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.
Change in Organization Structure
On December 31, 2013, through the creation of a new holding company structure (the “Holding Company Reorganization”), EarthLink, Inc. merged into EarthLink, LLC, which became a wholly-owned subsidiary of a new publicly traded parent company, EarthLink Holdings Corp. We expect the new holding company design will enhance our corporate structure and provide greater flexibility and efficiency from a management, operations, customer, regulatory, accounting, financial and tax perspective. As the Holding Company Reorganization occurred at the parent company level, the remainder of our subsidiaries, operations and customers were not affected. Accordingly, the historical financial statements reflect the effect of the reorganization for all periods presented. Following the Holding Company Reorganization, EarthLink Holdings Corp. became the primary obligor on our outstanding debt obligations and EarthLink, LLC became a guarantor and a restricted subsidiary. The Holding Company Reorganization was effected under Section 251(g) of the Delaware General Corporation Law which provides for the formation of a holding company structure without a stockholder vote. Existing shares of EarthLink, Inc. common stock were converted into the same number of shares of common stock of EarthLink Holdings Corp.
Overview
EarthLink Holdings Corp. (“EarthLink” or the “Company”), together with its consolidated subsidiaries, is a leading communications and IT services provider, empowering businesses with a fully-managed, end-to-end communications, IT and virtualization portfolio including cloud computing, IT security, colocation, enterprise-class hosted applications, secure network connectivity and IT support services. We operate two reportable segments, Business Services and Consumer Services. Our Business Services segment provides a broad range of data, voice and IT services to retail and wholesale business customers. Our Consumer Services segment provides nationwide Internet access and related value-added services to residential customers. We operate an extensive network including more than 28,000 route miles of fiber, 90 metro fiber rings and eight secure enterprise-class data centers that provide data and voice IP service coverage across more than 90 percent of the United States.
Business Strategy
Our business strategy is to be the premier communications and IT services provider for mid-market and enterprise customers. We believe IT services is an emerging market with significant opportunity for growth. Our
goal is to use our nationwide network and newly developed and acquired IT services to be a one-stop ubiquitous provider of these services to larger and multi-location enterprise customers.
We are also focused on maximizing the cash flow generated by our traditional voice and data products. The key elements of our business strategy are as follows:
|
|
•
|
Offer a complete package of communications and IT services products.
We provide a nationwide suite of business voice, data and IT services. We are focused on maintaining a broad suite of products and services and offering solutions to address the evolving business and infrastructure needs of our customers. In 2012 and 2013, we expanded our IT solutions footprint with four additional data centers and invested capital to extend our core fiber IP network. We also acquired CenterBeam in July 2013 to further grow our IT services portfolio, specifically around customer end-point management. We believe our broad suite of products allows us to compete for larger and more complex customers.
|
|
|
•
|
Increase revenues from growth products and services.
Revenues from some of our products and services have been declining due to economic, competitive, technological and regulatory developments and we expect some of these revenues to continue to decline. We are attempting to manage this decline by working with our customers to replace or augment declining products with our growth products, where financially and technically feasible to do so. Our growth products are MultiProtocol Label Switching ("MPLS"), hosted voice and IT services such as virtualization and virtual tech care. We are also focused on growing revenues for these products by enhancing our sales force efforts and increasing brand awareness for our IT services. We also aim to grow our wholesale services as we capitalize on unique and new fiber routes within our footprint.
|
|
|
•
|
Provide a superior customer experience.
We are committed to providing high-quality customer service and continuing to monitor customer satisfaction in all facets of our business. We believe exceeding customers’ expectations for service increases loyalty and reduces churn. We also believe that our broad communications and IT services portfolio and blend of access technologies for connectivity enable us to provide high-quality customer service by solving a wide range of issues faced by our customers and prospects. We are focused on creating a customer-focused organization that will provide a quality approach to offering and supporting EarthLink products and services.
|
|
|
•
|
Optimize our cost structure.
We are currently focused on optimizing the cost structure of our business by reducing network costs, streamlining our internal processes and operations and maximizing the cash flows generated from traditional voice and data products. The success of our operating efficiency and cost reduction initiatives is necessary to align costs with declining revenues for some of our products as non-variable costs place further pressure on margins.
|
|
|
•
|
Opportunistically consider potential strategic acquisitions.
We continue to evaluate acquisition opportunities as we become aware of them. We believe that targeted corporate acquisitions, when available at the right economics, can be an effective means to improve our product, network, and data center capabilities or to accelerate revenue growth. Our acquisition strategy may include investments or acquisitions of new product and services capabilities, network assets or business customers to achieve greater national scale.
|
Challenges and Risks
The primary challenge we face is executing on our business strategy to be the premier communications and IT services provider, and more specifically to continue to grow revenues from our growth products and services. Contributing to this challenge are the following: responding to competitive and economic pressures, reducing churn in our existing customer base, providing products and services that meet changing customer needs on a timely and cost-effective basis, and adapting to regulatory changes and initiatives. Another primary challenge is managing the rate of decline in revenues for our traditional products. To address these challenges, we are targeting larger customers who have lower churn profiles, focusing efforts on customer retention,
upselling additional growth products and services to existing customers,
implementing cost efficiencies in order to maximize cash flows
and seeking to make costs more variable.
Our future success for growth depends on the timing and market acceptance of our new products and services, our ability to market our services to new customers, our ability to differentiate our services from those of our competitors, our ability to maintain and expand our sales to existing customers, our ability to strengthen awareness of our brand, our ability to provide quality implementation and customer support for these products and the reliability and quality of our services.
Revenue Sources
Business Services
.
Our Business Services segment earns revenue by providing a broad range of data, voice and IT services to retail and wholesale business customers. We present our Business Services revenue in the following three categories: (1) retail services, which includes data, voice and IT services provided to business customers; (2) wholesale services, which includes the sale of transmission capacity to other telecommunications carriers and businesses; and (3) other services, which primarily consists of web hosting. Our IT services, which are included within our retail services, include data centers, virtualization, security, applications, premises-based solutions, managed solutions and support services. Revenues generally consist of recurring monthly charges for such services; usage fees; installation fees; termination fees; and administrative fees.
Consumer Services
.
Our Consumer Services segment earns revenue by providing nationwide Internet access and related value-added services to residential customers. We present our Consumer Services in two categories: (1) access services, which includes narrowband access services and broadband access services; and (2) value-added services, which includes revenues from ancillary services sold as add-on features to EarthLink’s Internet access services, such as security products, premium email only, home networking and email storage; search revenues; and advertising revenues. Revenues generally consist of recurring monthly charges for such services.
General Developments in our Business
Key developments in our business during 2013 are described below:
|
|
•
|
Issued $300.0 million aggregate principal amount of 7.375% Senior Secured Notes due 2020 (the “Senior Secured Notes”) in May 2013 and used the net proceeds, together with available cash, to fund a tender offer and redemption of our ITC^DeltaCom 10.5% Senior Secured Notes due April 2016 (the "ITC^DeltaCom Notes"), which had been assumed in connection with our acquisition of ITC^DeltaCom, Inc. ("ITC^DeltaCom"). The debt issuance and redemption will reduce the amount of interest we will pay going forward.
|
|
|
•
|
Acquired substantially all of the assets of CenterBeam, Inc. ("CenterBeam"), a privately-held information technology managed service provider delivering cloud computing and hosted IT services to mid-sized businesses, in July 2013 for a total consideration of approximately $23.5 million to further grow our IT services portfolio by adding IT services customer scale, expanded IT support center resources and complementary products and capabilities.
|
|
|
•
|
Sold our ITC^DeltaCom telecom systems business in August 2013, which was a low margin business that generated mostly non-recurring revenue streams.
|
|
|
•
|
Completed the roll out of four additional data centers, launched our next generation cloud hosting platform in five of our eight data centers and expanded our fiber network with additional unique routes.
|
|
|
•
|
Made progress in the integration of our operating support systems and began to leverage some of these new capabilities in pursuing our business strategy.
|
|
|
•
|
Generated revenues of
$1.2 billion
in 2013, a
7%
decrease during the year consisting of a
$53.2 million
decrease in Business Services revenue and a
$41.3 million
decrease in Consumer Services revenue. The decreases were primarily driven by declines in traditional voice and data products. However, partially offsetting these declines was an increase in sales of growth products for our Business Services and a decrease in churn for our Consumer Services.
|
|
|
•
|
Generated a net loss of
$538.8 million
in 2013, which reflects a $255.6 million goodwill impairment and related tax impact, a $265.3 million increase to our income tax provision due to the recording of a full valuation allowance against our deferred tax assets, an increase in restructuring, acquisition and integration costs and 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
$227.1 million
in 2013, a decrease from
$283.9 million
in the prior year primarily due to the decrease in revenues from traditional voice and data products, as well as increased costs to grow our business.
|
|
|
•
|
Made $20.8 million of dividend payments to shareholders and repurchased 1.2 million shares of common stock for $6.1 million during the year.
|
Trends in our Business
Our financial results are impacted by several significant trends, which are described below.
Industry factors
.
We operate in the communications and IT services industry, which is characterized by intense competition, industry consolidation resulting in larger competitors, an evolving regulatory environment, changing technology and changes in customer needs. We expect these trends to continue. In addition, merger and acquisition transactions and other factors have reduced the number of vendors from which we may purchase network elements that we leverage to operate our business.
Traditional business services revenues
.
Our traditional voice and data business service revenues, specifically traditional voice and lower-end, single site broadband services, have been declining due to competitive pressures and changes in the industry, and we expect this trend to continue. We have also experienced an increase in churn for these retail products, especially as customers come out of contract term. To counteract trends in our Business Services revenues, we are focused on building long-term customer relationships, offering customers a bundle that includes our growth services and focusing on larger, more complex customers who have a lower churn profile. As a result, sales in our growth products have increased and the mix of new sales is shifting towards our growth products. We are also taking steps to lower the cost structure of our Business Services operations.
IT services
.
The industry for cloud, managed security and IT services is relatively new and continues to evolve. The IT services market is growing as security needs, compliance requirements and IT costs increase. IT services currently represents the smallest proportion of our Business Services revenues. However, we believe this represents a significant growth area for our business and there is opportunity for EarthLink to address this market nationally. As a result, we have been taking steps to accelerate our transition into an IT services company. Specifically, we are focusing on larger geographic markets where there are more customers with a propensity to buy IT services, increasing our efforts in Search Engine Marketing to drive leads for our inside sales force, increasing brand awareness for our IT services and adding additional technical talent in the field to support our IT services sales efforts.
Economic conditions
.
Many of our customers are small and medium-sized businesses. We believe these businesses are more likely to be affected by economic downturns than larger, more established businesses. We believe that the financial and economic pressures faced by our customers in this environment of diminished consumer spending, corporate downsizing and tightened credit have had, and may continue to have, an adverse effect on our results of operations, including longer sales cycles and increased customer demands for price reductions in connection with contract renewals. Additionally, our consumer access services are discretionary and dependent upon levels of consumer spending. Unfavorable economic conditions could cause customers to slow spending in the future, which could adversely affect our revenues and churn.
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 and competitive pressures in the industry. In addition, we have implemented, and expect to continue to implement, targeted price increases, which could negatively impact our churn rates. To counteract trends in our consumer revenues, we are focused on customer retention, operational efficiency and adding customers through marketing channels that we believe will produce an acceptable rate of return.
Business Outlook
We expect continued declines in Business Services revenues from traditional voice and data products. Revenues may also be adversely impacted by churn, competition, regulatory changes, timing and market acceptance of our newer products and services, shifting patterns of use, convergence of technology and general economic conditions. However, to counteract these pressures, we continue to emphasize our diverse portfolio of communications and IT services and are focused on growing our suite of growth and IT services. We are also focused on growing our wholesale services as we capitalize on new and unique fiber routes within our footprint. As a result, we expect the mix of our retail Business Service revenues to change over time, from traditional products to growth products and services. As our product mix shifts towards growth products, revenues may be impacted in the near term by longer sales cycles and installations and higher costs to deliver these services. We expect our consumer access subscriber base and revenues to continue to decrease due to limited sales and marketing activities, competition from cable, DSL and wireless providers, declines in gross broadband subscriber additions and the continued maturation of the market for narrowband Internet access. However, we expect the rate of churn and revenue decline to continue to decline as our customer base becomes longer tenured.
Consolidated Results of Operations
The following comparison of statement of operations data is affected by our acquisition of One Communications on April 1, 2011. The results of operations of One Communications are included in our operating results beginning on the acquisition date. The following comparison of statement of operations data is also affected, to a lesser extent, by our other acquisitions and transactions completed during 2011 including STS Telecom, Logical Solutions and Business Vitals, LLC, among others, and our CenterBeam transaction completed during 2013.
The following table sets forth statement of operations data for the years ended
December 31, 2011, 2012 and 2013
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
2011
|
|
2012
|
|
2013
|
|
(in thousands)
|
Revenues
|
$
|
1,300,543
|
|
|
$
|
1,335,135
|
|
|
$
|
1,240,606
|
|
Operating costs and expenses:
|
|
|
|
|
|
|
|
Cost of revenues (exclusive of depreciation and amortization shown separately below)
|
581,264
|
|
|
632,616
|
|
|
600,742
|
|
Selling, general and administrative (exclusive of of depreciation and amortization shown separately below)
|
397,574
|
|
|
429,087
|
|
|
426,070
|
|
Depreciation and amortization
|
159,993
|
|
|
183,165
|
|
|
183,114
|
|
Impairment of goodwill
|
—
|
|
|
—
|
|
|
255,599
|
|
Restructuring, acquisition and integration-related costs
|
32,068
|
|
|
18,244
|
|
|
40,030
|
|
Total operating costs and expenses
|
1,170,899
|
|
|
1,263,112
|
|
|
1,505,555
|
|
Income (loss) from operations
|
129,644
|
|
|
72,023
|
|
|
(264,949
|
)
|
Interest expense and other, net
|
(70,640
|
)
|
|
(63,416
|
)
|
|
(60,686
|
)
|
Income (loss) from continuing operations before income taxes
|
59,004
|
|
|
8,607
|
|
|
(325,635
|
)
|
Income tax (provision) benefit
|
(21,731
|
)
|
|
1,331
|
|
|
(211,231
|
)
|
Net income (loss)
|
37,273
|
|
|
9,938
|
|
|
(536,866
|
)
|
Loss from discontinued operations, net of tax
|
(2,706
|
)
|
|
(2,418
|
)
|
|
(1,961
|
)
|
Net income (loss)
|
$
|
34,567
|
|
|
$
|
7,520
|
|
|
$
|
(538,827
|
)
|
Revenues
The following table presents our revenues for the years ended
December 31, 2011, 2012 and 2013
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
2012 vs 2011
|
|
2013 vs 2012
|
|
2011
|
|
2012
|
|
2013
|
|
$ Change
|
|
% Change
|
|
$ Change
|
|
% Change
|
|
(dollars in thousands)
|
Business Services
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Retail services
|
$
|
766,098
|
|
|
$
|
845,664
|
|
|
$
|
793,940
|
|
|
$
|
79,566
|
|
|
10
|
%
|
|
$
|
(51,724
|
)
|
|
(6
|
)%
|
Wholesale services
|
136,224
|
|
|
151,910
|
|
|
151,071
|
|
|
15,686
|
|
|
12
|
%
|
|
(839
|
)
|
|
(1
|
)%
|
Other
|
22,376
|
|
|
19,851
|
|
|
19,216
|
|
|
(2,525
|
)
|
|
(11
|
)%
|
|
(635
|
)
|
|
(3
|
)%
|
Total revenues
|
924,698
|
|
|
1,017,425
|
|
|
964,227
|
|
|
92,727
|
|
|
10
|
%
|
|
(53,198
|
)
|
|
(5
|
)%
|
Consumer Services
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Access services
|
323,998
|
|
|
269,533
|
|
|
231,448
|
|
|
(54,465
|
)
|
|
(17
|
)%
|
|
(38,085
|
)
|
|
(14
|
)%
|
Value-added services
|
51,847
|
|
|
48,177
|
|
|
44,931
|
|
|
(3,670
|
)
|
|
(7
|
)%
|
|
(3,246
|
)
|
|
(7
|
)%
|
Total revenues
|
375,845
|
|
|
317,710
|
|
|
276,379
|
|
|
(58,135
|
)
|
|
(15
|
)%
|
|
(41,331
|
)
|
|
(13
|
)%
|
Total revenues
|
$
|
1,300,543
|
|
|
$
|
1,335,135
|
|
|
$
|
1,240,606
|
|
|
$
|
34,592
|
|
|
3
|
%
|
|
$
|
(94,529
|
)
|
|
(7
|
)%
|
Business Services
Retail Services
. Retail services include data, voice and IT services (including data centers, virtualization, security, applications, premises-based solutions, managed solutions and support services) provided to business customers. The following table presents the primary reasons for the changes in Business Services retail revenues for the years ended
December 31, 2012 and 2013
compared to the prior years:
|
|
|
|
|
|
|
|
|
|
2012 vs 2011
|
|
2013 vs 2012
|
|
(in millions)
|
Due to acquisitions (a)
|
$
|
104.3
|
|
|
$
|
8.6
|
|
Due to growth products (b)
|
—
|
|
|
18.7
|
|
Due to IT services (c)
|
12.2
|
|
|
13.5
|
|
Due net favorable settlements and reserve adjustments (d)
|
9.4
|
|
|
(9.4
|
)
|
Due to decline in traditional voice and data products (e)
|
(46.3
|
)
|
|
(83.1
|
)
|
Total change in Business Services retail revenues
|
$
|
79.6
|
|
|
$
|
(51.7
|
)
|
______________
|
|
(a)
|
Increase in 2012 due to the inclusion of revenues from One Communications for a full year in 2012 compared to a partial period in 2011, as the acquisition occurred on April 1, 2011. Increase in 2013 due to the inclusion of revenues from CenterBeam beginning in July 2013.
|
|
|
(b)
|
Increase in 2013 due to sales of growth products, including MPLS and hosted voice. During 2012, this amount was included in the decline in traditional voice and data products as we were still integrating our reporting systems and were not able to capture this detail separately.
|
|
|
(c)
|
Increase due to IT Services transactions entered into during 2011 and new product launches to expand our IT services portfolio.
|
|
|
(d)
|
Change due to net favorable settlements and reserve adjustments of $9.4 million during 2012.
|
|
|
(e)
|
Decrease due to decline in certain traditional voice and data products, including traditional voice, lower-end, single site broadband services and web hosting. Revenues for these traditional voice and data products have been decreasing due to competition in the industry, the migration of customers to more advanced services and a decreased emphasis on selling these services. The decrease in 2012 was partially offset by sales of growth products, including MPLS and hosted voice.
|
Wholesale Services
. Wholesale services includes the sale of transmission capacity to other telecommunications carriers and businesses. The increase in wholesale services revenues during the year ended December 31, 2012 compared to the prior year was primarily due to the inclusion of revenues from One Communications for a full year in 2012 compared to a partial period in 2011. The decrease in wholesale services revenues during the year ended December 31, 2013 compared to the prior year was primarily due to an increase in customer churn in the current year and a favorable settlement with a telecommunications carrier recorded during the prior year. This was partially offset by a $1.2 million favorable adjustment associated with the One Communications acquisition recognized during the year ended December 31, 2013 and an increase in transport and usage revenues as we capitalize on unique fiber routes.
Other Services.
Other services consists primarily of web hosting and certain equipment-related revenue. The decreases in other services revenues during the years ended December 31, 2012 and 2013 compared to the prior years were primarily due to a decrease in average web hosting accounts.
Consumer Services
Access services
. Access services include narrowband access services (including traditional, fully-featured narrowband access and value-priced narrowband access) and broadband access services (including high-speed access via DSL and cable and VoIP). Access service revenues consist of recurring monthly charges for narrowband and broadband access services; usage fees; installation fees; termination fees; and fees for equipment.
The decreases in consumer access revenues during the years ended December 31, 2012 and 2013 compared to the prior years were due to decreases in narrowband access and broadband access revenues. This was primarily due to a decrease in average consumer access subscribers, which were
1.5 million
,
1.2 million
and
1.1 million
during the years ended
December 31, 2011, 2012 and 2013
, respectively. The decrease in average consumer access subscribers resulted from limited sales and marketing activities, the continued maturation of and competition in the market for Internet access and competitive pressures in the industry. However, we continue to focus on the retention of customers and on marketing channels that we believe will produce an acceptable rate of
return. Our monthly consumer subscriber churn rates were
2.6%
,
2.4%
and
2.1%
during the years ended
December 31, 2011, 2012 and 2013
, respectively, which moderated the decline in average consumer subscribers. Churn rates decreased due to the increased tenure of our consumer subscriber base. Slightly offsetting the decreases in revenues during the years ended December 31, 2012 and 2013 compared to the prior years was an increase in average revenue per subscriber due to targeted price increases implemented over the past year and a change in mix of subscribers.
Value-added services revenues.
Value-added services revenues consist of revenues from ancillary services sold as add-on features to our Internet access services, such as security products, premium email only, home networking and email storage; search revenues; and advertising revenues.
We derive these revenues from fees charged for ancillary services; fees generated through revenue sharing arrangements with online partners whose products and services can be accessed through our web properties, such as the Google
™
search engine; and fees charged for advertising on our various web properties.
The decreases in value-added services revenues during the years ended December 31, 2012 and 2013 compared to the prior years were due primarily to a decrease in revenues from our security and home networking services and a decrease in search and advertising revenues. These decreases were attributable to the overall decline in the average number of consumer subscribers.
Cost of revenues
The following table presents our cost of revenues for the years ended
December 31, 2011, 2012 and 2013
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
2012 vs 2011
|
|
2013 vs 2012
|
|
2011
|
|
2012
|
|
2013
|
|
$ Change
|
|
% Change
|
|
$ Change
|
|
% Change
|
|
(dollars in thousands)
|
Business Services
|
$
|
463,782
|
|
|
$
|
527,514
|
|
|
$
|
506,245
|
|
|
$
|
63,732
|
|
|
14
|
%
|
|
$
|
(21,269
|
)
|
|
(4
|
)%
|
Consumer Services
|
117,482
|
|
|
105,102
|
|
|
94,497
|
|
|
(12,380
|
)
|
|
(11
|
)%
|
|
(10,605
|
)
|
|
(10
|
)%
|
Total cost of revenues
|
$
|
581,264
|
|
|
$
|
632,616
|
|
|
$
|
600,742
|
|
|
$
|
51,352
|
|
|
9
|
%
|
|
$
|
(31,874
|
)
|
|
(5
|
)%
|
Business Services
Cost of revenues for our Business Services segment 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; the costs of providing IT services; and the cost of equipment sold to customers.
The following table presents the primary reasons for the changes in Business Services cost of revenues for the years ended
December 31, 2012 and 2013
compared to the prior years:
|
|
|
|
|
|
|
|
|
|
2012 vs 2011
|
|
2013 vs 2012
|
|
(in millions)
|
Due to acquisitions (a)
|
$
|
58.0
|
|
|
$
|
3.0
|
|
Due to IT services (b)
|
8.3
|
|
|
4.6
|
|
Due to change in reserves for regulatory audits (c)
|
8.3
|
|
|
(15.5
|
)
|
Due to favorable settlements (d)
|
—
|
|
|
(3.8
|
)
|
Due to decline in traditional voice and data products, offset by growth (e)
|
(10.9
|
)
|
|
(9.6
|
)
|
Total change in Business Services cost of revenues
|
$
|
63.7
|
|
|
$
|
(21.3
|
)
|
______________
|
|
(a)
|
Increase in 2012 due to the inclusion of cost of revenues from One Communications for a full year in 2012 compared to a partial period in 2011. Increase in 2013 due to inclusion of CenterBeam cost of revenues beginning in July 2013.
|
|
|
(b)
|
Increase due to IT services transactions entered into during 2011 and new product launches to expand our IT services portfolio.
|
|
|
(c)
|
Increase in 2012 due to an $8.3 million charge recorded in the second quarter of 2012 to increase our reserves for regulatory audits, primarily an audit conducted by the Universal Service Administrative Company on previous ITC^DeltaCom Universal Service Fund assessments and payments. Decrease in 2013 due to the $8.3 million charge recorded in the prior year and a $7.2 million favorable adjustment recorded in the third quarter of 2013 to decrease our reserves for regulatory audits resulting from final interpretation and resolution of certain regulatory audits, primarily the audit by the Universal Service Administrative Company
|
|
|
(d)
|
Decrease due to certain favorable settlements recognized during 2013, including: a $1.8 million favorable adjustment due to the renegotiation of an IRU agreement recorded as a liability in purchase accounting for ITC^DeltaCom; a $0.9 million favorable adjustment for an arbitrator's final decision with respect to post-closing working capital adjustments relating to the One Communications acquisition; and a $1.1 million favorable settlement with a telecommunication vendor.
|
|
|
(e)
|
Decrease due to decline in certain traditional voice and data products, including traditional voice, lower-end, single site broadband services and web hosting, partially offset by sales of growth products which include MPLS and hosted VoIP.
|
Consumer Services
Cost of revenues for our Consumer Services segment primarily consists of telecommunications fees and network operations costs incurred to provide our Internet access 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 for use with our services. Our principal providers for narrowband services are AT&T, GlobalPOPs and Windstream. We also purchase lesser amounts of narrowband services from certain regional and local providers. Our principal providers of broadband connectivity are AT&T Inc., Bright House Networks, CenturyLink, Inc., Comcast Corporation, Megapath, Time Warner Cable and Verizon Communications, Inc. Many of our agreements have a short term or operate on a month-to-month basis. We cannot be certain of renewal or non-termination of our contracts or that legislative or regulatory factors will not affect our contracts.
The decreases in Consumer Services cost of revenues during the years ended December 31, 2012 and 2013 compared to the prior years were primarily due to the declines in the average number of consumer services subscribers. Partially offsetting this decrease was an increase in our average cost per subscriber. Our agreements with certain service providers generally have volume based tiered pricing which is leading to higher unit costs as we see a decline in subscribers over time. Also contributing to the increase was a shift in the mix to customers with higher costs associated with delivering services.
Selling, general and administrative
The following table presents our selling, general and administrative expenses for the years ended
December 31, 2011, 2012 and 2013
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
2012 vs 2011
|
|
2013 vs 2012
|
|
2011
|
|
2012
|
|
2013
|
|
$ Change
|
|
% Change
|
|
$ Change
|
|
% Change
|
|
(dollars in thousands)
|
Selling, general and administrative expenses
|
$
|
397,574
|
|
|
$
|
429,087
|
|
|
$
|
426,070
|
|
|
$
|
31,513
|
|
|
8
|
%
|
|
$
|
(3,017
|
)
|
|
(1
|
)%
|
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 the primary reasons for the changes in selling, general and administrative expenses for the years ended December 31, 2012 and 2013 compared to the prior years:
|
|
|
|
|
|
|
|
|
|
2012 vs 2011
|
|
2013 vs 2012
|
|
(in millions)
|
Due to acquisitions (a)
|
$
|
43.3
|
|
|
$
|
3.6
|
|
Due to decrease in people-related costs (b)
|
(8.3
|
)
|
|
(9.9
|
)
|
Due to change in stock-based compensation expense (c)
|
(3.3
|
)
|
|
2.8
|
|
Due to change in other selling, general and administrative (d)
|
(0.2
|
)
|
|
0.5
|
|
Total change in selling, general and administrative expenses
|
$
|
31.5
|
|
|
$
|
(3.0
|
)
|
______________
|
|
(a)
|
Increase in 2012 due to the inclusion of selling, general and administrative expenses from One Communications and STS Telecom for a full year in 2012 compared to partial periods in 2011. Increase in 2013 due to the inclusion of CenterBeam selling, general and administrative expenses beginning in July 2013.
|
|
|
(b)
|
Decrease primarily due to cost savings realized from workforce reductions and other synergies from integrating our businesses. Also contributing was an increase in personnel costs being classified in capitalized labor and integration-related costs.
|
|
|
(c)
|
Decrease in 2012 due to lower headcount, which resulted in fewer grants. Increase in 2013 due to higher grants and stock-based compensation expense recognized for the acceleration of vesting in connection with certain employee terminations.
|
|
|
(d)
|
Change in other selling, general and administrative costs such as professional fees, property taxes, commissions, outsourced labor, travel, insurance, occupancy costs and advertising.
|
Depreciation and amortization
The following table presents our depreciation and amortization expense for the years ended
December 31, 2011, 2012 and 2013
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
2012 vs 2011
|
|
2013 vs 2012
|
|
2011
|
|
2012
|
|
2013
|
|
$ Change
|
|
% Change
|
|
$ Change
|
|
% Change
|
|
(dollars in thousands)
|
Depreciation expense
|
$
|
100,774
|
|
|
$
|
112,489
|
|
|
$
|
116,744
|
|
|
$
|
11,715
|
|
|
12
|
%
|
|
$
|
4,255
|
|
|
4
|
%
|
Amortization expense
|
59,219
|
|
|
70,676
|
|
|
66,370
|
|
|
11,457
|
|
|
19
|
%
|
|
(4,306
|
)
|
|
(6
|
)%
|
Total depreciation and amortization
|
$
|
159,993
|
|
|
$
|
183,165
|
|
|
$
|
183,114
|
|
|
$
|
23,172
|
|
|
14
|
%
|
|
$
|
(51
|
)
|
|
—
|
%
|
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. Property and equipment is depreciated using the straight-line method over the estimated useful lives of the various asset classes. Customer installation and acquisition costs are amortized over the actual weighted average initial contract terms of contracts initiated each month, assuming a customer churn factor. Leasehold improvements are depreciated using the straight-line method over the shorter of the estimated useful life or the remaining term of the lease. Definite-lived intangible assets, which primarily consist of subscriber bases and customer relationships, acquired software and technology, trade names and other assets, are amortized on a straight-line basis over their estimated useful lives, which range from three to six years.
The following table presents the primary reasons for the changes in depreciation and amortization expense for the years ended December 31, 2012 and 2013 compared to the prior years:
|
|
|
|
|
|
|
|
|
|
2012 vs 2011
|
|
2013 vs 2012
|
|
(in millions)
|
Due to depreciation expense from acquisitions (a)
|
$
|
12.8
|
|
|
$
|
0.2
|
|
Due to amortization expense from acquisitions (b)
|
10.9
|
|
|
0.8
|
|
Due to other changes in depreciation expense (c)
|
(1.1
|
)
|
|
4.0
|
|
Due to other changes in amortization expense (d)
|
0.6
|
|
|
(5.1
|
)
|
Total change in depreciation and amortization
|
$
|
23.2
|
|
|
$
|
(0.1
|
)
|
______________
|
|
(a)
|
Increase in 2012 due to depreciation expense resulting from property and equipment obtained in the acquisitions of One Communications on April 1, 2011 and STS Telecom on March 2, 2011. Increase in 2013 due to inclusion of CenterBeam depreciation expense beginning July 1, 2013.
|
|
|
(b)
|
Increase in 2012 due to amortization expense resulting from the definite-lived intangible assets obtained in the acquisitions of One Communications on April 1, 2011 and STS Telecom on March 2, 2011. Increase in 2013 due to amortization expense resulting from the definite-lived intangible assets obtained in the acquisition of CenterBeam on July 1, 2013.
|
|
|
(c)
|
Decrease in depreciation expense in 2012 primarily due to assets becoming fully depreciated during the year. Increase in depreciation expense in 2013 primarily due to an increase in capital expenditures, including customer acquisition costs, costs to maintain and enhance our network and costs for data center and fiber expansion. Also contributing to the increase in 2013 was accelerated depreciation expense on property and equipment that was disposed of during the year.
|
|
|
(d)
|
Increase in amortization expense in 2012 primarily due to a change in useful life for certain One Communications intangible assets, offset by definite-lived intangible assets becoming fully amortized during the year. Decrease in
|
amortization expense in 2013 primarily due to definite-lived intangible assets becoming fully amortized during the year.
Impairment of goodwill
Interim goodwill test.
During the first quarter of 2013, we recognized a $256.7 million non-cash impairment charge to goodwill related to our Business Services reporting unit, of which $255.6 million is included in continuing operations and $1.1 million is reflected in discontinued operations. We test our goodwill annually during the fourth quarter of each fiscal year or when events or changes in circumstances indicate that goodwill might be impaired. Our stock price and market capitalization declined during the three months ended March 31, 2013 following the announcement in mid-February 2013 of our fourth quarter 2012 earnings and 2013 financial guidance. As a result of the sustained decrease in stock price and market capitalization, we performed an interim goodwill test in conjunction with the preparation of our financial statements for the three months ended March 31, 2013. The primary factor contributing to the impairment was a change in the discount rate and market multiples as a result of the change in these market conditions, both key assumptions used in the determination of fair value.
Impairment testing of goodwill is required at the reporting unit level and involves a two-step process. We identified two reporting units, Business Services and Consumer Services, for evaluating goodwill. Each of these reporting units constitutes a business for which discrete financial information is available and segment management regularly reviews the operating results. The first step of the impairment test involves comparing the estimated fair values of our reporting units with the reporting units' carrying amounts, including goodwill. We estimated the fair values of our reporting units based on weighting of the income and market approaches. These models use 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. Under the market approach, the fair value was estimated using the guideline company method. We selected guideline companies in the industry in which each reporting unit operates.
Upon completion of the first step, we determined that the carrying value of our Business Services reporting unit exceeded its estimated fair value, so a second step was performed to compare the carrying amount of goodwill to the implied fair value of that goodwill. The implied fair value of goodwill for the Business Services reporting unit was determined in the same manner as utilized to recognize goodwill in a business combination. To determine the implied value of goodwill, fair values were allocated to the assets and liabilities of the Business Services reporting unit as of March 31, 2013. The implied fair value of goodwill was measured as the excess of the fair value of the Business Services reporting unit over the fair value of its assets and liabilities. The impairment loss of $256.7 million during the first quarter of 2013 was measured as the amount the carrying value of goodwill exceeded the implied fair value of the goodwill.
Annual goodwill test.
We did not record any impairment of goodwill during the years ended 2011 or 2012. In addition, our annual test of impairment for fiscal 2013 did not result in an impairment. However, approximately $50.3 million of goodwill attributable to our Business Services reporting unit and $88.9 million of goodwill attributable to our Consumer Services reporting unit remains as of December 31, 2013. Deterioration in market conditions or 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.
Restructuring, acquisition and integration-related costs
Restructuring, acquisition and integration-related costs consisted of the following during the years ended
December 31, 2011, 2012 and 2013
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
2012 vs 2011
|
|
2013 vs 2012
|
|
2011
|
|
2012
|
|
2013
|
|
$ Change
|
|
% Change
|
|
$ Change
|
|
% Change
|
|
(dollars in thousands)
|
Integration-related costs
|
$
|
4,044
|
|
|
$
|
10,452
|
|
|
$
|
21,622
|
|
|
$
|
6,408
|
|
|
158
|
%
|
|
$
|
11,170
|
|
|
107
|
%
|
Severance, retention and other employee costs
|
16,460
|
|
|
6,067
|
|
|
14,844
|
|
|
(10,393
|
)
|
|
(63
|
)%
|
|
8,777
|
|
|
145
|
%
|
Transaction-related costs
|
5,756
|
|
|
1,399
|
|
|
1,021
|
|
|
(4,357
|
)
|
|
(76
|
)%
|
|
(378
|
)
|
|
(27
|
)%
|
Facility-related costs
|
5,530
|
|
|
479
|
|
|
2,328
|
|
|
(5,051
|
)
|
|
(91
|
)%
|
|
1,849
|
|
|
386
|
%
|
Legacy plan restructuring costs
|
278
|
|
|
(153
|
)
|
|
215
|
|
|
(431
|
)
|
|
(155
|
)%
|
|
368
|
|
|
241
|
%
|
Restructuring, acquisition and integration-related costs
|
$
|
32,068
|
|
|
$
|
18,244
|
|
|
$
|
40,030
|
|
|
$
|
(13,824
|
)
|
|
(43
|
)%
|
|
$
|
21,786
|
|
|
119
|
%
|
Restructuring, acquisition and integration-related costs consist of costs related to EarthLink’s restructuring, acquisition and integration-related activities. Such costs include: 1) integration-related costs, such as system conversion, rebranding costs and integration-related consulting and employee costs; 2) severance, retention and other employee termination costs associated with acquisition and integration activities and with certain voluntary employee separations; 3) transaction-related costs, which are direct costs incurred to effect a business combination, such as advisory, legal, accounting, valuation and other professional fees; and 4) facility-related costs, such as lease termination and asset impairments. 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)
.
The decrease in restructuring, acquisition and integration-related costs during the year ended December 31, 2012 compared to the prior year was primarily due to a decline in certain up-front costs related to our 2010 and 2011 acquisitions, such as severance costs incurred to eliminate duplicate positions, transaction costs incurred to effect the transactions and facility-related costs to exit duplicate facilities. Partially offsetting this decline was an increase in integration-related costs, as we incurred costs to integrate operating support systems and networks.
The increase in restructuring, acquisition and integration-related costs during the year ended December 31, 2013 compared to the prior year was primarily due to an increase in costs to integrate operating support systems, networks and certain billing systems as we worked to complete several significant integration milestones during the year; costs related to our acquisition of CenterBeam; employee termination costs associated with certain voluntary employee separations; and costs to exit duplicate facilities. In addition, during the first quarter of 2013, we restructured our sales organization in order to better meet the needs of the IT services market, which resulted in a reduction in our sales workforce and some offices closing. We also decided to exit telecom systems sales early in 2013 to enable focus on our hosted VoIP platform for new voice customers, which resulted in a small number of position eliminations.
Interest expense and other, net
The following table presents our interest expense and other, net, for the years ended
December 31, 2011, 2012 and 2013
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
2012 vs 2011
|
|
2013 vs 2012
|
|
2011
|
|
2012
|
|
2013
|
|
$ Change
|
|
% Change
|
|
$ Change
|
|
% Change
|
|
(dollars in thousands)
|
Interest expense
|
$
|
74,949
|
|
|
$
|
64,331
|
|
|
$
|
60,495
|
|
|
$
|
(10,618
|
)
|
|
(14
|
)%
|
|
$
|
(3,836
|
)
|
|
(6
|
)%
|
Interest income
|
(4,678
|
)
|
|
(2,076
|
)
|
|
(84
|
)
|
|
2,602
|
|
|
(56
|
)%
|
|
1,992
|
|
|
(96
|
)%
|
Other, net
|
369
|
|
|
1,161
|
|
|
275
|
|
|
792
|
|
|
215
|
%
|
|
(886
|
)
|
|
(76
|
)%
|
Total interest expense and other, net
|
$
|
70,640
|
|
|
$
|
63,416
|
|
|
$
|
60,686
|
|
|
$
|
(7,224
|
)
|
|
(10
|
)%
|
|
$
|
(2,730
|
)
|
|
(4
|
)%
|
Interest expense and other, net, is primarily comprised of interest expense incurred on our debt and capital leases, amortization of debt issuance costs, debt premiums, and debt discounts; interest earned on our cash, cash equivalents and marketable securities; and other miscellaneous income and expense items.
The decrease in interest expense and other, net, during the year ended December 31, 2012 compared to the prior year was primarily due to the redemption and repayment of our outstanding $255.8 million principal amount of convertible senior notes due 2026 on November 15, 2011, as well as the redemption of $32.5 million aggregate principal amount of our 10.5% ITC^DeltaCom Notes on December 6, 2012. Partially offsetting this was a decrease in interest income due to lower investment yields and a decrease in our average cash and marketable securities.
The decrease in interest expense and other, net, during the year ended December 31, 2013 compared to the prior year was primarily due to lower interest expense resulting from the issuance of 7.375% Senior Secured Notes and repayment of our remaining ITC^DeltaCom Notes in May 2013. In May 2013, we issued $300.0 million aggregate principal amount of 7.375% Senior Secured Notes. Also in May 2013, we completed a tender offer and redemption of all outstanding principal of our 10.5% ITC^DeltaCom Notes. Partially offsetting the decrease in interest expense was a $2.0 million loss on repayment of debt recorded in connection with the redemption of our ITC^DeltaCom Notes and a $2.0 million decrease in interest income due to lower cash and marketable securities. We recognized a net loss of $2.0 million as a result of $16.2 million of premiums paid for the acquisition of ITC^DeltaCom Notes, net of a $14.2 million write-off of the unamortized premium on debt.
Income tax (provision)
benefit
The following table presents the components of the income tax (provision)
benefit
for the years ended
December 31, 2011, 2012 and 2013
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
2011
|
|
2012
|
|
2013
|
|
(in thousands)
|
Current (provision) benefit
|
$
|
(3,777
|
)
|
|
$
|
1,224
|
|
|
$
|
1,639
|
|
Deferred (provision ) benefit
|
(17,954
|
)
|
|
107
|
|
|
(212,870
|
)
|
Total income tax (provision) benefit
|
$
|
(21,731
|
)
|
|
$
|
1,331
|
|
|
$
|
(211,231
|
)
|
During the year ended December 31, 2011, the current tax provision was due to state income and federal and state alternative minimum tax ("AMT") amounts payable due to the net operating loss carryforward limitations associated with the AMT calculation and the non-cash deferred tax provision was due primarily to the utilization of net operating loss carryforwards. During the year ended December 31, 2012, the current and non-cash deferred benefits were primarily due to the tax impact of changes to our state deferred income tax rates and the resulting impact on the re-measurement of deferred tax assets and liabilities recorded on the balance sheet as of January 1, 2012; the release of valuation allowance related to specific state net operating losses; and the reversal of state related uncertain tax positions in the current year due to statute expirations. During the year ended December 31, 2013, the current tax benefit was primarily related to expense for Canadian tax amounts payable, prior year state tax items and penalties and interest related to uncertain tax positions, which is offset with benefit from the current release of uncertain tax positions related to prior years. During the year ended December 31, 2013, the non-cash deferred tax provision was due primarily to the recording of a valuation allowance against deferred tax assets (as further described below).
The tax provision for the year ended December 31, 2013 includes a $266.3 million non-cash charge to record a valuation allowance against our deferred tax assets. During the three months ended December 31, 2013, we entered into a three-year cumulative loss position. For purposes of assessing the realization of the deferred tax assets, this cumulative loss position is considered significant negative evidence. Also during the three months ended December 31, 2013, management reassessed its projections of future taxable income. This change in projections, coupled with its cumulative loss position caused management to modify its assessment of the realizability of its deferred tax asset and conclude that a full valuation allowance, exclusive of our deferred tax liabilities with indefinite useful lives and our capital loss carryforward, was necessary.
We will reassess 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.
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 received
$0.6 million
of cash and recorded an
$0.8 million
receivable for contingent consideration expected to be received over the next four years. No gain or loss was recognized on the sale. 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 Business Services segment.
The following table presents summarized results of operations related to discontinued operations for the years ended
December 31, 2011, 2012 and 2013
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
2011
|
|
2012
|
|
2013
|
|
(in thousands)
|
Revenues
|
$
|
13,561
|
|
|
$
|
13,842
|
|
|
$
|
6,141
|
|
Operating costs and expenses
|
(18,096
|
)
|
|
(17,860
|
)
|
|
(8,102
|
)
|
Income tax benefit
|
1,829
|
|
|
1,600
|
|
|
—
|
|
Loss from discontinued operations, net of tax
|
$
|
(2,706
|
)
|
|
$
|
(2,418
|
)
|
|
$
|
(1,961
|
)
|
Segment Results of Operations
We operate two reportable segments, Business Services and Consumer Services. We present our segment information along the same lines that our chief executive reviews our operating results in assessing performance and allocating resources. Our Business Services segment earns revenue by providing a broad range of data, voice and IT services to businesses and communications carriers. Our Consumer Services segment provides nationwide Internet access and related value-added services to residential customers.
We evaluate the performance of our operating segments 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 include expenses over which segment managers have direct discretionary control, such as advertising and marketing programs, customer support expenses, operations expenses, product development expenses, certain technology and facilities expenses, billing operations and provisions for doubtful accounts. Segment operating income excludes 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 and stock-based compensation expense, as they are not considered in the measurement of segment performance.
Business Services Segment
The following table sets forth operating results for our Business Services segment for the years ended
December 31, 2011, 2012 and 2013
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
2012 vs 2011
|
|
2013 vs 2012
|
|
2011
|
|
2012
|
|
2013
|
|
$ Change
|
|
% Change
|
|
$ Change
|
|
% Change
|
|
(dollars in thousands)
|
Revenues
|
$
|
924,698
|
|
|
$
|
1,017,425
|
|
|
$
|
964,227
|
|
|
$
|
92,727
|
|
|
10
|
%
|
|
$
|
(53,198
|
)
|
|
(5
|
)%
|
Cost of revenues
|
463,782
|
|
|
527,514
|
|
|
506,245
|
|
|
63,732
|
|
|
14
|
%
|
|
(21,269
|
)
|
|
(4
|
)%
|
Segment operating expenses
|
293,211
|
|
|
332,542
|
|
|
342,630
|
|
|
39,331
|
|
|
13
|
%
|
|
10,088
|
|
|
3
|
%
|
Segment operating income
|
$
|
167,705
|
|
|
$
|
157,369
|
|
|
$
|
115,352
|
|
|
$
|
(10,336
|
)
|
|
(6
|
)%
|
|
$
|
(42,017
|
)
|
|
(27
|
)%
|
The increase in Business Services revenues during the year ended December 31, 2012 compared to the prior year was primarily due to a full year of One Communications revenues in 2012 compared to a partial period 2011; revenues from our IT services transactions entered into during 2011 and new product launches over the year; partially offset by continued declines in revenues for certain traditional voice and data products, including traditional voice, web hosting and lower-end, single site broadband services. The decrease in Business Services revenues during the year ended
December 31, 2013
compared to the prior year was primarily due to continued declines in revenues for traditional voice and data products, partially offset by revenues from our growth products, including MPLS, hosted voice and IT services, and revenues from CenterBeam beginning in July 2013. For more detail, please see discussion under "Revenues" in "Consolidated Results of Operations" elsewhere in this section.
The decrease in Business Services operating income during the year ended December 31, 2012 compared to the prior year was primarily due to the decline in traditional voice and data products. The decrease in Business Services operating income during the year ended
December 31, 2013
compared to the prior year was primarily due to the continued decline in revenues for traditional voice and data products. In addition, costs increased due to investments in our growth products and due to the change in mix of products to growth products, which are more costly to deliver.
Consumer Services Segment
Consumer Services Operating Metrics
The following table sets forth subscriber and operating data for our Consumer Services segment for the years ended
December 31, 2011, 2012 and 2013
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
2011
|
|
2012
|
|
2013
|
Consumer Subscriber Activity
|
|
|
|
|
|
|
Subscribers at beginning of year
|
1,636,000
|
|
|
1,350,000
|
|
|
1,139,000
|
|
Gross organic subscriber additions
|
184,000
|
|
|
146,000
|
|
|
105,000
|
|
Churn
|
(470,000)
|
|
|
(357,000)
|
|
|
(268,000)
|
|
Subscribers at end of year (a)
|
1,350,000
|
|
|
1,139,000
|
|
|
976,000
|
|
|
|
|
|
|
|
Consumer Metrics
|
|
|
|
|
|
|
Average narrowband subscribers (b)
|
830,000
|
|
|
678,000
|
|
|
582,000
|
|
Average broadband subscribers (b)
|
654,000
|
|
|
562,000
|
|
|
473,000
|
|
Average consumer subscribers (b)
|
1,484,000
|
|
|
1,240,000
|
|
|
1,055,000
|
|
|
|
|
|
|
|
ARPU (c)
|
$
|
21.10
|
|
|
$
|
21.34
|
|
|
$
|
21.83
|
|
Churn rate (d)
|
2.6
|
%
|
|
2.4
|
%
|
|
2.1
|
%
|
(a) Subscriber counts do not include new nonpaying 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.
(b) Average subscribers is calculated by averaging the ending monthly subscribers or accounts for the
thirteen
months preceding and including the end of the year.
(c) 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.
(d) 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.
Consumer Services Operating Results
The following table sets forth operating results for our Consumer Services segment for the years ended
December 31, 2011, 2012 and 2013
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
2012 vs 2011
|
|
2013 vs 2012
|
|
2011
|
|
2012
|
|
2013
|
|
$ Change
|
|
% Change
|
|
$ Change
|
|
% Change
|
|
(dollars in thousands)
|
Revenues
|
$
|
375,845
|
|
|
$
|
317,710
|
|
|
$
|
276,379
|
|
|
$
|
(58,135
|
)
|
|
(15
|
)%
|
|
$
|
(41,331
|
)
|
|
(13
|
)%
|
Cost of revenues
|
117,482
|
|
|
105,102
|
|
|
94,497
|
|
|
(12,380
|
)
|
|
(11
|
)%
|
|
(10,605
|
)
|
|
(10
|
)%
|
Segment operating expenses
|
73,293
|
|
|
67,526
|
|
|
50,623
|
|
|
(5,767
|
)
|
|
(8
|
)%
|
|
(16,903
|
)
|
|
(25
|
)%
|
Segment operating income
|
$
|
185,070
|
|
|
$
|
145,082
|
|
|
$
|
131,259
|
|
|
$
|
(39,988
|
)
|
|
(22
|
)%
|
|
$
|
(13,823
|
)
|
|
(10
|
)%
|
The decreases in Consumer Services revenues and operating income during the years ended December 31, 2012 and 2013 compared to the prior years were primarily due to the continued maturation of and competition in the market for consumer Internet access and competitive pressures in the industry. The decreases in revenue were partially offset by decreases in operating expenses as our consumer subscriber base has decreased and become longer-tenured. Our longer tenured customers require less customer service and technical support and have a lower frequency of non-payment.
Liquidity and Capital Resources
The following table sets forth summarized cash flow data for the years ended
December 31, 2011, 2012 and 2013
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
2012 vs 2011
|
|
2013 vs 2012
|
|
2011
|
|
2012
|
|
2013
|
|
$ Change
|
|
% Change
|
|
$ Change
|
|
% Change
|
|
(dollars in thousands)
|
Net cash provided by operating activities
|
$
|
146,234
|
|
|
$
|
191,055
|
|
|
$
|
124,156
|
|
|
$
|
44,821
|
|
|
31
|
%
|
|
$
|
(66,899
|
)
|
|
(35
|
)%
|
Net cash provided by (used in) investing activities
|
141,594
|
|
|
(163,836
|
)
|
|
(112,500
|
)
|
|
(305,430
|
)
|
|
(216
|
)%
|
|
51,336
|
|
|
31
|
%
|
Net cash used in financing activities
|
(318,997
|
)
|
|
(81,381
|
)
|
|
(52,641
|
)
|
|
237,616
|
|
|
74
|
%
|
|
28,740
|
|
|
35
|
%
|
Net decrease in cash and cash equivalents
|
$
|
(31,169
|
)
|
|
$
|
(54,162
|
)
|
|
$
|
(40,985
|
)
|
|
$
|
(22,993
|
)
|
|
(74
|
)%
|
|
$
|
13,177
|
|
|
24
|
%
|
Operating activities
The increase in cash provided by operating activities during the year ended December 31, 2012 compared to the prior year was primarily due to the inclusion of a full period of cash generated by One Communications in 2012 compared to a partial period in 2011. Also contributing to the increase was an increase in accounts payable and accrued liabilities, primarily related to timing of certain payments to network providers. This was partially offset by severance, transaction and other integration-related costs and an increase in interest payments.
The decrease in cash provided by operating activities during the year ended December 31, 2013 compared to the prior year period was primarily due to the overall decrease in revenues as well as an increase in payments for acquisition, restructuring and integration-related activities.
Investing activities
The change in cash flows from investing activities during the year ended
December 31, 2012
compared to the prior year was primarily due to $307.4 million change in cash associated with investments in marketable securities. During the year ended December 31, 2011, we received cash of $290.1 million for sales and maturities of investments in marketable securities, net of purchases. During the year ended December 31, 2012, we used cash of $17.2 million for purchases of marketable securities, net of sales and maturities. Also contributing to the decrease was a $45.4 million increase in capital expenditures, primarily due to a full year of One Communications of capital expenditures, network and technology center related projects and customer acquisition costs. The overall decrease in cash flows from investing activities was offset by a $43.1 million decrease in cash used for acquisitions, net of cash acquired.
The decrease in net cash used in investing activities during the year ended December 31, 2013 compared to the prior year period was primarily due to a $64.1 million change in net cash from purchases and sales of marketable securities. During the year ended December 31, 2012, we used $17.2 million of cash for purchases of marketable securities, net of sales and maturities. During the year ended December 31, 2013, we generated $46.9 million of cash from sales and maturities of marketable securities, net of purchases. Also contributing was a $3.7 million decrease in capital expenditures. Partially offsetting these decreases was $16.8 million of cash used for our acquisition of CenterBeam in July 2013.
Financing activities
The decrease in net cash used in financing activities during the year ended
December 31, 2012
compared to the prior year was primarily due to a $215.0 million net change in cash flows from debt activities, a $21.6 million decrease in repurchases of common stock and a $1.8 million decrease in dividend payments. During the year ended December 31, 2011, we used $250.3 million for repayment of debt and capital lease obligations and during the year ended December 31, 2012, we used $35.3 million for repayment of debt and capital lease obligations. During the year ended December 31, 2011, we repurchased 6.3 million shares of our common stock for $47.0 million and during the year ended December 31, 2012, we repurchased 3.7 million shares of our common stock for $25.4 million. Dividend payments were $22.9 million and $21.1 million during the years ended December 31, 2011 and 2012, respectively, reflecting quarterly dividends of $0.05 per share.
The decrease in net cash used in financing activities during the year ended December 31, 2013 compared to the prior year was primarily due to a $19.3 million decrease in repurchases of common stock, a $9.4 million decrease in net cash used for debt and capital lease transactions and a $0.3 million decrease in dividends paid. During the year ended December 31, 2012, we repurchased 3.7 million shares of our common stock for $25.4 million compared to 1.1 million shares of our common stock for $6.1 million during the year ended December 31, 2013. During the year ended December 31, 2012, we used $35.3 million for repayments of debt and capital lease obligations, compared to $25.8 million net cash used for debt transactions during the year ended December 31, 2013, which are more fully described below. Dividend payments were $21.1 million and $20.8 million during the years ended December 31, 2012 and 2013, respectively, reflecting quarterly dividends of $0.05 per share.
In May 2013, we completed a private placement of $300.0 million aggregate principal amount of Senior Secured Notes, resulting in net proceeds of $292.6 million after deducting transaction fees of $7.4 million. We used proceeds from the private placement, together with available cash, to fund a tender offer and redemption of our ITC^DeltaCom Notes. We used approximately $314.8 million to repay the ITC^DeltaCom Notes, which consisted of $292.3 million of outstanding principal amount, $16.2 million of premiums and $6.3 million of accrued and unpaid interest. In May 2013, we also amended and restated our revolving credit facility and paid $1.9 million of transaction fees and expenses. Finally, in connection with our acquisition of CenterBeam in July 2013, we assumed and repaid $6.5 million of debt.
Future uses of cash
Our primary future cash requirements relate to outstanding indebtedness, capital expenditures and investments in our Business Services segment. In addition, we have historically used cash for dividends and we may use cash in the future to make strategic acquisitions or repurchase common stock or debt.
Debt and interest.
We expect to use cash to service our outstanding indebtedness, including our $300.0 million aggregate principal amount of Senior Notes due in May 2019, our $300.0 million aggregate principal amount of Senior Secured Notes due in June 2020 and any future borrowings under our $135.0 million revolving credit facility.
Capital expenditures
. We expect to incur capital expenditures of approximately
$125.0 million
to
$135.0 million
during 2014. 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 Business Services segment.
One of our key strategies is to grow our Business Services revenue. We are deploying a wide array of cloud, managed security and IT support services. We expect to invest cash in sales and marketing efforts and resources required to support our business services, including investments in search engine marketing campaigns and advertising to increase brand awareness.
Dividends
. During the years ended
December 31, 2011, 2012 and 2013
, cash dividends declared were
$0.20
per common share. 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 invest in or acquire other companies, to repurchase common stock or to repurchase or redeem debt. We expect to continue to evaluate and consider potential strategic transactions that we believe may complement or grow our business. Although we continue to consider and evaluate potential strategic transactions, there can be no assurance that we will be able to consummate any such transaction. In addition, we continue to evaluate our business, including evaluating ways to reduce the cost structure of our business, and may incur costs for additional restructuring activities.
Our cash requirements depend on numerous factors, including costs required to integrate our acquisitions, costs incurred to redeem or repurchase debt, the size and types of future acquisitions in which we may engage, the costs required to maintain our network infrastructure, the outcome of various telecommunications-related disputes and proceedings, the pricing of our services and the level of resources used for our sales and marketing activities, among others. In addition, our use of cash in connection with acquisitions may limit other potential uses of our cash, including stock repurchases, debt repayments or repurchases and dividend payments.
Future sources of cash
Our principal sources of liquidity are our cash, cash equivalents and marketable securities, as well as the cash flow we generate from our operations. During the years ended
December 31, 2011, 2012 and 2013
, we generated
$146.2 million
,
$191.1 million
and
$124.2 million
in cash from operations, respectively. As of
December 31, 2013
, we had
$116.6 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.
Another source of liquidity is our revolving credit facility. We have a credit agreement providing for a senior secured revolving credit facility with aggregate revolving commitments of $135.0 million. The senior secured revolving credit facility terminates in May 2017, and at that time any amounts outstanding thereunder shall be due and payable in full. As of
December 31, 2013
, no amounts had been drawn or were outstanding under the 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, service outstanding indebtedness, capital requirements and investment 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 $135.0 million 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 and raise future capital. 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 sets forth our contractual obligations and commercial commitments as of
December 31, 2013
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Payment Due by Period
|
|
|
Total
|
|
2014
|
|
2015-
2016
|
|
2017-
2018
|
|
After 5 Years
|
|
|
(in thousands)
|
Long-term debt (1)
|
|
$
|
600,000
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
600,000
|
|
Interest payments on long-term debt (2)
|
|
285,078
|
|
|
48,750
|
|
|
97,500
|
|
|
97,500
|
|
|
41,328
|
|
Purchase commitments (3)
|
|
106,960
|
|
|
50,603
|
|
|
43,161
|
|
|
6,127
|
|
|
7,069
|
|
Operating leases (4)
|
|
181,717
|
|
|
40,436
|
|
|
51,934
|
|
|
47,106
|
|
|
42,241
|
|
Capital leases (5)
|
|
25,889
|
|
|
3,305
|
|
|
7,759
|
|
|
6,146
|
|
|
8,679
|
|
Total (6)
|
|
$
|
1,199,644
|
|
|
$
|
143,094
|
|
|
$
|
200,354
|
|
|
$
|
156,879
|
|
|
$
|
699,317
|
|
__________________________________________
|
|
(1)
|
Long-term debt includes principal payments on outstanding debt obligations. Long-term debt excludes unamortized discounts and premiums. As of
December 31, 2013
, we had $600.0 million aggregate principal amount of debt outstanding, consisting of
$300.0 million
of 8.875% Senior Notes due May 15, 2019 and $300.0 million of 7.375% Senior Secured Notes due June 1, 2020.
|
|
|
(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; and certain commitments regarding employee agreements.
|
|
|
(4)
|
These amounts represent base rent payments under non-cancellable operating leases for facilities and equipment that expire in various years through
2018
, as well as an allocation for operating expenses. Not included in these amounts is expected sublease income of
$2.1 million
,
$1.1 million
,
$1.1 million
,
$1.1 million
and
$0.9 million
during the years ended December 31, 2014, 2015, 2016, 2017 and 2018, respectively.
|
|
|
(5)
|
Represents remaining payments under capital leases, including interest.
|
|
|
(6)
|
The table does not include our reserve for uncertain tax positions, which as of
December 31, 2013
total
$21.6 million
, as the specific timing of any cash payments relating to this obligation cannot be projected with reasonable certainty.
|
Debt Covenants
Under the indentures governing our debt agreements, acceleration on principal payments would occur upon payment default or violation of debt covenants. We were in compliance with all covenants under our debt agreements as of
December 31, 2013
.
Off-Balance Sheet Arrangements
As of
December 31, 2013
, 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, 2013
, we had utilized approximately
$682.1 million
pursuant to the authorizations and had
$67.9 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.
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. Set forth below is a discussion of the presentation and use of Adjusted EBITDA and Unlevered Free Cash Flow, the non-GAAP financial measures used by management.
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 intangible assets, restructuring, acquisition and integration-related costs, and loss from discontinued operations, net of tax. 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 intangible assets, restructuring, acquisition and integration-related costs, and loss from discontinued operations, net of tax, less cash used for purchases of property and equipment.
These non-GAAP financial measures are commonly used in the industry and are presented because management believes they provide relevant and useful information to investors. Management uses these non-GAAP financial measures to evaluate the performance of its business. Management also uses Unlevered Free Cash Flow to assess its ability to fund capital expenditures, fund growth and service debt. Management believes that excluding the effects of certain non-cash and non-operating items enables investors to better understand and analyze the current period’s results and provides a better measure of comparability.
There are limitations to using these non-GAAP financial measures. Adjusted EBITDA and Unlevered Free Cash Flow are not indicative of cash provided or used by 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.
The following table presents a reconciliation of Adjusted EBITDA to the most closely related financial measure reported under GAAP for the years ended
December 31, 2011, 2012 and 2013
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
2011
|
|
2012
|
|
2013
|
|
(in thousands)
|
Net income (loss)
|
$
|
34,567
|
|
|
$
|
7,520
|
|
|
$
|
(538,827
|
)
|
Interest expense and other, net
|
70,640
|
|
|
63,416
|
|
|
60,686
|
|
Income tax provision (benefit)
|
21,731
|
|
|
(1,331
|
)
|
|
211,231
|
|
Depreciation and amortization
|
159,993
|
|
|
183,165
|
|
|
183,114
|
|
Stock-based compensation expense
|
13,466
|
|
|
10,462
|
|
|
13,275
|
|
Impairment of goodwill
|
—
|
|
|
—
|
|
|
255,599
|
|
Restructuring, acquisition and integration-related costs
|
32,068
|
|
|
18,244
|
|
|
40,030
|
|
Loss from discontinued operations, net of tax
|
2,706
|
|
|
2,418
|
|
|
1,961
|
|
Adjusted EBITDA
|
$
|
335,171
|
|
|
$
|
283,894
|
|
|
$
|
227,069
|
|
The following table presents a reconciliation of Unlevered Free Cash Flow to the most closely related financial measure reported under GAAP for the years ended
December 31, 2011, 2012 and 2013
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
2011
|
|
2012
|
|
2013
|
|
(in thousands)
|
Net income (loss)
|
$
|
34,567
|
|
|
$
|
7,520
|
|
|
$
|
(538,827
|
)
|
Interest expense and other, net
|
70,640
|
|
|
63,416
|
|
|
60,686
|
|
Income tax provision (benefit)
|
21,731
|
|
|
(1,331
|
)
|
|
211,231
|
|
Depreciation and amortization
|
159,993
|
|
|
183,165
|
|
|
183,114
|
|
Stock-based compensation expense
|
13,466
|
|
|
10,462
|
|
|
13,275
|
|
Impairment of goodwill
|
—
|
|
|
—
|
|
|
255,599
|
|
Restructuring, acquisition and integration-related costs
|
32,068
|
|
|
18,244
|
|
|
40,030
|
|
Loss from discontinued operations, net of tax
|
2,706
|
|
|
2,418
|
|
|
1,961
|
|
Purchases of property and equipment
|
(101,967
|
)
|
|
(147,360
|
)
|
|
(143,614
|
)
|
Unlevered Free Cash Flow
|
$
|
233,204
|
|
|
$
|
136,534
|
|
|
$
|
83,455
|
|
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, 2011, 2012 and 2013
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
2011
|
|
2012
|
|
2013
|
|
(in thousands)
|
Net cash provided by operating activities
|
$
|
146,234
|
|
|
$
|
191,055
|
|
|
$
|
124,156
|
|
Income tax provision (benefit)
|
21,731
|
|
|
(1,331
|
)
|
|
211,231
|
|
Non-cash income taxes
|
(17,954
|
)
|
|
107
|
|
|
(212,870
|
)
|
Interest expense and other, net
|
70,640
|
|
|
63,416
|
|
|
60,686
|
|
Amortization of debt discount, premium and issuance costs
|
(11,136
|
)
|
|
1,945
|
|
|
(2,061
|
)
|
Restructuring, acquisition and integration-related costs
|
32,068
|
|
|
18,244
|
|
|
40,030
|
|
Changes in operating assets and liabilities
|
91,301
|
|
|
7,930
|
|
|
5,662
|
|
Purchases of property and equipment
|
(101,967
|
)
|
|
(147,360
|
)
|
|
(143,614
|
)
|
Other, net
|
2,287
|
|
|
2,528
|
|
|
235
|
|
Unlevered Free Cash Flow
|
$
|
233,204
|
|
|
$
|
136,534
|
|
|
$
|
83,455
|
|
|
|
|
|
|
|
|
Net cash provided by (used in) investing activities
|
$
|
141,594
|
|
|
$
|
(163,836
|
)
|
|
$
|
(112,500
|
)
|
Net cash used in financing activities
|
$
|
(318,997
|
)
|
|
$
|
(81,381
|
)
|
|
$
|
(52,641
|
)
|
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.
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|
|
|
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 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 income.
|
|
|
|
|
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, 2013 would have affected net loss by approximately $4.9 million during the year ended December 31, 2013.
|
|
|
|
|
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, 2013 would have affected net loss by approximately $0.9 million during the year ended December 31, 2013.
|
|
|
|
|
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.
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.
|
During the three months ended December 31, 2013, we recorded income tax expense of $266.3 million to record 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 provision in the statement of comprehensive income.
As of December 31, 2013, we had unrecognized tax benefits of $21.6 million. Within the next twelve months, it is reasonably possible that approximately $5.5 million of the total uncertain tax positions recorded will reverse, primarily due to the expiration of statutes of limitation in various jurisdictions. Approximately $5.7 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 and allocate goodwill to our reporting units based on the reporting units expected to benefit from the acquisition generating the goodwill.
|
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 weighting of the income and market approaches. These models use 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. Under the market approach, we estimate the fair value using the guideline company method. We select guideline companies in the industry where each reporting unit operates. We primarily use revenue and EBITDA multiples based on the multiples of the selected guideline companies.
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 last three years other than the adoption of the new guidance in 2011 allowing the option to first assess qualitative factors to determine whether it is necessary to perform the two-step quantitative impairment test.
During the first quarter of 2013, we performed an interim goodwill test and recognized a $256.7 million non-cash impairment charge to goodwill related to our Business Services reporting unit. The impairment was based on an analysis of a number of factors after a decline in our market capitalization following the announcement of our fourth quarter 2012 earnings and 2013 financial guidance. The primary factor contributing to the impairment was a change in the discount rate and market multiples as a result of the change in these market conditions, both key assumptions used in the determination of fair value. We did not record any impairment of goodwill during the years ended 2011 or 2012.
As of December 31, 2013, we had approximately $139.2 million of goodwill. Of the total goodwill, $50.3 million was allocated to our Business Services reporting unit and $88.9 million was allocated to our Consumer Services reporting unit. Our fiscal 2013 impairment test indicated the estimated fair value of our Consumer Services reporting unit substantially exceeded the carrying value and therefore was not at risk of future impairment. The estimated fair value of our Business Services reporting unit exceeded its carrying value by approximately 47%. Deterioration in estimated future cash flows in this reporting unit 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 the Business Services reporting unit 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 IT services and other 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 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. We did not recognize any material impairment charges 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.
|
|
|
|
|
Business Combinations
|
|
|
We account 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 and the net of the acquisition date fair values of the assets acquired and the liabilities assumed. During the measurement period, which may be up to one year from the acquisition date, adjustments to the assets acquired and liabilities assumed are recorded to goodwill. Upon the conclusion of the measurement period, any subsequent adjustments are recorded to our Consolidated Statements of Comprehensive Income (Loss).
|
Accounting for business combinations requires our management to make significant estimates and assumptions about intangible assets, obligations assumed and pre-acquisition contingencies, including uncertain tax positions and tax-related valuation allowances, reserves for billing disputes and revenue reserves. Critical estimates in valuing certain of the intangible assets include, but are not limited to, future expected cash flows from customer relationships and developed technologies; the acquired company's brand and competitive position, as well as assumptions about the period of time the acquired brand will continue to be used in the combined company's product portfolio; and discount rates.
|
Although we believe the assumptions and estimates we have made in the past have been reasonable and appropriate, they are inherently uncertain. As a result, actual results may differ from estimates.
|
|
|
|
|
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, 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
During the year ended December 31, 2012, we recorded an $8.3 million charge to increase our reserves for regulatory audits, primarily an audit that was conducted by the Universal Service Administrative Company on previous ITC^DeltaCom Universal Service Fund assessments and payments, because the amount became probable and estimable during the period. During the year ended December 31, 2013, we recorded a $7.2 million favorable adjustment to decrease our reserves for regulatory audits resulting from final interpretation and resolution of certain regulatory audits, primarily the audit by the Universal Service Administrative Company.
We have not made any material changes in the accounting methodology used to accrue for loss contingencies during the last three years
|
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 we may not be able to execute our strategy to be a leading communications and IT services provider, which could adversely affect our results of operations and cash flows; (2) that we may not be able to grow 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; (3) that our failure to achieve operating efficiencies will adversely affect our results of operations; (4) that as a result of our continuing review of our business, we may have to undertake further restructuring plans that would require additional charges, including incurring facility exit and restructuring charges; (5) that we may be unsuccessful integrating acquisitions into our business, which could result in operating difficulties, losses and other adverse consequences; (6) 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; (7) that unfavorable general economic conditions could harm our business; (8) that we may be unable to successfully identify, manage and assimilate future acquisitions, which could adversely affect our results of operations; (9) that we face significant competition in the communications and IT services industry that could reduce our profitability; (10) that failure to retain existing customers could adversely affect our results of operations and cash flows; (11) 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; (12) 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; (13) that our operating performance will suffer if we are not offered competitive rates for the access services we need to provide our long distance services; (14) that we may experience reductions in switched access and reciprocal compensation revenue; (15) that failure to obtain and maintain necessary permits and rights-of-way could interfere with our network infrastructure and operations; (16) that we have substantial business relationships with several large telecommunications carriers, and some of our customer agreements may not continue due to financial difficulty, acquisitions, non-renewal or other factors, which could adversely affect our wholesale revenue and results of operations; (17) that we obtain a majority of our network equipment and software from a limited number of third-party suppliers; (18) 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; (19) that our commercial and alliance arrangements may not be renewed or may not generate expected benefits, which could adversely affect our results of operations; (20) our consumer business is dependent on the availability of third-party network service providers; (21) that we face significant competition in the Internet access industry that could reduce our profitability; (22) that the continued decline of our consumer access subscribers will adversely affect our results of operations; (23) that potential regulation of Internet service providers could adversely affect our operations; (24) that cyber security breaches could harm our business; (25) that privacy concerns relating to our business could damage our reputation and deter current and potential users from using our services; (26) 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; (27) that our business depends on effective business support systems and processes; (28) 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; (29) 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; (30) that we may not be able to protect our intellectual property; (31) 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; (32) that government regulations could adversely affect our business or force us to change our business practices; (33) that our business may suffer if third parties are unable to provide services or terminate their relationships with us; (34) that we may be required to recognize impairment charges on our goodwill and intangible assets, which would adversely affect our results of operations and financial position; (35) that we may not realize our deferred tax assets, 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; (36) that our indebtedness could adversely affect our financial health and limit our ability to react to changes in our industry; (37) 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; (38) that our debt agreements include restrictive covenants, and failure to comply with these covenants could trigger acceleration of payment of outstanding indebtedness; (39) that we may reduce, or cease payment of, quarterly cash dividends; (40) that our stock price may be volatile; (41) 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 (42) 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
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, 2012 and 2013, 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, 2013. 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, 2012 and 2013, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2013, 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, 2013, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (1992 framework) and our report dated February 25, 2014 expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
Atlanta, Georgia
February 25, 2014
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, 2013, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (1992 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 CenterBeam, Inc., which is included in the 2013 consolidated financial statements of EarthLink Holdings Corp.
and constituted $24,434,669 and $24,040,983 of total and net assets, respectively, as of December 31, 2013 and $8,593,887 and $566,448 of revenues and net loss, respectively, 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 CenterBeam, Inc.
In our opinion, EarthLink Holdings Corp. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2013, 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 as of December 31, 2012 and 2013, 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, 2013 of EarthLink Holdings Corp. and our report dated February 25, 2014 expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
Atlanta, Georgia
February 25, 2014
EARTHLINK HOLDINGS CORP.
CONSOLIDATED BALANCE SHEETS
|
|
|
|
|
|
|
|
|
|
December 31,
2012
|
|
December 31,
2013
|
|
(in thousands, except per share data)
|
ASSETS
|
Current assets:
|
|
|
|
|
|
Cash and cash equivalents
|
$
|
157,621
|
|
|
$
|
116,636
|
|
Marketable securities
|
42,073
|
|
|
—
|
|
Restricted cash
|
1,013
|
|
|
—
|
|
Accounts receivable, net of allowance of $7,872 and $8,615 as of December 31, 2012 and 2013, respectively
|
112,765
|
|
|
100,792
|
|
Prepaid expenses
|
17,171
|
|
|
15,945
|
|
Deferred income taxes, net
|
15,954
|
|
|
549
|
|
Other current assets
|
20,303
|
|
|
13,930
|
|
Total current assets
|
366,900
|
|
|
247,852
|
|
Long-term marketable securities
|
4,778
|
|
|
—
|
|
Property and equipment, net
|
418,966
|
|
|
438,321
|
|
Long-term deferred income taxes, net
|
195,012
|
|
|
—
|
|
Goodwill
|
379,415
|
|
|
139,215
|
|
Other intangible assets, net
|
214,685
|
|
|
155,428
|
|
Other long-term assets
|
19,654
|
|
|
26,502
|
|
Total assets
|
$
|
1,599,410
|
|
|
$
|
1,007,318
|
|
LIABILITIES AND STOCKHOLDERS’ EQUITY
|
Current liabilities:
|
|
|
|
|
|
Accounts payable
|
$
|
18,792
|
|
|
$
|
33,440
|
|
Accrued payroll and related expenses
|
31,003
|
|
|
35,041
|
|
Other accrued liabilities
|
129,572
|
|
|
88,225
|
|
Deferred revenue
|
51,690
|
|
|
49,689
|
|
Current portion of long-term debt and capital lease obligations
|
1,375
|
|
|
1,489
|
|
Total current liabilities
|
232,432
|
|
|
207,884
|
|
Long-term debt and capital lease obligations
|
614,890
|
|
|
606,442
|
|
Long-term deferred income taxes, net
|
—
|
|
|
2,221
|
|
Other long-term liabilities
|
33,284
|
|
|
28,553
|
|
Total liabilities
|
880,606
|
|
|
845,100
|
|
Commitments and contingencies (See Note 16)
|
|
|
|
|
|
Stockholders’ equity:
|
|
|
|
|
|
Preferred stock, $0.01 par value, 100,000 shares authorized, 0 shares issued and outstanding as of December 31, 2012 and 2013
|
—
|
|
|
—
|
|
Common stock, $0.01 par value, 300,000 shares authorized, 196,919 and 197,491 shares issued as of December 31, 2012 and 2013, respectively, and 102,739 and 101,876 shares outstanding as of December 31, 2012 and 2013, respectively
|
1,969
|
|
|
1,975
|
|
Additional paid-in capital
|
2,057,974
|
|
|
2,047,607
|
|
Accumulated deficit
|
(606,148
|
)
|
|
(1,144,975
|
)
|
Treasury stock, at cost, 94,180 and 95,615 shares as of December 31, 2012 and 2013, respectively
|
(735,003
|
)
|
|
(742,389
|
)
|
Accumulated other comprehensive income
|
12
|
|
|
—
|
|
Total stockholders’ equity
|
718,804
|
|
|
162,218
|
|
Total liabilities and stockholders’ equity
|
$
|
1,599,410
|
|
|
$
|
1,007,318
|
|
The accompanying notes are an integral part of these financial statements.
EARTHLINK HOLDINGS CORP.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
2011
|
|
2012
|
|
2013
|
|
(in thousands, except per share data)
|
Revenues
|
|
$
|
1,300,543
|
|
|
$
|
1,335,135
|
|
|
$
|
1,240,606
|
|
Operating costs and expenses:
|
|
|
|
|
|
|
|
|
Cost of revenues (exclusive of depreciation and amortization shown separately below)
|
|
581,264
|
|
|
632,616
|
|
|
600,742
|
|
Selling, general and administrative (exclusive of depreciation and amortization shown separately below)
|
|
397,574
|
|
|
429,087
|
|
|
426,070
|
|
Depreciation and amortization
|
|
159,993
|
|
|
183,165
|
|
|
183,114
|
|
Impairment of goodwill
|
|
—
|
|
|
—
|
|
|
255,599
|
|
Restructuring, acquisition and integration-related costs
|
|
32,068
|
|
|
18,244
|
|
|
40,030
|
|
Total operating costs and expenses
|
|
1,170,899
|
|
|
1,263,112
|
|
|
1,505,555
|
|
Income (loss) from operations
|
|
129,644
|
|
|
72,023
|
|
|
(264,949
|
)
|
Interest expense and other, net
|
|
(70,640
|
)
|
|
(63,416
|
)
|
|
(60,686
|
)
|
Income (loss) from continuing operations before income taxes
|
|
59,004
|
|
|
8,607
|
|
|
(325,635
|
)
|
Income tax (provision) benefit
|
|
(21,731
|
)
|
|
1,331
|
|
|
(211,231
|
)
|
Income (loss) from continuing operations
|
|
37,273
|
|
|
9,938
|
|
|
(536,866
|
)
|
Loss from discontinued operations, net of tax
|
|
(2,706
|
)
|
|
(2,418
|
)
|
|
(1,961
|
)
|
Net income (loss)
|
|
$
|
34,567
|
|
|
$
|
7,520
|
|
|
$
|
(538,827
|
)
|
|
|
|
|
|
|
|
Other comprehensive income (loss), net of tax:
|
|
|
|
|
|
|
Unrealized holding gains (losses) on investments, net of tax
|
|
(255
|
)
|
|
26
|
|
|
(12
|
)
|
Other comprehensive income (loss), net of tax
|
|
(255
|
)
|
|
26
|
|
|
(12
|
)
|
Comprehensive income (loss)
|
|
$
|
34,312
|
|
|
$
|
7,546
|
|
|
$
|
(538,839
|
)
|
|
|
|
|
|
|
|
Basic net income (loss) per share
|
|
|
|
|
|
|
|
|
Continuing operations
|
|
$
|
0.34
|
|
|
$
|
0.09
|
|
|
$
|
(5.23
|
)
|
Discontinued operations
|
|
(0.03
|
)
|
|
(0.02
|
)
|
|
(0.02
|
)
|
Basic net income (loss) per share
|
|
$
|
0.32
|
|
|
$
|
0.07
|
|
|
$
|
(5.25
|
)
|
Basic weighted average common shares outstanding
|
|
108,098
|
|
|
105,221
|
|
|
102,599
|
|
|
|
|
|
|
|
|
Diluted net income (loss) per share
|
|
|
|
|
|
|
Continuing operations
|
|
$
|
0.34
|
|
|
$
|
0.09
|
|
|
$
|
(5.23
|
)
|
Discontinued operations
|
|
(0.02
|
)
|
|
(0.02
|
)
|
|
(0.02
|
)
|
Diluted net income (loss) per share
|
|
$
|
0.32
|
|
|
$
|
0.07
|
|
|
$
|
(5.25
|
)
|
Diluted weighted average common shares outstanding
|
|
108,949
|
|
|
105,983
|
|
|
102,599
|
|
|
|
|
|
|
|
|
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
|
|
Accumulated Other Comprehensive Income (Loss)
|
|
Total Stockholders' Equity
|
|
|
Shares
|
|
Amount
|
|
|
|
Shares
|
|
Amount
|
|
|
|
|
(in thousands)
|
Balance as of December 31, 2010
|
|
191,825
|
|
|
$
|
1,918
|
|
|
$
|
2,061,555
|
|
|
$
|
(648,235
|
)
|
|
(83,443
|
)
|
|
$
|
(657,611
|
)
|
|
$
|
241
|
|
|
$
|
757,868
|
|
Exercise of stock options and vesting of restricted stock units
|
|
1,379
|
|
|
14
|
|
|
605
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
619
|
|
Tax withholdings related to net share settlements of restricted stock units and stock options
|
|
—
|
|
|
—
|
|
|
(5,572
|
)
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(5,572
|
)
|
Dividends paid on shares outstanding and restricted stock units
|
|
—
|
|
|
—
|
|
|
(22,913
|
)
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(22,913
|
)
|
Dividends payable on restricted stock units
|
|
—
|
|
|
—
|
|
|
702
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
702
|
|
Stock-based compensation expense
|
|
—
|
|
|
—
|
|
|
13,497
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
13,497
|
|
Issuance of common stock in connection with acquisition of One Communications
|
|
2,998
|
|
|
30
|
|
|
23,568
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
23,598
|
|
Return of One Communications escrow shares
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(233
|
)
|
|
(1,834
|
)
|
|
—
|
|
|
(1,834
|
)
|
Change in deferred tax asset
|
|
—
|
|
|
—
|
|
|
(144
|
)
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(144
|
)
|
Repurchases of common stock
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(6,333
|
)
|
|
(46,989
|
)
|
|
—
|
|
|
(46,989
|
)
|
Unrealized holding losses, net of tax
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(255
|
)
|
|
(255
|
)
|
Net income
|
|
—
|
|
|
—
|
|
|
—
|
|
|
34,567
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
34,567
|
|
Balance as of December 31, 2011
|
|
196,202
|
|
|
1,962
|
|
|
2,071,298
|
|
|
(613,668
|
)
|
|
(90,009
|
)
|
|
(706,434
|
)
|
|
(14
|
)
|
|
753,144
|
|
Exercise of stock options and vesting of restricted stock units
|
|
717
|
|
|
7
|
|
|
333
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
340
|
|
Tax withholdings related to net share settlements of restricted stock units and stock options
|
|
—
|
|
|
—
|
|
|
(2,379
|
)
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(2,379
|
)
|
Dividends paid on shares outstanding and restricted stock units
|
|
—
|
|
|
—
|
|
|
(21,128
|
)
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(21,128
|
)
|
Dividends payable on restricted stock units
|
|
—
|
|
|
—
|
|
|
(299
|
)
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(299
|
)
|
Stock-based compensation expense
|
|
—
|
|
|
—
|
|
|
10,471
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
10,471
|
|
Return of One Communications escrow shares
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(422
|
)
|
|
(3,154
|
)
|
|
—
|
|
|
(3,154
|
)
|
Change in deferred tax asset
|
|
—
|
|
|
—
|
|
|
(322
|
)
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(322
|
)
|
Repurchases of common stock
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(3,749
|
)
|
|
(25,415
|
)
|
|
—
|
|
|
(25,415
|
)
|
Unrealized holding gains, net of tax
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
26
|
|
|
26
|
|
Net income
|
|
—
|
|
|
—
|
|
|
—
|
|
|
7,520
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
7,520
|
|
Balance as of December 31, 2012
|
|
196,919
|
|
|
1,969
|
|
|
2,057,974
|
|
|
(606,148
|
)
|
|
(94,180
|
)
|
|
(735,003
|
)
|
|
12
|
|
|
718,804
|
|
Vesting of restricted stock units
|
|
572
|
|
|
6
|
|
|
(6
|
)
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
Tax withholdings related to net share settlements of restricted stock units
|
|
—
|
|
|
—
|
|
|
(2,009
|
)
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(2,009
|
)
|
Dividends paid on shares outstanding and restricted stock units
|
|
—
|
|
|
—
|
|
|
(20,795
|
)
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(20,795
|
)
|
Dividends payable on restricted stock units
|
|
—
|
|
|
—
|
|
|
(576
|
)
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(576
|
)
|
Stock-based compensation expense
|
|
—
|
|
|
—
|
|
|
13,275
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
13,275
|
|
Return of One Communications escrow shares
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(231
|
)
|
|
(1,320
|
)
|
|
—
|
|
|
(1,320
|
)
|
Change in deferred tax asset
|
|
—
|
|
|
—
|
|
|
(256
|
)
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(256
|
)
|
Repurchases of common stock
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(1,204
|
)
|
|
(6,066
|
)
|
|
—
|
|
|
(6,066
|
)
|
Unrealized holding losses, net of tax
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(12
|
)
|
|
(12
|
)
|
Net loss
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(538,827
|
)
|
|
—
|
|
|
—
|
|
|
—
|
|
|
(538,827
|
)
|
Balance as of December 31, 2013
|
|
197,491
|
|
|
$
|
1,975
|
|
|
$
|
2,047,607
|
|
|
$
|
(1,144,975
|
)
|
|
(95,615
|
)
|
|
$
|
(742,389
|
)
|
|
$
|
—
|
|
|
$
|
162,218
|
|
The accompanying notes are an integral part of these consolidated financial statements.
EARTHLINK HOLDINGS CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
2011
|
|
2012
|
|
2013
|
Cash flows from operating activities:
|
(in thousands)
|
Net income (loss)
|
$
|
34,567
|
|
|
$
|
7,520
|
|
|
$
|
(538,827
|
)
|
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
|
|
|
|
|
|
|
Depreciation and amortization
|
159,993
|
|
|
183,165
|
|
|
183,114
|
|
Impairment of goodwill
|
—
|
|
|
—
|
|
|
255,599
|
|
Loss on disposals and impairments of fixed assets
|
3,871
|
|
|
1,531
|
|
|
406
|
|
Non-cash income taxes
|
17,954
|
|
|
(107
|
)
|
|
212,870
|
|
Stock-based compensation
|
13,466
|
|
|
10,462
|
|
|
13,275
|
|
Amortization of debt discount, premium and issuance costs
|
11,136
|
|
|
(1,945
|
)
|
|
2,061
|
|
(Gain) loss on conversion and repayment of debt
|
(2,449
|
)
|
|
(808
|
)
|
|
2,080
|
|
Other operating activities
|
(1,003
|
)
|
|
(833
|
)
|
|
(760
|
)
|
(Increase) decrease in accounts receivable, net
|
(4,045
|
)
|
|
(386
|
)
|
|
12,039
|
|
(Increase) decrease in prepaid expenses and other assets
|
(19,241
|
)
|
|
583
|
|
|
6,245
|
|
Decrease in accounts payable and accrued and other liabilities
|
(78,795
|
)
|
|
(7,040
|
)
|
|
(22,321
|
)
|
Increase (decrease) in deferred revenue
|
10,780
|
|
|
(1,087
|
)
|
|
(1,625
|
)
|
Net cash provided by operating activities
|
146,234
|
|
|
191,055
|
|
|
124,156
|
|
Cash flows from investing activities:
|
|
|
|
|
|
Purchases of property and equipment
|
(101,967
|
)
|
|
(147,360
|
)
|
|
(143,614
|
)
|
Purchases of marketable securities
|
(29,621
|
)
|
|
(73,060
|
)
|
|
(41,209
|
)
|
Sales and maturities of marketable securities
|
319,729
|
|
|
55,816
|
|
|
88,060
|
|
Purchase of businesses, net of cash acquired
|
(43,095
|
)
|
|
—
|
|
|
(16,806
|
)
|
Purchase of customer relationships
|
—
|
|
|
—
|
|
|
(1,195
|
)
|
Change in restricted cash
|
489
|
|
|
768
|
|
|
1,013
|
|
Other investing activities
|
(3,941
|
)
|
|
—
|
|
|
1,251
|
|
Net cash provided by (used in) investing activities
|
141,594
|
|
|
(163,836
|
)
|
|
(112,500
|
)
|
Cash flows from financing activities:
|
|
|
|
|
|
Proceeds from issuance of debt, net of issuance costs
|
278,256
|
|
|
—
|
|
|
290,565
|
|
Repayment of debt and capital lease obligations
|
(528,550
|
)
|
|
(35,287
|
)
|
|
(316,392
|
)
|
Repurchases of common stock
|
(46,989
|
)
|
|
(25,415
|
)
|
|
(6,066
|
)
|
Payment of dividends
|
(22,913
|
)
|
|
(21,128
|
)
|
|
(20,795
|
)
|
Proceeds from exercises of stock options
|
619
|
|
|
338
|
|
|
—
|
|
Other financing activities
|
580
|
|
|
111
|
|
|
47
|
|
Net cash used in financing activities
|
(318,997
|
)
|
|
(81,381
|
)
|
|
(52,641
|
)
|
Net decrease in cash and cash equivalents
|
(31,169
|
)
|
|
(54,162
|
)
|
|
(40,985
|
)
|
Cash and cash equivalents, beginning of year
|
242,952
|
|
|
211,783
|
|
|
157,621
|
|
Cash and cash equivalents, end of year
|
$
|
211,783
|
|
|
$
|
157,621
|
|
|
$
|
116,636
|
|
The accompanying notes are an integral part of these financial statements.
EARTHLINK HOLDINGS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Organization
Change in Organizational Structure
On December 31, 2013, through the creation of a new holding company structure (the “Holding Company Reorganization”), EarthLink, Inc. merged into EarthLink, LLC, which became a wholly-owned subsidiary of a new publicly traded parent company, EarthLink Holdings Corp. As the Holding Company Reorganization occurred at the parent company level, the remainder of EarthLink, Inc.'s subsidiaries, operations and customers were not affected. Accordingly, the historical financial statements reflect the effect of the reorganization for all periods presented.
The Holding Company Reorganization was effected under Section 251(g) of the Delaware General Corporation Law which provides for the formation of a holding company structure without a stockholder vote. EarthLink, Inc. merged with and into EarthLink, LLC, a Delaware limited liability company and a direct, wholly-owned subsidiary of EarthLink Holdings Corp., with EarthLink, LLC surviving the merger as a direct, wholly-owned subsidiary of EarthLink Holdings Corp. At the effective time of the merger and in connection with the Holding Company Reorganization, all of the shares of common stock of the EarthLink, Inc. were converted into the same number of shares of common stock of EarthLink Holdings Corp. The directors and executive officers of EarthLink Holdings Corp. immediately after completion of the Holding Company Reorganization are comprised of the same persons who were directors of and executive officers of EarthLink, Inc. immediately prior to the Holding Company Reorganization.
Following the Holding Company Reorganization, EarthLink Holdings Corp. became the primary obligor on the Company's outstanding debt obligations and EarthLink, LLC became a guarantor and a restricted subsidiary.
Description of Business
EarthLink Holdings Corp. (“EarthLink” or the “Company”), together with its consolidated subsidiaries, is a leading communications and IT services provider to business and residential customers in the United States. The Company operates
two
reportable segments, Business Services and Consumer Services. The Company’s Business Services segment provides a broad range of data, voice and IT services to retail and wholesale business customers. The Company’s Consumer Services segment provides nationwide Internet access and related value-added services to residential customers. The Company operates an extensive network including more than
28,000
route fiber miles,
90
metro fiber rings and
eight
enterprise-class data centers that provide d ata and voice IP service coverage across more than
90 percent
of the United States. For further information concerning the Company’s reportable segments, see Note 19, “Segment Information.”
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.
Discontinued Operations
The operating results of the Company's telecom systems business acquired as part of ITC^DeltaCom, Inc. ("ITC^DeltaCom") have been separately presented as discontinued operations for all periods presented. See Note
6, "Discontinued Operations," for further discussion.
Reclassifications
Certain amounts in the prior year financial statements have been reclassified to conform to the current year presentation. Specifically, certain deferred tax asset and liability amounts disclosed in Note 15, "Income Taxes," as of December 31, 2012 were reclassified to conform to the current year presentation.
EARTHLINK HOLDINGS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
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; revenue reserves for billings to other carriers; expected results of disputed vendor charges for cost of services; the use, recoverability, and/or realizability of certain assets, including deferred tax assets; useful lives of intangible assets and property and equipment; the fair values of assets acquired and liabilities assumed in acquisitions of businesses, including acquired intangible assets; facility exit and restructuring liabilities; fair values of investments; 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 and 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 are recorded to the Company's 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.
Restricted Cash
The Company classifies any cash or investments that collateralize outstanding letters of credit or certain operating or performance obligations of the Company as restricted cash. Restricted cash is classified according to the duration of the restriction and the purpose for which the restriction exists.
Marketable Securities
Marketable securities consist of investments with original maturities greater than
three months
at the date of acquisition. Marketable securities with maturities less than
one year
from the balance sheet date are classified as short-term marketable securities. Marketable securities with maturities greater than
one year
from the balance sheet date are classified as long-term marketable securities. These investments primarily consist of corporate debt securities, government and agency notes (which include U.S. treasury securities and government-sponsored debt securities), commercial paper, certificates of deposit and municipal bonds. These securities are classified as available for sale. Available-for-sale securities are carried at fair value, with any unrealized gains and losses, net of tax, included in accumulated other comprehensive
income
(loss) as a separate component of stockholders’ equity and in total comprehensive
income
(loss). Amounts reclassified out of accumulated other comprehensive income (loss) into earnings are determined on a specific identification basis. Realized gains and losses on marketable securities are determined on a specific identification basis and included in interest expense and other, net, in the Consolidated Statements of Comprehensive Income (Loss).
EARTHLINK HOLDINGS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Allowance for Doubtful Accounts
The Company maintains an allowance for doubtful accounts for accounts receivable amounts 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 EarthLink's customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required. Allowances for doubtful accounts are recorded as a selling, general and administrative expense in the Consolidated Statements of Comprehensive Income (Loss).
The Company's allowance for doubtful accounts was
$7.9 million
and
$8.6 million
as of
December 31, 2012 and 2013
, respectively. The Company recorded bad debt expense of
$9.9 million
,
$8.6 million
and
$9.8 million
during the years ended
December 31, 2011, 2012 and 2013
, respectively. The Company's write-offs of uncollectible accounts were
$3.8 million
,
$8.0 million
and
$9.0 million
during the years ended
December 31, 2011, 2012 and 2013
, respectively.
Inventories
Inventories consist of finished goods and are stated at the lower of cost or market value, using the first-in, first-out method. Inventories are included in other current assets in the Consolidated Balance Sheets.
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 for maintenance and repairs are charged to operating expense as incurred. Upon retirements or sales, the original cost and related accumulated depreciation are removed from the respective accounts and any gains and losses are included in depreciation and amortization expense in the Consolidated Statements of Comprehensive Income (Loss). Upon impairment, the Company accelerates depreciation of the asset and such cost is included in also included in depreciation and amortization expense 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
|
|
15–30 years
|
Communications and fiber optic network
|
|
10–20 years
|
Computer equipment and software
|
|
2–5 years
|
Office and other equipment
|
|
2–5 years
|
Customer acquisition costs
|
|
31–36 months
|
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 its Business Services 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 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 actual 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 purchase method of accounting. The Company does not amortize goodwill. The Company tests its goodwill
EARTHLINK HOLDINGS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
annually during the fourth quarter of its fiscal year or when events and circumstances indicate that those assets might have an other than temporary impairment. 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 the reporting unit using discounted expected future 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 would be recognized in an amount equal to the excess.
Other intangible assets consist primarily 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. The Company had no indefinite-lived intangible assets as of
December 31, 2012 and 2013
.
Long-Lived Assets
The Company evaluates the recoverability of long-lived assets, including property and equipment and purchased 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 only 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.
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 holiday 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 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 retire upon termination of the associated lease agreement and the return of facilities to pre-lease condition. The fair value of the obligation is also capitalized as property and equipment and amortized over the estimated useful life of the associated asset. The Company's asset retirement obligations were
$4.3 million
and
$4.2 million
as of
December 31, 2012 and 2013
, respectively, and are included in other long-term liabilities in the Consolidated Balance Sheets.
Revenue Recognition
General.
EarthLink 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. EarthLink's customers generally pay in advance for their services, and revenue is recognized ratably over the service period. Advance payments from customers for invoiced services that have not yet been performed are recorded as deferred revenue in the Consolidated Balance Sheets.
The Company's Business Services segment earns revenue by providing a broad range of data, voice and IT services to retail and wholesale business customers. The Company presents its Business Services revenue into the following categories: (1) retail services, which includes data, voice and IT services provided to businesses and enterprise organizations; (2) wholesale services, which includes the sale of transmission capacity to other telecommunications carriers; and (3) other services, which includes web hosting. Revenues generally consist of recurring monthly charges for such services; usage fees; installation fees; equipment fees; termination fees; and administrative fees.
EARTHLINK HOLDINGS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The Company's Consumer Services segment earns revenue by providing nationwide Internet access and related value-added services. The Company presents its Consumer Services revenue into the following categories: (1) access services, which includes narrowband and broadband Internet access services and (2) value-added services, which includes revenues from ancillary services sold as add-on features to EarthLink's Internet access services, such as security products, premium email only, home networking and email storage; search revenues; and advertising revenues. Revenues generally consist of recurring monthly charges for such services; usage fees; installation fees; termination fees; and fees for equipment.
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. 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 the customer and recording the net amount as revenue.
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 actual 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 we believe 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 currently 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; the costs of equipment sold to customers; and other costs directly related to our network and IT services. 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
EARTHLINK HOLDINGS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
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 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 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
$8.6 million
,
$8.6 million
and
$9.1 million
during the years ended
December 31, 2011, 2012 and 2013
, respectively.
Stock-Based Compensation
As of
December 31, 2013
, EarthLink had various stock-based compensation plans, which are more fully described in Note 13, "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.
Restructuring, Acquisition and Integration-Related Costs
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 consist of costs related to EarthLink’s restructuring, acquisition and integration-related activities. Such costs include: 1) integration-related costs, such as system conversion, rebranding costs and integration-related consulting and employee costs; 2) severance, retention and other employee termination costs associated with acquisition and integration activities and with certain voluntary employee separations; 3) transaction-related costs, which are direct costs incurred to effect a business combination, such as advisory, legal, accounting, valuation and other professional fees; and 4) facility-related costs, such as lease termination and asset impairments.
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 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.
EARTHLINK HOLDINGS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
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, debt premiums and debt discounts; interest earned on the Company's cash, cash equivalents and marketable securities; 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, 2011, 2012 and 2013
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
2011
|
|
2012
|
|
2013
|
|
|
(in thousands)
|
Interest expense
|
|
$
|
74,949
|
|
|
$
|
64,331
|
|
|
$
|
60,495
|
|
Interest income
|
|
(4,678
|
)
|
|
(2,076
|
)
|
|
(84
|
)
|
Other, net
|
|
369
|
|
|
1,161
|
|
|
275
|
|
Interest expense and other, net
|
|
$
|
70,640
|
|
|
$
|
63,416
|
|
|
$
|
60,686
|
|
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, 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.
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 net deferred tax assets if it is "more-likely-than-not" that those assets will not be realized. EarthLink 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).
Earnings per Share
Basic earnings per share represents net income (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, restricted stock units and convertible debt (collectively "Common Stock Equivalents"), were exercised or converted into common stock. The dilutive effect of outstanding stock options, restricted stock units and convertible debt 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.
Comprehensive Income (Loss)
Comprehensive income (loss) as presented in the Consolidated Statements of Comprehensive Income (Loss) for the years ended
December 31, 2011, 2012 and 2013
includes unrealized gains and losses, net of tax, on certain investments classified as available-for-sale.
EARTHLINK HOLDINGS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
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, marketable securities and trade receivables. In addition, credit risk for the Company's cash equivalents and marketable securities may be exacerbated by unfavorable economic conditions. If financial markets experience prolonged periods of decline, the value or liquidity of the Company's cash equivalents and marketable securities could decline and result in an other-than-temporary decline in fair value, which could adversely affect the Company's financial position, results of operations and cash flows. The Company's investment policy limits investments to investment grade instruments. As of December 31, 2013, the Company had no investments in marketable securities.
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, 2012 and 2013
, no customer accounted for more than
10%
of gross accounts receivable.
Supply Risk
. The Company's business depends on the 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. The Company's short- and long-term investments in marketable securities as of December 31, 2012 consisted of available-for-sale securities that were carried at fair value.
EARTHLINK HOLDINGS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
3. Earnings per Share
The following table sets forth the computation for basic and diluted net income (loss) per share for the years ended
December 31, 2011, 2012 and 2013
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
2011
|
|
2012
|
|
2013
|
|
(in thousands, except per share data)
|
Numerator
|
|
|
|
|
|
|
Income (loss) from continuing operations
|
$
|
37,273
|
|
|
$
|
9,938
|
|
|
$
|
(536,866
|
)
|
Loss from discontinued operations, net of tax
|
(2,706
|
)
|
|
(2,418
|
)
|
|
(1,961
|
)
|
Net income (loss)
|
$
|
34,567
|
|
|
$
|
7,520
|
|
|
$
|
(538,827
|
)
|
|
|
|
|
|
|
|
Denominator
|
|
|
|
|
|
Basic weighted average common shares outstanding
|
108,098
|
|
|
105,221
|
|
|
102,599
|
|
Dilutive effect of Common Stock Equivalents
|
851
|
|
|
762
|
|
|
—
|
|
Diluted weighted average common shares outstanding
|
108,949
|
|
|
105,983
|
|
|
102,599
|
|
|
|
|
|
|
|
Basic net income (loss) per share
|
|
|
|
|
|
Continuing operations
|
$
|
0.34
|
|
|
$
|
0.09
|
|
|
$
|
(5.23
|
)
|
Discontinued operations
|
(0.03
|
)
|
|
(0.02
|
)
|
|
(0.02
|
)
|
Basic net income (loss) per share
|
$
|
0.32
|
|
|
$
|
0.07
|
|
|
$
|
(5.25
|
)
|
|
|
|
|
|
|
Diluted net income (loss) per share
|
|
|
|
|
|
Continuing operations
|
$
|
0.34
|
|
|
$
|
0.09
|
|
|
$
|
(5.23
|
)
|
Discontinued operations
|
(0.02
|
)
|
|
(0.02
|
)
|
|
(0.02
|
)
|
Diluted net income (loss) per share
|
$
|
0.32
|
|
|
$
|
0.07
|
|
|
$
|
(5.25
|
)
|
During the years ended
December 31, 2011 and 2012
, approximately
1.9 million
and
3.5 million
, respectively, stock options and restricted stock units were excluded from the calculation of diluted earnings per share because their effect would have been anti-dilutive. The Company has not included the effect of Common Stock Equivalents in the calculation of diluted earnings per share for the year ended December 31, 2013 because such inclusion would have an anti-dilutive effect due to the Company's net loss. Anti-dilutive securities could be dilutive in future periods.
4.
Acquisitions
One Communications
On April 1, 2011, EarthLink completed its acquisition of 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. EarthLink acquired
100%
of One Communications in a merger transaction with One Communications surviving as a wholly-owned subsidiary of EarthLink. The primary reason for the acquisition was to further transform the Company into a network and communications provider for business customers by expanding its IP network footprint. EarthLink has included the financial results of One Communications in its consolidated financial statements from the date of the acquisition.
Pursuant to the terms of the merger agreement, the aggregate merger consideration for One Communications was
$370.0 million
, which included assumption and repayment of debt and other liabilities and certain working capital and other adjustments. EarthLink issued a total of
3.0 million
shares in connection with the One Communications acquisition, which consisted of
1.3 million
shares deposited in escrow (discussed below) and
1.7 million
shares issued to One Communications shareholders. Pursuant to the merger agreement, the following escrow transactions have occurred:
EARTHLINK HOLDINGS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
|
|
•
|
EarthLink deposited
$13.5 million
(combination of cash and approximately
0.8 million
shares of common stock) into an escrow account to secure potential post-closing adjustments to the aggregate consideration relating to working capital and other similar adjustments. This was included in the aggregate merger consideration. As of December 31, 2012, approximately
$1.4 million
of cash and
0.2 million
shares of common stock valued at
$1.4 million
have been returned to EarthLink. During the year ended
December 31, 2013
, an arbitrator made a final decision with respect to the post-closing working capital adjustments. Pursuant to the arbitrator's decision, the Company received an additional
$1.9 million
of cash and
0.2 million
shares of common stock valued at
$1.3 million
from the escrow account. As of December 31, 2013, the Company still had certain claims outstanding related to other non-working capital adjustments.
|
|
|
•
|
EarthLink deposited
$7.5 million
(combination of cash and approximately
0.5 million
shares of common stock) into an escrow account to fund certain post-closing employment-related obligations of the Company on the terms provided in the escrow agreement. This was accounted for separately from the purchase price allocation. As of December 31, 2012, the entire
$7.5 million
escrow had been returned to EarthLink and none of the escrow account remained outstanding.
|
The resulting fair value of consideration transferred was
$39.9 million
which consisted of
$20.0 million
in cash and
$19.9 million
for the issuance of EarthLink common stock. The assets acquired and liabilities assumed of One Communications were recognized at their acquisition date fair values.
The following table presents the allocation of the consideration transferred (in thousands):
|
|
|
|
|
Acquired Assets:
|
|
|
Cash and cash equivalents
|
$
|
11,304
|
|
Property and equipment
|
144,538
|
|
Goodwill
|
87,377
|
|
Intangible assets
|
185,850
|
|
Other assets
|
68,752
|
|
Total assets
|
497,821
|
|
|
|
|
Assumed Liabilities:
|
|
|
Debt
|
(266,275
|
)
|
Deferred revenue
|
(11,379
|
)
|
Deferred tax liability, net
|
(2,055
|
)
|
Other liabilities
|
(178,185
|
)
|
Total liabilities
|
(457,894
|
)
|
Total consideration
|
$
|
39,927
|
|
Included in other assets is accounts receivable with an estimate of fair value of
$48.1 million
and a gross contractual value of
$57.5 million
. The difference represents the Company’s best estimate of the contractual cash flows that will not be collected.
Goodwill arising from the acquisition was attributable to the assembled workforce and expected synergies and economies of scale from combining the operations of EarthLink and One Communications. All of the goodwill was assigned to the Company’s Business Services segment. Approximately
59%
of the goodwill is deductible for income tax purposes.
The following table summarizes the components of intangible assets acquired in connection with the One Communications acquisition (in thousands):
|
|
|
|
|
|
|
|
Fair Value
|
|
Useful Life
|
Customer relationships
|
$
|
168,600
|
|
|
5 years
|
Developed technology
|
12,000
|
|
|
3 years
|
Trade name
|
3,900
|
|
|
3 years
|
Other
|
1,350
|
|
|
5 years
|
Total intangible assets
|
$
|
185,850
|
|
|
|
EARTHLINK HOLDINGS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Saturn Telecommunication Services Inc.
On March 2, 2011, EarthLink acquired Saturn Telecommunication Services Inc. and affiliates ("STS Telecom"), a privately-held provider of IP communication and information technology services to small and medium-sized businesses primarily in Florida. STS Telecom operates a sophisticated Voice-over-Internet Protocal ("VoIP") platform. The primary reason for the acquisition was for the Company to leverage STS Telecom's expertise in managed hosted VoIP on a nationwide basis as part of its VoIP offerings and to gain its customer base and cash flows.
The fair value of consideration transferred was
$22.9 million
, which consisted of cash paid to acquire the outstanding equity interests of STS Telecom. The acquisition was accounted for as a business combination. The assets acquired and liabilities assumed of STS Telecom were recognized at their acquisition date fair values. In allocating the purchase price based on estimated fair values, EarthLink recorded approximately
$21.3 million
of goodwill,
$17.9 million
of identifiable intangible assets,
$2.8 million
of tangible assets and
$19.2 million
of net liabilities assumed. EarthLink has included the financial results of STS Telecom in its consolidated financial statements from the date of acquisition. Pro forma financial information for STS Telecom has not been presented, as the effects were not material to the Company's consolidated financial statements.
CenterBeam
On July 1, 2013, EarthLink acquired substantially all of the assets of CenterBeam, Inc. ("CenterBeam"), a privately-held information technology managed service provider delivering cloud computing and hosted IT services to mid-sized businesses. With this acquisition, EarthLink intends to further grow its IT services portfolio by adding IT services customer scale, expanded IT support center resources and complementary products and capabilities.
The fair value of consideration transferred was
$23.5 million
, which included
$16.8 million
of cash and
$6.7 million
for the assumption and repayment of debt and other obligations. The acquisition was accounted for as a business combination. The assets acquired and liabilities assumed of CenterBeam were recognized at their acquisition date fair values. In allocating the purchase price based on estimated fair values, EarthLink recorded approximately
$16.7 million
of goodwill,
$6.4 million
of identifiable intangible assets,
$0.8 million
of property and equipment and
$0.4 million
of net other liabilities. Substantially all of the goodwill is expected to be deductible for income tax purposes. EarthLink has included the financial results of CenterBeam in its consolidated financial statements from the date of acquisition. Pro forma financial information for CenterBeam has not been presented, as the effects were not material to the Company's consolidated financial statements.
Other
During the year ended December 31, 2011, EarthLink acquired certain other companies and purchased certain assets to expand its IT services and products offerings for a total of
$13.0 million
of cash consideration and
$1.2 million
of debt repayment. These acquisitions were not significant individually or in the aggregate. Purchased identifiable intangible assets related to these acquisitions was
$5.2 million
and residual goodwill was
$8.4 million
. EarthLink has included the financial results of these companies in its consolidated financial statements from the date of acquisition.
5. Restructuring, Acquisition and Integration-Related Costs
Restructuring, acquisition and integration-related costs consist of costs related to EarthLink’s restructuring, acquisition and integration-related activities. Such costs include: 1) integration-related costs, such as system conversion, rebranding costs and integration-related consulting and employee costs; 2) severance, retention and other employee termination costs associated with acquisition and integration activities and with certain voluntary employee separations; 3) transaction-related costs, which are direct costs incurred to effect a business combination, such as advisory, legal, accounting, valuation and other professional fees; and 4) facility-related costs, such as lease termination and asset impairments. 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). Restructuring, acquisition and integration-related costs consisted of the following during the years ended
December 31, 2011, 2012 and 2013
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
2011
|
|
2012
|
|
2013
|
|
(in thousands)
|
Integration-related costs
|
$
|
4,044
|
|
|
$
|
10,452
|
|
|
$
|
21,622
|
|
Severance, retention and other employee costs
|
16,460
|
|
|
6,067
|
|
|
14,844
|
|
Transaction-related costs
|
5,756
|
|
|
1,399
|
|
|
1,021
|
|
Facility-related costs
|
5,530
|
|
|
479
|
|
|
2,328
|
|
Legacy plan restructuring costs
|
278
|
|
|
(153
|
)
|
|
215
|
|
Restructuring, acquisition and integration-related costs
|
$
|
32,068
|
|
|
$
|
18,244
|
|
|
$
|
40,030
|
|
Restructuring, acquisition and integration-related costs recorded during the years ended December 31, 2011, 2012 and 2013 primarily includes costs incurred in connection with the Company's acquisitions and costs incurred in connection with integrating operating support systems, networks and certain billing systems. Restructuring, acquisition and integration-related costs recorded during the year ended December 31, 2013 includes costs incurred to restructure the Company's sales organization to better meet the needs of the IT services market, which resulted in a reduction in the Company's sales workforce and some office closings. The Company recorded
$2.2 million
of severance costs and
$0.6 million
of facility-related costs in connection with this restructuring, which is included in restructuring, acquisition and integration-related costs in the Consolidated Statement of Comprehensive Income (Loss). Restructuring, acquisition and integration-related costs recorded during the year ended December 31, 2013 also includes
$1.7 million
of employee termination costs associated with certain voluntary employee separations.
EARTHLINK HOLDINGS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
6. Discontinued Operations
The operating results of the Company's telecom systems business acquired as part of 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 received
$0.6 million
of cash and recorded an
$0.8 million
receivable for contingent consideration expected to be received over the next four years. No gain or loss was recognized on the sale. 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 Business Services segment.
The following table presents summarized results of operations related to discontinued operations for the years ended
December 31, 2011, 2012 and 2013
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
2011
|
|
2012
|
|
2013
|
|
(in thousands)
|
Revenues
|
$
|
13,561
|
|
|
$
|
13,842
|
|
|
$
|
6,141
|
|
Operating costs and expenses
|
(18,096
|
)
|
|
(17,860
|
)
|
|
(8,102
|
)
|
Income tax benefit
|
1,829
|
|
|
1,600
|
|
|
—
|
|
Loss from discontinued operations, net of tax
|
$
|
(2,706
|
)
|
|
$
|
(2,418
|
)
|
|
$
|
(1,961
|
)
|
7. Investments
The Company’s marketable securities consisted of the following as of
December 31, 2012
and
2013
:
|
|
|
|
|
|
|
|
|
|
As of December 31, 2012
|
|
As of December 31, 2013
|
|
(in thousands)
|
Corporate debt securities
|
$
|
30,181
|
|
|
$
|
—
|
|
Government and agency securities
|
5,314
|
|
|
—
|
|
Commercial paper
|
9,293
|
|
|
—
|
|
Certificates of deposit
|
1,552
|
|
|
—
|
|
Municipal bonds
|
511
|
|
|
—
|
|
Total marketable securities
|
46,851
|
|
|
—
|
|
Less: classified as current
|
(42,073
|
)
|
|
—
|
|
Total long-term marketable securities
|
$
|
4,778
|
|
|
$
|
—
|
|
The following tables summarize gross unrealized gains and losses as of
December 31, 2012
on the Company’s marketable securities designated as available-for-sale:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of December 31, 2012
|
|
Amortized
Cost
|
|
Gross
Unrealized
Losses
|
|
Gross
Unrealized
Gains
|
|
Estimated
Fair
Value
|
|
(in thousands)
|
Corporate debt securities
|
$
|
30,173
|
|
|
$
|
—
|
|
|
$
|
8
|
|
|
$
|
30,181
|
|
Government and agency notes
|
5,311
|
|
|
—
|
|
|
3
|
|
|
5,314
|
|
Commercial paper
|
9,292
|
|
|
—
|
|
|
1
|
|
|
9,293
|
|
Certificates of deposit
|
1,552
|
|
|
—
|
|
|
—
|
|
|
1,552
|
|
Municipal bonds
|
511
|
|
|
—
|
|
|
—
|
|
|
511
|
|
|
$
|
46,839
|
|
|
$
|
—
|
|
|
$
|
12
|
|
|
$
|
46,851
|
|
EARTHLINK HOLDINGS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
8. Property and Equipment
Property and equipment consisted of the following as of
December 31, 2012 and 2013
:
|
|
|
|
|
|
|
|
|
|
|
|
As of December 31, 2012
|
|
As of December 31, 2013
|
|
|
(in thousands)
|
Communications and fiber optic networks
|
|
$
|
461,750
|
|
|
$
|
551,848
|
|
Computer equipment and software
|
|
184,701
|
|
|
231,818
|
|
Land and buildings
|
|
42,860
|
|
|
42,056
|
|
Leasehold improvements
|
|
36,582
|
|
|
37,754
|
|
Office and other equipment
|
|
17,444
|
|
|
15,679
|
|
Work in progress
|
|
47,355
|
|
|
32,168
|
|
Property and equipment, gross
|
|
790,692
|
|
|
911,323
|
|
Less accumulated depreciation
|
|
(371,726
|
)
|
|
(473,002
|
)
|
Property and equipment, net
|
|
$
|
418,966
|
|
|
$
|
438,321
|
|
Depreciation expense, which includes depreciation expense associated with property under capital leases, was
$100.8 million
,
$112.5 million
and
$116.7 million
for the years ended
December 31, 2011, 2012 and 2013
, respectively.
During the year ended December 31, 2013, the Company wrote-off and retired abandoned and disposed property and equipment that had a cost basis of
$18.3 million
and accumulated depreciation of
$14.9 million
.
9.
Goodwill and Other Intangible Assets
Goodwill
The changes in the carrying amount of goodwill by operating segment during the year ended
December 31, 2013
were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consumer
Services
Segment
|
|
Business
Services
Segment
|
|
Total
|
|
(in thousands)
|
Balance as of December 31, 2012
|
|
|
|
|
|
|
|
|
Goodwill
|
$
|
88,920
|
|
|
$
|
378,373
|
|
|
$
|
467,293
|
|
Accumulated impairment loss
|
—
|
|
|
(87,878
|
)
|
|
(87,878
|
)
|
|
88,920
|
|
|
290,495
|
|
|
379,415
|
|
|
|
|
|
|
|
Impairment of goodwill
|
—
|
|
|
(256,700
|
)
|
|
(256,700
|
)
|
Goodwill acquired
|
—
|
|
|
16,669
|
|
|
16,669
|
|
Goodwill disposed
|
—
|
|
|
(169
|
)
|
|
(169
|
)
|
|
|
|
|
|
|
Balance as of December 31, 2013
|
|
|
|
|
|
|
|
|
Goodwill
|
88,920
|
|
|
394,873
|
|
|
483,793
|
|
Accumulated impairment loss
|
—
|
|
|
(344,578
|
)
|
|
(344,578
|
)
|
|
$
|
88,920
|
|
|
$
|
50,295
|
|
|
$
|
139,215
|
|
EARTHLINK HOLDINGS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Other Intangible Assets
The following table presents the components of the Company’s acquired identifiable intangible assets included in the accompanying Consolidated Balance Sheets as of
December 31, 2012 and 2013
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of December 31, 2012
|
|
As of December 31, 2013
|
|
Gross
Carrying
Value
|
|
Accumulated
Amortization
|
|
Net
Carrying
Value
|
|
Gross
Carrying
Value
|
|
Accumulated
Amortization
|
|
Net
Carrying
Value
|
|
(in thousands)
|
Customer relationships
|
$
|
361,961
|
|
|
$
|
(160,513
|
)
|
|
$
|
201,448
|
|
|
$
|
366,651
|
|
|
$
|
(219,030
|
)
|
|
$
|
147,621
|
|
Developed technology and software
|
24,311
|
|
|
(14,801
|
)
|
|
9,510
|
|
|
26,261
|
|
|
(19,194
|
)
|
|
7,067
|
|
Trade names
|
9,121
|
|
|
(6,345
|
)
|
|
2,776
|
|
|
9,121
|
|
|
(8,796
|
)
|
|
325
|
|
Other
|
1,800
|
|
|
(849
|
)
|
|
951
|
|
|
1,800
|
|
|
(1,385
|
)
|
|
415
|
|
|
$
|
397,193
|
|
|
$
|
(182,508
|
)
|
|
$
|
214,685
|
|
|
$
|
403,833
|
|
|
$
|
(248,405
|
)
|
|
$
|
155,428
|
|
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 and trade names 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, 2013
, the weighted average amortization periods were
5.3
years for customer relationships,
3.8
years for developed technology and software,
3.3
years for trade names and
4.4
years for other identifiable intangible assets.
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, 2011, 2012 and 2013
was as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
2011
|
|
2012
|
|
2013
|
|
(in thousands)
|
Amortization expense
|
$
|
59,219
|
|
|
$
|
70,676
|
|
|
$
|
66,370
|
|
Based on the current amount of definite-lived intangible assets, the Company expects to record amortization expense of approximately
$62.7 million
,
$60.7 million
,
$29.6 million
,
$1.9 million
and
$0.5 million
during the years ending December 31,
2014
,
2015
,
2016
,
2017
and 2018, 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
Interim Test of Goodwill.
During the first quarter of 2013, the Company recognized a
$256.7 million
non-cash impairment charge to goodwill related to its Business Services reporting unit, of which
$255.6 million
is included in continuing operations and
$1.1 million
is reflected in discontinued operations. The impairment was based on an analysis of a number of factors after a decline in the Company's market capitalization following the announcement of its fourth quarter 2012 earnings and 2013 financial guidance. The primary factor contributing to the impairment was a change in the discount rate and market multiples as a result of the change in these market conditions, both key assumptions used in the determination of fair value.
The Company tests its goodwill annually during the fourth quarter of each fiscal year or when events or changes in circumstances indicate that goodwill might be impaired. The Company's stock price and market capitalization declined during the three months ended March 31, 2013 following the announcement in mid-February 2013 of the Company's fourth quarter 2012 earnings and 2013 financial guidance. As a result of the sustained decrease in stock price and market capitalization, the Company performed an interim goodwill test in conjunction with the preparation of its financial statements for the three months ended March 31, 2013.
Impairment testing of goodwill is required at the reporting unit level and involves a two-step process. The Company identified
two
reporting units, Business Services and Consumer Services, for evaluating goodwill. Each of these reporting units constitutes a business for which discrete financial information is available and segment management regularly reviews the operating results. The first step of the impairment test involves comparing the estimated fair values of the Company's reporting units with
EARTHLINK HOLDINGS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
the reporting units' carrying amounts, including goodwill. The Company estimated the fair values of its reporting units based on weighting of the income and market approaches. These models use 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. Under the market approach, the fair value was estimated using the guideline company method. The Company selected guideline companies in the industry in which each reporting unit operates.
Upon completion of the first step, the Company determined that the carrying value of its Business Services reporting unit exceeded its estimated fair value, so a second step was performed to compare the carrying amount of goodwill to the implied fair value of that goodwill. The implied fair value of goodwill for the Business Services reporting unit was determined in the same manner as utilized to recognize goodwill in a business combination. To determine the implied value of goodwill, estimated fair values were allocated to the identifiable assets and liabilities of the Business Services reporting unit as of March 31, 2013. The implied fair value of goodwill was measured as the excess of the fair value of the Business Services reporting unit over the fair value of its identifiable assets and liabilities. The impairment loss of
$256.7 million
during the first quarter 2013 was measured as the amount the carrying value of goodwill exceeded the implied fair value of the goodwill. Of this amount,
$49.3 million
was deductible for tax purposes.
Annual Test of Goodwill
. The Company did not record any goodwill impairment charges during the years ended December 31, 2011 and 2012. The annual impairment test during the fourth quarters of
2011
,
2012
and
2013
indicated that the fair value of the Company's reporting units exceeded their carrying values.
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
2013
impairment test. The Company identified
two
reporting units for evaluating goodwill for the
2013
annual impairment test, which were Business Services and Consumer Services. 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 based on weighting of the income and market approaches. These models use 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. Under the market approach, the fair value was estimated using the guideline company method. The Company selected guideline companies in the industry where each reporting unit operates.
Definite-Lived Intangible Assets
. The Company did not record any impairment charges for its definite-lived intangible assets during the years ended
December 31, 2011, 2012 and 2013
.
10. Other Accrued Liabilities
Other accrued liabilities consisted of the following as of
December 31, 2012 and 2013
:
|
|
|
|
|
|
|
|
|
|
As of December 31, 2012
|
|
As of December 31, 2013
|
|
(in thousands)
|
Accrued taxes and surcharges
|
$
|
33,016
|
|
|
$
|
25,628
|
|
Accrued communications costs
|
39,174
|
|
|
23,602
|
|
Accrued interest
|
11,066
|
|
|
5,289
|
|
Amounts due to customers
|
15,913
|
|
|
9,890
|
|
Other
|
30,403
|
|
|
23,816
|
|
Total other accrued liabilities
|
$
|
129,572
|
|
|
$
|
88,225
|
|
EARTHLINK HOLDINGS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
11. 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, 2012 and 2013
:
|
|
|
|
|
|
|
|
|
|
As of December 31, 2012
|
|
As of December 31, 2013
|
|
(in thousands)
|
EarthLink senior secured notes due June 2020
|
$
|
—
|
|
|
$
|
300,000
|
|
EarthLink senior notes due May 2019
|
300,000
|
|
|
300,000
|
|
Unamortized discount on EarthLink senior notes due May 2019
|
(8,818
|
)
|
|
(7,762
|
)
|
ITC^DeltaCom senior secured notes due April 2016
|
292,300
|
|
|
—
|
|
Unamortized premium on ITC^DeltaCom senior secured notes due April 2016
|
15,694
|
|
|
—
|
|
Capital lease obligations
|
17,089
|
|
|
15,693
|
|
Carrying value of debt and capital lease obligations
|
616,265
|
|
|
607,931
|
|
Less current portion of debt and capital lease obligations
|
(1,375
|
)
|
|
(1,489
|
)
|
Long-term debt and capital lease obligations
|
$
|
614,890
|
|
|
$
|
606,442
|
|
EARTHLINK HOLDINGS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
EarthLink 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 were recorded in other long-term assets 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. In connection with the issuance of the Senior Secured Notes, the Company entered into a registration rights agreement with the original purchasers pursuant to which the Company was required to complete 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. 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 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 will 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 are the Company's and 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 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, 2013
, 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, 2013, the indenture governing the Company's Senior Secured Notes permitted approximately
$46.2 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 Senior Notes due May 2019
General.
In May 2011, the Company completed a private placement of
$300.0 million
aggregate principal amount of
8.875%
Senior Notes due 2019 (the “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
. In September 2011, in accordance with the registration rights granted to the original purchasers of the Senior Notes, the
EARTHLINK HOLDINGS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
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 will 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 may 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 certain of the Company’s wholly-owned subsidiaries (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, 2013
, 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, 2013, the indenture governing the Company's Senior Notes permitted approximately
$171.4 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.
ITC^DeltaCom Senior Secured Notes due April 2016
General
. In connection with the EarthLink’s acquisition of ITC^DeltaCom in December 2010, EarthLink assumed ITC^DeltaCom’s outstanding
$325.0 million
aggregate principal amount of
10.5%
senior secured notes due on April 1, 2016 (the “ITC^DeltaCom Notes”). The ITC^DeltaCom Notes were recorded at acquisition date fair value, which was based on publicly-quoted market prices. The ITC^DeltaCom Notes accrued interest at a rate of
10.5%
per year. Interest on the ITC^DeltaCom Notes was payable semi-annually in cash in arrears on April 1 and October 1 of each year. The maturity date of the ITC^DeltaCom Notes was April 1, 2016.
Repurchases and Redemptions.
Under the indenture for the ITC^DeltaCom Notes, following the consummation of EarthLink's acquisition, ITC^DeltaCom was required to offer to repurchase any or all of the ITC^DeltaCom Notes at
101%
of their principal amount. As a result, approximately
$0.2 million
outstanding principal amount of the ITC^DeltaCom Notes was repurchased in January 2011.
In December 2012, the Company exercised its right to call for the redemption of
10%
of the aggregate principal amount of its outstanding ITC^DeltaCom Notes. The Company redeemed
$32.5 million
aggregate principal amount of the ITC^DeltaCom Notes on December 6, 2012. The redemption price was equal to
103%
of the principal amount thereof, plus accrued and unpaid interest. Upon completion of the redemption,
$292.3 million
aggregate principal amount of the ITC^DeltaCom Notes remained outstanding. The Company recognized an
$0.8 million
gain on redemption.
EARTHLINK HOLDINGS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
In May 2013, the Company commenced a cash tender offer (the “Tender Offer”) for any and all of the
$292.3 million
outstanding principal amount of the ITC^DeltaCom Notes. Approximately
$129.6 million
aggregate principal amount (or
44.36%
) of the ITC^DeltaCom Notes were validly tendered in May 2013 at a price equal to
105.875%
of the principal amount thereof, plus accrued and unpaid interest. In June 2013, the Company redeemed the remaining
$162.7 million
aggregate principal amount of the ITC^DeltaCom Notes at a redemption price equal to
105.250%
of the principal amount thereof, plus accrued and unpaid interest. As a result, all of the remaining obligations under the indenture for the ITC^DeltaCom Notes have been terminated and no principal amount remains outstanding. The Company paid an aggregate of
$314.8 million
in the Tender Offer and redemption, which consisted of
$292.3 million
of outstanding principal amount,
$16.2 million
of premiums and
$6.3 million
of accrued and unpaid interest. The Company recognized a
$2.0 million
net loss on the Tender Offer and redemption, consisting of the
$16.2 million
of premiums paid, net of
$14.2 million
for the write-off of unamortized premium on debt. This loss is included in interest expense and other, net, in the Consolidated Statement of Comprehensive Income (Loss). The payment of the premium in included in repayment of debt and capital lease obligations in the Consolidated Statement of Cash Flows.
Revolving Credit Facility
General.
In May 2013, the Company entered into an amended and restated credit agreement (the “Credit Agreement”) providing for a senior secured revolving credit facility with aggregate revolving commitments of
$135.0 million
. This senior secured revolving credit facility replaced the Company's existing
$150.0 million
senior secured credit facility. The senior secured revolving credit facility terminates on May 29, 2017, and all amounts outstanding thereunder shall be due and payable in full. The Company paid
$1.9 million
of transaction fees and expenses related to the amended senior secured revolving credit facility, which are being amortized to interest expense over the life of the credit facility using the straight-line method. 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, 2013
, the Company’s Commitment Fee was
0.5%
and the Company’s borrowing cost would be LIBOR plus
3.25%
for LIBOR Rate Loans and the Base Rate plus
2.25%
for Base Rate Loans. No loans were outstanding under the senior secured revolving credit facility as of
December 31, 2013
. However,
$1.7 million
of letters of credit were outstanding under the facility’s Letter of Credit Sublimit as of
December 31, 2013
.
The Company is the borrower under the Credit Agreement. All obligations of the borrower under the Credit Agreement are guaranteed by substantially all 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. The obligations of the Company and the subsidiary guarantors under the Credit Agreement, as well as obligations under certain treasury management, interest protection or other hedging arrangements entered into with a lender, 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 or security interests in substantially all of the Company's and the subsidiary guarantors' present and future assets (subject to certain exclusions set forth in the Credit Agreement).
Prepayment.
The Company may prepay the senior secured revolving 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 senior secured 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 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 existing 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.
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 3.0 to 1.0. As of
December 31, 2013
, the Company was in compliance with these covenants.
Financial Information Under Rule 3-10 of Regulation S-X
The Company’s Senior Notes and Senior Secured 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
EARTHLINK HOLDINGS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
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, following the Holding Company Reorganization, 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 Senior Notes and Senior Secured Notes. Based on these facts, and in accordance with Securities and Exchange Commission 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. Depreciation expense related to assets under capital leases is included in depreciation and amortization expense in the Consolidated Statements of Comprehensive Income (Loss). Minimum lease payments under capital leases as of
December 31, 2013
are as follows:
|
|
|
|
|
Year Ending December 31,
|
(in thousands)
|
2014
|
$
|
3,305
|
|
2015
|
3,250
|
|
2016
|
4,509
|
|
2017
|
3,090
|
|
2018
|
3,056
|
|
Thereafter
|
8,679
|
|
Total minimum lease payments
|
25,889
|
|
Less amounts representing interest
|
(10,196
|
)
|
Total capital lease obligations
|
$
|
15,693
|
|
12. 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, 2013
, the Company had
$67.9 million
available under the current authorizations. The Company may repurchase its common stock from time to time in compliance with the Securities and Exchange Commission’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.
The following table presents repurchases under the Company's share repurchase program for the years ended
December 31, 2011, 2012 and 2013
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
2011
|
|
2012
|
|
2013
|
|
(in thousands)
|
Total shares repurchased
|
6,333
|
|
|
3,749
|
|
|
1,116
|
|
Total value of shares repurchased
|
$
|
46,989
|
|
|
$
|
25,415
|
|
|
$
|
5,604
|
|
The Company also repurchased
0.1 million
shares for
$0.5 million
from a former Board of Director member in a private transaction pursuant to a stock purchase agreement following his resignation from the Board of Directors in November 2013.
EARTHLINK HOLDINGS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Escrow Transactions
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, 2011, 2012 and 2013
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
2011
|
|
2012
|
|
2013
|
|
(in thousands)
|
Total shares returned
|
233
|
|
|
422
|
|
|
231
|
|
Total value of shares returned
|
$
|
1,834
|
|
|
$
|
3,154
|
|
|
$
|
1,320
|
|
Dividends
During the years ended
December 31, 2011, 2012 and 2013
, 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
$22.9 million
,
$21.1 million
and
$20.8 million
, respectively, during the years ended
December 31, 2011, 2012 and 2013
. 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, Senior Notes and senior secured revolving credit facility contain restrictions on the amount of dividends the Company can pay.
13. Stock-Based Compensation
Stock-based compensation expense was
$13.5 million
,
$10.5 million
and
$13.3 million
during the years ended
December 31, 2011, 2012 and 2013
, 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
23.5 million
shares, of which approximately
15.1 million
shares were still available for grant as of
December 31, 2013
. 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, 2013
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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, 2012
|
3,723
|
|
|
$
|
8.12
|
|
|
|
|
|
|
Granted
|
2,301
|
|
|
6.08
|
|
|
|
|
|
|
Exercised
|
—
|
|
|
—
|
|
|
|
|
|
|
Forfeited and expired
|
(454
|
)
|
|
7.45
|
|
|
|
|
|
|
Outstanding as of December 31, 2013
|
5,570
|
|
|
7.33
|
|
|
7.0
|
|
$
|
—
|
|
Vested and expected to vest as of December 31, 2013
|
5,036
|
|
|
7.33
|
|
|
7.0
|
|
$
|
—
|
|
Exercisable as of December 31, 2013
|
2,014
|
|
|
8.53
|
|
|
3.9
|
|
$
|
—
|
|
The aggregate intrinsic value amounts in the table above represent the closing price of the Company’s common stock on
December 31, 2013
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, 2013
. The total intrinsic value of options exercised during the years ended
December 31, 2011, 2012 and 2013
was
$0.1 million
,
$0.1 million
and
$0.0 million
, respectively. 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, 2013
, there was
$2.1 million
of total unrecognized compensation cost related to stock options. That cost is expected to be recognized over a weighted-average period of
2.6 years
.
The following table summarizes the status of the Company’s stock options as of
December 31, 2013
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock Options
|
Stock Options Outstanding
|
|
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)
|
|
|
$
|
6.08
|
|
|
to
|
|
$
|
6.08
|
|
|
2,183
|
|
|
9.1
|
|
$
|
6.08
|
|
|
—
|
|
|
$
|
—
|
|
6.86
|
|
|
to
|
|
7.32
|
|
|
425
|
|
|
3.4
|
|
7.18
|
|
|
425
|
|
|
7.18
|
|
7.51
|
|
|
to
|
|
7.51
|
|
|
1,884
|
|
|
8.1
|
|
7.51
|
|
|
587
|
|
|
7.51
|
|
7.64
|
|
|
to
|
|
11.82
|
|
|
1,078
|
|
|
2.1
|
|
9.61
|
|
|
1,002
|
|
|
9.70
|
|
$
|
6.08
|
|
|
to
|
|
$
|
11.82
|
|
|
5,570
|
|
|
7.0
|
|
$
|
7.33
|
|
|
2,014
|
|
|
$
|
8.53
|
|
EARTHLINK HOLDINGS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The Company did not grant any stock options during the year ended December 31, 2011. The fair value of stock options granted during the years ended
December 31, 2012 and 2013
was estimated using the Black-Scholes option-pricing model with the following assumptions:
|
|
|
|
|
|
Year Ended December 31,
|
|
2012
|
|
2013
|
Dividend yield
|
2.69%
|
|
3.29%
|
Expected volatility
|
32.50%
|
|
31.20%
|
Risk-free interest rate
|
0.81%
|
|
0.88%
|
Expected life
|
5 years
|
|
5 years
|
The weighted average grant date fair value of options granted during the years ended
December 31, 2012 and 2013
was
$1.65
per share and
$1.19
per share, respectively. 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, 2013
:
|
|
|
|
|
|
|
|
|
Restricted
Stock Units
|
|
Weighted
Average
Grant Date
Fair Value
|
|
(in thousands)
|
|
|
Outstanding as of December 31, 2012
|
2,981
|
|
|
$
|
7.90
|
|
Granted
|
2,621
|
|
|
6.01
|
|
Vested
|
(875
|
)
|
|
8.05
|
|
Forfeited
|
(791
|
)
|
|
6.95
|
|
Outstanding as of December 31, 2013
|
3,936
|
|
|
$
|
6.80
|
|
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, 2011, 2012 and 2013
was
$8.22
,
$7.51
and
$6.01
, respectively. As of
December 31, 2013
, there was
$10.5 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
. The total fair value of shares vested during the years ended
December 31, 2011, 2012 and 2013
was
$15.6 million
,
$7.4 million
and
$5.7 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.
14. 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
$3.2 million
,
$3.9 million
and
$3.7 million
during the years ended
December 31, 2011, 2012 and 2013
, respectively.
EARTHLINK HOLDINGS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
15. Income Taxes
The following table presents the components of the income tax (provision)
benefit
from continuing operations for the years ended
December 31, 2011, 2012 and 2013
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
2011
|
|
2012
|
|
2013
|
|
(in thousands)
|
Current
|
|
|
|
|
|
Federal
|
$
|
(1,491
|
)
|
|
$
|
(159
|
)
|
|
$
|
(115
|
)
|
State
|
(2,286
|
)
|
|
1,383
|
|
|
1,807
|
|
Foreign
|
—
|
|
|
—
|
|
|
(53
|
)
|
Total Current
|
(3,777
|
)
|
|
1,224
|
|
|
1,639
|
|
Deferred
|
|
|
|
|
|
Federal
|
(19,476
|
)
|
|
(2,580
|
)
|
|
(199,454
|
)
|
State
|
1,522
|
|
|
2,687
|
|
|
(13,416
|
)
|
Total Deferred
|
(17,954
|
)
|
|
107
|
|
|
(212,870
|
)
|
Total income tax (provision) benefit from continuing operations
|
$
|
(21,731
|
)
|
|
$
|
1,331
|
|
|
$
|
(211,231
|
)
|
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, 2011, 2012 and 2013
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
2011
|
|
2012
|
|
2013
|
|
|
(in thousands)
|
Federal income tax (provision) benefit at statutory rate (35%)
|
|
$
|
(20,719
|
)
|
|
$
|
(3,013
|
)
|
|
$
|
113,955
|
|
State income taxes, net of federal benefit
|
|
(2,197
|
)
|
|
(703
|
)
|
|
7,677
|
|
Non-deductible expenses
|
|
(220
|
)
|
|
(280
|
)
|
|
(771
|
)
|
Net change to valuation allowance
|
|
370
|
|
|
1,348
|
|
|
(266,561
|
)
|
Change in state tax rate
|
|
(185
|
)
|
|
1,985
|
|
|
4,725
|
|
Uncertain tax positions
|
|
1,220
|
|
|
1,893
|
|
|
1,434
|
|
Non-deductible goodwill
|
|
—
|
|
|
—
|
|
|
(72,213
|
)
|
Other
|
|
—
|
|
|
101
|
|
|
523
|
|
Income tax (provision) benefit from continuing operations
|
|
$
|
(21,731
|
)
|
|
$
|
1,331
|
|
|
$
|
(211,231
|
)
|
EARTHLINK HOLDINGS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Deferred tax assets and liabilities include the following as of
December 31, 2012 and 2013
:
|
|
|
|
|
|
|
|
|
|
|
|
As of December 31,
|
|
|
2012
|
|
2013
|
|
|
(in thousands)
|
Current deferred tax assets:
|
|
|
|
|
Accrued liabilities and reserves
|
|
$
|
10,834
|
|
|
$
|
7,054
|
|
Net operating loss carryforwards
|
|
902
|
|
|
—
|
|
Other
|
|
9,873
|
|
|
10,278
|
|
Valuation allowance
|
|
(2,605
|
)
|
|
(14,832
|
)
|
Current deferred tax liabilities:
|
|
|
|
|
Accrued liabilities and reserves
|
|
(751
|
)
|
|
(1,661
|
)
|
Other
|
|
(2,299
|
)
|
|
(290
|
)
|
Total net current deferred tax assets
|
|
15,954
|
|
|
549
|
|
Non-current deferred tax assets:
|
|
|
|
|
Net operating loss carryforwards
|
|
$
|
195,440
|
|
|
$
|
249,908
|
|
Capital loss carryforward
|
|
—
|
|
|
1,909
|
|
Alternative minimum tax carryforward
|
|
14,988
|
|
|
14,973
|
|
Accrued liabilities and reserves
|
|
7,602
|
|
|
3,978
|
|
Subscriber base and other intangible assets
|
|
36,586
|
|
|
54,860
|
|
Other
|
|
22,919
|
|
|
13,978
|
|
Valuation allowance
|
|
(35,990
|
)
|
|
(290,604
|
)
|
Non-current deferred tax liabilities:
|
|
|
|
|
Subscriber base and other intangible assets
|
|
(41,544
|
)
|
|
(38,024
|
)
|
Accrued liabilities and reserves
|
|
(316
|
)
|
|
(3,094
|
)
|
Indefinite lived intangible assets
|
|
(1,925
|
)
|
|
(2,522
|
)
|
Other
|
|
(2,748
|
)
|
|
(7,583
|
)
|
Total net non-current deferred tax asset (liability)
|
|
195,012
|
|
|
(2,221
|
)
|
Net deferred tax asset (liability)
|
|
$
|
210,966
|
|
|
$
|
(1,672
|
)
|
Effective Tax Rate.
The effective rate of
-65%
differs from the federal statutory rate of
35%
primarily due to the recording of a valuation allowance (as further described below), the impairment of non-deductible goodwill and state taxes. The valuation allowance recorded for the year ended December 31, 2013 decreased the effective tax rate by approximately
82%
. The impairment of non-deductible goodwill decreased the effective tax rate by approximately
22%
. The state items increased the effective tax rate by approximately
4%
and primarily relate to changes to the Company's state deferred income tax rates and the resulting impact on the re-measurement of deferred tax assets and liabilities; and the reversal of state related uncertain tax positions in the current year due to statute expirations. The current tax benefit for the year ended December 31, 2013 was primarily related to expense for Canadian tax amounts payable, prior year state tax items and penalties and interest related to uncertain tax positions, which is offset with benefit from the current release of uncertain tax positions related to prior years. The non-cash deferred tax expense was due primarily to the recording of the valuation allowance and the impairment of tax deductible goodwill.
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.
EARTHLINK HOLDINGS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
During the three months ended December 31, 2013, the Company entered into a cumulative loss position. For purposes of assessing the realization of the deferred tax assets, this cumulative loss position is considered significant negative evidence. This cumulative taxable loss position, along with the evaluation of all sources of taxable income available to realize the deferred tax asset, has caused management to conclude that the Company will not be able to fully realize its deferred tax assets in the future. During the three months ended December 31, 2013, the Company recorded a
$266.3 million
, or
$2.61
per share, non-cash charge to record a valuation allowance against its deferred tax assets, which is included in the income tax provision in the Consolidated Statement of Comprehensive Loss. As of December 31, 2013, the Company has recorded a valuation allowance of
$305.4 million
against its net deferred tax asset, exclusive of its deferred tax liabilities with indefinite useful lives.
The valuation of deferred tax assets requires judgment based on the weight of all available evidence. During the fourth quarter of 2013, management reassessed its projections of future taxable income. This change in projections, coupled with its cumulative loss position caused management to modify its assessment of the realizability of its deferred tax asset and conclude that a full valuation allowance, exclusive of its deferred tax liabilities with indefinite useful lives, was necessary.
Management will reassess 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.
Deferred tax assets and NOLs.
As of December 31, 2012 and 2013, the Company had gross NOLs for federal income tax purposes totaling approximately
$493.6 million
and
$620.8 million
, respectively, which begin to expire in 2020. Of these federal NOLs approximately
$350.5 million
were limited under Internal Revenue Code Section 382 in 2012 and 2013. As of December 31, 2012 and 2013, the Company had net NOLs for state income tax purposes totaling approximately
$23.4 million
and
$32.6 million
, respectively, which started to expire in 2013. 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, 2013 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, 2012 and 2013, the Company had alternative minimum tax credits of approximately
$15.0 million
and
$15.0 million
. These credits do not have an expiration date. As of December 31, 2013, the Company had capital loss carryforwards of approximately
$1.9 million
which will expire as of December 31, 2018 if unused.
Uncertain tax positions.
The Company has identified its federal tax return and its state tax returns in Alabama, Georgia, California, New York, Massachusetts
,
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, 2013 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, 2012 and 2013
,
$0.7 million
and
$0.5 million
, respectively, of interest and
$0.8 million
and
$0.8 million
of penalties, respectively, had been accrued.
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, 2011, 2012 and 2013
is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
2011
|
|
2012
|
|
2013
|
|
(in thousands)
|
Balance as of January 1
|
$
|
18,367
|
|
|
$
|
24,560
|
|
|
$
|
23,400
|
|
Additions for tax positions of prior years
|
192
|
|
|
19
|
|
|
63
|
|
Adjustments to tax positions under purchase accounting
|
7,812
|
|
|
399
|
|
|
—
|
|
Decreases for tax positions related to prior years
|
(1,811
|
)
|
|
(1,578
|
)
|
|
(1,835
|
)
|
Balance as of December 31
|
$
|
24,560
|
|
|
$
|
23,400
|
|
|
$
|
21,628
|
|
During the year ended
December 31, 2012
,
$0.4 million
of uncertain tax positions resulting from the acquisition of One Communications were recorded through acquisition accounting.
As of December 31, 2013, it is reasonably possible that approximately
$5.5 million
of the total uncertain tax positions recorded will reverse within the next twelve months, primarily due to the expiration of statutes of limitation in various jurisdictions. Of the total uncertain tax positions recorded on the balance sheet,
$5.7 million
would impact the effective tax rate once settled.
16. Commitments and Contingencies
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, 2011, 2012 and 2013
for all operating leases, excluding rent and operating expenses associated with facilities exited as part of the Company's restructuring plans, was
$13.7 million
,
$14.2 million
and
$14.0 million
, respectively.
Minimum lease commitments (including estimated operating expenses) under non-cancelable leases, including commitments associated with facilities exited as part of the Company's restructuring plans, as of
December 31, 2013
are as follows:
|
|
|
|
|
Year Ending December 31,
|
(in thousands)
|
2014
|
$
|
40,436
|
|
2015
|
27,985
|
|
2016
|
23,949
|
|
2017
|
22,458
|
|
2018
|
24,648
|
|
Thereafter
|
42,241
|
|
Total minimum lease payments, including estimated operating expenses
|
181,717
|
|
Less aggregate contracted sublease income
|
(6,310
|
)
|
|
$
|
175,407
|
|
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 and obligations for certain advertising spending under non-cancelable agreements. In addition, the Company has certain commitments regarding employee agreements. The following table summarizes commitments under these agreements as of
December 31, 2013
:
|
|
|
|
|
Year Ending December 31,
|
(in thousands)
|
2014
|
$
|
50,603
|
|
2015
|
28,803
|
|
2016
|
14,358
|
|
2017
|
3,804
|
|
2018
|
2,323
|
|
Thereafter
|
7,069
|
|
Total
|
$
|
106,960
|
|
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, 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'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 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. During the second quarter of 2012, the Company recorded an
$8.3 million
charge as cost of revenue to increase its reserves for regulatory audits, primarily an audit that was conducted by the Universal Service Administrative Company on previous ITC^DeltaCom Universal Service Fund assessments and payments, because the amount became probable and estimable during the period. During the third quarter of 2013, the Company recorded a
$7.2 million
favorable adjustment to its reserves for regulatory audits due to final interpretation and resolution of certain regulatory audits, primarily the audit that was conducted by the Universal Service Administrative Company.
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. Most of these matters are in preliminary stages. 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 it is reasonably assured of the collection of these claims. 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.
EARTHLINK HOLDINGS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
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
$3.5 million
for unrecorded disputed amounts.
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.
17. 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.
Assets measured at fair value on a recurring basis
As of December 31, 2012, the Company held certain assets that are required to be measured at fair value on a recurring basis. These included the Company’s cash equivalents and marketable securities. The following table presents the Company’s assets that are measured at fair value on a recurring basis as of December 31, 2012:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair Value Measurements as of December 31, 2012 Using
|
Description
|
Carrying
Value
|
|
Fair
Value
|
|
Quoted Prices
in Active
Markets for
Identical Assets
(Level 1)
|
|
Significant
Other
Observable
Inputs
(Level 2)
|
|
Significant
Unobservable
Inputs
(Level 3)
|
|
(in thousands)
|
Cash equivalents
|
$
|
27,854
|
|
|
$
|
27,854
|
|
|
$
|
27,854
|
|
|
$
|
—
|
|
|
$
|
—
|
|
Government and agency securities
|
30,181
|
|
|
30,181
|
|
|
—
|
|
|
30,181
|
|
|
—
|
|
Corporate debt securities
|
5,314
|
|
|
5,314
|
|
|
—
|
|
|
5,314
|
|
|
—
|
|
Commercial paper
|
9,293
|
|
|
9,293
|
|
|
—
|
|
|
9,293
|
|
|
—
|
|
Certificates of deposit
|
1,552
|
|
|
1,552
|
|
|
—
|
|
|
1,552
|
|
|
—
|
|
Municipal bonds
|
511
|
|
|
511
|
|
|
—
|
|
|
511
|
|
|
—
|
|
Total
|
$
|
74,705
|
|
|
$
|
74,705
|
|
|
$
|
27,854
|
|
|
$
|
46,851
|
|
|
$
|
—
|
|
As of December 31, 2012, the Company classified its cash equivalents within Level 1 because these securities were valued based on quoted market prices in active markets. The Company classified its government and agency securities, corporate debt securities, commercial paper and certificates of deposit within Level 2 because these securities were valued based on quoted prices in markets that are less active, broker or dealer quotations or alternative pricing sources with reasonable levels of price transparency. The Company utilized an independent pricing service to assist in obtaining fair-value pricing for its Level 2 securities. Where observable market data was available, the pricing service used a weighted average price from a variety of data providers. Where observable market data was not readily available, the pricing service used a pricing model appropriate to the type and structure of the security. The Company periodically evaluated the reasonableness of these models.
Assets and liabilities measured at fair value on a nonrecurring basis
Disclosures are required for certain assets and liabilities that are measured at fair value on a nonrecurring basis in periods subsequent to initial recognition. Such measurements of fair value relate primarily to long-lived asset impairments. During the
EARTHLINK HOLDINGS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
first quarter of 2013, the Company recognized a
$256.7 million
non-cash impairment charge to goodwill related to its Business Services reporting unit. See Note 9, "Goodwill and Other Intangible Assets," for more information regarding the impairment of good will and the fair value methodology. There were no other material long-lived asset impairments during the years ended
December 31, 2011, 2012 and 2013
.
Fair value of debt
The estimated fair values of the Company’s debt was determined based on Level 2 input using observable market prices in less active markets. The following table presents the fair value of the Company’s debt, excluding capital leases, as of
December 31, 2012 and 2013
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of December 31, 2012
|
|
As of December 31, 2013
|
|
Carrying
|
|
|
|
Carrying
|
|
|
|
Amount
|
|
Fair Value
|
|
Amount
|
|
Fair Value
|
|
(in thousands)
|
EarthLink Senior Secured Notes
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
300,000
|
|
|
$
|
303,663
|
|
EarthLink Senior Notes
|
291,182
|
|
|
315,000
|
|
|
292,238
|
|
|
304,470
|
|
ITC^DeltaCom Notes
|
307,994
|
|
|
306,915
|
|
|
—
|
|
|
—
|
|
Total debt, excluding capital leases
|
$
|
599,176
|
|
|
$
|
621,915
|
|
|
$
|
592,238
|
|
|
$
|
608,133
|
|
18. Supplemental Disclosure of Cash Flow Information
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
|
2011
|
|
2012
|
|
2013
|
|
|
(in thousands)
|
|
|
|
|
|
|
|
Cash paid during the year for interest
|
|
$
|
59,170
|
|
|
$
|
66,513
|
|
|
$
|
62,309
|
|
Cash paid during the year for income taxes
|
|
4,375
|
|
|
2,910
|
|
|
1,316
|
|
19. Segment Information
The Company reports segment information along the same lines that its chief executive officer reviews its operating results in assessing performance and allocating resources. The Company operates
two
reportable segments, Business Services and Consumer Services. The Company’s Business Services segment provides a broad range of data, voice and IT services to retail and wholesale business customers. The Company’s Consumer Services segment provides nationwide Internet access and related value-added services to residential customers.
The Company evaluates performance of its segments 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 include costs over which segment managers have 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 excludes 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, and stock-based compensation expense, as they are not considered in the measurement of segment performance.
Information on reportable segments and a reconciliation to consolidated income from operations for the years ended
December 31, 2011, 2012 and 2013
is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
2011
|
|
2012
|
|
2013
|
|
(in thousands)
|
Business Services
|
|
|
|
|
|
|
|
|
Revenues
|
$
|
924,698
|
|
|
$
|
1,017,425
|
|
|
$
|
964,227
|
|
Cost of revenues (excluding depreciation and amortization)
|
463,782
|
|
|
527,514
|
|
|
506,245
|
|
Gross margin
|
460,916
|
|
|
489,911
|
|
|
457,982
|
|
Direct segment operating expenses
|
293,211
|
|
|
332,542
|
|
|
342,630
|
|
Segment operating income
|
$
|
167,705
|
|
|
$
|
157,369
|
|
|
$
|
115,352
|
|
Consumer Services
|
|
|
|
|
|
|
|
|
Revenues
|
$
|
375,845
|
|
|
$
|
317,710
|
|
|
$
|
276,379
|
|
Cost of revenues (excluding depreciation and amortization)
|
117,482
|
|
|
105,102
|
|
|
94,497
|
|
Gross margin
|
258,363
|
|
|
212,608
|
|
|
181,882
|
|
Direct segment operating expenses
|
73,293
|
|
|
67,526
|
|
|
50,623
|
|
Segment operating income
|
$
|
185,070
|
|
|
$
|
145,082
|
|
|
$
|
131,259
|
|
Consolidated
|
|
|
|
|
|
|
|
|
Revenues
|
$
|
1,300,543
|
|
|
$
|
1,335,135
|
|
|
$
|
1,240,606
|
|
Cost of revenues
|
581,264
|
|
|
632,616
|
|
|
600,742
|
|
Gross margin
|
719,279
|
|
|
702,519
|
|
|
639,864
|
|
Direct segment operating expenses
|
366,504
|
|
|
400,068
|
|
|
393,253
|
|
Segment operating income
|
352,775
|
|
|
302,451
|
|
|
246,611
|
|
Depreciation and amortization
|
159,993
|
|
|
183,165
|
|
|
183,114
|
|
Impairment of goodwill
|
—
|
|
|
—
|
|
|
255,599
|
|
Restructuring, acquisition and integration-related costs
|
32,068
|
|
|
18,244
|
|
|
40,030
|
|
Corporate operating expenses
|
31,070
|
|
|
29,019
|
|
|
32,817
|
|
Income (loss) from operations
|
$
|
129,644
|
|
|
$
|
72,023
|
|
|
$
|
(264,949
|
)
|
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 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)
Information on revenues by groups of similar services and by segment for the years ended
December 31, 2011, 2012 and 2013
is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31,
|
|
2011
|
|
2012
|
|
2013
|
|
(in thousands)
|
Business Services
|
|
|
|
|
|
|
|
|
Retail services
|
$
|
766,098
|
|
|
$
|
845,664
|
|
|
$
|
793,940
|
|
Wholesale services
|
136,224
|
|
|
151,910
|
|
|
151,071
|
|
Other services
|
22,376
|
|
|
19,851
|
|
|
19,216
|
|
Total revenues
|
924,698
|
|
|
1,017,425
|
|
|
964,227
|
|
Consumer Services
|
|
|
|
|
|
|
|
|
Access services
|
323,998
|
|
|
269,533
|
|
|
231,448
|
|
Value-added services
|
51,847
|
|
|
48,177
|
|
|
44,931
|
|
Total revenues
|
375,845
|
|
|
317,710
|
|
|
276,379
|
|
Total Revenues
|
$
|
1,300,543
|
|
|
$
|
1,335,135
|
|
|
$
|
1,240,606
|
|
The Company’s Business Services segment earns revenue by providing a broad range of data, voice and IT services to retail and wholesale business customers. The Company presents its Business Services revenue in the following three categories: (1) retail services, which includes data, voice and IT services provided to business customers; (2) wholesale services, which includes the sale of transmission capacity to other telecommunications carriers and businesses; and (3) other services, which primarily consists of web hosting. The Company's IT services, which are included within its retail services, include data centers, virtualization, security, applications, premises-based solutions, managed solutions and support services. Revenues generally consist of recurring monthly charges for such services; usage fees; installation fees; termination fees; and administrative fees.
The Company’s Consumer Services segment earns revenue by providing nationwide Internet access and related value-added services to residential customers. The Company presents its Consumer Services revenue in the following two categories: (1) access services, which includes narrowband and broadband Internet access services; and (2) value-added services, which includes revenues from ancillary services sold as add-on features to EarthLink’s Internet access services, such as security products, premium email only, home networking and email storage; search revenues; and advertising revenues. Revenues generally consist of recurring monthly charges for such services; usage fees; installation fees; termination fees; and fees for equipment.
EARTHLINK HOLDINGS CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
20. 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, 2013
. 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.
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Three Months Ended
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Mar. 31,
2012
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June 30,
2012
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Sept. 30,
2012
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Dec. 31,
2012
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Mar. 31,
2013
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June 30,
2013
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Sept. 30,
2013
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Dec. 31,
2013
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(unaudited)
(in thousands, except per share data)
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Revenues
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$
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341,091
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$
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334,479
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$
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330,839
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|
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$
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328,726
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$
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316,788
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$
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313,401
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$
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308,578
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$
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301,839
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Cost of revenues
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157,048
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165,554
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155,343
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154,671
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152,866
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152,938
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144,760
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150,178
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Income (loss) from operations (1)
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27,377
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14,726
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15,862
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14,058
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(252,872
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)
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3,935
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(1,710
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)
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(14,302
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)
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Loss from discontinued operations, net of tax (2)
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(709
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)
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(499
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)
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(491
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)
|
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(719
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)
|
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(1,105
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)
|
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(292
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)
|
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(225
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)
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(339
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)
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Net income (loss) (1)(3)
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7,263
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(1,106
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)
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1,372
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(9
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)
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(236,415
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)
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(11,201
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)
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(11,338
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)
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(279,873
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)
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Net income (loss) per share (4):
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Basic
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$
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0.07
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$
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(0.01
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)
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$
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0.01
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$
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—
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$
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(2.30
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)
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$
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(0.11
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)
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$
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(0.11
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)
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$
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(2.74
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)
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Diluted
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$
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0.07
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$
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(0.01
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)
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$
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0.01
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$
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—
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$
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(2.30
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)
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$
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(0.11
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)
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$
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(0.11
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)
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$
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(2.74
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)
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_______________________________________________________________________________
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(1)
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Loss from operations and net loss for the three months ended March 31, 2013 includes a $
255.6 million
non-cash impairment charge to goodwill related to the Company's Business Services reporting unit. The impairment was based on an analysis of a number of factors after a decline in the Company's market capitalization following the announcement of its fourth quarter 2012 earnings and 2013 financial guidance.
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(2)
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The operating results of the Company's telecom systems business acquired as part of ITC^DeltaCom have been separately presented as discontinued operations for all periods presented. On August 2, 2013, the Company sold its telecom systems business.
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(3)
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Net loss for the three months ended December 31, 2013 includes a non-cash charge of
$266.3 million
to establish a valuation allowance related to the Company's deferred tax assets. These deferred tax assets related primarily to net operating loss carryforwards which the Company determined it would not "more-likely-than-not" be able to utilize.
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(4)
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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.
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