TWER Towerstream Corporation (CE)

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

The following discussion and analysis summarizes the significant factors affecting our condensed consolidated results of operations, financial condition and liquidity position for the three months ended March 31, 2016. This discussion and analysis should be read in conjunction with our audited financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2015 and the condensed consolidated unaudited financial statements and related notes included elsewhere in this filing. The following discussion and analysis contains forward-looking statements that reflect our plans, estimates, and beliefs. Our actual results could differ materially from those discussed in the forward-looking statements.

Forward-Looking Statements

Forward-looking statements in this Quarterly Report on Form 10-Q, including without limitation, statements related to our plans, strategies, objectives, expectations, intentions and adequacy of resources, are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Investors are cautioned that such forward-looking statements involve risks and uncertainties including without limitation the following: (i) our plans, strategies, objectives, expectations and intentions are subject to change at any time at our discretion; (ii) our plans and results of operations will be affected by our ability to manage growth and competition; and (iii) other risks and uncertainties indicated from time to time in our filings with the Securities and Exchange Commission.

In some cases, you can identify forward-looking statements by terminology such as ‘‘may,’’ ‘‘will,’’ ‘‘should,’’ ‘‘could,’’ ‘‘expects,’’ ‘‘plans,’’ ‘‘intends,’’ ‘‘anticipates,’’ ‘‘believes,’’ ‘‘estimates,’’ ‘‘predicts,’’ ‘‘potential,’’ or ‘‘continue’’ or the negative of such terms or other comparable terminology. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance, or achievements. Moreover, neither we nor any other person assumes responsibility for the accuracy and completeness of such statements. Readers are cautioned not to place too much reliance on these forward-looking statements which speak only as of the date hereof. We are under no duty to update any of the forward-looking statements after the date of this Quarterly Report on Form 10-Q.

Non-GAAP Measures and Reconciliations to GAAP Measures

We prepare our financial statements in accordance with generally accepted accounting principles (“GAAP”). We use certain Non-GAAP measures to monitor our business performance. These Non-GAAP measures are not recognized under GAAP. Accordingly, investors are cautioned about using or relying on these measures as alternatives to recognized GAAP measures. Our methods of calculating these measures may not be comparable to similar measures presented by other companies.

Characteristics of Revenues and Expenses

Infrastructure and access expenses relate directly to maintaining our network and providing connectivity to our customers. Infrastructure primarily relates to our Points-of-Presence ("PoPs") where we install a substantial amount of equipment, mostly on the roof, which we utilize to connect numerous customers to the internet. We enter into long term lease agreements to maintain our equipment on these PoPs and these rent payments comprise the majority of our infrastructure and access costs. Access expenses primarily consist of bandwidth connectivity agreements that we enter into with national service providers.

Network operations costs relate to the daily operations of our network and ensuring that our customers have connectivity within the terms of our service level agreement. We have employees based in our largest markets who are dedicated to ensuring that our network operates effectively on a daily basis. Other employees monitor network operations from our network operating center which is located at our corporate headquarters. Payroll comprises approximately 55 to 60% of network operations costs. Information technology systems and support comprises approximately 20 to 25% of network operations costs.

Customer support costs relate to our continuing communications with customers regarding their service level agreement. Payroll comprises approximately 75 to 80% of customer support costs. Other costs include travel expenses to service customer locations, shipping, troubleshooting, and facilities related expenses.

Sales and marketing expenses primarily consist of the salaries, benefits, travel and other costs of our sales and marketing teams, as well as marketing initiatives and business development expenses.

General and administrative expenses include costs attributable to corporate overhead and the overall support of our operations. Salaries and other related payroll costs for executive management and finance personnel are included in this category. Other costs include accounting, legal and other professional services, and other general operating expenses.

Overview – Fixed Wireless

We provide fixed wireless broadband services to commercial customers and deliver access over a wireless network transmitting over both regulated and unregulated radio spectrum. Our service supports bandwidth on demand, wireless redundancy, virtual private networks, disaster recovery, bundled data and video services. We currently provide service to business customers in twelve metropolitan markets.

As of March 31, 2016, we operated in twelve metropolitan markets consisting of New York, Boston, Los Angeles, Chicago, San Francisco, Miami, Seattle, Dallas-Fort Worth, Houston, Philadelphia, Las Vegas-Reno and Providence-Newport. Although we provide services in multiple markets, these operations have been aggregated into one reportable segment based on the similar economic characteristics among all markets, including the nature of the services provided and the type of customers purchasing such services. The markets were launched at different times, and as a result, may have different operating metrics based on their size and stage of maturation. We incur significant up-front costs in order to establish a network presence in a new market. These costs include building PoPs and network costs. Other material costs include hiring and training sales and marketing personnel who will be dedicated to securing customers in that market. Once we have established a network presence in a new market, we are capable of servicing a significant number of customers. The rate of customer additions varies from market to market, and we are unable to predict how many customers will be added in a market during any specific period.

Overview - Shared Wireless Infrastructure  

Three Months Ended March 31, 2016 Compared to Three Months Ended March 31, 2015

Continuing Operations – Fixed Wireless

Revenues. Revenues totaled $6,734,090 during the three months ended March 31, 2016 compared to $7,172,467 during the three months ended March 31, 2015 representing a decrease of $438,377, or 6%. The decrease principally related to a 7% decrease in the base of customers billed on a monthly recurring basis.

Customer churn totaled 1.65% during the three months ended March 31, 2016 compared to 1.86% during the three months ended March 31, 2015. Churn represents the percent of revenue lost on a monthly basis from customers who have cancelled their contract. Effective January 1, 2016, we have modified our methodology to conform to common practice in the telecommunications industry. Revenue adjustments associated with customers who are modifying the (i) amount of their bandwidth or (ii) the pricing terms of their contract will no longer be included in the calculation of customer churn. Customer churn calculated under the previous methodology would have totaled 1.84% and 2.03% for the three months ended March 31, 2016 and 2015, respectively.   Our goal is to maintain churn levels below industry averages of approximately 2.00%. Churn levels can fluctuate from period to period depending upon whether customers move to a location not serviced by the Company, go out of business, or a myriad of other reasons.

Depreciation and Amortization. Depreciation and amortization totaled $2,527,647 during the three months ended March 31, 2016 compared to $2,347,873 during the three months ended March 31, 2015 representing an increase of $179,774 or 8%. Depreciation expense totaled $2,322,974 during the three months ended March 31, 2016 compared to $2,249,805 during the three months ended March 31, 2015 representing an increase of $73,169, or 3%.  

Amortization expense totaled $204,673 during the three months ended March 31, 2016 compared to $98,068 during the three months ended March 31, 2015 representing an increase of $106,605, or more than 100%. Amortization expense relates to intangible assets recorded in connection with acquisitions and other transactions, and can fluctuate significantly from period to period depending upon the timing of acquisitions and other transactions, the relative amounts of intangible assets recorded, and the amortization periods. The increase related entirely to amortization associated with the TWC transaction which closed in March 2016.

Network O perations . Network operations totaled $1,291,188 during the three months ended March 31, 2016 compared to $1,334,432 during the three months ended March 31, 2015 representing a decrease of $43,244, or 3%. Payroll costs totaled $771,839 in the 2016 period compared to $735,010 in the 2015 period representing an increase of $36,829, or 5%. Average headcount was slightly lower in the 2016 period. Field activities expense totaled $145,858 during the three months ended March 31, 2016 compared to $142,657 during the three months ended March 31, 2015 representing an increase of $3,201, or 2%. Information technology support expenses totaled $254,084 in the 2016 period compared to $322,154 in the 2015 period representing a decrease of $68,070, or 21%, as the Company internally absorbed certain functions that were previously provided by third parties. Network support costs totaled $119,407 during the three months ended March 31, 2016 compared to $134,611 during the three months ended March 31, 2015 representing a decrease of $15,204, or 11%. These costs can fluctuate from period to period and the dollar change is not meaningful.

Customer Support . Customer support totaled $543,191 during the three months ended March 31, 2016 compared to $672,883 during the three months ended March 15, 2015 representing a decrease of $129,692, or 19%. Payroll expense totaled $416,098 during the 2016 period compared to $517,610 during the 2015 period representing a decrease of $101,512, or 20%. Average headcount was lower in the 2016 period as the Company consolidated departments and improved efficiencies. Other customer support costs totaled $127,093 during the three months ended March 31, 2016 compared to $155,273 during the 2015 period representing a decrease of $28,180, or 18%. This decrease was principally attributable to lower customer troubleshooting costs which can fluctuate from period to period.

Sales and Marketing. Sales and marketing expenses totaled $1,494,920 during the three months ended March 31, 2016 compared to $1,330,682 during the three months ended March 31, 2015 representing an increase of $164,238, or 12%. Payroll costs totaled $966,855 during the 2016 period compared to $829,117 during the 2015 period representing an increase of $137,738, or 17%. The increase related to higher headcount in connection with the opening of a new sales office in Florida in the first quarter of 2015. Advertising expenses totaled $183,077 during the three months ended March 31, 2016 compared to $279,040 during the three months ended March 31, 2015 representing a decrease of $95,963, or 34%. The Company has significantly reduced its Internet marketing initiatives in connection with its current marketing focus on specific businesses in certain connected buildings rather than marketing broadly to all businesses in a market. Outside commissions totaled $205,929 in the 2016 period compared to $127,005 in the 2015 period representing an increase of $78,924, or 62%. The increase relates almost exclusively to the Company’s residual program which pays continuing commissions as long as the referred business is a customer. Other costs totaled $139,059 during the three months ended March 31, 2016 compared to $95,520 during the three months ended March 31, 2015 representing an increase of $43,539, or 46%. The increase primarily relates to a decision to close the sales office in Florida.

General and Administrative. General and administrative expenses totaled $1,979,792 for the three months ended March 31, 2016 compared to $1,984,072 for the three months ended March 31, 2015 representing a decrease of $4,280, or less than 1%. Payroll costs increased to $764,707 in the 2016 period compared to $588,523 in the 2015 period representing an increase of $176,184, or 30%. The increase related to severance payments to the Company’s former Chief Executive Officer (“CEO”). Stock based compensation increased to $318,169 during the three months ended March 31, 2016 compared to $211,157 during the three months ended March 31, 2015 representing an increase of $107,012, or 51%. The increase substantially related to a full quarter of expense during the quarter ended March 31, 2016 associated with a September 2015 grant made to all employees which was not applicable during the quarter ended March 31, 2015. Professional services fees totaled $410,380 during the three months ended March 31, 2016 compared to $396,649 during the three months ended March 31, 2015 representing an increase of $13,731, or 3%. The increase was primarily attributed to higher audit fees due to the complexities associated with accounting for the termination of the shared wireless infrastructure business. Corporate travel expenses totaled $48,853 in the 2016 period compared to $166,231 in the 2015 period representing a decrease of $117,378, or 71%. The decrease related to the cancellation of the President’s club trip for top performers and lower travel expenses at the CEO level. Acquisitions expense totaled $31,925 during the three months ended March 31, 2016 compared to $107,700 during the three months ended March 31, 2015 representing a decrease of $75,775, or 70%. Acquisition related expenses can vary from period to period depending on the level of activity during a period. Customer related expenses decreased by approximately $25,000 in the 2016 period due to lower bad debt expense and costs related to being a public company also decreased by approximately $25,000 compared to the 2015 period.

Interest Expense, Net.  Interest expense, net totaled $1,607,120 during the three months ended March 31, 2016 compared to $1,664,264 during the three months ended March 31, 2015 representing a decrease of $57,144, or 3%. Interest expense relates to the $35 million secured term loan which closed in October 2014.

Loss from Continuing Operations . Loss from continuing operations totaled $5,261,495 during the three months ended March 31, 2016 compared to $4,660,710 during the three months ended March 31, 2015 representing an increase of $600,785, or 13%. Revenues decreased by $438,377 in the 2016 period which represented 73% of the increased loss. Higher operating expenses in the 2016 period represented $219,552, or 37%, of the increased loss.

Discontinued Operations – Shared Wireless

Infrastructure and access. Infrastructure and access totaled $2,523,222 during the three months ended March 31, 2016 compared to $3,697,156 during the three months ended March 31, 2015 representing a decrease of $1,173,934, or 32%. Rent expense for rooftop locations totaled $1,900,791 in the 2016 period compared to $3,461,498 in the 2015 period representing a decrease of $1,560,707, or 45%. The reduction reflects the termination of lease agreements during the fourth quarter of 2015, primarily in Chicago, San Francisco, and Miami. Loss on fixed assets totaled $528,364 during the three months ended March 31, 2016 compared to zero during the three months ended March 31, 2015. During the first quarter of 2016, the Company sold certain network infrastructure assets to a major cable company. The Company determined to shut down the remaining network locations and recognized a loss of $528,364 which represented the net book value of capitalized installation costs as well as equipment which could not be redeployed into the fixed wireless network.

Depreciation. Depreciation totaled $638,681 during the three months ended March 31, 2016 compared to $1,031,510 during the three months ended March 31, 2015 representing a decrease of $392,829 or 38%. The Company terminated business activities in certain markets in the fourth quarter of 2015 and wrote off $1.6 million of network assets which represented 24% of the depreciable base at December 31, 2015. This resulted in lower depreciation in the 2016 period.

Network Operations. Network operations totaled $183,583 during the three months ended March 31, 2016 compared to $195,394 during the three months ended March 31, 2015 representing a decrease of $11,811, or 6%. Payroll expense totaled $145,066 during the 2016 period compared to $186,324 during the 2015 period representing a decrease of $41,258. The business was terminated in early March 2016 resulting in less than a full quarter of payroll costs in the 2016 period. Other costs totaled $38,517 during the 2016 period compared to $9,435 during the 2015 period representing an increase of $29,082. Certain costs were incurred in the 2016 period related to the termination of the business.

Customer Support Services. Customer support services totaled $69,804 during the three months ended March 31, 2016 compared to $82,312 during the three months ended March 31, 2015 representing a decrease of $12,508 or 15%. The business was terminated in early March 2016 resulting in less than a full quarter of costs in the 2016 period.

Sales and Marketing. Sales and marketing expenses totaled $246 during the three months ended March 31, 2016 compared to $43,612 during the three months ended March 31, 2015 representing a decrease of $43,366, or 99%. The decrease reflects a lack of sales and marketing efforts prior to terminating the business in March 2016.

General and Administrative. General and administrative expenses totaled $47,333 during the three months ended March 31, 2016 compared to zero during the three months ended March 31, 2015. The increase reflects professional services fees incurred in the 2016 period for terminating the business.

Loss from Discontinued Operations. Loss from discontinued operations for the three months ended March 31, 2016 totaled $1,731,825 compared to $4,262,356 for the three months ended March 31, 2015 representing a decrease of $2,530,531, or 59%. Infrastructure and access costs decreased by $1,173,934 representing 46% of the decrease. Gain on sale of assets increased by $1,177,742 representing 47% of the decrease.

Liquidity and Capital Resources

Changes in capital resources during the three months ended March 31, 2016 and 2015 are described below.

The accompanying condensed consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. As of March 31, 2016, the Company had cash and cash equivalents of approximately $9.6 million and working capital of approximately $3.8 million. The Company has incurred significant operating losses since inception and continues to generate losses from operations and as of March 31, 2016, the Company has an accumulated deficit of $163.2 million. These matters raise substantial doubt about the Company’s ability to continue as a going concern. The condensed consolidated financial statements do not include any adjustments relating to the recoverability and classification of asset amounts or the classification of liabilities that might be necessary should the Company be unable to continue as a going concern.  

Net Cash (Used In) Provided by Financing Activities . Net cash used in financing activities for the three months ended March 31, 2016 totaled $234,822 compared to net cash used in financing activities of $211,658 for the three months ended March 31, 2015, representing an increase of $23,164. The majority of the payments for both periods related to capital lease payments.

Discontinued Operations

Net Cash Used In Operating Activities. Net cash used in operating activities for the three months ended March 31, 2016 totaled $2,094,261 compared to $2,895,703 for the three months ended March 31, 2015 representing a decrease of $801,442, or 28%. Operating activities for the discontinued business were partially curtailed in the fourth quarter of 2015 which resulted in lower cash requirements in the first quarter of 2016

Net Cash Used in Investing Activities. Net cash provided by investing activities for the three months ended March 31, 2016 totaled $124,130 compared to net cash used of $117,470 for the three months ended March 31, 2015 representing a change of $241,600. Cash capital expenditures totaled $118,470 in the 2015 period compared to zero in the 2016 period which reflected the Company’s decision in the fourth quarter of 2015 to exit the shared wireless infrastructure business.

Net Cash (Used In) Provided by Financing Activities . There were no financing activities during either period.

Other Considerations

Debt Financing . In October 2014, we entered into a loan agreement (the “Loan Agreement”) with Melody Business Finance, LLC (the “Lender”). The Lender provided us with a five-year $35 million secured term loan (the “Financing”). The Financing was issued at a 3% discount and the Company incurred $2,893,739 in debt issuance costs. Net proceeds were $31,056,260.

The loan bears interest at a rate equal to the greater of (i) the sum of the most recently effective one month LIBOR as in effect on each payment date plus 7% or (ii) 8% per annum, and additional paid in kind (“PIK”), or deferred, interest that accrues at 4% per annum.

The aggregate principal amount outstanding plus all accrued and unpaid interest is due in October 2019. The Company has the option of making principal payments (i) on or before October 16, 2016 (the “Second Anniversary”) but only for the full amount outstanding and (ii) after the Second Anniversary in minimum amount(s) of $5 million.

In connection with the Loan Agreement and pursuant to a Warrant and Registration Rights Agreement, we issued warrants (the “Warrants”) to purchase 3.6 million shares of common stock of which two-thirds have an exercise price of $1.26 and one-third have an exercise price of $0.01, subject to standard anti-dilution provisions. The Warrants have a term of seven and a half years. We have agreed to include the shares of common stock underlying the Warrants in a registration statement that must be filed no later than December 31, 2016.

Operating Leases. We have entered into operating leases related to roof rights, cellular towers, office space, and equipment leases under various non-cancelable agreements expiring through April 2025. Certain of these operating leases include extensions, at our option, for additional terms ranging from 1 to 25 years. Amounts associated with the extension periods have not been included in the table above as it is not presently determinable which options, if any, we will elect to exercise.

Long-Term Debt . We have entered into a loan agreement with Melody Business Finance, LLC. The $35 million term loan becomes due in October 2019. Accrued PIK interest totaled $2,120,475 as of March 31, 2016.

Capital Lease. We have entered into capital leases to acquire property and equipment expiring through June 2018.

Critical Accounting Policies

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America 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 amounts of revenues and expenses. Critical accounting policies are those that require the application of management’s most difficult, subjective or complex judgments, often because of the need to make estimates about the effect of matters that are inherently uncertain and that may change in subsequent periods. In preparing the financial statements, we utilize available information, including our past history, industry standards and the current economic environment, among other factors, in forming our estimates and judgments, giving appropriate consideration to materiality. Actual results may differ from these estimates. In addition, other companies may utilize different estimates which may impact the comparability of our results of operations to other companies in our industry. We believe that of our significant accounting policies, the following may involve a higher degree of judgment and estimation, or are fundamentally important to our business.

Revenue Recognition. We normally enter into contractual agreements with our customers for periods ranging between one to three years. We recognize the total revenue provided under a contract ratably over the contract period including any periods under which we have agreed to provide services at no cost. Deferred revenues are recognized as a liability when billings are issued in advance of the date when revenues are earned. We recognize revenue when (i) persuasive evidence of an arrangement exists, (ii) delivery or installation has been completed, (iii) the customer accepts and verifies receipt, and (iv) collectability is reasonably assured.

Long-Lived Assets . Long-lived assets with definite lives consist primarily of property and equipment, and intangible assets such as acquired customer relationships. Long-lived assets are evaluated periodically for impairment or whenever events or circumstances indicate their carrying value may not be recoverable. Conditions that would result in an impairment charge include a significant decline in the fair 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 that the carrying amount of an asset or group of assets is not recoverable. When such events or circumstances arise, an estimate of the future undiscounted cash flows produced by the asset, or the appropriate grouping of assets, is compared to the asset’s carrying value to determine if impairment exists. If the asset is determined to be impaired, the impairment loss is measured based on the excess of its carrying value over its fair value. Assets to be disposed of are reported at the lower of their carrying value or net realizable value.

Off-Balance Sheet Arrangements. We have no off-balance sheet arrangements, financings, or other relationships with unconsolidated entities known as ‘‘Special Purposes Entities.’’