Changes in these estimates and assumptions could materially affect the amount or timing of valuation allowance releases.
|
|
|
|
|
|
|
|
Description
|
Judgments and Uncertainties
|
Effect if Actual Results Differ From Assumptions
|
|
Goodwill
|
|
|
|
We perform an impairment test of our goodwill annually during the fourth quarter of our fiscal year (October 1) or when events and circumstances indicate goodwill might be impaired. Impairment testing of goodwill is required at the reporting unit level and involves a two-step process. However, we may first assess the qualitative factors to determine whether it is necessary to perform the two-step quantitative goodwill impairment test.
The first step of the impairment test involves comparing the estimated fair value of our reporting units with the reporting unit's carrying amount, including goodwill. If we determine that the carrying value of a reporting unit exceeds its estimated fair value, we perform a second step to compare the carrying amount of goodwill to the implied fair value of that goodwill. The implied fair value of goodwill is determined in the same manner as utilized to recognize goodwill in a business combination. If the carrying amount of goodwill exceeds the implied fair value of that goodwill, an impairment loss would be recognized in an amount equal to the excess.
We evaluate our reporting units on an annual basis or when events or circumstances indicate our reporting units might change.
|
Application of the goodwill impairment test requires judgment, including performing the qualitative assessment, the identification of reporting units, assigning assets and liabilities to reporting units, assigning goodwill to reporting units, and determining the fair value of each reporting unit.
We estimate the fair values of our reporting units based on the income approach. This model uses significant unobservable inputs, or Level 3 inputs, as defined by the fair value hierarchy. Under the income approach, we calculate the fair value of the reporting unit based on the present value of estimated cash flows using a discounted cash flow method. The significant assumptions used in the discounted cash flow method include internal forecasts and projections developed by management for planning purposes, available industry/market data, strategic plans, discount rates and the growth rate to calculate the terminal value.
The assumptions with the most significant impact on the fair value of the reporting unit are those related to the discount rate, the terminal value, future operating cash flows and the growth rate.
These types of analyses contain uncertainties because they require management to make assumptions and to apply judgment to estimate industry economic factors and the profitability of future business strategies.
|
We have not made any material changes in the accounting methodology used to evaluate impairment of goodwill during the past three years.
During the third quarter of 2015, we performed an interim goodwill test as a result of a change in reporting units. The impairment test indicated the estimated fair value of our reporting units exceeded their carrying values and did not result in any goodwill impairment charge.
As of December 31, 2016, we had approximately $142.4 million of goodwill. Our fiscal 2016 annual impairment test indicated the estimated fair value of our reporting units exceeded their carrying values. However, deterioration in estimated future cash flows in our reporting units could result in future goodwill impairment. We continue to monitor events and circumstances which may affect the fair value of this reporting unit.
Examples of events or circumstances that could have a negative effect on the estimated fair value of our reporting units include (i) changes in technology or customer demands that were not anticipated; (ii) competition or regulatory developments in the industry that may adversely affect profitability; (iii) a prolonged weakness in general economic conditions; (iv) a sustained decrease in share price; (v) volatility in the equity and debt markets which could result in a higher discount rate; and (vi) the inability to execute our strategy to grow our growth products. If the assumptions used in the impairment analysis are not met or materially change, we may be required to recognize an impairment loss.
There have been no significant events since the timing of our fiscal 2016 annual impairment test that would have triggered additional impairment testing.
|
|
|
|
|
|
|
|
Description
|
Judgments and Uncertainties
|
Effect if Actual Results Differ From Assumptions
|
|
Long-lived assets
|
|
|
|
We depreciate property and equipment and amortize intangible assets using the straight-line method over the estimated useful lives of the assets. Estimates of useful lives are based on the nature of the underlying assets as well as our experience with similar assets and intended use. We periodically review estimated useful lives for reasonableness.
We evaluate recoverability of long-lived assets, including property and equipment and definite-lived intangible assets, when events or changes in circumstances indicate that the carrying amount may not be recoverable.
|
Estimates of useful lives can differ from actual useful lives due to the inherent uncertainty in making these estimates.
Our impairment tests contain uncertainties because they require management to make assumptions and apply judgment to estimate future cash flows and asset fair values including, subscriber additions, churn, prices, marketing spending, operating costs and capital spending. Significant judgment is involved in estimating these factors, and they include inherent uncertainties.
|
We have not made any material changes in the accounting methodology we use to account for long-lived assets during the past three years.
During the year ended December 31, 2014, we recorded $14.3 million for impairment of long-lived assets, which consisted of impairment of work in progress for information technology projects not expected to be used, impairment of software licenses not expected to be used and impairment of certain assets held for sale. We did not recognize any other material impairment charges for our long-lived assets during the past three years.
During the year ended December 31, 2015, we recorded additional amortization expense of $5.7 million as a result of a change in estimate in December 2014 for the estimated useful lives of certain customer relationships. We did not have any other material changes in useful lives for our long-lived assets during the past three years.
We do not believe there is a reasonable likelihood that there will be a material change in the future estimates or assumptions used to account for long-lived assets.
|
|
|
|
|
|
|
|
Loss Contingencies
|
|
|
|
We are party to various legal proceedings and other disputes arising in the normal course of business, including, but not limited to, regulatory audits, E911 payments, trademark and patent infringement, billing disputes, rights of access, tax, consumer protection, employment and tort. We accrue for such matters when it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated. Where it is probable that a liability has been incurred and there is a range of expected loss for which no amount in the range is more likely than any other amount, we accrue at the low end of the range. We review our accruals each reporting period.
|
Significant judgment is required to determine both likelihood of there being and the estimated amount of a loss related to such matters. In addition, we are subject to significant regulation, and regulatory matters are subject to differing interpretations.
Until the final resolution of such matters, there may be an exposure to loss in excess of the amount recorded, and such amounts could be material. Should any of our estimates and assumptions change, it could have a material impact on our business, consolidated financial position, results of operations or cash flows
|
We have not made any material changes in the accounting methodology used to accrue for loss contingencies during the past three years.
During the year ended December 31, 2014, we recorded a $2.2 million liability for a loss contingency that became probable and estimable during the year. Such amount was settled and paid during the year ended December 31, 2015.
|
Cautionary Note Concerning Factors That May Affect Future Results
The Management's Discussion and Analysis and other portions of this Annual Report on Form 10-K include "forward-looking" statements (rather than historical facts) that are subject to risks and uncertainties that could cause actual results to differ materially from those described. Although we believe that the expectations expressed in these forward-looking statements are reasonable, we cannot promise that our expectations will turn out to be correct. Our actual results could be materially different from and worse than our expectations. With respect to such forward-looking statements, we seek the protections afforded by the Private Securities Litigation Reform Act of 1995. These risks include, without limitation (1) that the Windstream merger agreement limits our respective ability to pursue alternatives to the merger, and in certain instances requires payment of a termination fee, which could deter a third party from proposing an alternative transaction to the merger; (2) that we will be subject to business uncertainties and contractual restrictions while the proposed Windstream merger is pending that could adversely affect our business; (3) that our stockholders will have reduced ownership and voting interests after the Windstream merger and will exercise less influence over management of Windstream than they currently exercise over management of EarthLink; (4) that our stockholders will have different rights with respect to their holdings following the merger; (5) that we may not be able to execute our strategy to successfully operate as a leading managed network, security and cloud services provider, which could adversely affect our results of operations and cash flows; (6) that we may not be able to increase revenues from our growth products and services to offset declining revenues from our traditional products and services, which could adversely affect our results of operations and cash flows; (7) that if we are unable to adapt to changes in technology and customer demands, we may not remain competitive, and our revenues and operating results could suffer; (8) that failure to achieve operating efficiencies and otherwise reduce costs would adversely affect our results of operations and cash flows; (9) that we may have to undertake further restructuring plans that would require additional charges; (10) that we may be unable to successfully divest non-strategic products, which could adversely affect our results of operations; (11) that acquisitions we complete could result in operating difficulties, dilution, increased liabilities, diversion of management attention and other adverse consequences, which could adversely affect our results of operations; (12) that we face significant competition in our business markets, which could adversely affect our results of operations; (13) that failure to retain existing customers could adversely affect our results of operations and cash flows; (14) that decisions by legislative or regulatory authorities, including the Federal Communications Commission, relieving incumbent carriers of certain regulatory requirements, and possible further deregulation in the future, may restrict our ability to provide services and may increase the costs we incur to provide these services; (15) that if we are unable to interconnect with AT&T, Verizon and other incumbent carriers on acceptable terms, our ability to offer competitively priced local telephone services will be adversely affected; (16) that the continued decline in switched access and reciprocal compensation revenue will adversely affect our results of operations; (17) that failure to obtain and maintain necessary permits and rights-of-way could interfere with our network infrastructure and operations; (18) that if our larger carrier customers terminate the service they receive from us, our wholesale revenue and results of operations could be adversely affected; (19) that we obtain a majority of our network equipment and software from a limited number of third-party suppliers; (20) that work stoppages experienced by other communications companies on whom we rely for service could adversely impact our ability to provision and service our customers; (21) that our commercial and alliance arrangements may not be renewed or may not generate expected benefits, which could adversely affect our results of operations; (22) that our consumer business is dependent on the availability of third-party network service providers; (23) that we face significant competition in the Internet access industry that could reduce our profitability; (24) that the continued decline of our consumer access subscribers will adversely affect our results of operations; (25) that lack of regulation governing wholesale Internet service providers could adversely affect our operations; (26) that cyber security breaches could harm our business; (27) that privacy concerns relating to our business could damage our reputation and deter current and potential users from using our services; (28) that interruption or failure of our network, information systems or other technologies could impair our ability to provide our services, which could damage our reputation and harm our operating results; (29) that our business depends on effective business support systems and processes; (30) that if we, or other industry participants, are unable to successfully defend against disputes or legal actions, we could face substantial liabilities or suffer harm to our financial and operational prospects; (31) that we may be accused of infringing upon the intellectual property rights of third parties, which is costly to defend and could limit our ability to use certain technologies in the future; (32) that we may not be able to protect our intellectual property; (33) that we may be unable to hire and retain sufficient qualified personnel, and the loss of any of our key executive officers could adversely affect us; (34) that unfavorable general economic conditions could harm our business; (35) that government regulations could adversely affect our business or force us to change our business practices; (36) that our business may suffer if third parties are unable to provide services or terminate their relationships with us; (37) that we may be required to recognize impairment charges on our goodwill and other intangible assets, which would adversely affect our results of operations and financial position; (38) that we may have exposure to greater than anticipated tax liabilities and we may be limited in the use of our net operating losses and certain other tax attributes in the future; (39) that our indebtedness could adversely affect our financial health and limit our ability to react to changes in our business and industry; (40) that we may require substantial capital to support business growth, and this capital may not be available to us on acceptable terms, or at all; (41) that our debt agreements include restrictive covenants, and failure to comply with these covenants could trigger acceleration of payment of outstanding indebtedness; (42) that we may reduce, or cease payment of, quarterly cash dividends; (43) that our stock price may be volatile; (44) that provisions of our certificate of incorporation, bylaws and other elements of our capital structure could limit our share price and delay a change of control of the company; and (45) that our bylaws designate the
Court of Chancery of the State of Delaware as the sole and exclusive forum for certain types of actions and proceedings that may be initiated by our stockholders, which could limit our stockholders’ flexibility in obtaining a judicial forum for disputes with us or our directors, officers or employees. These risks and uncertainties are described in greater detail in Item 1A of Part I, "Risk Factors."
Item 8. Financial Statements And Supplementary Data.
EARTHLINK HOLDINGS CORP.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consolidated Statements of Comprehensive Income (Loss) for the years ended December 31, 2014, 2015 and 2016
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and
Stockholders of EarthLink Holdings Corp.
We have audited the accompanying consolidated balance sheets of EarthLink Holdings Corp. as of December 31, 2015 and 2016, and the related consolidated statements of comprehensive income (loss), stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2016. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of EarthLink Holdings Corp. at December 31, 2015 and 2016, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2016, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), EarthLink Holdings Corp.'s internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated February 24, 2017 expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
Atlanta, Georgia
February 24, 2017
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and
Stockholders of EarthLink Holdings Corp.
We have audited EarthLink Holdings Corp.’s internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). EarthLink Holdings Corp.’s management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
As indicated in the accompanying Management’s Report on Internal Control Over Financial Reporting, management’s assessment of and conclusion on the effectiveness of internal control over financial reporting did not include the internal controls of Boston Retail Partners, LLC, which is included in the 2016 consolidated financial statements of EarthLink Holdings Corp. and constituted $12.2 million of total assets as of December 31, 2016 and $4.7 million of revenues for the year then ended. Our audit of internal control over financial reporting of EarthLink Holdings Corp. also did not include an evaluation of the internal control over financial reporting of Boston Retail Partners, LLC.
In our opinion, EarthLink Holdings Corp. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2016, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of EarthLink Holdings Corp. as of December 31, 2015 and 2016, and the related consolidated statements of comprehensive income (loss), stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2016 of EarthLink Holdings Corp. and our report dated February 24, 2017 expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
Atlanta, Georgia
February 24, 2017
EARTHLINK HOLDINGS CORP.
CONSOLIDATED BALANCE SHEETS
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31,
2015
|
|
December 31,
2016
|
|
|
(in thousands, except per share data)
|
|
ASSETS
|
|
Current assets:
|
|
|
|
|
|
|
Cash and cash equivalents
|
$
|
91,296
|
|
|
$
|
51,529
|
|
|
Accounts receivable, net of allowance of $3,537 and $2,999 as of December 31, 2015 and 2016, respectively
|
74,724
|
|
|
76,765
|
|
|
Prepaid expenses
|
14,187
|
|
|
15,557
|
|
|
Other current assets
|
9,724
|
|
|
7,142
|
|
|
Total current assets
|
189,931
|
|
|
150,993
|
|
|
Property and equipment, net
|
372,504
|
|
|
331,119
|
|
|
Goodwill
|
137,751
|
|
|
142,411
|
|
|
Other intangible assets, net
|
25,325
|
|
|
2,360
|
|
|
Other long-term assets
|
9,141
|
|
|
8,763
|
|
|
Total assets
|
$
|
734,652
|
|
|
$
|
635,646
|
|
|
|
|
|
|
|
LIABILITIES AND STOCKHOLDERS’ EQUITY
|
|
Current liabilities:
|
|
|
|
|
|
|
Accounts payable
|
$
|
18,442
|
|
|
$
|
15,782
|
|
|
Accrued payroll and related expenses
|
50,532
|
|
|
34,884
|
|
|
Other accrued liabilities
|
64,305
|
|
|
56,472
|
|
|
Deferred revenue
|
40,229
|
|
|
37,051
|
|
|
Current portion of long-term debt and capital lease obligations
|
6,787
|
|
|
4,444
|
|
|
Total current liabilities
|
180,295
|
|
|
148,633
|
|
|
Long-term debt and capital lease obligations
|
505,613
|
|
|
437,458
|
|
|
Long-term deferred income taxes, net
|
3,876
|
|
|
4,494
|
|
|
Other long-term liabilities
|
22,022
|
|
|
24,873
|
|
|
Total liabilities
|
711,806
|
|
|
615,458
|
|
|
Commitments and contingencies (See Note 15)
|
|
|
|
|
|
|
Stockholders’ equity:
|
|
|
|
|
|
|
Preferred stock, $0.01 par value, 100,000 shares authorized, 0 shares issued and outstanding as of December 31, 2015 and 2016
|
—
|
|
|
—
|
|
|
Common stock, $0.01 par value, 300,000 shares authorized, 200,207 and 201,879 shares issued as of December 31, 2015 and 2016, respectively, and 103,880 and 105,503 shares outstanding as of December 31, 2015 and 2016, respectively
|
2,002
|
|
|
2,019
|
|
|
Additional paid-in capital
|
2,026,638
|
|
|
2,016,575
|
|
|
Accumulated deficit
|
(1,260,937
|
)
|
|
(1,253,257
|
)
|
|
Treasury stock, at cost, 96,327 and 96,376 shares as of December 31, 2015 and 2016, respectively
|
(744,857
|
)
|
|
(745,149
|
)
|
|
Total stockholders’ equity
|
22,846
|
|
|
20,188
|
|
|
Total liabilities and stockholders’ equity
|
$
|
734,652
|
|
|
$
|
635,646
|
|
The accompanying notes are an integral part of these financial statements.
EARTHLINK HOLDINGS CORP.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
|
2014
|
|
2015
|
|
2016
|
|
|
(in thousands, except per share data)
|
|
Revenues
|
|
$
|
1,176,895
|
|
|
$
|
1,097,252
|
|
|
$
|
959,874
|
|
|
Operating costs and expenses:
|
|
|
|
|
|
|
|
|
|
Cost of revenues (exclusive of depreciation and amortization shown separately below)
|
|
557,436
|
|
|
500,628
|
|
|
442,608
|
|
|
Selling, general and administrative (exclusive of depreciation and amortization shown separately below)
|
|
419,019
|
|
|
368,763
|
|
|
319,231
|
|
|
Depreciation and amortization
|
|
186,872
|
|
|
188,315
|
|
|
135,248
|
|
|
Impairment of long-lived assets
|
|
14,334
|
|
|
—
|
|
|
—
|
|
|
Restructuring, acquisition and integration-related costs
|
|
20,088
|
|
|
19,320
|
|
|
17,807
|
|
|
Total operating costs and expenses
|
|
1,197,749
|
|
|
1,077,026
|
|
|
914,894
|
|
|
Income (loss) from operations
|
|
(20,854
|
)
|
|
20,226
|
|
|
44,980
|
|
|
Gain on sale of businesses
|
|
—
|
|
|
—
|
|
|
9,128
|
|
|
Interest expense and other, net
|
|
(56,261
|
)
|
|
(50,972
|
)
|
|
(40,660
|
)
|
|
Loss on extinguishment of debt
|
|
—
|
|
|
(9,734
|
)
|
|
(4,823
|
)
|
|
Income (loss) from continuing operations before income taxes
|
|
(77,115
|
)
|
|
(40,480
|
)
|
|
8,625
|
|
|
Income tax benefit (provision)
|
|
4,744
|
|
|
(2,730
|
)
|
|
(945
|
)
|
|
Income (loss) from continuing operations
|
|
(72,371
|
)
|
|
(43,210
|
)
|
|
7,680
|
|
|
Loss from discontinued operations, net of tax
|
|
(381
|
)
|
|
—
|
|
|
—
|
|
|
Net income (loss) and comprehensive income (loss)
|
|
$
|
(72,752
|
)
|
|
$
|
(43,210
|
)
|
|
$
|
7,680
|
|
|
|
|
|
|
|
|
|
|
Basic net income (loss) per share
|
|
|
|
|
|
|
|
|
|
Continuing operations
|
|
$
|
(0.71
|
)
|
|
$
|
(0.42
|
)
|
|
$
|
0.07
|
|
|
Discontinued operations
|
|
—
|
|
|
—
|
|
|
—
|
|
|
Basic net income (loss) per share
|
|
$
|
(0.71
|
)
|
|
$
|
(0.42
|
)
|
|
$
|
0.07
|
|
|
Basic weighted average common shares outstanding
|
|
102,313
|
|
|
103,388
|
|
|
105,194
|
|
|
|
|
|
|
|
|
|
|
Diluted net income (loss) per share
|
|
|
|
|
|
|
|
|
|
Continuing operations
|
|
$
|
(0.71
|
)
|
|
$
|
(0.42
|
)
|
|
$
|
0.07
|
|
|
Discontinued operations
|
|
—
|
|
|
—
|
|
|
—
|
|
|
Diluted net income (loss) per share
|
|
$
|
(0.71
|
)
|
|
$
|
(0.42
|
)
|
|
$
|
0.07
|
|
|
Diluted weighted average common shares outstanding
|
|
102,313
|
|
|
103,388
|
|
|
108,596
|
|
|
|
|
|
|
|
|
|
The accompanying notes are an integral part of these financial statements.
EARTHLINK HOLDINGS CORP.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Common Stock
|
|
Additional Paid-in Capital
|
|
Accumulated Deficit
|
|
Treasury Stock
|
|
Total Stockholders' Equity
|
|
|
Shares
|
|
Amount
|
|
|
|
Shares
|
|
Amount
|
|
|
|
(in thousands)
|
|
Balance as of December 31, 2013
|
197,491
|
|
|
$
|
1,975
|
|
|
$
|
2,047,607
|
|
|
$
|
(1,144,975
|
)
|
|
(95,615
|
)
|
|
$
|
(742,389
|
)
|
|
$
|
162,218
|
|
|
Vesting of restricted stock units
|
1,132
|
|
|
11
|
|
|
(11
|
)
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
Tax withholdings related to net share settlements of restricted stock units
|
—
|
|
|
—
|
|
|
(3,418
|
)
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(3,418
|
)
|
|
Dividends paid on shares outstanding and restricted stock units
|
—
|
|
|
—
|
|
|
(16,013
|
)
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(16,013
|
)
|
|
Change in dividends payable on restricted stock units
|
—
|
|
|
—
|
|
|
(5,383
|
)
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(5,383
|
)
|
|
Stock-based compensation expense
|
—
|
|
|
—
|
|
|
12,600
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
12,600
|
|
|
Return of One Communications escrow shares
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(56
|
)
|
|
(258
|
)
|
|
(258
|
)
|
|
Repurchases of common stock
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(656
|
)
|
|
(2,210
|
)
|
|
(2,210
|
)
|
|
Net loss
|
—
|
|
|
—
|
|
|
—
|
|
|
(72,752
|
)
|
|
—
|
|
|
—
|
|
|
(72,752
|
)
|
|
Balance as of December 31, 2014
|
198,623
|
|
|
1,986
|
|
|
2,035,382
|
|
|
(1,217,727
|
)
|
|
(96,327
|
)
|
|
(744,857
|
)
|
|
74,784
|
|
|
Vesting of restricted stock units and exercise of stock options
|
1,584
|
|
|
16
|
|
|
1,699
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
1,715
|
|
|
Tax withholdings related to net share settlements of restricted stock units and stock options
|
—
|
|
|
—
|
|
|
(3,102
|
)
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(3,102
|
)
|
|
Dividends paid on shares outstanding and restricted stock units
|
—
|
|
|
—
|
|
|
(26,388
|
)
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(26,388
|
)
|
|
Change in dividends payable on shares outstanding and restricted stock units
|
—
|
|
|
—
|
|
|
4,453
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
4,453
|
|
|
Stock-based compensation expense
|
—
|
|
|
—
|
|
|
14,594
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
14,594
|
|
|
Net loss
|
—
|
|
|
—
|
|
|
—
|
|
|
(43,210
|
)
|
|
—
|
|
|
—
|
|
|
(43,210
|
)
|
|
Balance as of December 31, 2015
|
200,207
|
|
|
2,002
|
|
|
2,026,638
|
|
|
(1,260,937
|
)
|
|
(96,327
|
)
|
|
(744,857
|
)
|
|
22,846
|
|
|
Vesting of restricted stock units and exercise of stock options
|
1,672
|
|
|
17
|
|
|
235
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
252
|
|
|
Tax withholdings related to net share settlements of restricted stock units
|
—
|
|
|
—
|
|
|
(4,355
|
)
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(4,355
|
)
|
|
Dividends paid on shares outstanding and restricted stock units
|
—
|
|
|
—
|
|
|
(22,023
|
)
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(22,023
|
)
|
|
Change in dividends payable on shares outstanding and restricted stock units
|
—
|
|
|
—
|
|
|
(112
|
)
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(112
|
)
|
|
Stock-based compensation expense
|
—
|
|
|
—
|
|
|
16,192
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
16,192
|
|
|
Return of One Communications escrow shares
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(49
|
)
|
|
(292
|
)
|
|
(292
|
)
|
|
Net income
|
—
|
|
|
—
|
|
|
—
|
|
|
7,680
|
|
|
—
|
|
|
—
|
|
|
7,680
|
|
|
Balance as of December 31, 2016
|
201,879
|
|
|
$
|
2,019
|
|
|
$
|
2,016,575
|
|
|
$
|
(1,253,257
|
)
|
|
(96,376
|
)
|
|
$
|
(745,149
|
)
|
|
$
|
20,188
|
|
The accompanying notes are an integral part of these consolidated financial statements.
EARTHLINK HOLDINGS CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
2014
|
|
2015
|
|
2016
|
|
Cash flows from operating activities:
|
(in thousands)
|
|
Net income (loss)
|
$
|
(72,752
|
)
|
|
$
|
(43,210
|
)
|
|
$
|
7,680
|
|
|
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
|
|
|
|
|
|
|
|
Depreciation and amortization
|
186,872
|
|
|
188,315
|
|
|
135,248
|
|
|
Impairment of long-lived assets
|
14,334
|
|
|
—
|
|
|
—
|
|
|
Gain on sale of businesses
|
—
|
|
|
—
|
|
|
(9,128
|
)
|
|
Non-cash income taxes
|
591
|
|
|
677
|
|
|
570
|
|
|
Stock-based compensation
|
12,600
|
|
|
14,594
|
|
|
16,192
|
|
|
Amortization of debt discount and issuance costs
|
4,104
|
|
|
3,703
|
|
|
3,091
|
|
|
Loss on extinguishment of debt
|
—
|
|
|
9,734
|
|
|
4,823
|
|
|
Other operating activities
|
(81
|
)
|
|
356
|
|
|
(683
|
)
|
|
Decrease (increase) in accounts receivable, net
|
8,191
|
|
|
17,892
|
|
|
(4,546
|
)
|
|
Decrease (increase) in prepaid expenses and other assets
|
4,457
|
|
|
3,281
|
|
|
(1,861
|
)
|
|
Decrease in accounts payable and accrued and other liabilities
|
(12,792
|
)
|
|
(24,171
|
)
|
|
(31,318
|
)
|
|
(Decrease) increase in deferred revenue
|
(5,529
|
)
|
|
(3,723
|
)
|
|
5,897
|
|
|
Net cash provided by operating activities
|
139,995
|
|
|
167,448
|
|
|
125,965
|
|
|
Cash flows from investing activities:
|
|
|
|
|
|
|
Purchases of property and equipment
|
(102,863
|
)
|
|
(87,468
|
)
|
|
(84,071
|
)
|
|
Purchase of business, net of cash acquired
|
—
|
|
|
—
|
|
|
(10,359
|
)
|
|
Proceeds from sale of businesses
|
—
|
|
|
—
|
|
|
30,427
|
|
|
Other investing activities
|
86
|
|
|
—
|
|
|
—
|
|
|
Net cash used in investing activities
|
(102,777
|
)
|
|
(87,468
|
)
|
|
(64,003
|
)
|
|
Cash flows from financing activities:
|
|
|
|
|
|
|
Proceeds from issuance of debt, net of issuance costs
|
—
|
|
|
89,761
|
|
|
67,522
|
|
|
Repayment of debt and capital lease obligations
|
(1,498
|
)
|
|
(187,905
|
)
|
|
(147,479
|
)
|
|
Payment of dividends
|
(16,013
|
)
|
|
(26,388
|
)
|
|
(22,023
|
)
|
|
Repurchases of common stock
|
(2,210
|
)
|
|
—
|
|
|
—
|
|
|
Proceeds from exercises of stock options
|
—
|
|
|
1,715
|
|
|
251
|
|
|
Net cash used in financing activities
|
(19,721
|
)
|
|
(122,817
|
)
|
|
(101,729
|
)
|
|
Net increase (decrease) in cash and cash equivalents
|
17,497
|
|
|
(42,837
|
)
|
|
(39,767
|
)
|
|
Cash and cash equivalents, beginning of year
|
116,636
|
|
|
134,133
|
|
|
91,296
|
|
|
Cash and cash equivalents, end of year
|
$
|
134,133
|
|
|
$
|
91,296
|
|
|
$
|
51,529
|
|
The accompanying notes are an integral part of these financial statements.
EARTHLINK HOLDINGS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Organization
EarthLink Holdings Corp. (“EarthLink” or the “Company”), together with its consolidated subsidiaries, is a leading managed network, security and cloud services provider to business and residential customers in the United States. The Company provides a broad range of data, voice and managed network services to retail and wholesale business customers. The Company also provides nationwide Internet access and related value-added services to residential customers. The Company operates an extensive network including more than
29,000
route fiber miles and
90
metro fiber rings. Through its owned and leased facilities, the Company provides data and voice IP service coverage across more than
90 percent
of the United States. The Company operates
four
reportable segments aligned around distinct customer categories: Enterprise/Mid-Market, Small Business, Carrier/Transport and Consumer. For further information concerning the Company’s reportable segments, see Note 18, “Segment Information.”
On November 5, 2016, the Company entered into a definitive merger agreement with Windstream Holdings, Inc. (“Windstream”) under which the Company and Windstream will merge in an all-stock transaction valued at approximately
$1.1 billion
. Under the terms of the merger agreement, EarthLink’s shareholders will receive
0.818
shares of Windstream common stock for each EarthLink share owned. Upon closing of the transaction, Windstream shareholders will own approximately
51%
and EarthLink shareholders will own approximately
49%
of the combined company. The transaction was approved by the EarthLink and Windstream shareholders on February 24, 2017. The transaction remains subject to customary closing conditions and is expected to close in the first quarter of 2017.
2.
Summary of Significant Accounting Policies
Basis of Consolidation
The consolidated financial statements of EarthLink include the accounts of its wholly-owned subsidiaries. All significant intercompany transactions have been eliminated.
Use of Estimates
The preparation of financial statements in conformity with U.S. generally accepted accounting principles ("GAAP") requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and the disclosure of contingent assets and liabilities in the consolidated financial statements and accompanying footnotes. Actual results could differ from those estimates. On an ongoing basis, the Company evaluates its estimates, including, but not limited to, those related to the allowance for doubtful accounts; the useful lives of intangible assets and property and equipment; the use, recoverability, and/or realizability of certain assets, including deferred tax assets and acquired intangible assets; facility exit and restructuring liabilities; revenue reserves for billings to other carriers; expected results of disputed vendor charges for cost of revenues; stock-based compensation expense; unrecognized tax benefits; and contingent liabilities. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable.
Business Combinations
The Company accounts for business combinations by recognizing all of the assets acquired and liabilities assumed at the acquisition date fair value. Goodwill as of the acquisition date is measured as the excess of consideration transferred over the net of the acquisition date fair values of the assets acquired and the liabilities assumed. While the Company uses its best estimates and assumptions as a part of the purchase price allocation process to accurately value assets acquired and liabilities assumed at the acquisition date, the Company's estimates are inherently uncertain and subject to refinement. As a result, during the measurement period, which may be up to one year from the acquisition date, the Company records adjustments to the assets acquired and liabilities assumed, with the corresponding offset to goodwill. Upon the conclusion of the measurement period, any subsequent adjustments arising from new facts and circumstances are recorded to the Consolidated Statements of Comprehensive Income (Loss).
Cash and Cash Equivalents
Cash and cash equivalents consist of cash and highly liquid investments with original maturities of three months or less at the date of acquisition. Cash equivalents are stated at amortized cost, which approximates fair value.
EARTHLINK HOLDINGS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Accounts Receivable and Allowance for Doubtful Accounts
Accounts receivable consist principally of trade receivables from customers and are generally unsecured and due within 30 days. The Company maintains an allowance for doubtful accounts for accounts receivable that may not be collectible. In assessing the adequacy of the allowance for doubtful accounts, management considers a number of factors, including the aging of the accounts receivable balances, historical collection experience and a specific customer's ability to meet its financial obligations to the Company. If the financial condition of the Company's customers were to deteriorate, resulting in an inability to make payments, additional allowances may be required. Bad debt expense related to allowances for doubtful accounts is included in selling, general and administrative expenses in the Consolidated Statements of Comprehensive Income (Loss).
The Company's allowance for doubtful accounts was
$3.5 million
and
$3.0 million
as of
December 31, 2015 and 2016
, respectively. The Company's bad debt expense was
$8.7 million
,
$6.2 million
and
$5.3 million
during the years ended
December 31, 2014, 2015 and 2016
, respectively. The Company's write-offs of uncollectible accounts were
$11.1 million
,
$8.9 million
and
$5.8 million
during the years ended
December 31, 2014, 2015 and 2016
, respectively.
Property and Equipment
Property and equipment are stated at cost less accumulated depreciation. Property and equipment acquired in connection with business combinations are recorded at acquisition date fair value. The costs of additions, replacements and substantial improvements are capitalized, while the costs of maintenance and repairs are charged to operating expense as incurred. Upon retirements or sales, the Company removes the original cost and related accumulated depreciation and any gains and losses are included in income (loss) from operations in the Consolidated Statements of Comprehensive Income (Loss). Upon impairment, the Company accelerates depreciation of the asset and such cost is included in income (loss) from operations in the Consolidated Statements of Comprehensive Income (Loss).
Depreciation expense is determined using the straight-line method over the estimated useful lives of the various asset classes. Leasehold improvements are depreciated using the straight-line method over the shorter of the estimated useful life or the remaining term of the lease. When leases are extended, the remaining useful lives of leasehold improvements are increased as appropriate, but not for a period in excess of the remaining lease term. The estimated useful lives of property and equipment are as follows:
|
|
|
|
|
|
|
Buildings
|
|
20–40 years
|
|
Communications and fiber optic network
|
|
5–20 years
|
|
Computer equipment and software
|
|
3–5 years
|
|
Office and other equipment
|
|
3–5 years
|
|
Customer acquisition costs
|
|
3 years
|
|
Leasehold improvements
|
|
Shorter of estimated useful life or lease term
|
The Company capitalizes costs directly related to the design, deployment and expansion of its network and operating support systems, including employee-related costs. The Company also capitalizes customer installation and acquisition costs related to certain business customers to the extent they are recoverable. Customer installation costs represent nonrecurring fees paid to other telecommunications carriers for services performed by the carriers when the Company orders last mile facilities in connection with new customers acquired by the Company. Customer acquisition costs include external and internal personnel costs directly associated with the provisioning of new customer orders. Such customer acquisition costs represent incremental direct costs incurred by the Company that would not have been incurred absent a new customer contract. Customer installation and acquisition costs are amortized over the weighted average initial contract terms of contracts initiated each month, assuming a customer churn factor.
Goodwill and Other Intangible Assets
Goodwill is the excess of the purchase price over the fair value of identifiable net assets acquired in business combinations accounted for under the acquisition method of accounting. The Company does not amortize goodwill. The Company tests its goodwill annually during the fourth quarter of its fiscal year or when events and circumstances indicate that those assets might not be recoverable. Impairment testing of goodwill is required at the reporting unit level (operating segment or one level below operating segment) and involves a two-step process. Prior to performing the two-step impairment test, the Company may make a qualitative assessment of the likelihood of goodwill impairment in order to determine whether a detailed quantitative analysis is required. The first step of the impairment test involves comparing the estimated fair values of the Company's reporting units with the reporting units' carrying amounts, including goodwill. The Company estimates the fair value of its reporting units using discounted expected future
EARTHLINK HOLDINGS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
cash flows. If the carrying amount of the reporting unit exceeds its fair value, a second step is performed to compare the carrying amount of goodwill to the implied fair value of that goodwill. If the carrying amount of goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized in an amount equal to the excess.
Other intangible assets consist of customer relationships, developed technology and software, trade names and other assets acquired in conjunction with the purchases of businesses or purchases of assets from other companies. When management determines material intangible assets are acquired in conjunction with the purchase of a business, the Company determines the fair values of the identifiable intangible assets by taking into account management's own analysis and an independent third party valuation specialist's appraisal. Intangible assets determined to have definite lives are amortized over their estimated useful lives.
Long-Lived Assets
The Company evaluates the recoverability of long-lived assets, including property and equipment and definite-lived intangible assets, for impairment when events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Conditions that would necessitate an impairment assessment include a significant decline in the observable market value of an asset, a significant change in the extent or manner in which an asset is used or a significant adverse change that would indicate the carrying amount of an asset or group of assets is not recoverable. For long-lived assets to be held and used, the Company recognizes an impairment loss if its carrying amount is not recoverable through its undiscounted cash flows and measures the impairment loss, if any, based on the difference between the carrying amount and fair value. Long-lived assets held for sale are reported at the lower of cost or fair value less costs to sell. During the year ended December 31, 2014, the Company recorded
$14.3 million
for impairment of long-lived assets, which consisted of impairment of work in progress for information technology projects not expected to be used, impairment of software licenses not expected to be used and impairment of certain assets held for sale. The impairment loss is classified within impairment of long-lived assets in the Consolidated Statement of Comprehensive Loss.
Leases
The Company categorizes leases at their inception as either operating or capital leases depending on certain criteria. Certain of the Company's operating lease agreements include scheduled rent escalations or rent holidays over the term of the lease. The Company recognizes rent expense on a straight-line basis over the term of the lease. The difference between rent expense and rent paid is recorded as deferred rent and included in other accrued liabilities in the Consolidated Balance Sheets. Incentives granted under certain leases are treated as a reduction of the Company's rent expense on a straight-line basis over the term of the related lease agreement. Leasehold improvements funded by the lessor under operating leases are recorded as leasehold improvements and deferred rent.
Asset Retirement Obligations
The Company has asset retirement obligations associated with certain assets within leased facilities that the Company is contractually obligated to restore to their previous condition upon exit from the lease. The fair value of the obligation is also capitalized as property and equipment and amortized over the estimated useful life of the associated asset over the shorter of estimated useful life or lease term. The Company's asset retirement obligations were
$3.3 million
and
$2.9 million
as of
December 31, 2015 and 2016
, respectively, and are included in other long-term liabilities in the Consolidated Balance Sheets.
Revenue Recognition
General.
The Company recognizes revenue when persuasive evidence of an arrangement exists, services have been provided or products have been delivered, the sales price is fixed or determinable and collectibility is reasonably assured. The Company's customers generally are billed in advance for their services, and revenue is recognized ratably over the service period. Advance billings from customers for invoiced services that have not yet been performed are recorded as deferred revenue in the Consolidated Balance Sheets.
The Company generates revenues by providing a broad range of data, voice and managed network services to business and residential customers. The Company’s revenues primarily consist of the following:
|
|
|
|
•
|
Monthly recurring charges for providing data, voice and managed network services; transmission capacity; and Internet access and related value-added services;
|
|
|
|
|
•
|
Equipment revenues; and
|
|
|
|
|
•
|
Non-recurring and other revenues, such as installation fees, termination fees and administrative fees.
|
EARTHLINK HOLDINGS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Multiple element arrangements.
Revenues may be part of multiple element arrangements, such as equipment sold with data and voices services. For multiple element arrangements, the Company separates deliverables into units of accounting and recognizes revenue for each unit of accounting based on evidence of each unit's relative selling price to the total arrangement consideration, assuming all other revenue recognition criteria have been met, limited to amounts currently billable under the terms of the Company's contracts. Each deliverable is considered a separate unit of accounting if the delivered item has stand-alone value to the customer. The Company uses a hierarchy to determine the selling price to be used for allocating revenue to deliverables: 1) the price the Company sells the same unit for when the Company sells it separately; 2) the price another vendor would sell a generally interchangeable item; or 3) the Company's best estimate of the stand-alone price.
Gross versus net revenue recognition.
The Company offers certain services that are provided by third-party vendors. When the Company is the primary obligor in a transaction, has latitude in establishing prices, is the party determining the service specifications or has several but not all of these indicators, the Company records the revenue on a gross basis. If the Company is not the primary obligor and/or a third-party vendor has latitude in establishing prices, the Company records revenue associated with the related subscribers on a net basis, netting the cost of revenue associated with the service against the gross amount billed to the customer.
Activation and installation.
When the Company receives service activation and installation fee revenues in advance of the provision of services, the Company defers the service activation and installation fee revenues and amortizes them over the weighted average initial contract terms of contracts initiated each month, assuming a customer churn factor. The costs associated with such activation and installation activities are deferred and recognized as operating expense over the same period to the extent they are recoverable based on future revenues.
Sales credit reserves.
The Company makes estimates for potential future sales credits to be issued in respect of earned revenues, related to billing errors, service interruptions and customer disputes which are recorded as a reduction in revenue. The Company analyzes historical credit activity and changes in customer demands related to current billing and service interruptions when evaluating its credit reserve requirements. The Company reserves known billing errors and service interruptions as incurred. The Company reviews customer disputes and reserves against those the Company believes to be valid claims. The Company also estimates a sales credit reserve related to unknown billing errors and disputes based on historical credit activity. Experience indicates that the invoices that are provided to other telecommunications providers are often subject to significant billing disputes. Experience also has shown that these disputes can require a significant amount of time to resolve given the complexities and regulatory issues surrounding the customer relationships.
Taxes Collected from Customers and Remitted to Governmental Authorities
The Company records all taxes billed to its customers and remitted to governmental authorities, including Universal Service Fund contributions and sales, use and excise taxes, on a net basis in the Consolidated Statements of Comprehensive Income (Loss).
Cost of Revenues
Cost of revenues includes costs directly associated with providing products and services to the Company's customers. Cost of revenues does not include depreciation and amortization expense. Cost of revenues includes the cost of connecting customers to the Company's networks via leased facilities; the costs of leasing components of its network facilities; costs paid to third-party providers for interconnect access and transport services; fees paid to suppliers of our value-added services; fees paid to content providers for information provided on online properties; and the cost of equipment sold to customers. The Company utilizes other carriers to provide services where the Company does not have facilities. The Company utilizes a number of different carriers to terminate its long distance calls outside of its network.
These costs include an estimate of charges for which invoices have not yet been received, and are based upon the estimated number of transmission lines and facilities in service, estimated minutes of use and estimated amounts accrued for pending disputes with other carriers, as well as upon the contractual rates charged by the Company's service providers. Subsequent adjustments to these estimates may occur after the bills are received for the actual costs incurred, but these adjustments generally are not expected to be material to operating results. Experience indicates that the invoices that are received from other telecommunications providers are often subject to significant billing disputes. Experience also has shown that these disputes can require a significant amount of time to resolve given the complexities and regulatory issues affecting the vendor relationships. The Company maintains reserves for any anticipated exposure associated with these billing disputes. The reserves are reviewed on a monthly basis, but are subject to changes in estimates and management judgment as new information becomes available. Given the length of time the Company
EARTHLINK HOLDINGS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
has historically required to resolve these disputes, disputes may be resolved or require adjustment in future periods and relate to costs invoiced, accrued or paid in prior periods. The Company believes its reserves for billing disputes are adequate.
Selling, General and Administrative Expense
The Company's selling, general and administrative expenses consist of expenses related to sales and marketing, customer service, network operations, information technology, regulatory, billing and collections, corporate administration, and legal and accounting. Such costs include salaries and related employee costs (including stock-based compensation), outsourced labor, professional fees, property taxes, travel, insurance, rent, advertising and other administrative expenses.
Advertising Costs
Advertising costs are expensed as incurred and included in selling, general and administrative expense in the Consolidated Statements of Comprehensive Income (Loss). Advertising expenses were
$7.8 million
,
$5.6 million
and
$5.8 million
during the years ended
December 31, 2014, 2015 and 2016
, respectively.
Stock-Based Compensation
As of
December 31, 2016
, the Company had various stock-based compensation plans, which are more fully described in Note 11, "Stock-Based Compensation." The Company measures compensation cost for all stock awards at fair value on the date of grant and recognizes compensation expense over the requisite service period for awards expected to vest. The Company estimates the fair value of stock options using the Black-Scholes valuation model, and determines the fair value of restricted stock units based on the quoted price of EarthLink’s common stock on the date of grant
.
Such value is recognized as expense over the requisite service period, net of estimated forfeitures, using the straight-line attribution method. For performance-based awards, the Company recognizes expense over the requisite service period, net of estimated forfeitures, using the accelerated attribution method when it is probable that the performance measure will be achieved. The estimate of awards that will ultimately vest requires significant judgment, and to the extent actual results or updated estimates differ from the Company’s current estimates, such amounts will be recorded as a cumulative adjustment in the period estimates are revised. The Company considers many factors when estimating expected forfeitures, including types of awards, employee class and historical employee attrition rates. Actual results, and future changes in estimates, may differ substantially from the Company’s current estimates.
Contingencies
The Company is party to various legal proceedings and other disputes arising in the normal course of business, including, but not limited to, regulatory audits, E911 payments, trademark and patent infringement, billing disputes, rights of access, tax, consumer protection, employment and tort. The Company accrues for such matters when it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated. When it is probable that a liability has been incurred and there is a range of expected loss for which no amount in the range is more likely than any other amount, the Company accrues at the low end of the range. The Company reviews its accruals each reporting period.
Restructuring, Acquisition and Integration-Related Costs
Restructuring, acquisition and integration-related costs consist of costs related to the Company's restructuring, acquisition and integration-related activities. Restructuring, acquisition and integration-related costs are expensed in the period in which the costs are incurred and the services are received. Restructuring, acquisition and integration-related costs include the following:
|
|
|
|
•
|
Integration-related costs, such as system conversion and integration-related consulting and employee costs. The Company is also undertaking a long-term network optimization project designed to consolidate traffic onto network facilities operated by the Company and reduce the usage of other carriers’ networks. Integration-related costs associated with this initiative include costs to migrate traffic to lower cost circuits and to terminate existing contracts prior to their expiration;
|
|
|
|
|
•
|
Severance, retention and other employee termination costs associated with acquisition and integration activities and as a result of evaluations of our operating structure;
|
|
|
|
|
•
|
Facility-related costs, such as lease termination and asset impairments; and
|
|
|
|
|
•
|
Transaction-related costs, which are direct costs incurred to effect a business combination, such as advisory, legal, accounting, valuation and other professional fees.
|
The Company recognizes a liability for costs associated with an exit or disposal activity when the liability is incurred. Facility exit and restructuring liabilities include estimates for, among other things, severance payments and amounts due under lease obligations, net of estimated sublease income, if any. Key variables in determining lease estimates include operating expenses due under lease arrangements, the timing and amounts of sublease rental payments, tenant improvement costs and brokerage and other related
EARTHLINK HOLDINGS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
costs. The Company periodically evaluates and, if necessary, adjusts its estimates based on currently-available information. Such adjustments are classified as restructuring, acquisition and integration-related costs in the Consolidated Statements of Comprehensive Income (Loss).
Post-Employment Benefits
Post-employment benefits primarily consist of the Company's severance plans. When the Company has either a formal severance plan or a history of consistently providing severance benefits representing a substantive plan, the Company recognizes severance costs when they are both probable and reasonably estimable.
Interest Expense and Other, Net
Interest expense and other, net, is comprised of interest expense incurred on the Company's debt and capital leases; amortization of debt issuance costs and debt discounts; interest earned on the Company's cash and cash equivalents; and other miscellaneous income and expense items. The following table presents the Company's interest expense and other, net, during the years ended
December 31, 2014, 2015 and 2016
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
|
2014
|
|
2015
|
|
2016
|
|
|
|
(in thousands)
|
|
Interest expense
|
|
$
|
56,382
|
|
|
$
|
49,979
|
|
|
$
|
40,711
|
|
|
Other, net
|
|
(121
|
)
|
|
993
|
|
|
(51
|
)
|
|
Interest expense and other, net
|
|
$
|
56,261
|
|
|
$
|
50,972
|
|
|
$
|
40,660
|
|
Income Taxes
The Company recognizes deferred tax assets and liabilities for the estimated future tax consequences attributable to differences between the financial reporting and tax bases of existing assets and liabilities. Deferred tax assets and liabilities are measured using tax rates in effect for the year in which the temporary differences are expected to reverse. A valuation allowance is recorded to reduce the carrying amounts of deferred tax assets if it is "more-likely-than-not" that those assets will not be realized. The Company considers many factors when assessing the likelihood of future realization, including the Company's recent cumulative earnings experience by taxing jurisdiction, expectations of future taxable income, prudent and feasible tax planning strategies that are available, the carryforward periods available to the Company for tax reporting purposes and other relevant factors.
The Company records a liability for unrecognized tax benefits resulting from uncertain tax positions taken or expected to be taken in a tax return. The Company recognizes interest and penalties, if any, related to unrecognized tax benefits as income tax (provision) benefit in the Consolidated Statements of Comprehensive Income (Loss).
Discontinued Operations
The operating results of the Company's telecom systems business acquired as part of ITC^DeltaCom ("ITC^DeltaCom") have been separately presented as discontinued operations for all periods presented. On August 2, 2013, the Company sold its telecom systems business. The Company has no significant continuing involvement in the operations or significant continuing direct cash flows. The telecom systems results of operations were previously included in the Company's legacy Business Services segment.
The following table presents summarized results of operations related to discontinued operations for the year ended December 31, 2014:
|
|
|
|
|
|
|
|
|
Year Ended
|
|
|
December 31, 2014
|
|
|
(in thousands)
|
|
Revenues
|
$
|
116
|
|
|
Operating costs and expenses
|
(497
|
)
|
|
Loss from discontinued operations, net of tax
|
$
|
(381
|
)
|
EARTHLINK HOLDINGS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Earnings per Share
Basic earnings per share represents net loss divided by the weighted average number of common shares outstanding during the reported period. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock, including stock options and restricted stock units (collectively "Common Stock Equivalents"), were exercised or converted into common stock. The dilutive effect of outstanding stock options and restricted stock units is reflected in diluted earnings per share by application of the treasury stock method. In applying the treasury stock method for stock-based compensation arrangements, the assumed proceeds are computed as the sum of the amount the employee must pay upon exercise, the amount of compensation cost attributed to future services and not yet recognized and the amount of excess tax benefits, if any, that would be credited to additional paid-in capital assuming exercise of the awards.
Certain Risks and Concentrations
Credit Risk
. Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of cash and cash equivalents and trade receivables. Accounts receivable are typically unsecured and are derived from revenues earned from customers primarily located in the U.S. Credit risk with respect to trade receivables is limited because a large number of geographically diverse customers make up the customer base. Additionally, the Company maintains allowances for potential credit losses. As of
December 31, 2015 and 2016
, no customer accounted for more than
10%
of gross accounts receivable.
Supply Risk
. The Company's business depends on the availability, capacity, affordability, reliability and security of third-party network service providers. Only a small number of providers offer the network services the Company requires, and the majority of its network services are currently purchased from a limited number of network service providers. Although management believes that alternate network providers could be found in a timely manner, any disruption of these services could have a material adverse effect on the Company's financial position, results of operations and cash flows.
Fair Value of Financial Instruments
The carrying amounts of the Company's cash, cash equivalents, trade receivables and trade payables approximate their fair values because of their nature and respective durations.
Recently Issued Accounting Pronouncements
Revenue Recognition
. In May 2014, the Financial Accounting Standards Board (the "FASB") issued authoritative guidance on revenue from contracts with customers. The new guidance outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. The core principle of the revenue model is that an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The new standard requires significantly expanded disclosures about revenue contract assets and liabilities. The new standard also includes new accounting principles related to the deferral and amortization of contract acquisition and fulfillment costs. In August 2015, the FASB issued guidance that deferred the effective date by one year. The standard is now required to be adopted by public business entities in annual periods beginning on or after December 15, 2017, and interim periods within those annual periods, and may be applied on a full retrospective or modified retrospective approach. Early adoption at the original effective date is permitted.
The Company has elected to adopt the standard in the first quarter of the fiscal year ending December 31, 2018 utilizing the modified retrospective basis. The Company has established a cross-functional team to implement the standard and in the process of implementing changes to its systems, processes and internal controls to meet the standard's reporting and disclosure requirements. While the Company has not fully quantified the effects of the standard on its consolidated financial statements, the Company has determined that the requirement to defer incremental contract acquisition costs, including sales commissions, and recognize such costs over the contract period or expected customer life will result in the recognition of a deferred charge within the Company's consolidated balance sheets. The Company is continuing to evaluate the impact of the implementation of this standard on its financial statements.
Going Concern
. In August 2014, the FASB issued authoritative guidance related to the disclosure of uncertainties about an entity's ability to continue as a going concern. The new guidance requires management to evaluate whether there are conditions and events that raise substantial doubt about the entity’s ability to continue as a going concern within one year after the financial statements and to provide related footnote disclosures if so. The new standard is effective for fiscal years ending after December 31, 2016,
EARTHLINK HOLDINGS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
and annual and interim periods thereafter. Early adoption is permitted. The Company adopted this standard in the fourth quarter of 2016. The adoption did not have a material impact on the Company's financial statements.
Leases
. In February 2016, the FASB issued authoritative guidance on accounting for leases. The new guidance requires the recognition of lease assets and lease liabilities by lessees for those leases classified as operating leases. As of the lease commencement date, a lessee is required to recognize a liability for its lease obligation (initially measured at the present value of the future lease payments not yet paid over the lease term) and an asset for its right to use the underlying asset equal to the lease liability, adjusted for lease payments made at or before lease commencement, lease incentives, and any initial direct costs. The new standard is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. Early adoption is permitted. The Company is evaluating the impact of the implementation of this standard on its financial statements.
Share-Based Payments
. In March 2016, the FASB issued authoritative guidance, which simplifies several aspects of the accounting for employee share-based payment transactions, including the accounting for income taxes, forfeitures and statutory tax withholding requirements, as well as classification in the statement of cash flows. The new standard is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2016. Early adoption is permitted. The Company is evaluating the impact of the implementation of this standard on its financial statements.
Statement of Cash Flows
. In August 2016, the FASB issued authoritative guidance that clarifies how entities should classify certain cash receipts and cash payments on the statement of cash flows with the objective of reducing the existing diversity in practice related to eight specific cash flow issues. The new standard is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2017. Early adoption is permitted. The Company does not expect the adoption of this standard to have a material impact on its financial statements.
Restricted Cash
. In November 2016, the FASB issued authoritative guidance that requires restricted cash to be included in the cash and cash equivalents balance in the statement of cash flows. An entity is required to reconcile total cash, cash equivalents and restricted cash in the statement of cash flows to the amounts in the balance sheet and disclose the nature of the restricted cash balances. The new standard is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2017. Early adoption is permitted. The Company does not expect the adoption of this standard to have a material impact on its financial statements.
Goodwill
. In January 2017, the FASB issued authoritative guidance that simplifies the accounting for goodwill impairments by eliminating Step 2 from the goodwill impairment test. Instead, if "the carrying amount of a reporting unit exceeds its fair value, an impairment loss shall be recognized in an amount equal to that excess, limited to the total amount of goodwill allocated to that reporting unit." The new standard is effective for annual and any interim impairment tests for periods beginning after December 15, 2019. Early adoption is allowed for all entities as of January 1, 2017, for annual and any interim impairment tests occurring after January 1, 2017.
EARTHLINK HOLDINGS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
3. Earnings Per Share
The following table presents the computation for basic and diluted net income (loss) per share for the years ended
December 31, 2014, 2015 and 2016
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
2014
|
|
2015
|
|
2016
|
|
|
(in thousands, except per share data)
|
|
Numerator
|
|
|
|
|
|
|
|
Income (loss) from continuing operations
|
$
|
(72,371
|
)
|
|
$
|
(43,210
|
)
|
|
$
|
7,680
|
|
|
Loss from discontinued operations, net of tax
|
(381
|
)
|
|
—
|
|
|
—
|
|
|
Net income (loss)
|
$
|
(72,752
|
)
|
|
$
|
(43,210
|
)
|
|
$
|
7,680
|
|
|
|
|
|
|
|
|
|
|
Denominator
|
|
|
|
|
|
|
Basic weighted average common shares outstanding
|
102,313
|
|
|
103,388
|
|
|
105,194
|
|
|
Dilutive effect of Common Stock Equivalents
|
—
|
|
|
—
|
|
|
3,402
|
|
|
Diluted weighted average common shares outstanding
|
102,313
|
|
|
103,388
|
|
|
108,596
|
|
|
|
|
|
|
|
|
|
Basic net income (loss) per share
|
|
|
|
|
|
|
Continuing operations
|
$
|
(0.71
|
)
|
|
$
|
(0.42
|
)
|
|
$
|
0.07
|
|
|
Discontinued operations
|
—
|
|
|
—
|
|
|
—
|
|
|
Basic net income (loss) per share
|
$
|
(0.71
|
)
|
|
$
|
(0.42
|
)
|
|
$
|
0.07
|
|
|
|
|
|
|
|
|
|
Diluted net income (loss) per share
|
|
|
|
|
|
|
Continuing operations
|
$
|
(0.71
|
)
|
|
$
|
(0.42
|
)
|
|
$
|
0.07
|
|
|
Discontinued operations
|
—
|
|
|
—
|
|
|
—
|
|
|
Diluted net income (loss) per share
|
$
|
(0.71
|
)
|
|
$
|
(0.42
|
)
|
|
$
|
0.07
|
|
The Company has not included the effect of Common Stock Equivalents in the calculation of diluted earnings per share for the years ended December 31, 2014 and 2015 because such inclusion would have an anti-dilutive effect due to the Company's net loss. As of December 31, 2014 and 2015, the Company had
8.3 million
and
8.7 million
stock options and restricted stock units outstanding, respectively, which were excluded from the determination of dilutive earnings per share. During the year ended December 31, 2016, approximately
0.7 million
stock options and restricted stock units were excluded from the calculation of diluted earnings per share because their effect would have been anti-dilutive. Anti-dilutive securities could be dilutive in future periods.
4.
Acquisition
On July 13, 2016, the Company acquired Boston Retail Partners, LLC (“BRP”), a privately-held management consulting firm focused on the retail industry, for initial consideration of approximately
$11.7 million
, plus possible earn-out payments which could increase the purchase price by up to
$5.6 million
. The primary purpose of the transaction was to provide additional professional services capabilities in connection with the Company's strategy to be a leading managed network, security and cloud services provider for multi-location retail and service businesses.
The acquisition was accounted for as a business combination. The assets acquired and liabilities assumed of BRP were recognized at their acquisition date fair values. In allocating the purchase price based on estimated fair values, EarthLink recorded approximately
$7.9 million
of goodwill,
$3.4 million
of identifiable intangible assets,
$1.5 million
of net other assets and a
$1.1 million
liability for possible earn-out payments. The allocation of the consideration transferred was based upon a preliminary valuation and the Company’s estimates and assumptions are subject to change. The primary areas of the preliminary purchase price allocation that are not yet finalized relate to working capital adjustments, the fair value of intangible assets, income and non-income based taxes and residual goodwill. EarthLink has included the financial results of BRP in its consolidated financial statements from the date
EARTHLINK HOLDINGS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
of acquisition. Pro forma financial information for BRP has not been presented, as the effects were not material to the Company's consolidated financial statements.
5. Sale of Businesses
On February 1, 2016, the Company sold certain assets related to its IT services product offerings. The primary purpose of the sale was to simplify operations and provide more flexibility to invest in new capabilities and services to drive growth in the Company's core business. The purchase price in the transaction was
$29.6 million
, subject to post-closing contingencies that could increase or decrease the purchase price by up to
$5.0 million
. The Company received
$26.6 million
of cash. The other
$3.0 million
of consideration was deposited into an escrow account to fund potential indemnification obligations. The Company recognized a pretax gain of
$6.3 million
and recorded a
$2.0 million
deferred gain for contingent consideration. The gain is included in gain on sale of businesses in the Consolidated Statement of Comprehensive Income (Loss). The carrying amount of the IT services assets was
$17.5 million
, which included
$11.4 million
of property and equipment,
$2.3 million
of goodwill,
$3.5 million
of other intangible assets and
$0.3 million
of other assets and liabilities. Total revenue of the Company's IT services business was approximately
$45.4 million
,
$45.1 million
and
$3.4 million
, respectively, during the years ended
December 31, 2014, 2015 and 2016
. The sale of the IT services business did not represent a strategic shift in the Company's business nor did it have a major effect on the Company's consolidated results of operations, financial position or cash flows, and accordingly, did not qualify for reporting as a discontinued operation. The IT services business was previously included in the Company's Enterprise/Mid-Market and Small Business segments.
On July 15, 2016, the Company sold approximately 12,000 consumer customer relationships to one of its network providers for
$3.8 million
of cash and recognized a pretax gain of
$2.8 million
. The gain is included in gain on sale of businesses in the Consolidated Statement of Comprehensive Income (Loss). The carrying amount of the disposed assets was
$1.0 million
. The customer relationships were previously included in the Company's Consumer segment.
6. Property and Equipment
The Company's property and equipment consisted of the following as of
December 31, 2015 and 2016
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2015
|
|
December 31, 2016
|
|
|
|
(in thousands)
|
|
Communications and fiber optic networks
|
|
$
|
619,699
|
|
|
$
|
634,936
|
|
|
Computer equipment and software
|
|
278,139
|
|
|
255,055
|
|
|
Land and buildings
|
|
42,477
|
|
|
42,623
|
|
|
Leasehold improvements
|
|
29,407
|
|
|
26,237
|
|
|
Office and other equipment
|
|
15,688
|
|
|
14,906
|
|
|
Work in progress
|
|
13,786
|
|
|
11,401
|
|
|
Property and equipment, gross
|
|
999,196
|
|
|
985,158
|
|
|
Less accumulated depreciation
|
|
(626,692
|
)
|
|
(654,039
|
)
|
|
Property and equipment, net
|
|
$
|
372,504
|
|
|
$
|
331,119
|
|
Depreciation expense, which includes amortization of property under capital leases, was
$123.7 million
,
$122.2 million
and
$112.4 million
for the years ended
December 31, 2014, 2015 and 2016
, respectively.
During the year ended December 31, 2016, the Company wrote-off, retired or impaired property and equipment that had a cost basis and accumulated depreciation of
$64.9 million
.
EARTHLINK HOLDINGS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
7.
Goodwill and Other Intangible Assets
Goodwill
The following table presents changes in the carrying amount of goodwill by operating segment during the year ended
December 31, 2016
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Enterprise/
|
|
Small
|
|
Carrier/
|
|
|
|
|
|
|
Mid-Market
|
|
Business
|
|
Transport
|
|
Consumer
|
|
Total
|
|
|
(in thousands)
|
|
Balance as of December 31, 2015
|
|
|
|
|
|
|
|
|
|
|
Goodwill
|
$
|
237,982
|
|
|
$
|
57,137
|
|
|
$
|
98,290
|
|
|
$
|
88,920
|
|
|
$
|
482,329
|
|
|
Accumulated impairment loss
|
(208,443
|
)
|
|
(50,045
|
)
|
|
(86,090
|
)
|
|
—
|
|
|
(344,578
|
)
|
|
|
29,539
|
|
|
7,092
|
|
|
12,200
|
|
|
88,920
|
|
|
137,751
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Goodwill acquired
|
7,947
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
7,947
|
|
|
Goodwill disposed
|
(1,516
|
)
|
|
(746
|
)
|
|
—
|
|
|
(1,025
|
)
|
|
(3,287
|
)
|
|
|
6,431
|
|
|
(746
|
)
|
|
—
|
|
|
(1,025
|
)
|
|
4,660
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance as of December 31, 2016
|
|
|
|
|
|
|
|
|
|
|
Goodwill
|
244,413
|
|
|
56,391
|
|
|
98,290
|
|
|
87,895
|
|
|
486,989
|
|
|
Accumulated impairment loss
|
(208,443
|
)
|
|
(50,045
|
)
|
|
(86,090
|
)
|
|
—
|
|
|
(344,578
|
)
|
|
|
$
|
35,970
|
|
|
$
|
6,346
|
|
|
$
|
12,200
|
|
|
$
|
87,895
|
|
|
$
|
142,411
|
|
Other Intangible Assets
The following table presents the components of the Company’s acquired identifiable intangible assets as of
December 31, 2015 and 2016
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of December 31, 2015
|
|
As of December 31, 2016
|
|
|
Gross
Carrying
Value
|
|
Accumulated
Amortization
|
|
Net
Carrying
Value
|
|
Gross
Carrying
Value
|
|
Accumulated
Amortization
|
|
Net
Carrying
Value
|
|
|
(in thousands)
|
|
Customer relationships
|
$
|
346,825
|
|
|
$
|
(323,365
|
)
|
|
$
|
23,460
|
|
|
$
|
339,858
|
|
|
$
|
(338,307
|
)
|
|
$
|
1,551
|
|
|
Developed technology and software
|
26,261
|
|
|
(24,396
|
)
|
|
1,865
|
|
|
25,311
|
|
|
(25,311
|
)
|
|
—
|
|
|
Trade names
|
1,521
|
|
|
(1,521
|
)
|
|
—
|
|
|
1,801
|
|
|
(1,564
|
)
|
|
237
|
|
|
Other
|
—
|
|
|
—
|
|
|
—
|
|
|
630
|
|
|
(58
|
)
|
|
572
|
|
|
Other intangible assets, net
|
$
|
374,607
|
|
|
$
|
(349,282
|
)
|
|
$
|
25,325
|
|
|
$
|
367,600
|
|
|
$
|
(365,240
|
)
|
|
$
|
2,360
|
|
Definite-lived intangible assets are amortized over their estimated useful lives. The Company amortizes its customer relationships using the straight-line method to match the estimated cash flow generated by such assets, and amortizes its developed technology, trade names and other intangible assets using the straight-line method because a pattern to which the expected benefits will be consumed or otherwise used up could not be reliably determined. As of
December 31, 2016
, the weighted average amortization periods were
5.3
years for customer relationships,
4.7
years for trade names and
5.0
years for other identifiable intangible assets. As a result of a change in estimate for the estimated useful lives of certain customer relationships in December 2014, the results of operations for the year ended December 31, 2015 included additional amortization expense of
$5.7 million
, or
$0.05
per share, respectively. During the year ended
December 31, 2016
, the Company sold intangible assets that had a gross carrying value of
$10.4 million
and a net carrying value of
$3.5 million
.
EARTHLINK HOLDINGS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Amortization of intangible assets, which is included in depreciation and amortization in the Consolidated Statements of Comprehensive Income (Loss), for the years ended
December 31, 2014, 2015 and 2016
was as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
2014
|
|
2015
|
|
2016
|
|
|
(in thousands)
|
|
Amortization expense
|
$
|
63,177
|
|
|
$
|
66,164
|
|
|
$
|
22,824
|
|
Based on the current amount of definite-lived intangible assets, the Company expects to record amortization expense of approximately
$0.8 million
,
$0.8 million
,
$0.5 million
,
$0.1 million
and
$0.1 million
during the years ending December 31,
2017
,
2018
,
2019
, 2020 and 2021, respectively. Actual amortization expense to be reported in future periods could differ materially from these estimates as a result of acquisitions, changes in useful lives and other relevant factors.
Impairment Tests of Goodwill and Intangible Assets
Annual Test of Goodwill
. Impairment testing of goodwill is required at the reporting unit level and involves a two-step process. However, the Company may first assess qualitative factors to determine whether it is necessary to perform the two-step quantitative goodwill impairment test. The Company elected to forgo the qualitative assessment of goodwill for its fiscal
2016
impairment test. The first step of the impairment test involves comparing the estimated fair values of the Company's reporting units with the reporting units' carrying amounts, including goodwill. The Company identified
four
reporting units for evaluating goodwill for the
2016
annual impairment test, which were Enterprise/Mid-Market, Small Business, Carrier/Transport and Consumer. Each of these reporting units constitutes a business for which discrete financial information is available and segment management regularly reviews the operating results. The Company evaluates its reporting units on an annual basis.
The Company estimated the fair values of its reporting units for its fiscal
2016
impairment test based on the income approach. This model uses significant unobservable inputs, or Level 3 inputs, as defined by the fair value hierarchy. Under the income approach, the fair value of the reporting unit was estimated based on the present value of estimated cash flows using a discounted cash flow method. The significant assumptions used in the discounted cash flow method included internal forecasts and projections developed by management for planning purposes, available industry/market data, strategic plans, discount rates and the growth rate to calculate the terminal value.
The annual impairment test during the fourth quarters of
2014
,
2015
and
2016
indicated that the fair value of the Company's reporting units exceeded their carrying values.
2015 Interim Test of Goodwill.
Prior to September 30, 2015, the Company identified two reporting units for evaluating goodwill, Business Services and Consumer Services. In connection with changes in the Company's organizational, operational and reporting structure, effective September 30, 2015, the Company identified four reporting units for evaluating goodwill: Enterprise/Mid-Market, Small Business, Carrier/Transport and Consumer. Each of these reporting units constituted a business for which discrete financial information is available and segment management regularly reviews the operating results. As a result of the change in reporting units, the Company performed an interim goodwill test immediately prior to the change in reporting units at the legacy reporting unit level and immediately after the change in reporting units at the new reporting unit level.
The Company elected to forgo the qualitative assessment of goodwill for its interim impairment tests. The Company estimated the fair values of its reporting units based on the income approach. This model uses significant unobservable inputs, or Level 3 inputs, as defined by the fair value hierarchy. Under the income approach, the fair value of the reporting unit was estimated based on the present value of estimated cash flows using a discounted cash flow method. The significant assumptions used in the discounted cash flow method included internal forecasts and projections developed by management for planning purposes, available industry/market data, strategic plans, discount rates and the growth rates to calculate the terminal value.
The interim impairment tests as of September 30, 2015 indicated that the fair value of the Company’s reporting units, both prior to the change in reporting units at the legacy reporting unit level and immediately after the change in reporting units at the new reporting unit level, exceeded their carrying values. As a result, the Company did not record any impairment of goodwill.
Definite-Lived Intangible Assets
. The Company did not record any impairment charges for its definite-lived intangible assets during the years ended
December 31, 2014, 2015 and 2016
.
EARTHLINK HOLDINGS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
8. Other Accrued Liabilities
The Company's other accrued liabilities consisted of the following as of
December 31, 2015 and 2016
:
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2015
|
|
December 31, 2016
|
|
|
(in thousands)
|
|
Accrued taxes and surcharges
|
$
|
14,663
|
|
|
$
|
13,766
|
|
|
Accrued communications costs
|
23,201
|
|
|
16,332
|
|
|
Customer-related liabilities
|
7,854
|
|
|
5,501
|
|
|
Accrued interest
|
3,822
|
|
|
2,712
|
|
|
Other
|
14,765
|
|
|
18,161
|
|
|
Total other accrued liabilities
|
$
|
64,305
|
|
|
$
|
56,472
|
|
9. Long-Term Debt and Capital Lease Obligations
The Company’s long-term debt and capital lease obligations consisted of the following as of
December 31, 2015 and 2016
:
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2015
|
|
December 31, 2016
|
|
|
(in thousands)
|
|
Senior secured notes due June 2020
|
$
|
300,000
|
|
|
$
|
300,000
|
|
|
Unamortized debt issue costs on senior secured notes due June 2020
|
(4,723
|
)
|
|
(3,654
|
)
|
|
Senior notes due May 2019
|
173,925
|
|
|
76,557
|
|
|
Unamortized discount and debt issue costs on senior notes due May 2019
|
(5,393
|
)
|
|
(1,711
|
)
|
|
Senior secured term loan
|
—
|
|
|
48,750
|
|
|
Unamortized debt issue costs on senior secured term loan
|
—
|
|
|
(541
|
)
|
|
Senior secured revolving credit facility
|
35,000
|
|
|
10,000
|
|
|
Capital lease obligations
|
13,591
|
|
|
12,501
|
|
|
Carrying value of debt and capital lease obligations
|
512,400
|
|
|
441,902
|
|
|
Less current portion of debt and capital lease obligations
|
(6,787
|
)
|
|
(4,444
|
)
|
|
Long-term debt and capital lease obligations
|
$
|
505,613
|
|
|
$
|
437,458
|
|
2016 Transactions
During the the year ended December 31, 2016, the Company redeemed
$90.0 million
aggregate principal amount of its
8.875%
Senior Notes due 2019 (the “Senior Notes”) at a redemption price equal to
102.219%
of the principal amount thereof, plus accrued and unpaid interest. The Company used
$34.0 million
of existing cash, a
$50.0 million
term loan and
$10.0 million
under its senior secured revolving credit facility to fund the redemption, call premium and accrued interest. During the year ended December 31, 2016, the Company also repurchased
$7.4 million
outstanding principal of its
8.875%
Senior Notes in the open market for
$7.4 million
, plus accrued and unpaid interest.
The Company recognized a
$4.5 million
loss on extinguishment of debt on the above transactions, consisting of the write-off of unamortized discount on debt, the write-off of debt issuance costs and payment of premium on the repurchase. The losses are included in loss on extinguishment of debt in the Consolidated Statement of Comprehensive Income (Loss). The payment of premiums is included in repayment of debt and capital lease obligations in the Consolidated Statement of Cash Flows.
During the year ended December 31, 2016, the Company repaid a total of
$45.0 million
of its senior secured revolving credit facility, and drew a total of
$20.0 million
of its senior secured revolving credit facility, for a net decrease of
$25.0 million
during the the year. On June 30, 2016, the Company refinanced its senior secured revolving credit facility. See "2016 Credit Facility" below for more information. As of December 31, 2016, the Company had
$10.0 million
outstanding under its senior secured revolving credit facility, which was classified within long-term debt and capital lease obligations.
EARTHLINK HOLDINGS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
2015 Transactions
During the year ended December 31, 2015, pursuant to terms under the indenture and authorization by the Board of Directors, the Company redeemed
$70.0 million
aggregate principal amount of its Senior Notes at a redemption price of
104.438%
of the principal amount thereof, or
$73.1 million
, plus accrued and unpaid interest. During the year ended December 31, 2015, the Company also repurchased
$56.1 million
outstanding principal of its Senior Notes in the open market for
$58.3 million
, plus accrued and unpaid interest.
The Company recognized a
$9.7 million
loss on extinguishment of debt on the above transactions during the year ended December 31, 2015, consisting of
$5.2 million
for premiums paid on the repurchase,
$2.5 million
for the write-off of unamortized discount on debt and
$2.0 million
for the write-off of unamortized debt issuance costs. The losses are included in loss on extinguishment of debt in the Consolidated Statement of Comprehensive Income (Loss). The payment of premiums is included in repayment of debt and capital lease obligations in the Consolidated Statement of Cash Flows.
During the year ended December 31, 2015, the Company drew a total of
$90.0 million
under its senior secured revolving credit facility, net of issuance costs, and repaid a total of
$55.0 million
of its senior secured revolving credit facility, for a net increase of
$35.0 million
during the the year. As of December 31, 2015, the Company had
$35.0 million
outstanding under its senior secured revolving credit facility, of which
$5.0 million
was classified within current portion of long-term debt and capital lease obligations and
$30.0 million
was classified within long-term debt and capital lease obligations.
Senior Secured Notes due June 2020
General
. In May 2013, the Company completed a private placement of
$300.0 million
aggregate principal amount of
7.375%
Senior Secured Notes due 2020 (the “Senior Secured Notes”). The Senior Secured Notes were issued at
100%
of their principal amount, resulting in gross proceeds of approximately
$300.0 million
and net proceeds of
$292.6 million
after deducting transaction fees and expenses of
$7.4 million
. The transaction fees and expenses are classified as a direct deduction of long-term debt and capital lease obligations in the Consolidated Balance Sheet and are being amortized to interest expense on a straight-line basis over the life of the Senior Secured Notes. The effective interest rate of the Senior Secured Notes is
7.73%
, which includes the stated interest rate and the transaction fees and expenses. In August 2013, in accordance with the registration rights granted to the original purchasers of the Senior Secured Notes, the Company completed an exchange offer of the privately placed Senior Secured Notes for new
7.375%
Senior Secured Notes due 2020 registered with the Securities and Exchange Commission ("SEC") with substantially identical terms to the original Senior Secured Notes.
The Senior Secured Notes accrue interest at a rate of
7.375%
per year, payable on June 1 and December 1 of each year, commencing on December 1, 2013. The Senior Secured Notes mature on June 1, 2020. No principal amount is due until June 1, 2020.
Redemption
. The Company may redeem the Senior Secured Notes, in whole or in part, (i) from June 1, 2016 until May 31, 2017 at a price equal to
105.531%
of the principal amount of the Senior Secured Notes redeemed; (ii) from June 1, 2017 until May 31, 2018 at a price equal to
103.688%
of the principal amount of the Senior Secured Notes redeemed; (iii) from June 1, 2018 until May 31, 2019 at a price equal to
101.844%
of the principal amount of the Senior Secured Notes redeemed; and (iv) from June 1, 2019 and thereafter at a price equal to
100%
of the principal amount of the Senior Secured Notes redeemed, in each case plus accrued and unpaid interest. Prior to June 1, 2016, the Company may also redeem the Senior Secured Notes, in whole or in part, at a price equal to
100%
of the aggregate principal amount of the Senior Secured Notes to be redeemed plus a make-whole premium and accrued and unpaid interest. In addition, prior to June 1, 2016, the Company may redeem up to
35%
of the aggregate principal amount of the Senior Secured Notes with the net cash proceeds of certain equity offerings at a price equal to
107.375%
of the principal amount of the Senior Secured Notes redeemed, plus accrued and unpaid interest.
Ranking and Guaranty
. The Senior Secured Notes and the related guarantees of certain of the Company’s wholly-owned subsidiaries (the “Guarantors”) senior secured obligations and rank equally with all of the Company's and the Guarantors' other senior secured indebtedness. The Senior Secured Notes and the guarantees are secured by a first-priority lien on substantially all of EarthLink's assets and the assets of the Guarantors (subject to certain exceptions and permitted liens).
Covenants
. The indenture governing the Senior Secured Notes includes covenants which, subject to certain exceptions, limit the ability of the Company and its Restricted Subsidiaries (as defined in the indenture) to, among other things, incur additional indebtedness, make certain types of restricted payments, create liens, transfer and sell assets, enter into certain transactions with
EARTHLINK HOLDINGS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
affiliates, issue or sell stock of subsidiaries, engage in sale-leaseback transactions and create restrictions on dividends or other payments by restricted subsidiaries. Upon a change of control (as defined in the indenture), the Company may be required to make an offer to repurchase the Senior Secured Notes at
101%
of their principal amount, plus accrued and unpaid interest. The indenture governing the Senior Secured Notes also contains customary events of default. As of
December 31, 2016
, the Company was in compliance with these covenants.
The indenture governing the Senior Secured Notes contains covenants regarding the Company's ability to make Restricted Payments (as defined in the indenture), including certain dividends, stock purchases, debt repayments and investments. As of
December 31, 2016
, the indenture governing the Company's Senior Secured Notes permitted approximately
$212.4 million
in Restricted Payments. The Company's ability to make Restricted Payments varies over time, and is determined, in part, by the extent that the Company's cumulative EBITDA exceeds
300%
of its cumulative interest expense.
Senior Notes due May 2019
General.
In May 2011, the Company completed a private placement of
$300.0 million
aggregate principal amount of Senior Notes. The Senior Notes were issued at
96.555%
of their principal amount, resulting in gross proceeds of approximately
$289.7 million
and net proceeds of
$280.2 million
after deducting transaction fees of
$9.5 million
. The effective interest rate of the Senior Notes is
9.83%
, which includes the stated interest rate, the original issue discount and the transaction fees. In September 2011, in accordance with the registration rights granted to the original purchasers of the Senior Notes, the Company completed an exchange offer of the privately placed Senior Notes for new
8.875%
Senior Notes due 2019 registered with the SEC with substantially identical terms to the original Senior Notes.
The Senior Notes accrue interest at a rate of
8.875%
per year, payable on May 15 and November 15 of each year, commencing on November 15, 2011. The Senior Notes mature on May 15, 2019. No principal amount is due until May 15, 2019.
Redemption.
The Company may redeem the Senior Notes, in whole or in part, (i) from May 15, 2015 until May 15, 2016 at a price equal to
104.438%
of the principal amount of the Senior Notes redeemed; (ii) from May 15, 2016 until May 15, 2017 at a price equal to
102.219%
of the principal amount of the Senior Notes redeemed; and (iii) from May 15, 2017 at a price equal to
100%
of the principal amount of the Senior Notes redeemed, in each case plus accrued and unpaid interest. Prior to May 15, 2015, the Company may also redeem the Senior Notes, in whole or in part, at a price equal to
100%
of the aggregate principal amount of the Senior Notes to be redeemed plus a make-whole premium and accrued and unpaid interest. In addition, prior to May 15, 2014, the Company was able to redeem up to
35%
of the aggregate principal amount of the Senior Notes with the net cash proceeds of certain equity offerings at a price equal to
108.875%
of the principal amount of the Senior Notes redeemed, plus accrued and unpaid interest.
Ranking and Guaranty.
The Senior Notes and the related guarantees of the Guarantors are the Company’s and the Guarantors’ unsecured senior obligations and rank equally with all of the Company’s and the Guarantors’ other senior indebtedness.
Covenants.
The indenture governing the Senior Notes includes covenants which, subject to certain exceptions, limit the ability of the Company and its Restricted Subsidiaries (as defined in the indenture) to, among other things, incur additional indebtedness, make certain types of restricted payments, incur liens on assets of the Company or the Restricted Subsidiaries, engage in asset sales and enter into transactions with affiliates. Upon a change of control (as defined in the indenture), the Company may be required to make an offer to repurchase the Notes at
101%
of their principal amount, plus accrued and unpaid interest. The indenture governing the Senior Notes also contains customary events of default. As of
December 31, 2016
, the Company was in compliance with these covenants.
The indenture governing the Senior Notes contains covenants regarding the Company's ability to make Restricted Payments (as defined in the indenture), including certain dividends, stock purchases, debt repayments and investments. As of
December 31, 2016
, the indenture governing the Company's Senior Notes permitted approximately
$340.6 million
in Restricted Payments. The Company's ability to make Restricted Payments varies over time, and is determined, in part, by the extent that the Company's cumulative EBITDA exceeds
300%
of its cumulative interest expense.
EARTHLINK HOLDINGS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
2016 Credit Facility
General.
In June 2016, the Company entered into a second amended and restated credit agreement (the “Credit Agreement”) providing for a new senior secured revolving credit facility with aggregate revolving commitments of up to
$125.0 million
and an up to
$50.0 million
delayed draw senior secured term loan (together, the "Credit Facility"). The senior secured revolving credit facility replaced the Company’s previous
$135.0 million
senior secured credit facility. The Company paid
$2.5 million
of transaction fees and expenses related to the new Credit Facility, which are being amortized to interest expense over the life of the Credit Facility. The payment of transaction fees is included in proceeds from issuance of debt, net of issuance costs, in the Consolidated Statement of Cash Flows. The Company wrote-off
$0.2 million
of unamortized debt issuance costs related to the previous
$135.0 million
senior secured revolving credit facility. The loss is included in loss on extinguishment of debt in the Consolidated Statements of Comprehensive Income (Loss).
Commitment fees and borrowing costs under this facility vary and are based the Company’s most recent Consolidated Leverage Ratio (as defined in the Credit Agreement). As of
December 31, 2016
, the Company’s Commitment Fee was
0.5%
and the Company’s borrowing cost was LIBOR plus
3.25%
for LIBOR Rate Loans and the Base Rate plus
2.25%
for Base Rate Loans. As of
December 31, 2016
, the interest rate on the Company's senior secured revolving credit facility and term loan was
4.06%
. As of
December 31, 2016
,
$1.4 million
of letters of credit were outstanding under the facility’s Letter of Credit Sublimit.
The amended and restated credit facility matures on June 30, 2021 and all amounts outstanding thereunder shall be due and payable in full, except that if the Company's Senior Secured Notes have not been repaid in full by February 29, 2020, the maturity date will be February 29, 2020. The term loan is subject to quarterly amortization of principal, commencing with the first fiscal quarter ending after the term loan is funded, as set forth as follows with the remaining outstanding principal amount (and any accrued and unpaid interest) due on February 29, 2020: Year 1, 5.0%; Year 2, 5.0%; Year 3, 7.5%, Year 4, 7.5%; and Year 5, 10.0%. During the year ended
December 31, 2016
, the Company made quarterly principal payments of
$1.3 million
on the term loan.
The Credit Facility may in the future be increased by up to $50.0 million (so long as the aggregate amount of the Credit Facility does not exceed $175.0 million) with additional commitments from the current lenders or other financial institutions reasonably acceptable to the administrative agent and the satisfaction of conditions contained in the Credit Agreement.
The Company is the borrower under the Credit Facility. All obligations of the borrower under the Credit Agreement are guaranteed by each of the Company’s existing direct and indirect domestic subsidiaries and will be guaranteed by certain of the Company’s future direct and indirect domestic subsidiaries (other than immaterial subsidiaries). The obligations of the Company and the subsidiary guarantors under the Credit Facility, as well as obligations under any treasury management, interest protection or other hedging arrangements entered into with a lender (or affiliate thereof), are secured by (subject to certain liens permitted by the Credit Agreement) liens, which rank equally with the Company’s other senior secured indebtedness, on and security interests in, (i) substantially all of the Company’s and the subsidiary guarantors’ present and future personal property assets (subject to certain exclusions set forth in the Credit Agreement), (ii) certain of the Company’s and the subsidiary guarantors’ present and future real estate owned in fee simple that is required by the Credit Agreement to be mortgaged, (iii) all present and future shares of the capital stock of the Company’s and the subsidiary guarantors’ present and future subsidiaries (excluding any stock in excess of 66% of the voting stock of non-U.S. subsidiaries), and (iv) all proceeds and products of the foregoing property and assets.
Prepayment
. The Company may prepay the Credit Facility in whole or in part at any time without premium or penalty, subject to reimbursement of the lenders’ breakage and redeployment costs in the case of prepayment of LIBOR borrowings. The Company may irrevocably reduce or terminate the unutilized portion of the revolving credit facility at any time without penalty.
Covenants
. The Credit Agreement contains representations and warranties, covenants and events of default with respect to the Company and its subsidiaries that are customarily applicable to senior secured credit facilities. The negative covenants contained in the Credit Agreement include restrictions on the ability of the Company and its subsidiaries to, among other things, incur additional indebtedness, make capital expenditures, incur liens on assets, engage in certain mergers, acquisitions or divestitures, pay dividends or make other distributions, voluntarily prepay certain other indebtedness (including certain prepayments of the Company’s senior secured notes and senior notes), enter into transactions with affiliates, make investments, and change the nature of their businesses, and amend the terms of certain other indebtedness (including the Company’s existing notes), in each case subject to certain exceptions set forth in the Credit Agreement.
EARTHLINK HOLDINGS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Additionally, the Credit Agreement requires the Company to maintain a consolidated net leverage ratio of not greater than 3.5 to 1.0 (with restrictions on cash netting) and a consolidated interest coverage ratio of not less than 2.5 to 1.0. The Company was in compliance with all covenants as of
December 31, 2016
.
Financial Information Under Rule 3-10 of Regulation S-X
The Company’s Senior Notes and Senior Secured Notes (the "Notes") are fully and unconditionally guaranteed, jointly and severally, on a senior unsecured basis by each of the Company’s existing and future domestic subsidiaries, other than certain subsidiaries that are minor (the “Guarantor Subsidiaries”). All of the Guarantor Subsidiaries are
100%
owned by the Company and have, jointly and severally, fully and unconditionally guaranteed, to each holder of the Notes, the full and prompt performance of the Company’s obligations under the Notes and the indenture governing the Notes, including the payment of principal (or premium, if any) and interest on the Notes, on an equal and ratable basis. Further, the Company has no independent assets or operations, and there are no significant restrictions on the ability of its consolidated subsidiaries to transfer funds to the Company in the form of cash dividends, loans or advances. The Company’s assets consist solely of investments it has made in its consolidated subsidiaries, and its operations consist solely of changes in its investment in subsidiaries and interest associated with the Notes. Based on these facts, and in accordance with SEC Regulation S-X Rule 3-10, “Financial statements of guarantors and issuers of guaranteed securities registered or being registered,” the Company is not required to provide condensed consolidating financial information for the subsidiary guarantors.
Capital Lease Obligations
The Company maintains capital leases relating to equipment and indefeasible right-to-use fiber agreements. Minimum lease payments under capital leases as of
December 31, 2016
are as follows:
|
|
|
|
|
|
|
|
Year Ending December 31,
|
(in thousands)
|
|
2017
|
$
|
3,427
|
|
|
2018
|
3,445
|
|
|
2019
|
3,475
|
|
|
2020
|
3,298
|
|
|
2021
|
2,122
|
|
|
Thereafter
|
911
|
|
|
Total minimum lease payments
|
16,678
|
|
|
Less amounts representing interest
|
(4,177
|
)
|
|
Total capital lease obligations
|
$
|
12,501
|
|
10. Stockholders’ Equity
Share Repurchases
Since the inception of the Company’s share repurchase program, the Board of Directors has authorized a total of
$750.0 million
for the repurchase of EarthLink’s common stock. As of
December 31, 2016
, the Company had
$65.7 million
available under the current authorizations. The Company may repurchase its common stock from time to time in compliance with the SEC’s regulations and other legal requirements, including through the use of derivative transactions, and subject to market conditions and other factors. The share repurchase program does not require the Company to acquire any specific number of shares and may be terminated by the Board of Directors at any time. In addition, the agreements governing the Company’s Senior Secured Notes and Senior Notes and the Company's Credit Agreement contain restrictions on the ability of the Company to repurchase common stock.
The Company repurchased
0.7 million
of common stock under its share repurchase program for
$2.2 million
during the year ended December 31, 2014. The Company did not repurchase any common stock under its share repurchase program during the years ended December 31, 2015 or 2016.
EARTHLINK HOLDINGS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Escrow Transactions
On April 1, 2011, the Company acquired One Communications Corp. (“One Communications”), a privately-held integrated telecommunications solutions provider serving customers in the northeast, mid-Atlantic and upper midwest sections of the United States. Pursuant to the One Communications merger agreement, the Company deposited shares into an escrow account to fund certain post-closing employment obligations and to secure potential post-closing working capital and other adjustments. The following table presents shares returned from the One Communications escrow fund and recorded as treasury stock for the years ended December 31, 2014 and 2016. No shares were returned from the One Communications escrow fund during the year ended December 31, 2015. As of December 31, 2016, no claims remained outstanding and the escrow has been closed.
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
2014
|
|
2016
|
|
|
(in thousands)
|
|
Total shares returned
|
56
|
|
|
49
|
|
|
Total value of shares returned
|
$
|
258
|
|
|
$
|
292
|
|
Dividends
During the years ended
December 31, 2014, 2015 and 2016
, cash dividends declared were
$0.20
,
$0.20
and
$0.20
per common share, respectively. The Company also pays cash dividend amounts on each outstanding restricted stock unit to be paid at the time the restricted stock unit vests. Cash dividend amounts are forfeited if the restricted stock units do not vest. Total dividend payments were
$16.0 million
,
$26.4 million
and
$22.0 million
, respectively, during the years ended
December 31, 2014, 2015 and 2016
. The decision to declare future dividends is made at the discretion of the Board of Directors and will depend on, among other things, the Company’s results of operations, financial condition, cash requirements, investment opportunities and other factors the Board of Directors may deem relevant. In addition, the agreements governing the Company’s Senior Secured Notes and Senior Notes and the Company's Credit Agreement contain restrictions on the amount of dividends the Company can pay.
11. Stock-Based Compensation
Stock-based compensation expense was
$12.6 million
,
$14.6 million
and
$16.2 million
during the years ended
December 31, 2014, 2015 and 2016
, respectively. The Company has classified stock-based compensation expense within selling, general and administrative expense, the same operating expense line item as cash compensation paid to employees.
Stock Incentive Plans
The Company has granted options and restricted stock units to employees and non-employee directors to purchase the Company’s common stock under various stock incentive plans. Under the plans, employees and non-employee directors are eligible to receive awards of various forms of equity-based incentive compensation, including stock options, restricted stock, restricted stock units, phantom share units and performance awards, among others. The plans are administered by the Board of Directors or the Leadership and Compensation Committee of the Board of Directors, which determine the terms of the awards granted. Stock options are generally granted with an exercise price equal to the closing market value of EarthLink common stock on the date of grant, have a term of ten years or less, and vest over terms of four years from the date of grant. Restricted stock units are granted with various vesting terms that range from one to three years from the date of grant. The Company's various stock incentive plans provide for the issuance of a maximum of
12.0 million
shares, of which approximately
8.6 million
shares were still available for grant as of
December 31, 2016
. Upon exercise of stock options or vesting of restricted stock units, the Company will issue authorized but unissued common stock.
EARTHLINK HOLDINGS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Options Outstanding
The following table summarizes stock option activity as of and for the year ended
December 31, 2016
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock Options
|
|
Weighted
Average
Exercise
Price
|
|
Weighted
Average
Remaining
Contractual
Term (Years)
|
|
Aggregate
Intrinsic
Value
|
|
|
(shares and dollars in thousands)
|
|
Outstanding as of December 31, 2015
|
908
|
|
|
$
|
6.52
|
|
|
|
|
|
|
|
Granted
|
—
|
|
|
—
|
|
|
|
|
|
|
|
Exercised
|
(41
|
)
|
|
6.08
|
|
|
|
|
|
|
|
Forfeited and expired
|
(184
|
)
|
|
8.44
|
|
|
|
|
|
|
|
Outstanding as of December 31, 2016
|
683
|
|
|
6.04
|
|
|
6.0
|
|
$
|
201
|
|
|
Vested and expected to vest as of December 31, 2016
|
647
|
|
|
6.07
|
|
|
5.9
|
|
$
|
186
|
|
|
Exercisable as of December 31, 2016
|
444
|
|
|
6.39
|
|
|
5.6
|
|
$
|
101
|
|
The aggregate intrinsic value amounts in the table above represent the closing price of the Company’s common stock on
December 31, 2016
in excess of the exercise price, multiplied by the number of stock options outstanding, exercisable or vested and expected to vest, when the closing price is greater than the exercise price. This represents the amount that would have been received by the stock option holders if they had all exercised their stock options on
December 31, 2016
. The total intrinsic value of options exercised during the year ended December 31, 2016 was not material. The total intrinsic value of options exercised during the year ended December 31, 2015 was
$1.1 million
. There were no stock option exercises during the year ended December 31, 2014. The intrinsic value of stock options exercised represents the difference between the market value of Company’s common stock at the time of exercise and the exercise price, multiplied by the number of stock options exercised. As of
December 31, 2016
, there was
$0.1 million
of total unrecognized compensation cost related to stock options. That cost is expected to be recognized over a weighted-average period of
1.0 year
.
The following table summarizes the status of the Company’s stock options as of
December 31, 2016
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock Options Outstanding
|
|
Stock Options Exercisable
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
|
|
|
Average
|
|
Weighted
|
|
|
|
Weighted
|
|
|
|
|
|
Remaining
|
|
Average
|
|
|
|
Average
|
|
Range of
|
|
Number
|
|
Contractual
|
|
Exercise
|
|
Number
|
|
Exercise
|
|
Exercise Prices
|
|
Outstanding
|
|
Life
|
|
Price
|
|
Exercisable
|
|
Price
|
|
|
|
(in thousands)
|
|
|
|
|
|
(in thousands)
|
|
|
|
$
|
4.97
|
|
|
to
|
|
$
|
4.97
|
|
|
300
|
|
|
7.0
|
|
$
|
4.97
|
|
|
150
|
|
|
$
|
4.97
|
|
|
6.08
|
|
|
to
|
|
6.08
|
|
|
179
|
|
|
6.1
|
|
6.08
|
|
|
90
|
|
|
6.08
|
|
|
7.02
|
|
|
to
|
|
9.23
|
|
|
204
|
|
|
4.2
|
|
7.56
|
|
|
204
|
|
|
7.56
|
|
|
4.97
|
|
|
to
|
|
9.23
|
|
|
683
|
|
|
6.0
|
|
6.04
|
|
|
444
|
|
|
6.39
|
|
There were no stock options granted during the years ended December 31, 2015 and 2016. The fair value of stock options granted during the year ended December 31, 2014 was estimated using the Black-Scholes option-pricing model with the following assumptions:
|
|
|
|
|
|
|
Year Ended
|
|
|
December 31, 2014
|
|
Dividend yield
|
4.02%
|
|
Expected volatility
|
46.77%
|
|
Risk-free interest rate
|
1.60%
|
|
Expected life
|
5 years
|
EARTHLINK HOLDINGS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The weighted average grant date fair value of options granted during the year ended December 31, 2014 was
$1.48
per share. The dividend yield assumption was based on the Company's history of dividend payouts at the time of grant. The expected volatility was based on a combination of the Company's historical stock price and implied volatility. The selection of implied volatility data to estimate expected volatility was based upon the availability of prices for actively traded options on the Company's stock. The risk-free interest rate assumption was based upon the U.S. Treasury yield curve in effect at the time of grant for periods corresponding with the expected life of the option. The expected life of employee stock options represents the weighted-average period the stock options are expected to remain outstanding.
Restricted Stock Units
The following table summarizes restricted stock unit activity as of and for the year ended
December 31, 2016
:
|
|
|
|
|
|
|
|
|
|
|
|
Restricted
Stock Units
|
|
Weighted
Average
Grant Date
Fair Value
|
|
|
(in thousands)
|
|
|
|
Outstanding as of December 31, 2015
|
7,751
|
|
|
$
|
4.58
|
|
|
Granted
|
3,582
|
|
|
5.24
|
|
|
Vested
|
(2,420
|
)
|
|
4.90
|
|
|
Forfeited
|
(779
|
)
|
|
4.55
|
|
|
Outstanding as of December 31, 2016
|
8,134
|
|
|
$
|
4.77
|
|
The fair value of restricted stock units is determined based on the closing price of EarthLink’s common stock on the grant date. The weighted-average grant date fair value of restricted stock units granted during the years ended
December 31, 2014, 2015 and 2016
was
$4.14
,
$4.60
and
$5.24
, respectively. The total fair value of shares vested during the years ended
December 31, 2014, 2015 and 2016
was
$8.0 million
,
$9.2 million
and
$13.5 million
, respectively, which represents the closing price of the Company’s common stock on the vesting date multiplied by the number of restricted stock units that vested. As of
December 31, 2016
, there was
$18.7 million
of total unrecognized compensation cost related to nonvested restricted stock units. That cost is expected to be recognized over a weighted-average period of
1.8 years
.
12. Profit Sharing Plans
The Company sponsors the EarthLink Holdings Corp. 401(k) Plan ("Plan"), which qualifies as a deferred salary arrangement under Section 401(k) of the Internal Revenue Code. Under the Plan, participating employees may defer a portion of their pretax earnings up to the Internal Revenue Service annual contribution limit. The Company makes a matching contribution of
50%
of the first
6%
of base compensation that a participant contributes to the Plan. The Company's matching contributions vest over
four years
from the participant's date of hire. The Company contributed
$3.6 million
,
$3.9 million
and
$3.2 million
during the years ended
December 31, 2014, 2015 and 2016
, respectively.
13. Restructuring, Acquisition and Integration-Related Costs
Restructuring, acquisition and integration-related costs consisted of the following during the years ended
December 31, 2014, 2015 and 2016
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
2014
|
|
2015
|
|
2016
|
|
|
(in thousands)
|
|
Integration-related costs
|
$
|
9,043
|
|
|
$
|
5,924
|
|
|
$
|
8,135
|
|
|
Severance, retention and other employee costs
|
9,297
|
|
|
9,798
|
|
|
3,753
|
|
|
Facility-related costs
|
1,744
|
|
|
3,598
|
|
|
669
|
|
|
Transaction-related costs
|
4
|
|
|
—
|
|
|
5,250
|
|
|
Restructuring, acquisition and integration-related costs
|
$
|
20,088
|
|
|
$
|
19,320
|
|
|
$
|
17,807
|
|
Restructuring, acquisition and integration-related costs consist of costs related to the Company's restructuring, acquisition and integration-related activities. The Company recognizes a liability for costs associated with an exit or disposal activity when the liability is incurred. The Company recognizes severance costs when they are both probable and reasonably estimable. Restructuring, acquisition and integration-related costs include the following:
|
|
|
|
•
|
Integration-related costs, such as system conversion and integration-related consulting and employee costs. The Company is also undertaking a long-term network optimization project designed to consolidate traffic onto network facilities operated by the Company and reduce the usage of other carriers’ networks. Integration-related costs associated with this initiative include costs to migrate traffic to lower cost circuits and to terminate existing contracts prior to their expiration;
|
EARTHLINK HOLDINGS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
|
|
|
|
•
|
Severance, retention and other employee termination costs associated with acquisition and integration activities and as a result of evaluations of our operating structure;
|
|
|
|
|
•
|
Facility-related costs, such as lease termination and asset impairments; and
|
|
|
|
|
•
|
Transaction-related costs, which are direct costs incurred to effect a business combination, such as advisory, legal, accounting, valuation and other professional fees.
|
During the years ended December 31, 2014, 2015 and 2016, the Company recorded
$9.1 million
,
$13.4 million
and
$4.4 million
of restructuring costs, respectively, in connection with changes in its business strategy that resulted in reductions in workforce and the closing of certain sales offices and other facilities. Restructuring costs for the years ended December 31, 2014, 2015 and 2016 are included in restructuring, acquisition and integration-related costs in the Consolidated Statements of Comprehensive Income (Loss).
The following table summarizes activity for liability balances associated with facility exit and restructuring liabilities for the years ended December 31, 2014, 2015 and 2016:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Severance and Benefits
|
|
Facilities
|
|
Total
|
|
|
(in thousands)
|
|
Balance as of December 31, 2013
|
$
|
—
|
|
|
$
|
5,064
|
|
|
$
|
5,064
|
|
|
Accruals
|
7,337
|
|
|
1,744
|
|
|
9,081
|
|
|
Payments
|
(1,964
|
)
|
|
(2,095
|
)
|
|
(4,059
|
)
|
|
Balance as of December 31, 2014
|
5,373
|
|
|
4,713
|
|
|
10,086
|
|
|
Accruals
|
9,798
|
|
|
3,598
|
|
|
13,396
|
|
|
Payments
|
(11,632
|
)
|
|
(2,769
|
)
|
|
(14,401
|
)
|
|
Balance as of December 31, 2015
|
3,539
|
|
|
5,542
|
|
|
9,081
|
|
|
Accruals
|
3,753
|
|
|
669
|
|
|
4,422
|
|
|
Payments
|
(5,053
|
)
|
|
(2,703
|
)
|
|
(7,756
|
)
|
|
Balance as of December 31, 2016
|
$
|
2,239
|
|
|
$
|
3,508
|
|
|
$
|
5,747
|
|
As of
December 31, 2015
,
$5.4 million
of facility exit and restructuring liabilities were classified within current liabilities and
$3.7 million
were classified as other long-term liabilities. As of
December 31, 2016
,
$3.6 million
of facility exit and restructuring liabilities were classified within current liabilities and
$2.1 million
were classified as other long-term liabilities.
EARTHLINK HOLDINGS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
14. Income Taxes
The following table presents the components of the income tax
benefit
(provision) from continuing operations for the years ended
December 31, 2014, 2015 and 2016
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
2014
|
|
2015
|
|
2016
|
|
|
(in thousands)
|
|
Current
|
|
|
|
|
|
|
Federal
|
$
|
4,470
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
State
|
954
|
|
|
(1,974
|
)
|
|
(370
|
)
|
|
Foreign
|
(89
|
)
|
|
(79
|
)
|
|
(5
|
)
|
|
Total current
|
5,335
|
|
|
(2,053
|
)
|
|
(375
|
)
|
|
Deferred
|
|
|
|
|
|
|
Federal
|
(637
|
)
|
|
(634
|
)
|
|
(542
|
)
|
|
State
|
9
|
|
|
(52
|
)
|
|
(28
|
)
|
|
Foreign
|
37
|
|
|
9
|
|
|
—
|
|
|
Total deferred
|
(591
|
)
|
|
(677
|
)
|
|
(570
|
)
|
|
Income tax benefit (provision) from continuing operations
|
$
|
4,744
|
|
|
$
|
(2,730
|
)
|
|
$
|
(945
|
)
|
The following table summarizes the significant differences between the U.S. federal statutory tax rate and the Company's effective tax rate for financial statement purposes for the years ended
December 31, 2014, 2015 and 2016
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
|
2014
|
|
2015
|
|
2016
|
|
|
|
(in thousands)
|
|
Federal income tax benefit (provision) at statutory rate (35%)
|
|
$
|
26,990
|
|
|
$
|
14,168
|
|
|
$
|
(3,019
|
)
|
|
State income taxes, net of federal benefit
|
|
2,885
|
|
|
1,351
|
|
|
(1,370
|
)
|
|
Non-deductible expenses
|
|
(732
|
)
|
|
(326
|
)
|
|
(2,551
|
)
|
|
Net change to valuation allowance
|
|
(29,565
|
)
|
|
(15,165
|
)
|
|
7,513
|
|
|
Change in state tax rate
|
|
241
|
|
|
(2,081
|
)
|
|
(1,469
|
)
|
|
Uncertain tax positions
|
|
5,140
|
|
|
(1,164
|
)
|
|
(6
|
)
|
|
Other
|
|
(215
|
)
|
|
487
|
|
|
(43
|
)
|
|
Income tax benefit (provision) from continuing operations
|
|
$
|
4,744
|
|
|
$
|
(2,730
|
)
|
|
$
|
(945
|
)
|
EARTHLINK HOLDINGS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Deferred tax assets and liabilities include the following as of
December 31, 2015 and 2016
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of December 31,
|
|
|
|
2015
|
|
2016
|
|
|
|
(in thousands)
|
|
Deferred tax assets:
|
|
|
|
|
|
Net operating loss carryforwards
|
|
$
|
270,922
|
|
|
$
|
274,709
|
|
|
Capital loss carryforward
|
|
1,493
|
|
|
—
|
|
|
Alternative minimum tax carryforward
|
|
14,952
|
|
|
14,952
|
|
|
Accrued liabilities and reserves
|
|
7,501
|
|
|
6,107
|
|
|
Accrued bonus
|
|
13,217
|
|
|
8,096
|
|
|
Subscriber base and other intangible assets
|
|
48,286
|
|
|
48,007
|
|
|
Other
|
|
16,990
|
|
|
18,782
|
|
|
Valuation allowance
|
|
(348,791
|
)
|
|
(341,278
|
)
|
|
Total deferred tax assets
|
|
24,570
|
|
|
29,375
|
|
|
Deferred tax liabilities:
|
|
|
|
|
|
Fixed assets
|
|
(19,280
|
)
|
|
(21,015
|
)
|
|
Accrued liabilities and reserves
|
|
(4,334
|
)
|
|
(6,833
|
)
|
|
Indefinite-lived intangible assets
|
|
(3,922
|
)
|
|
(4,492
|
)
|
|
Other
|
|
(910
|
)
|
|
(1,529
|
)
|
|
Total deferred tax liabilities
|
|
(28,446
|
)
|
|
(33,869
|
)
|
|
Net deferred tax liabilities
|
|
$
|
(3,876
|
)
|
|
$
|
(4,494
|
)
|
Effective tax rate.
The effective rate of
11.0%
for the year ended December 31, 2016 differs from the federal statutory rate of
35%
primarily due to the change in valuation allowance, the impact of state taxes including the impact of changes in enacted state tax rates and the change in uncertain tax positions. Non-deductible expenses increased the effective tax rate by approximately
29.6%
. The change in the valuation allowance recorded for the year ended December 31, 2016 decreased the effective tax rate by approximately
87.1%
. State tax expense for the year end December 31, 2016 increased the effective tax rate by
15.9%
. Change in state tax rates increased the effective tax rate by
17.0%
. The current tax provision for the year ended December 31, 2016 was primarily related to state taxes. The non-cash deferred tax expense for the year ended December 31, 2016 was due primarily to the amortization of deferred tax liabilities with indefinite useful lives.
Valuation allowance.
A deferred tax asset is reduced by a valuation allowance if based on the weight of all available evidence, it is more likely than not (a likelihood of more than 50%) that the value of such assets will not be realized. The valuation allowance should be sufficient to reduce the deferred tax asset to the amount that is more likely than not to be realized. The determination of whether a deferred tax asset is realizable is based on weighting all available evidence, including both positive and negative evidence. The realization of deferred tax assets, including carryforwards and deductible temporary differences, depends upon the existence of sufficient taxable income of the same character during the carryback or carryforward period. All sources of taxable income available to realize the deferred tax asset, including the future reversal of existing temporary differences, future taxable income exclusive of reversing temporary differences and carryforwards, taxable income in carryback years and tax-planning strategies, should be considered.
Each reporting period, the Company assesses available positive and negative evidence and estimates if sufficient future taxable income will be generated to utilize the existing deferred tax assets. The Company has maintained a cumulative loss position since the period ended December 31, 2013. For purposes of assessing the realization of the deferred tax assets, this cumulative loss position is considered significant negative evidence. This cumulative loss position, along with the evaluation of all sources of taxable income available to realize the deferred tax asset, has caused management to conclude it is more likely than not that the Company will not be able to fully realize its deferred tax assets in the future. As a result, a full valuation allowance, exclusive of its deferred tax liabilities with indefinite useful lives, continues to be maintained against the Company’s net deferred tax assets.
EARTHLINK HOLDINGS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
During the year ended December 31, 2016, the Company reduced its valuation allowance related to its deferred tax assets by
$7.5 million
. As of December 31, 2016, the Company has recorded a valuation allowance of
$341.3 million
against its net deferred tax assets, exclusive of its deferred tax liabilities with indefinite useful lives.
Management assesses the realization of the deferred tax assets each reporting period. To the extent that the financial results of the Company improve and the deferred tax asset becomes realizable, the Company will reduce the valuation allowance through earnings.
The following table summarizes activity in the Company's valuation allowance, for both continuing and discontinued operations, for the years ended
December 31, 2014, 2015 and 2016
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
|
2014
|
|
2015
|
|
2016
|
|
|
|
(in thousands)
|
|
Balance as of January 1
|
|
$
|
(305,436
|
)
|
|
$
|
(333,627
|
)
|
|
$
|
(348,791
|
)
|
|
Charges/credits to income tax (provision) benefit
|
|
(29,721
|
)
|
|
(15,164
|
)
|
|
7,513
|
|
|
Other adjustments
|
|
1,530
|
|
|
—
|
|
|
—
|
|
|
Balance as of December 31
|
|
$
|
(333,627
|
)
|
|
$
|
(348,791
|
)
|
|
$
|
(341,278
|
)
|
NOLs and tax credits.
As of
December 31, 2014, 2015 and 2016
, the Company had gross NOLs for federal income tax purposes totaling approximately
$666.2 million
,
$681.0 million
and
$695.2 million
, respectively, which begin to expire in 2020. Of these federal NOLs approximately
$253.8 million
,
$207.3 million
and
$188.2 million
were limited under Internal Revenue Code Section 382 in 2014, 2015 and 2016, respectively. As of December 31, 2015 and 2016, the Company had net NOLs for state income tax purposes totaling approximately
$32.6 million
and
$31.4 million
, respectively, which began to expire in 2015. Under the Tax Reform Act of 1986, the Company's ability to use its federal and state NOLs and federal and state tax credit carry forwards to reduce future taxable income and future taxes, respectively, is subject to restrictions attributable to equity transactions that have resulted in a change of ownership as defined in Internal Revenue Code Section 382. As a result, the NOL amounts as of December 31, 2016 reflect the restriction on the Company's ability to use its acquired federal and state NOLs; however, the Company continues to evaluate potential changes to the Section 382 limitations associated with acquired federal and state NOLs. The utilization of these NOLs could be further restricted in future periods which could result in significant amounts of these NOLs expiring prior to benefiting the Company.
Future transactions and the timing of such transactions could cause an ownership change under Section 382 of the Internal Revenue Code. Such transactions may include our share repurchase program, additional issuances of common stock by us , and acquisitions or sales of shares by certain holders of our shares, including persons who have held, currently hold, or may accumulate in the future five percent or more of our outstanding stock. Many of these transactions are beyond our control.
As of December 31, 2015 and 2016, the Company had alternative minimum tax credits of approximately
$15.0 million
. These credits do not have an expiration date. As of December 31, 2015, the Company had capital loss carryforwards of approximately
$1.5 million
which were expected to be fully utilized as of December 31, 2016.
Uncertain tax positions.
The Company has identified its federal tax return and its state tax returns in Alabama, Georgia, California, Massachusetts
,
New York, North Carolina, Pennsylvania and Texas as material tax jurisdictions for purposes of calculating its uncertain tax positions. Periods extending back to 1997 are still subject to examination for all material jurisdictions. The Company believes that its income tax filing positions and deductions through the period ended December 31, 2016 will not result in a material adverse effect on the Company’s financial condition, results of operations or cash flow. The Company’s policy for recording interest and penalties associated with uncertain tax positions is to record such items as a component of income tax expense. As of
December 31, 2015 and 2016
,
$0.8 million
and
$0.9 million
, respectively, of interest and
$0.1 million
and
$0.1 million
of penalties, respectively, had been accrued. As of December 31, 2016, it is reasonably possible that approximately
$2.1 million
of the total gross uncertain tax positions recorded, including
$0.8 million
of associated interest and penalties, will reverse within the next twelve months, primarily due to the resolution of state tax examinations and the expiration of statutes of limitation in various jurisdictions.
EARTHLINK HOLDINGS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
A reconciliation of changes in the amount of unrecognized tax benefits for the years ended
December 31, 2014, 2015 and 2016
is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
2014
|
|
2015
|
|
2016
|
|
|
(in thousands)
|
|
Balance as of January 1
|
$
|
21,628
|
|
|
$
|
17,205
|
|
|
$
|
18,357
|
|
|
Additions for tax positions of prior years
|
—
|
|
|
1,332
|
|
|
—
|
|
|
Reductions as a result of lapses in applicable statute of limitations
|
(4,423
|
)
|
|
(180
|
)
|
|
(229
|
)
|
|
Balance as of December 31
|
$
|
17,205
|
|
|
$
|
18,357
|
|
|
$
|
18,128
|
|
Of the total gross uncertain tax benefits recorded on the balance sheet,
$1.5 million
would impact the effective tax rate once settled.
15. Commitments and Contingencies
Operating leases
The Company leases certain of its facilities under various non-cancelable operating leases. The facility leases generally require the Company to pay operating costs, including property taxes, insurance and maintenance, and generally contain annual escalation provisions as well as renewal options. Total rent expense (including operating expenses) during the years ended
December 31, 2014, 2015 and 2016
for all operating leases, excluding rent and operating expenses associated with facilities exited as part of the Company's restructuring plans, was
$35.6 million
,
$32.2 million
and
$29.4 million
, respectively.
Minimum lease commitments (including estimated operating expenses) under non-cancelable leases as of
December 31, 2016
are as follows:
|
|
|
|
|
|
|
|
Year Ending December 31,
|
(in thousands)
|
|
2017
|
$
|
31,533
|
|
|
2018
|
25,876
|
|
|
2019
|
20,991
|
|
|
2020
|
12,650
|
|
|
2021
|
9,143
|
|
|
Thereafter
|
11,692
|
|
|
Total minimum lease payments, including estimated operating expenses
|
111,885
|
|
|
Less aggregate contracted sublease income
|
(6,330
|
)
|
|
|
$
|
105,555
|
|
Purchase commitments
The Company has entered into agreements with vendors to purchase certain telecommunications services and equipment under non-cancelable agreements. The Company also has minimum commitments under network access agreements with several carriers under non-cancelable agreements. The following table summarizes commitments under these agreements as of
December 31, 2016
:
|
|
|
|
|
|
|
|
Year Ending December 31,
|
(in thousands)
|
|
2017
|
$
|
49,908
|
|
|
2018
|
34,055
|
|
|
2019
|
18,583
|
|
|
2020
|
7,168
|
|
|
2021
|
2,767
|
|
|
Thereafter
|
4,710
|
|
|
Total
|
$
|
117,191
|
|
EARTHLINK HOLDINGS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Legal proceedings and other disputes
General
. The Company is party to various legal proceedings and other disputes arising in the normal course of business, including, but not limited to, regulatory audits, E911 payments, trademark and patent infringement, billing disputes, rights of access, tax, consumer protection, employment and tort. The Company accrues for such matters when it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated. Where it is probable that a liability has been incurred and there is a range of expected loss for which no amount in the range is more likely than any other amount, the Company accrues at the low end of the range. The Company reviews its accruals each reporting period. The Company recorded a
$2.2 million
liability during the year ended December 31, 2014 for a loss contingency that became probable and estimable during the year. During the year ended December 31, 2015, a settlement was reached and payment was made for the recorded amount.
The Company's management believes that there are no disputes, litigation or other legal proceedings, audits or disputes asserted or pending against the Company that could have, individually or in the aggregate, a material adverse effect on its financial position, results of operations or cash flows, and believes that adequate provision for any probable and estimable losses has been made in the Company's consolidated financial statements. However, the ultimate result of any current or future litigation or other legal proceedings, audits or disputes is inherently unpredictable and could result in liabilities that are higher than currently predicted.
Regulatory audits
. The Company is subject to regulatory audits in the ordinary course of business with respect to various matters, including audits by local municipalities for E911 charges and audits by the Universal Service Administrative Company on universal service fund assessments and payments. These audits can cover periods for several years prior to the date the audit is undertaken and could result in the imposition of liabilities, interest and penalties if the Company's positions are not accepted by the auditing entity. The Company's financial statements contain reserves for certain of such potential liabilities.
Patents
. From time to time, the Company receives notices of infringement of patent rights from parties claiming to own patents related to certain of the Company's services and products. Certain of these claims are made by patent holding companies that are not operating companies. The alleging parties generally seek royalty payments for prior use as well as future royalty streams. The Company intends to vigorously defend its position with respect to these matters.
Billing disputes
. The Company is periodically involved in disputes related to its billings to other carriers for access to its network. The Company does not recognize revenue related to such matters until the period that revenues are determinable and it is reasonably assured of the collection of the amounts billed. In the event that a claim is made related to revenues previously recognized, the Company assesses the validity of the claim and adjusts the amount of revenue being recognized to the extent that the claim adjustment is considered probable and estimable. The Company recognized
$7.9 million
,
$5.2 million
and
$1.6 million
of net favorable disputes related to its billings to other carriers during the years ended
December 31, 2014, 2015 and 2016
, respectively, which are included in revenues in the Consolidated Statements of Comprehensive Income (Loss).
The Company periodically disputes network access charges that it is assessed by other companies with which the Company interconnects. The Company maintains adequate reserves for anticipated exposure associated with these billing disputes. The reserves are subject to changes in estimates and management judgment as new information becomes available. In view of the length of time historically required to resolve these disputes, they may be resolved or require adjustment in future periods and relate to costs invoiced, accrued or paid in prior periods. While the Company believes its reserves for billing disputes are adequate, it is reasonably possible that the Company could record additional expense of up to
$12.4 million
for unrecorded disputed amounts. The Company recognized
$11.7 million
,
$12.0 million
and
$13.9 million
for favorable disputes with telecommunication vendors during the years ended
December 31, 2014, 2015 and 2016
, respectively, which is included in cost of revenues in the Consolidated Statements of Comprehensive Loss.
Regulation
The Company's services are subject to varying degrees of federal, state and local regulation. These regulations are subject to ongoing proceedings at federal and state administrative agencies or within state and federal judicial systems. Results of these proceedings could change, in varying degrees, the manner in which the Company operates. The Company cannot predict the outcome of these proceedings or their effect on the Company's industry generally or upon the Company specifically.
EARTHLINK HOLDINGS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
16. Fair Value Measurements
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (an exit price). A three-tier fair value hierarchy is used to prioritize the inputs used in measuring fair value. These tiers include: Level 1, defined as observable inputs such as quoted prices in active markets; Level 2, defined as observable inputs other than quoted prices in active markets that are either directly or indirectly observable; and Level 3, defined as unobservable inputs for which little or no market data exists, therefore requiring an entity to develop its own assumptions.
Fair value of debt
The estimated fair value of the Company’s Senior Secured Notes and Senior Notes was determined based on Level 2 input using observable market prices in less active markets. The carrying amount of the Company’s senior secured term loan and senior secured revolving credit facility approximated their fair values as of
December 31, 2015 and 2016
. The following table presents the fair value of the Company’s debt, excluding capital leases, as of
December 31, 2015 and 2016
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of December 31, 2015
|
|
As of December 31, 2016
|
|
|
Carrying
|
|
|
|
Carrying
|
|
|
|
|
Amount
|
|
Fair Value
|
|
Amount
|
|
Fair Value
|
|
|
(in thousands)
|
|
Senior Secured Notes
|
$
|
295,277
|
|
|
$
|
305,439
|
|
|
$
|
296,346
|
|
|
$
|
316,200
|
|
|
Senior Notes
|
168,532
|
|
|
177,404
|
|
|
74,846
|
|
|
78,433
|
|
|
Senior secured term loan
|
—
|
|
|
—
|
|
|
48,211
|
|
|
48,750
|
|
|
Senior secured revolving credit facility
|
35,000
|
|
|
35,000
|
|
|
10,000
|
|
|
10,000
|
|
|
Total debt, excluding capital leases
|
$
|
498,809
|
|
|
$
|
517,843
|
|
|
$
|
429,403
|
|
|
$
|
453,383
|
|
17. Supplemental Disclosure of Cash Flow Information
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
|
2014
|
|
2015
|
|
2016
|
|
|
|
(in thousands)
|
|
Cash paid during the year for interest
|
|
$
|
52,317
|
|
|
$
|
47,705
|
|
|
$
|
38,730
|
|
|
Cash paid during the year for income taxes
|
|
1,071
|
|
|
625
|
|
|
1,158
|
|
18. Segment Information
General
The Company reports segment information along the same lines that its Chief Operating Decision Maker reviews its operating results in assessing performance and allocating resources. The Company's Chief Operating Decision Maker is its Chief Executive Officer. The Company's reportable segments are strategic business units that are aligned around distinct customer categories to optimize operations. The Company operates the following
four
reportable segments:
|
|
|
|
•
|
Enterprise/Mid-Market
. The Company’s Enterprise/Mid-Market segment provides a broad range of data, voice and managed network services to distributed multi-site business customers.
|
|
|
|
|
•
|
Small Business
. The Company’s Small Business segment provides a broad range of data, voice and managed network services to small, often single-site business customers.
|
|
|
|
|
•
|
Carrier/Transport
. The Company’s Carrier/Transport segment provides transmission capacity and other data, voice and managed network services to telecommunications carriers and large enterprises.
|
EARTHLINK HOLDINGS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
|
|
|
|
•
|
Consumer
. The Company’s Consumer segment provides nationwide Internet access and related value-added services to residential customers.
|
Change in Reporting Units
Prior to 2015, the Company operated two reportable segments, Business Services and Consumer Services. The Company’s Business Services segment provided a broad range of data, voice and managed network services to retail and wholesale business customers. The Company’s Consumer Services segment provided nationwide Internet access and related value-added services to residential customers. During the year ended December 31, 2015, the Company implemented certain organizational, operational and reporting changes that resulted in the disaggregation of its Business Services segment into three separate reportable segments: Enterprise/Mid-Market, Small Business and Carrier/Transport. The Consumer Services segment was not impacted. The Company reorganized its business around these business units to optimize operations. The Company began reporting the disaggregated information to its Chief Operating Decision Maker during the year ended December 31, 2015.
Segment information for the year ended December 31, 2014 has not been restated to reflect the Company’s new reportable segment structure. The Company began recording revenue and related cost of revenue transactions at the new segment level in 2015. Management has determined that it is impracticable to restate financial information prior to 2015 to conform to the new reportable segment structure due to the level of effort required to segment customers that terminated service prior to 2015 and identify the related cost of revenue associated with those customers, as this information is not available.
Segment Results
The following table presents segment results under the Company’s current reportable segment structure for the years ended
December 31, 2015 and 2016
:
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
2015
|
|
2016
|
|
|
(in thousands)
|
|
Enterprise/Mid-Market
|
|
|
|
|
|
Revenues
|
$
|
444,968
|
|
|
$
|
397,676
|
|
|
Cost of revenues (excluding depreciation and amortization)
|
221,347
|
|
|
203,928
|
|
|
Gross margin
|
223,621
|
|
|
193,748
|
|
|
Small Business
|
|
|
|
|
|
Revenues
|
297,039
|
|
|
223,776
|
|
|
Cost of revenues (excluding depreciation and amortization)
|
139,440
|
|
|
107,662
|
|
|
Gross margin
|
157,599
|
|
|
116,114
|
|
|
Carrier/Transport
|
|
|
|
|
Revenues
|
135,905
|
|
|
141,709
|
|
|
Cost of revenues (excluding depreciation and amortization)
|
61,979
|
|
|
63,158
|
|
|
Gross margin
|
73,926
|
|
|
78,551
|
|
|
Consumer
|
|
|
|
|
Revenues
|
219,340
|
|
|
196,713
|
|
|
Cost of revenues (excluding depreciation and amortization)
|
77,862
|
|
|
67,860
|
|
|
Gross margin
|
141,478
|
|
|
128,853
|
|
|
Total Segments
|
|
|
|
|
Revenues
|
1,097,252
|
|
|
959,874
|
|
|
Cost of revenues (excluding depreciation and amortization)
|
500,628
|
|
|
442,608
|
|
|
Gross margin
|
$
|
596,624
|
|
|
$
|
517,266
|
|
EARTHLINK HOLDINGS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The following table presents a reconciliation of segment gross margin to consolidated income (loss) before income taxes for the years ended
December 31, 2015 and 2016
:
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
2015
|
|
2016
|
|
|
(in thousands)
|
|
Segment gross margin
|
$
|
596,624
|
|
|
$
|
517,266
|
|
|
Operating costs and expenses:
|
|
|
|
|
Selling, general and administrative expenses
|
368,763
|
|
|
319,231
|
|
|
Depreciation and amortization
|
188,315
|
|
|
135,248
|
|
|
Restructuring, acquisition and integration-related costs
|
19,320
|
|
|
17,807
|
|
|
Total operating costs and expenses
|
576,398
|
|
|
472,286
|
|
|
Income from operations
|
20,226
|
|
|
44,980
|
|
|
Gain on sale of businesses
|
—
|
|
|
9,128
|
|
|
Interest expense and other, net
|
(50,972
|
)
|
|
(40,660
|
)
|
|
Loss on extinguishment of debt
|
(9,734
|
)
|
|
(4,823
|
)
|
|
Income (loss) from continuing operations before income taxes
|
$
|
(40,480
|
)
|
|
$
|
8,625
|
|
The Company evaluates performance of its segments based on segment gross margin. Segment gross margin includes revenues from external customers and related cost of revenues. Costs excluded from segment gross margin include selling, general and administrative expenses, depreciation and amortization, impairment of goodwill and intangible assets, restructuring, acquisition and integration-related costs, and interest expense and other, net, as they are not considered in the measurement of segment performance. Management continues to evaluate the segmentation of customers within the distinct customer categories, which may result in changes to segment information in the future.
The Company manages its working capital on a consolidated basis and does not allocate long-lived assets to segments. In addition, segment assets are not reported to, or used by, the Chief Operating Decision Maker and therefore, total segment assets and expenditures for additions of long-lived assets have not been disclosed.
The Company has not provided information about geographic segments because substantially all of the Company’s revenues, results of operations and identifiable assets are in the United States.
EARTHLINK HOLDINGS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
For comparability purposes, the following table presents segment results and a reconciliation to consolidated income (loss) from continuing operations before income taxes under the Company’s previous reportable segment structure for the years ended December 31, 2014, 2015 and 2016:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
2014
|
|
2015
|
|
2016
|
|
|
(in thousands)
|
|
Business Services
|
|
|
|
|
|
|
|
|
|
Revenues
|
$
|
930,931
|
|
|
$
|
877,912
|
|
|
$
|
763,161
|
|
|
Cost of revenues (excluding depreciation and amortization)
|
469,523
|
|
|
422,766
|
|
|
374,748
|
|
|
Gross margin
|
461,408
|
|
|
455,146
|
|
|
388,413
|
|
|
Direct segment operating expenses
|
345,982
|
|
|
316,220
|
|
|
273,966
|
|
|
Segment operating income
|
$
|
115,426
|
|
|
$
|
138,926
|
|
|
$
|
114,447
|
|
|
Consumer Services
|
|
|
|
|
|
|
|
|
|
Revenues
|
$
|
245,964
|
|
|
$
|
219,340
|
|
|
$
|
196,713
|
|
|
Cost of revenues (excluding depreciation and amortization)
|
87,913
|
|
|
77,862
|
|
|
67,860
|
|
|
Gross margin
|
158,051
|
|
|
141,478
|
|
|
128,853
|
|
|
Direct segment operating expenses
|
43,615
|
|
|
30,731
|
|
|
29,020
|
|
|
Segment operating income
|
$
|
114,436
|
|
|
$
|
110,747
|
|
|
$
|
99,833
|
|
|
Consolidated
|
|
|
|
|
|
|
|
|
|
Revenues
|
$
|
1,176,895
|
|
|
$
|
1,097,252
|
|
|
$
|
959,874
|
|
|
Cost of revenues (excluding depreciation and amortization)
|
557,436
|
|
|
500,628
|
|
|
442,608
|
|
|
Gross margin
|
619,459
|
|
|
596,624
|
|
|
517,266
|
|
|
Direct segment operating expenses
|
389,597
|
|
|
346,951
|
|
|
302,986
|
|
|
Segment operating income
|
229,862
|
|
|
249,673
|
|
|
214,280
|
|
|
Depreciation and amortization
|
186,872
|
|
|
188,315
|
|
|
135,248
|
|
|
Impairment of long-lived assets
|
14,334
|
|
|
—
|
|
|
—
|
|
|
Restructuring, acquisition and integration-related costs
|
20,088
|
|
|
19,320
|
|
|
17,807
|
|
|
Corporate operating expenses
|
29,422
|
|
|
21,812
|
|
|
16,245
|
|
|
Gain on sale of businesses
|
—
|
|
|
—
|
|
|
(9,128
|
)
|
|
Interest expense and other, net
|
56,261
|
|
|
50,972
|
|
|
40,660
|
|
|
Loss on extinguishment of debt
|
—
|
|
|
9,734
|
|
|
4,823
|
|
|
Income (loss) from continuing operations before income taxes
|
$
|
(77,115
|
)
|
|
$
|
(40,480
|
)
|
|
$
|
8,625
|
|
The Company evaluated performance of its previous segment structure based on segment operating income. Segment operating income includes revenues from external customers, related cost of revenues and operating expenses directly attributable to the segment, which included costs over which segment managers had direct discretionary control, such as advertising and marketing programs, customer support expenses, product development expenses, certain technology and facilities expenses, billing operations and provisions for doubtful accounts. Segment operating income excluded other income and expense items and certain expenses over which segment managers do not have discretionary control. Costs excluded from segment operating income include various corporate expenses (consisting of certain costs such as corporate management, human resources, finance and legal), depreciation and amortization, impairment of goodwill and intangible assets, restructuring, acquisition and integration-related costs, stock-based compensation expense, and interest expense and other, net, as they were not considered in the measurement of segment performance.
Revenues by Products and Services
The Company generates revenues by providing a broad range of data, voice and managed network services to business and residential customers. The Company’s revenues primarily consist of the following:
EARTHLINK HOLDINGS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
|
|
|
|
•
|
Monthly recurring charges for providing data, voice and managed network services; transmission capacity; and Internet access and related value-added services;
|
|
|
|
|
•
|
Equipment revenues; and
|
|
|
|
|
•
|
Non-recurring and other revenues, such as installation fees, termination fees and administrative fees.
|
The following table presents revenue detail for the years ended
December 31, 2014, 2015 and 2016
is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
2014
|
|
2015
|
|
2016
|
|
|
(in thousands)
|
|
Monthly recurring revenues
|
$
|
1,021,931
|
|
|
$
|
970,731
|
|
|
$
|
841,989
|
|
|
Usage revenues
|
124,266
|
|
|
99,227
|
|
|
82,513
|
|
|
Equipment revenues
|
14,731
|
|
|
15,201
|
|
|
15,920
|
|
|
Non-recurring and other revenues
|
15,967
|
|
|
12,093
|
|
|
19,452
|
|
|
Total revenues
|
$
|
1,176,895
|
|
|
$
|
1,097,252
|
|
|
$
|
959,874
|
|
19. Quarterly Financial Data (Unaudited)
The following table sets forth certain unaudited quarterly consolidated financial data for the eight quarters in the period ended
December 31, 2016
. In the opinion of the Company's management, this unaudited information has been prepared on the same basis as the audited consolidated financial statements and includes all material adjustments (consisting of normal recurring accruals and adjustments) necessary to present fairly the quarterly unaudited financial information. The operating results for any quarter are not necessarily indicative of results for any future period.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
Mar. 31,
2015
|
|
June 30,
2015
|
|
Sept. 30,
2015
|
|
Dec. 31,
2015
|
|
Mar. 31,
2016
|
|
June 30,
2016
|
|
Sept. 30,
2016
|
|
Dec. 31,
2016
|
|
|
|
(unaudited)
(in thousands, except per share data)
|
|
Revenues
|
|
$
|
282,447
|
|
|
$
|
283,664
|
|
|
$
|
270,904
|
|
|
$
|
260,237
|
|
|
$
|
254,262
|
|
|
$
|
240,357
|
|
|
$
|
235,125
|
|
|
$
|
230,130
|
|
|
Cost of revenues
|
|
129,462
|
|
|
127,048
|
|
|
122,391
|
|
|
121,727
|
|
|
115,206
|
|
|
110,934
|
|
|
109,540
|
|
|
106,928
|
|
|
Income (loss) from operations
|
|
5,091
|
|
|
10,566
|
|
|
5,750
|
|
|
(1,181
|
)
|
|
14,432
|
|
|
15,648
|
|
|
11,116
|
|
|
3,784
|
|
|
Net income (loss) (1)(2)
|
|
(10,483
|
)
|
|
(9,922
|
)
|
|
(10,523
|
)
|
|
(12,282
|
)
|
|
7,867
|
|
|
4,115
|
|
|
230
|
|
|
(4,532
|
)
|
|
Net income (loss) per share (3):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
(0.10
|
)
|
|
$
|
(0.10
|
)
|
|
$
|
(0.10
|
)
|
|
$
|
(0.12
|
)
|
|
$
|
0.08
|
|
|
$
|
0.04
|
|
|
$
|
—
|
|
|
$
|
(0.04
|
)
|
|
Diluted
|
|
$
|
(0.10
|
)
|
|
$
|
(0.10
|
)
|
|
$
|
(0.10
|
)
|
|
$
|
(0.12
|
)
|
|
$
|
0.07
|
|
|
$
|
0.04
|
|
|
$
|
—
|
|
|
$
|
(0.04
|
)
|
_______________________________________________________________________________
|
|
|
|
(1)
|
The Company recognized a gain of sale of businesses of
$5.7 million
and
$3.4 million
during the three months ended March 31, 2016 and September 30, 2016, respectively.
|
|
|
|
|
(2)
|
The Company recognized
$1.3 million
,
$6.0 million
and
$2.5 million
of losses of extinguishment of debt during the three months ended March 31, 2015, June 30, 2015 and September 30, 2015, respectively. The Company recognized
$0.2 million
,
$0.2 million
and
$4.4 million
of losses of extinguishment of debt during the three months ended March 31, 2016, June 30, 2016 and September 30, 2016, respectively.
|
|
|
|
|
(3)
|
The quarterly net income per share amounts will not necessarily add to the net income per share computed for the year because of the method used in calculating per share data.
|