Notes to
Unaudited
Condensed
Consolidated Financial Statements
Lumos Networks
Corp.
Note 1. Organization
Lumos Networks Corp. (“Lumos Networks” or the “Company”) is a fiber-based bandwidth infrastructure and service provider in the Mid-Atlantic region with a network of long-haul fiber, metro Ethernet and Ethernet rings
offering end-to-end connectivity in 26 markets in Virginia, West Virginia, North Carolina, Pennsylvania, Maryland, Ohio and Kentucky
. The Company serves carrier,
enterprise
and residential customers over its fiber network offering data, voice and IP services. The Company’s principal products and services include Multiprotocol Label Switching (“MPLS”) based Ethernet, Metro Ethernet (“Metro E”), Fiber to the Cell (“FTTC”) wireless backhaul and fiber transport services, wavelength transport services, IP services and other voice services.
In January 2017, the Company completed its acquisitions of Clarity Communications, LLC and DC74, LLC, for total consideration of up to approximately $15 million and $29.5 million, respectively, which expanded the Company’s operations into additional states in the southeastern region of the United States. See Note 4. Business Acquisitions for more information.
On February 18, 2017, the Company entered into a definitive agreement (“Merger Agreement”) by and among the Company, MTN Infrastructure TopCo, Inc. (“Parent”) and MTN Infrastructure BidCo, Inc. (“Merger Sub”), pursuant to which the Company will be
acquired by EQT Infrastructure
i
nvestment
s
trategy (“EQT
Infrastructure”), subject to
stockholder approval,
regulatory approval and other customary closing conditions (“the Merger” or “EQT Merger”). Pursuant to the Merger Agreement, each outstanding share of common stock of the Company
immediately
prior to the effective time of the Merger shall be automatically converted into the right to receive $18.00 in cash. See Note 3. EQT Merger for more information.
Note 2. Summary of Significant Accounting Policies
Principles of Consolidation and Basis of Presentation
The condensed consolidated financial statements include the accounts of the Company, Lumos Networks Operating Company, a wholly-owned subsidiary of the Company, and all of Lumos Networks Operating Company’s wholly-owned subsidiaries and those limited liability corporations where Lumos Networks Operating Company or certain of its subsidiaries, as managing member, exercise control. All significant intercompany accounts and transactions have been eliminated in consolidation.
In the opinion of management, the accompanying unaudited condensed consolidated financial statements as of and for the
three and nine months ended September 30, 2017
and
2016
contain all adjustments necessary to present fairly in all material respects the Company’s financial position and the results of operations and cash flows for all periods presented on the respective condensed consolidated financial statements included herein. The results of operations for the
three and nine months ended September 30, 2017
are not necessarily indicative of the results to be expected for the full year. The accompanying condensed consolidated balance sheet as of December 31, 2016 has been derived from the audited consolidated financial statements included in Part II, Item 8 of the Company’s Annual Report on Form 10-K for the year ended December 31, 2016.
Accounting Estimates
The preparation of condensed consolidated 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 and liabilities and disclosures of contingent assets and liabilities at the date of the condensed consolidated financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates. Significant items subject to such estimates and assumptions include the useful lives of fixed assets, the allowance for doubtful accounts and customer credits,
the valuation of deferred tax assets and/or liabilities
, asset retirement obligations, stock warrants and equity-based compensation, goodwill impairment assessments, contingent consideration obligations, reserves for employee benefit obligations and income tax uncertainties.
Changes in Accounting Principle
T
he Company adopted
Financial Accounting Standards Board (“FASB”) Accounting Standards Update (“ASU”)
2016-09, Compensation – Stock Compensation (Topic 718) (“ASU 2016-09”) in January 2017, which simplifies the accounting for share-based payment transactions and is effective for public companies for annual reporting periods beginning after December 15, 2016. Among other things, ASU 2016-09 provides for (i) the simplification of accounting presentation of excess tax benefits and tax deficiencies, (ii) an accounting policy election regarding forfeitures to use an estimate or account for when incurred, and (iii) simplification of cash flow presentation for statutory tax rate withholding. The adoption of ASU 2016-09, which resulted in the recognition of excess tax benefits through the condensed consolidated statement of operations and an accounting policy election made by the Company to eliminate the use of a forfeiture estimate and recognize forfeitures as they occur, resulted in the recognition of a cumulative effect
adjustment with a $1.6 million impact to accumulated deficit and a $1.9 million total impact to stockholders’ equity and deferred income taxes. There was no material impact on the Company’s condensed consolidated statement of cash flows, the condensed consolidated statement of operations, or net income
(loss)
or earnings
(loss)
per share. The adoption of the accounting policy election to record forfeitures as incurred and the recognition of excess tax benefits in the condensed consolidated statement of operations may increase the volatility of net income (loss)
in future periods
.
Revenue Recognition
The Company recognizes revenue when persuasive evidence of an arrangement exists, services are rendered or products are delivered, installed and functional, as applicable, the price to the buyer is fixed or determinable and collectability is reasonably assured. Certain services of the Company require payment in advance of service performance. In such cases, the Company records a service liability at the time of billing and subsequently recognizes revenue ratably over the service period. The Company bills customers certain transactional taxes on service revenues. These transactional taxes are not included in reported revenues as they are recognized as liabilities at the time customers are billed.
The Company earns revenue by providing services through access to and usage of its networks. Local service revenues are recognized as services are provided. Carrier data revenues are earned by providing switched access and other switched and dedicated services to other carriers.
Cash Equivalents and Marketable Securities
The Company considers its investment in all highly liquid debt instruments with an original maturity of three months or less, when purchased, to be cash equivalents.
The Company did not have any cash equiv
a
l
e
nts
or other marketable securities
as of September 30, 2017.
The Company’s marketable securities at December 31, 2016 consist of debt securities not classified as cash equivalents
, which
were classified as available-for-sale securities as of December 31, 2016.
Trade Accounts Receivable
The Company sells its services to other communication carriers and to
enterprise
and residential customers primarily in Virginia and West Virginia and portions of other states in the Mid-Atlantic region of the United States. The Company has credit and collection policies to maximize collection of trade receivables and requires advance payment for certain services. The Company estimates an allowance for doubtful accounts based on a review of specific customers with large receivable balances and for the remaining customer receivables the Company uses historical results, current and expected trends and changes in credit policies. Management believes the allowance adequately covers all anticipated losses with respect to trade receivables. Actual credit losses could differ from such estimates. The Company includes bad debt expense in selling, general and administrative in the condensed consolidated statements of operations.
Bad debt expense for
the
three months ended September 30, 2017 and 2016
was
$0.1
million
and
less than $0.1 million, respectively. B
ad debt expense for the
nine months ended September 30, 2017 and 2016
was
$0.3 million and
$
0.2 million
, respectively
.
The Company’s allowance for doubtful accounts
and customer credits
was
$
1
.
3
million
and $0.9 million
as of
September 30, 2017
and
December 31, 2016
, respectively
.
The following table presents a roll-forward of the Company’s allowance for doubtful accounts and customer credits from December 31, 2016 to
September 30, 2017
:
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Additions
|
|
|
|
|
|
|
(In thousands)
|
|
December 31, 2016
|
|
Charged to Expense
|
|
Charged to Other Accounts
|
|
Deductions
|
|
September 30, 2017
|
Allowance for doubtful accounts and customer credits
|
|
$
|
942
|
|
$
|
329
|
|
$
|
254
|
|
$
|
(230)
|
|
$
|
1,295
|
Property, Plant and Equipment and Other Long-Lived Assets (Excluding Goodwill and Indefinite-Lived Intangible Assets)
Property, plant and equipment, finite-lived intangible assets and long-term deferred charges are recorded at cost and are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount should be evaluated pursuant to the subsequent measurement guidance described in FASB Accounting Standards Codification (“ASC”) 360-10-35. Impairment is determined by comparing the carrying value of these long-lived assets to management’s best estimate of future undiscounted cash flows expected to result from the use of the assets. If the carrying value exceeds the estimated undiscounted cash flows, the excess of the asset’s carrying value over the estimated fair value is recorded as an impairment charge.
The Company believes that no impairment indicators exist as of
September 30, 2017
that would require the Company to perform impairment testing for long-lived assets, including property, plant and equipment, long-term deferred charges and finite-lived intangible assets to be held and used.
Depreciation of property, plant and equipment is
recorded
on a straight-line basis over the estimated useful lives of the assets,
which the Company reviews and updates based on historical experiences and future expectations.
Plant and equipment held under capital
leases are amortized on a straight-line basis over the shorter of the lease term or estimated useful life of the asset. Amortization of assets held under capital leases, including an indefeasible right of use agreement, is included with depreciation expense.
Intangibles with a finite life are classified as other intangibles on the condensed consolidated balance sheets. At
September 30, 2017
and December 31, 2016, other intangibles were comprised of the following:
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|
September 30, 2017
|
|
December 31, 2016
|
(Dollars in thousands)
|
Estimated Life
|
|
Gross
Amount
|
|
Accumulated Amortization
|
|
Gross
Amount
|
|
Accumulated Amortization
|
Customer relationships
|
6 to 15 yrs
|
|
$
|
115,808
|
|
$
|
(98,794)
|
|
$
|
103,108
|
|
$
|
(95,463)
|
Trademarks and franchise rights
|
4 to 15 yrs
|
|
|
3,262
|
|
|
(2,206)
|
|
|
2,862
|
|
|
(2,004)
|
Non-compete Agreements
|
2 to 3 yrs
|
|
|
30
|
|
|
(8)
|
|
|
-
|
|
|
-
|
Total
|
|
|
$
|
119,100
|
|
$
|
(101,008)
|
|
$
|
105,970
|
|
$
|
(97,467)
|
Included in the above amounts are indefinite-lived intangible assets of
$0.3
million, which are not subject to amortization. The Company amortizes its finite-lived intangible assets using the straight-line method unless it determines that another systematic method is more appropriate. The Company generally amortizes certain customer relationship intangibles and some acquired trademarks using an accelerated amortization method based on the pattern of estimated earnings from these assets.
The estimated life of amortizable intangible assets is determined from the unique factors specific to each asset, and the Company periodically
reviews and updates estimated lives based on current events and future expectations.
The Company capitalizes costs incurred to renew or extend the term of a recognized intangible asset and amortizes such costs over the remaining life of the asset.
No
such costs were incurred during the
three or nine months ended September 30, 2017
.
Amortization expense for the
three months ended September 30, 2017 and 2016
was $
1.
2
million and
$0
.6
million, respectively, and a
mortization expense for the
nine months ended September 30, 2017 and 2016
was $
3
.
5
million
and $
1.
9
million
, respectively.
Amortization expense for the remainder of 2017 and for the next five years is expected to be as follows:
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|
|
|
|
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|
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|
(In thousands)
|
|
Customer Relationships
|
|
Trademarks and Franchise Rights
|
|
Non-compete Agreements
|
|
Total
|
Remainder of 2017
|
|
$
|
1,154
|
|
$
|
68
|
|
$
|
4
|
|
$
|
1,226
|
2018
|
|
|
3,727
|
|
|
270
|
|
|
12
|
|
|
4,009
|
2019
|
|
|
3,443
|
|
|
247
|
|
|
6
|
|
|
3,696
|
2020
|
|
|
2,922
|
|
|
115
|
|
|
-
|
|
|
3,037
|
2021
|
|
|
2,531
|
|
|
25
|
|
|
-
|
|
|
2,556
|
2022
|
|
|
1,195
|
|
|
-
|
|
|
-
|
|
|
1,195
|
Goodwill and Indefinite-Lived Intangible Assets
Goodwill and certain trademarks are considered to be indefinite-lived intangible assets. Indefinite-lived intangible assets are not subject to amortization but are instead tested for impairment annually or more frequently if an event indicates that the asset might be impaired. The Company’s policy is to assess the recoverability of indefinite-lived intangible assets annually
with a measurement date of
October 1 and whenever adverse events or changes in circumstances indicate that impairment may have occurred.
The Company believes there have been no events or circumstances to cause it to evaluate the carrying amount of goodwill or indefinite-lived intangible assets during the
nine
months ended
September 30, 2017
.
Pension Benefits and Retirement Benefits Other Than Pensions
The Company sponsors a non-contributory defined benefit pension plan (the “Pension Plan”) covering all employees who meet eligibility requirements and were employed prior to October 1, 2003. The Company froze the Pension Plan effective December 31, 2012. As such, no further benefits are being accrued by participants for services rendered beyond that date.
For the
three and nine months ended September 30, 2017 and 2016
, the components of the Company’s net periodic benefit (income) cost for the Pension Plan were as follows:
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|
|
|
|
|
Three Months Ended September 30,
|
|
Nine Months Ended September 30,
|
(In thousands)
|
2017
|
|
2016
|
|
2017
|
|
2016
|
Service cost
|
$
|
-
|
|
$
|
-
|
|
$
|
-
|
|
$
|
-
|
Interest cost
|
|
648
|
|
|
674
|
|
|
1,944
|
|
|
2,022
|
Expected return on plan assets
|
|
(912)
|
|
|
(884)
|
|
|
(2,736)
|
|
|
(2,652)
|
Amortization of loss
|
|
236
|
|
|
262
|
|
|
708
|
|
|
786
|
Net periodic benefit (income) cost
|
$
|
(28)
|
|
$
|
52
|
|
$
|
(84)
|
|
$
|
156
|
Pension Plan assets were valu
ed at
$57.
2
million an
d
$55.6
million at
September 30, 2017
and December 31, 2016, respectively.
No
funding contributions were made
during the three or nine months ended September 30, 2017
, and the Company does not expect to make a funding contribution during the remainder of 2017.
The Company also provides life insurance benefits for retired employees
who
meet eligibility requirements through
two
postretirement welfare benefit plans (the “Other Postretirement Benefit Plans”). The Company had provided retiree medical benefits under these plans until those benefits were terminated effective
December 31, 201
4
. The Company did not incur
any
significant costs associated with these plans during the three
or nine months ended September 30, 2017 or 2016
.
The Company recognized expense for certain nonqualified pension plans for each of the
three months ended September 30, 2017 and 2016
of
$0.1
million, and less than
$0.1
million of this expense for each of these periods relates to the
amortization of actuarial loss. Expense for nonqua
lified pension plans for
each of
the
nine months ended September 30, 2017 and 2016
was
$
0.
4
million, and
$0.
3
million
and $0.2 million
of this expense
, respectively,
relates to the amortization of actuarial loss.
The gross amount reclassified out of accumulated other comprehensive loss
related to amortization of actuarial losses for retirement plans for each of the
three months ended September 30, 2017 and 2016
was $0.3 million,
a
nd
$
1
.
0
million for
each of
the
nine months ended September 30, 2017 and 2016
,
all of which has been reclassified to selling, general and administrative on the condensed consolidated statements of operations.
Income taxes associated with these reclassifications were
$0.1
million for each of the three months ended
September 30, 2017
and 2016
and
$
0.
4
million for
each of
the
nine months ended September 30, 2017 and 2016
.
Equity-based Compensation
The Company accounts for share-based employee compensation plans under FASB ASC 718,
Stock Compensation
.
Equity-based compensation expense from share-based equity awards is recorded with an offsetting increase to additional paid-in capital on the condensed consolidated balance sheets. For equity awards with only service conditions, the Company recognizes compensation cost on a straight-line basis over the requisite service period for the entire award.
Total equity-based compensation expense related to all of the share-based awards, annual employee bonuses paid in the form of immediately vested shares and the Company’s 401(k) matching contributions was $
1
.
2
million and $
1
.
7
million for the
three months ended September 30, 2017 and 2016
, respectively,
and $
9
.
2
million and $
8.5
million for the
nine months ended September 30, 2017 and 2016
, respectively,
which amounts are included in selling, general and administrative expenses on the condensed consolidated statements of operations.
Future charges for equity-based compensation related to instruments outstanding at
September 30, 2017
are estimated to be
$
1
.
1
million for the remainder of 2017, $
2
.
1
million in 2018, $
0.7
million in 2019 and less than $
0.1
million in 2020 and thereafter.
Fair Value Measurements
Fair value is defined as the amount 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. When determining the fair value measurements for assets and liabilities required to be recorded at fair value or for certain financial instruments for which disclosure of fair value is required, the Company uses fair value techniques that maximize the use of observable inputs and minimize the use of unobservable inputs to the extent possible. However, in situations where there is little, if any, market activity for the asset or liability at the measurement date, the fair value measurement reflects the Company’s own judgments about the assumptions that market participants would use in pricing the asset or liability. Those judgments are developed by the Company based on the best information available in the circumstances, including expected cash flows and appropriately risk-adjusted discount rates, available observable and unobservable inputs.
GAAP establishes a fair value hierarchy with three levels of inputs that may be used to measure fair value:
|
·
|
|
Level 1 –
Unadjusted quoted prices in active markets for identical assets or liabilities.
|
|
·
|
|
Level 2 –
Unadjusted quoted prices for similar assets or liabilities in active markets, or unadjusted quoted prices for identical or similar assets or liabilities in markets that are not active, or other inputs other than quoted prices that are observable for the asset or liability.
|
|
·
|
|
Level 3 –
Unobservable inputs for the asset or liability.
|
Recent Accounting Pronouncements
In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606) (“ASU 2014-09”), which will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective. ASU 2014-09 requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. In August 2015, the FASB issued ASU 2015-14, Revenue from Contracts with Customers (Topic 606) - Deferral of the Effective Date, which defers the effective date of ASU 2014-09 for public business entities from annual reporting periods beginning after December 15, 2016, to annual reporting periods beginning after December 15, 2017. Early application is permitted only as of annual reporting periods beginning after December 15, 2016. ASU 2014-09 permits the use of either the retrospective or cumulative effect transition method. In March 2016, the FASB issued ASU 2016-08, Revenue from Contracts with Customers (Topic 606) – Principal versus Agent Considerations (Reporting Gross versus Net) (“ASU 2016-08”), which clarifies implementation guidance on principal versus agent considerations. In April 2016, the FASB issued ASU 2016-10, Revenue from Contracts with Customers (Topic 606) – Identifying Performance Obligations and Licensing (“ASU 2016-10”), which clarifies guidance related to identifying performance obligations and licensing implementation guidance contained in ASU 2014-09. In May 2016, the FASB issued ASU 2016-12, Revenue from Contracts with Customers (Topic 606) – Narrow-Scope Improvements and Practical Expedients (“ASU 2016-12”), which addresses narrow-scope improvements to the guidance on collectability, noncash consideration, and completed contracts at transition. Additionally, the amendments in ASU 2016-12 provide a practical expedient for contract modifications at transition and an accounting policy election related to the presentation of sales taxes and other similar taxes collected from customers. Finally, in December 2016, the FASB issued ASU 2016-20, Technical Corrections and Improvements to Topic 606, Revenue from Contracts with customers, which makes minor corrections or improvements to ASU 2014-09.
The Company
has
complete
d
its
initial
impact assessment
and
is in the process of developing an implementation plan to include any potential process or system changes
. Although the full assessment of the impact to the Company’s results of operations, financial position and cash flows as a result of this guidance is ongoing, the Company expects that changes in the timing of and method of recognition for certain non-recurring charges received from customers and allocations of certain contract revenues to products and services may result in additional contract assets and liabilities in the consolidated balance sheet. In addition, the requirement to defer incremental contract acquisition costs, including sales commissions, and recognize such costs over the contract period or expected customer life may result in the recognition of a deferred charge within
the
consolidated balance sheets and could have the impact of deferring operating expenses.
The Company will adopt this new standard as of January 1, 2018 and currently expects to apply the modified retrospective method, which may result in a cumulative effect adjustment as of the date of adoption. Both the Company’s initial assessment and its selected transition method may change depending on the results of the Company’s final assessment of the impa
ct to its
consolidated
financial statements
and disclosures
.
In January 2016, the FASB issued ASU 2016-01, Financial Instruments - Overall (Topic 825): Recognition and Measurement of Financial Assets and Financial Liabilities (“ASU 2016-01”). The standard addresses certain aspects of recognition, measurement, presentation and disclosure of financial instruments. ASU 2016-01 is effective for public business entities for fiscal years, and interim periods within those years, beginning after December 15, 2017, and early adoption is not permitted. The Company does not expect the future adoption of ASU 2016-01 to have a material impact on its consolidated financial statements and disclosures.
In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842) (“ASU 2016-02”), which will replace most existing lease guidance in U.S. GAAP when it becomes effective. ASU 2016-02 requires an entity to recognize most leases, including operating leases, on the consolidated balance sheets of the lessee. ASU 2016-02 is effective for public business entities for annual reporting periods beginning after December 15, 2018, with early adoption permitted. ASU 2016-02 requires the use of a modified retrospective transition method with elective reliefs. The Company is still evaluating the effect that ASU 2016-02 will have on its consolidated financial statements and disclosures.
In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230) (“ASU 2016-15”), which addresses eight classification issues related to the statement of cash flows presentation, with the objective of reducing diversity in practice. The amendments in this ASU provide guidance on the following cash flow issues: 1) debt prepayment or debt extinguishment costs; 2) settlement of zero-coupon debt instruments; 3) contingent consideration payments made after a business combination; 4) proceeds from the settlement of insurance claims; 5) proceeds from the settlement of corporate-owned life insurance policies, including bank-owned life insurance policies; 6) distributions received from equity method investees; 7) beneficial interests in securitization transactions; and 8) separately identifiable cash flows and application of the predominance principle. ASU 2016-15 is effective for
public business entities for annual reporting periods beginning after December 31, 2017, with early adoption permitted. Although the Company is still evaluating the effect that ASU 2016-15 will have on its statement of cash flow and disclosures, the Company expects the standard will primarily impact the presentation of the earnouts associated with the business acquisitions completed in January 2017.
Under ASU 2016-15, the earnouts would be presented in the statement of cash flows as cash outflows for financing activities up to the amount of the original contingent consideration liability and the excess would be classified as cash outflows for operating activities.
In January 2017, the FASB issued ASU 2017-04, Intangibles – Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment (“ASU 2017-04”), which simplifies the accounting for goodwill impairment by eliminating Step 2 of the goodwill impairment test, which requires a hypothetical purchase price allocation. Under 2017-04, goodwill will be measured using the difference between the fair value and carrying value of the reporting unit. ASU 2017-04 is effective for public business entities for annual and interim reporting periods beginning after December 31, 2019, with early adoption permitted for goodwill impairment tests with measurement dates after January 1, 2017. The Company does not expect the future adoption of ASU 2017-04 to have a material impact on its consolidated financial statements and disclosures.
In March 2017, the FASB issued ASU 2017-07, Compensation
–
Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Periodic Postretirement Benefit Cost (“ASU 2017-07”), which requires the service cost component of net benefit cost to be reported in the same line item as compensation cost on the consolidated statements of operations. Under
ASU
2017-07 all other components of net benefit cost will be reported outside of operating income. ASU 2017-
0
7 is effective for public business entities for annual
and interim
reporting periods beginning after December
15, 2017 and retrospective application of the change in income statement presentation is required.
Based on current actuarial estimates, t
he Company
estimates
the future adoption
of
ASU 2017-07
would increase operating income by
less than
$0.5 million for
the
annual
period.
However,
the calculation of post retirement benefit cost is subject to significant estimates and assumptions and changes in these estimates could result in changes to the impact of ASU 2017-07 on the Company’s operating income when adopted.
In May 2017
, the FASB issued ASU 2017-09, Compensation – Stock Compensation (Topic 718): Scope of Modification Accounting (“ASU 2017-09”), which amends the scope of modification accounting for share-based payment arrangements and requires that a description of significant modifications for each period for which an income statement is presented along with the related increase or decrease in expense due to these modifications. ASU 2017-09 is effective for all public business entities for annual and interim per
iods beginning after December 15
, 2017 and early adoption is permitted at the beginning of an annual period for which interim or annual financial statements have not been issued.
The Company does not expect the future adoption of ASU 2017-09 to have a material impact on its consolidated financial statements
and disclosures
.
. T
Note 3.
EQT Merger
On February 18, 2017, the Company entered into
the
Merger Agreement by and among the Company, Parent and
Merger Sub
, pursuant to which the Company will be acquired by EQT Infrastructure
.
Upon the terms and subject to the conditions of the Merger Agreement, Merger Sub will merge with and into
the Company
, with
the Company
continuing as the surviving corporation and a wholly owned subsidiary of
the
Parent. As a result of the Merger, Lumos Networks will cease to be a publicly traded company, and the directors of Merger Sub will continue as the directors of the surviving corporation.
At the effective time of the
EQT
Merger, each outstanding share of
the Company’s
common stock will be converted automatically into the right to receive
$18.00
in cash, which amount
the Company
refer
s
to as the “Merger Consideration,” without interest and less any
applicable withholding taxes.
The completion of the EQT Merger, which is expected to close
before the end of
November
2017
, is subject to the satisfaction or waiver of certain conditions, including (i) the adoption of the Merger Agreement by the affirmative vote of the holders of a majority of the outstanding shares of common stock of the Company, (ii) the approval of the transaction by the Federal Communications Commission (the “FCC”), (iii) the filing of a voluntary notice with CFIUS and investigative procedures as deemed necessary by the agency, (iv) the provision of all required notices to applicable state public utility commissions and approval in return as required, (v) the expiration of the applicable waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976 (“HSR Act”), as amended, (vi) the absence of any proceeding, order or law enjoining or prohibiting the EQT Merger or the other transactions contemplated by the Merger Agreement, (vii) each party’s material performance of its obligations and compliance with its covenants, (viii) the accuracy of each party’s representations and warranties, subject to customary materiality qualifiers, and (ix) the absence of a material adverse effect on the Company. The HSR Act waiting period expired on April 3, 2017. The Company’s stockholders voted to approve the adoption of the Merger Agreement at the Company’s annual meeting of stockholders on May 24, 2017.
The Company has received all required regulatory approvals for the EQT Merger.
The consummation of the
EQT
Merger is not subject to a financing condition
,
although the funding of the equity financing and the debt financing is subject to the satisfaction of the conditions set forth in the applicable commitment letter under which such financing will be provided.
Under the Merger Agreement, if t
he Merger Agreement
is terminated by the Company
under specific circumstances
, the Company
may be required to pay
Parent a termination fee of
approximately
$16.1 million and if the Merger Agreement is terminated by Parent under specific circumstances, the Parent may be required to pay a termination fee of
approximately
$32.1 million to the Company.
During the
three and nine months ended September 30, 2017
, the Company incurred
$
0
.
5
million
an
d
$
3
.
7
million, respectively,
in
transaction
related c
harges associated with the EQT M
erger, which consist primarily of professional fees incurred from legal and investment banking services, which are included in selling, general and administrative expenses in the condensed consolidated statement of operations.
Note 4
. Business
Acquisitions
On January 4, 2017, the Company
acquired
100% of the
member
ship
interest
s
in
Clarity Communications, LLC,
(“Clarity”),
a North Carolina based fiber bandwidth provider
,
for a total purchase price of
up to
approximately
$15
million,
approximately
$10 million of which was paid in cash upon closing with the remaining $5 million subject to certain earnout provisions over a two year period following the closing date, which would be accelerated upon a change in control.
The earnout provisions are based upon achievement of certain monthly recurring revenue targets within the two year measurement period and are presented within other long-term liabilities in the Company’s conde
nsed consolidated balance sheet
s
.
Clarity
operates a 730 mile fiber n
etwork with 75 on-net locations, a majority of which are located in North Carolina, with additional operations in
South Carolina,
Alabama, Tennessee, and Georgia
.
The acquisition
of Clarity
was funded using cash on hand
and was considered an asset purchase for tax purposes
.
On January 31, 2017, the Company
acquired
100% of the
member
ship
interest
s
in
DC74 LLC,
(“DC74”),
a
Charlotte,
North Carolina based data center and managed services provider
,
for a total purchase price of
up to
$29.5
million,
consisting of
approximately
$23.5 million paid in cash upon closing
and up to
$6 million subject to certain earnout provisions over a 12-month period following the closing date
, which would vest upon a change in control
.
The earnout provisions are based upon achievement of certain monthly recurring revenue targets within the one year measurement period and are presented within other accrued liabilities in the Company’s condensed consolidated balance sheet
s
.
DC74
provides co-location
,
bandwidth and cross-connect
services in addition to
managed servi
ces and managed hosting at its three
data centers
.
The acquisition
of DC74
was funded using cash on hand and was considered an asset purchase for tax purposes.
The Company has accounted for the acquisitions of Clarity and DC74 under the acquisition method of accounting, in accordance with FASB ASC 805, Business Combinations, and will account for any measurement period adjustments under ASU 2015-16, Simplifying the Accounting for Measurement Period Adjustments. Under the acquisition method of accounting, the total purchase price is allocated to the tangible and intangible assets acquired and liabilities assumed in connection with the acquisitions based on their estimated fair values.
In the first quarter of 2017, t
he Company initially recognized
the assets
acquired and liabilities assumed
from the aforementioned
acquisitions based on
preliminary estimates of their acquisition date fair values. As additional information
regarding
the acquired assets and assumed liabilities
becomes known
, management may make
additional
adjustments to the opening balance sheet
s
of the acquired compan
ies
up to the end of the measurement period, which is no longer than a one
-
year period following the acquisition date. The determination of
the fair values of the acquired assets and
assumed
liabilities (and the related determination of estimated lives of depreciable tangible and identifiable intangible assets) requires significant judgment.
No material adjustments were made to these estimates during the three
or nine
months ended
September
30, 2017. Furthermore, a
s of
September
30
, 2017, the Company had
not
completed its fair value analyses
and calculations in sufficient detail necessary to arrive at the final estimates of the fair value of certain working capital and non-working capital acquired assets and assumed liabilities, including
, but not limited to, the
allocations to goodwill and intangible assets,
tangible fixed assets
and contingent consideration
obligation
s related to its acquisitions of Clarity and DC74. All information presented
with respect to working capital and non-working capital acquired assets and
assumed
liabilities
as it relates to these acquisitions is preliminary and subject to revision pending the
completion of the
fair value analys
es
.
The
preliminary
fair values of the assets acquired and liabilities assumed were determined using the income, cost, and market approaches. The cost and market approaches were used in combination to determine the fair value of the real and personal property and derivations of the income approach were predomina
n
tly used in valuing the intangible assets
and contingent
consideration obligations
associated with the earnout provisions.
The weighted average
useful life
for all acquired assets was
8.
9 years and the weighted average
useful life
by category was
9
.
0
years for customer
relationships,
4.
5
years for trademarks and 2.7 years for non-compete agreements.
The following table summarizes the Company's
preliminary
estimates of the acquisition date fair values of the assets
acquired
and liabilities
assumed from its
Clarity and DC74
acquisitions:
|
|
|
|
|
|
(In thousands)
|
Clarity Communications, LLC
January 4, 2017
|
|
DC74, LLC
January 31, 2017
|
Assets acquired
|
|
|
|
|
|
Cash
|
$
|
625
|
|
$
|
493
|
Other Current Assets
|
|
1,318
|
|
|
380
|
Property, Plant and Equipment
|
|
2,819
|
|
|
1,684
|
Goodwill
|
|
6,723
|
|
|
18,647
|
Intangible assets subject to amortization
|
|
|
|
|
|
Customer relationship intangible
|
|
4,300
|
|
|
8,400
|
Trademark intangible
|
|
200
|
|
|
200
|
Non-compete agreement intangible
|
|
20
|
|
|
10
|
Total intangible assets subject to amortization
|
|
4,520
|
|
|
8,610
|
Other Assets
|
|
34
|
|
|
47
|
Total assets acquired
|
|
16,039
|
|
|
29,861
|
Liabilities assumed
|
|
|
|
|
|
Current liabilities
|
|
853
|
|
|
445
|
Long-term liabilities
|
|
-
|
|
|
495
|
Total liabilities assumed
|
|
853
|
|
|
940
|
Net assets acquired
|
|
15,186
|
|
|
28,921
|
Less cash acquired
|
|
(625)
|
|
|
(493)
|
Net consideration paid
|
|
14,561
|
|
|
28,428
|
Less contingent consideration obligations
|
|
(4,600)
|
|
|
(4,900)
|
Net cash consideration paid at closing
|
$
|
9,961
|
|
$
|
23,528
|
The
preliminary goodwill resulting from these acquisit
i
ons in the amount of $6.7 million from Clarity and $
1
8.
6
million from DC74
are the result of the added network diversity, access to new markets and p
rospective
data
customers, operational synergies and the assembled workforce
.
Substantially
all
of the goodwill is expected to be deductible for
tax purposes in future periods
.
For segment reporting purposes, all of this goodwill was allocated to the Data operating segment.
A roll
-
forward of the
preliminary
segmented goodwill from December 31, 2016 to
September 30, 2017
is as follows:
|
|
|
|
|
|
|
|
|
(In thousands)
|
December 31, 2016
|
|
Acquisition Additions
|
|
September 30, 2017
|
Data
|
$
|
90,561
|
|
$
|
25,370
|
|
$
|
115,931
|
R&SB
|
|
9,736
|
|
|
-
|
|
|
9,736
|
RLEC Access
|
|
-
|
|
|
-
|
|
|
-
|
Total goodwill
|
$
|
100,297
|
|
$
|
25,370
|
|
$
|
125,667
|
The amount
s
of
Clarity
revenue and net
loss
included in the Company’s
condensed
consolidated statement of operations for the period
January 4, 2017
through
S
e
ptember
30, 2017
are $
4
.
9
million and $0.2
million, respectively
,
and
$
1.
6
million and $
0.
3
million for the three months ended
September
30, 2017
, respectively
.
The amount
s
of DC74 revenue and net
loss
included in the Company’s condensed consolidated statement of operations for the period January 31, 201
7 through
September
30, 2017
are
$
4
.
5
mi
llion and
$0.
2
million, respectively
,
and
$
1.7
million and $
0.
3
million for the three months ended
September
30, 2017, respectively
.
The pro forma results of the combined operations of the Company and Clarity and DC74 are not materially different
from
the Company’s
presented statement of operations for the
three and nine months ended September 30, 2017
and 2016
.
In connection with the acquisitions of Clarity and DC74, the Company incurred certain professional fees
(i.e., legal, accounting, regulatory, etc.)
, which have been included in selling, general and administrative expenses in the condensed consolidated statements of operations and in cash flows from
operating activities in the condensed consolidated statement of cash flows.
The Company
incurred
no
transaction costs
for
each
acquisition
during
the three months ended
September
30
, 2017
and
less than
$
0.1
million and
$
0.2
million
, for the
nine
months ended
September
30, 2017
in connection with
the
Clarity and DC74
acquisitions
, respectively
.
Note 5
. Cash Equivalents and Marketable Securities
As of September 30, 2017, the Company held no
cash equiv
alen
ts or other marketable
securities.
The Company’s cash equivalents and available-for-sale marketable securities reported at fair value as of
December 31, 2016
are summarized below:
|
|
|
(In thousands)
|
December 31, 2016
|
Cash equivalents:
|
|
|
Money market mutual funds
|
$
|
6,742
|
Corporate debt securities
|
|
413
|
Total cash equivalents
|
|
7,155
|
Marketable securities:
|
|
|
Variable rate demand notes
|
|
13,995
|
Commercial paper
|
|
7,370
|
Corporate debt securities
|
|
16,716
|
Total marketable securities, available-for-sale
|
|
38,081
|
|
|
|
Total cash equivalents and marketable securities
|
$
|
45,236
|
At
December 31, 2016
, the carrying values of the investments included in cash and cash equivalents approximated fair value. The aggregate amortized cost of the available-for-sale securities was not materially different from the aggregate fair value.
The Company received total proceeds of
$
4.5
million
and
$
3
2
.
3
million from the sale or maturity of available-for-sale marketable securities during the
three months ended September 30, 2017 and 2016
, respectively,
and $
42.1
million
and $
107.1
million during the nine months ended September 30, 2017 and 2016
, respectively
. The Company did not recognize any material realized net gains or losses and net unrealized holding
gains or losses
on available-for-sale marketable securities were less than $0.1 million for each of the
three and nine months ended September 30, 2017 and 2016
. Unrealized holding gains or losses are included in accumulated other comprehensive loss on the condensed consolidated balance sheets.
Note 6
. Disclosures About Segments of an Enterprise and Related Information
The Company’s operating segments generally align with its major product and service offerings and coincide with the way that the Company’s chief operating decision makers measure performance and allocate resources. The Company’s chief operating decision makers are its Chief Executive Officer and its Chief Financial Officer (collectively, the “CODMs”). The Company’s current reportable operating segments are data, residential and small business (“R&SB”) and RLEC access. A general description of the products and services offered and the customers served by each of these segments is as follows:
|
·
|
|
Data:
This segment includes the Company’s enterprise data (metro Ethernet, dedicated Internet, voice over IP (“VoIP”)
, data center
and private line), transport, and FTTC product and service groups. These businesses primarily serve enterprise and carrier customers utilizing the Company’s network of long-haul fiber, metro Ethernet and Ethernet rings located primarily in Virginia and West Virginia, and portions of
other states in the
Mid-Atlantic
region of the United States
.
|
|
·
|
|
R&SB:
This segment includes the following voice products: local lines, primary rate interface (“PRI”), long distance, toll and directory advertising and other voice services (excluding VoIP which are typically provided to enterprise customers and are included in the Company’s data segment) and the following IP services products: fiber-to-the-premise broadband XL, DSL, integrated access and video. These products are sold to residential and small business customers on the Company’s network and within the Company’s footprint. This segment also provides carrier customers access to the Company’s network located in competitive markets.
|
|
·
|
|
RLEC Access:
This segment provides carrier customers access to the Company’s network within the Company’s RLEC footprint and primarily includes switched access services.
|
Summarized financial information concerning the Company’s reportable segments is presented in the following table:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(In thousands)
|
|
Data
|
|
R&SB
|
|
RLEC
Access
|
|
Corporate (Unallocated)
|
|
Total
|
For the three months ended September 30, 2017:
|
Operating revenues
|
|
$
|
35,998
|
|
$
|
14,632
|
|
$
|
4,980
|
|
$
|
-
|
|
$
|
55,610
|
Cost of revenue
|
|
|
5,562
|
|
|
4,480
|
|
|
-
|
|
|
-
|
|
|
10,042
|
Gross profit
|
|
|
30,436
|
|
|
10,152
|
|
|
4,980
|
|
|
-
|
|
|
N/A
|
Direct operating and selling costs
|
|
|
2,454
|
|
|
1,091
|
|
|
155
|
|
|
-
|
|
|
3,700
|
Indirect operating costs
|
|
|
7,881
|
|
|
2,307
|
|
|
51
|
|
|
-
|
|
|
10,239
|
Corporate general and administrative costs
|
|
|
5,188
|
|
|
1,604
|
|
|
465
|
|
|
2,173
|
|
|
9,430
|
Adjusted EBITDA
(1)
|
|
|
14,913
|
|
|
5,150
|
|
|
4,309
|
|
|
-
|
|
|
N/A
|
Capital expenditures
|
|
|
10,069
|
|
|
1,355
|
|
|
-
|
|
|
1,326
|
|
|
12,750
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the nine months ended September 30, 2017:
|
Operating revenues
|
|
$
|
106,119
|
|
$
|
45,327
|
|
$
|
15,446
|
|
$
|
-
|
|
$
|
166,892
|
Cost of revenue
|
|
|
16,643
|
|
|
14,335
|
|
|
-
|
|
|
-
|
|
|
30,978
|
Gross profit
|
|
|
89,476
|
|
|
30,992
|
|
|
15,446
|
|
|
-
|
|
|
N/A
|
Direct operating and selling costs
|
|
|
6,940
|
|
|
3,337
|
|
|
472
|
|
|
-
|
|
|
10,749
|
Indirect operating costs
|
|
|
24,000
|
|
|
7,030
|
|
|
154
|
|
|
-
|
|
|
31,184
|
Corporate general and administrative costs
|
|
|
14,211
|
|
|
4,694
|
|
|
1,341
|
|
|
14,215
|
|
|
34,461
|
Adjusted EBITDA
(1)
|
|
|
44,325
|
|
|
15,931
|
|
|
13,479
|
|
|
-
|
|
|
N/A
|
Capital expenditures
|
|
|
30,755
|
|
|
5,259
|
|
|
-
|
|
|
933
|
|
|
36,947
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(In thousands)
|
|
Data
|
|
R&SB
|
|
RLEC
Access
|
|
Corporate (Unallocated)
|
|
Total
|
For the three months ended September 30, 2016:
|
Operating revenues
|
|
$
|
31,373
|
|
$
|
15,863
|
|
$
|
4,535
|
|
$
|
-
|
|
$
|
51,771
|
Cost of revenue
|
|
|
4,537
|
|
|
5,120
|
|
|
-
|
|
|
-
|
|
|
9,657
|
Gross profit
|
|
|
26,836
|
|
|
10,743
|
|
|
4,535
|
|
|
-
|
|
|
N/A
|
Direct operating and selling costs
|
|
|
2,014
|
|
|
1,227
|
|
|
175
|
|
|
-
|
|
|
3,416
|
Indirect operating costs
|
|
|
6,717
|
|
|
2,354
|
|
|
50
|
|
|
-
|
|
|
9,121
|
Corporate general and administrative costs
|
|
|
3,538
|
|
|
1,439
|
|
|
340
|
|
|
2,651
|
|
|
7,968
|
Adjusted EBITDA
(1)
|
|
|
14,567
|
|
|
5,723
|
|
|
3,970
|
|
|
-
|
|
|
N/A
|
Capital expenditures
|
|
|
18,197
|
|
|
2,565
|
|
|
-
|
|
|
(673)
|
|
|
20,089
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the nine months ended September 30, 2016:
|
Operating revenues
|
|
$
|
91,958
|
|
$
|
47,840
|
|
$
|
15,215
|
|
$
|
-
|
|
$
|
155,013
|
Cost of revenue
|
|
|
13,669
|
|
|
16,279
|
|
|
-
|
|
|
-
|
|
|
29,948
|
Gross profit
|
|
|
78,289
|
|
|
31,561
|
|
|
15,215
|
|
|
-
|
|
|
N/A
|
Direct operating and selling costs
|
|
|
5,600
|
|
|
3,509
|
|
|
492
|
|
|
-
|
|
|
9,601
|
Indirect operating costs
|
|
|
19,470
|
|
|
7,031
|
|
|
156
|
|
|
-
|
|
|
26,657
|
Corporate general and administrative costs
|
|
|
11,512
|
|
|
4,810
|
|
|
1,334
|
|
|
10,142
|
|
|
27,798
|
Adjusted EBITDA
(1)
|
|
|
41,707
|
|
|
16,211
|
|
|
13,233
|
|
|
-
|
|
|
N/A
|
Capital expenditures
|
|
|
60,379
|
|
|
6,988
|
|
|
-
|
|
|
(2,087)
|
|
|
65,280
|
(1)
Adjusted EBITDA is used by the Company’s CODMs to evaluate performance. Adjusted EBITDA, as defined by the Company, is net income or loss attributable to Lumos Networks Corp. before interest, income taxes, depreciation and amortization, accretion of asset retirement obligations, net income
or loss
attributable to noncontrolling interests, other income or expenses, equity-based compensation charges, amortization of actuarial losses on retirement plans, restructuring charges,
transaction
related charges
and changes in the fair value of contingent consideration obligations
.
N/A – Not Applicable
(as totals are not presented in the
condensed
consolidated statements of operations)
The Company’s CODMs do not currently review total assets by segment since the assets are centrally managed and some of the asse
ts are shared by the segments.
Management does review capital expenditures using success-based metrics that allow the Company to determine which segment product groups are driving investment in the network. Depreciation and amortization expense and certain corporate expenses that are excluded from the measurement of segment profit or loss are not alloca
ted to the operating segments.
The following table provides a reconc
iliation of the total of the Company’s
reportable segments measure of profit to
the Company’s
consolidated
income (
loss
)
before income taxes for the
three and nine months ended September 30, 2017 and 2016
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
Nine Months Ended September 30,
|
(In thousands)
|
|
2017
|
|
2016
|
|
2017
|
|
2016
|
Data Adjusted EBITDA
|
|
$
|
14,913
|
|
$
|
14,567
|
|
$
|
44,325
|
|
$
|
41,707
|
R&SB Adjusted EBITDA
|
|
|
5,150
|
|
|
5,723
|
|
|
15,931
|
|
|
16,211
|
RLEC Access Adjusted EBITDA
|
|
|
4,309
|
|
|
3,970
|
|
|
13,479
|
|
|
13,233
|
Total reportable segments measure of profit
|
|
|
24,372
|
|
|
24,260
|
|
|
73,735
|
|
|
71,151
|
Interest expense
|
|
|
(7,771)
|
|
|
(7,164)
|
|
|
(22,756)
|
|
|
(21,165)
|
Other income, net
|
|
|
8
|
|
|
48
|
|
|
647
|
|
|
320
|
Depreciation and amortization and accretion of asset retirement obligations
|
|
|
(14,483)
|
|
|
(12,762)
|
|
|
(43,716)
|
|
|
(37,119)
|
Amortization of actuarial losses
|
|
|
(326)
|
|
|
(338)
|
|
|
(977)
|
|
|
(1,013)
|
Equity-based compensation
|
|
|
(1,156)
|
|
|
(1,661)
|
|
|
(9,152)
|
|
|
(8,477)
|
Restructuring charges
|
|
|
-
|
|
|
384
|
|
|
(34)
|
|
|
(1,823)
|
Changes in fair value of contingent consideration obligations
|
|
|
(100)
|
|
|
-
|
|
|
(700)
|
|
|
-
|
Transaction related charges
|
|
|
(691)
|
|
|
(652)
|
|
|
(4,086)
|
|
|
(652)
|
(Loss) income before income taxes
|
|
$
|
(147)
|
|
$
|
2,115
|
|
$
|
(7,039)
|
|
$
|
1,222
|
No
single customer individually accounted for more than 10% of the Company’s total operating revenues
for the
three and nine months ended September 30, 2017 and 2016
. The Company’s five largest carrier customers, in the aggregate, accounted for
29
%
and
32%
of the
Company’s total operating revenues for the
three months ended
September 30, 2017
and 2016
, respectively
, and
30
% an
d 32% for the
nine months ended September 30, 2017 and 2016
, respectively
.
Revenues from these carrier customers were derived primarily from network access, data transport and FTTC services.
Note 7
. Long-Term Debt
As of
September 30, 2017
and
December 31, 2016
, the Company’s outstanding long-term debt consisted of the following:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2017
|
|
December 31, 2016
|
(In thousands)
|
|
Principal
|
|
Unamortized Discount and Debt Issuance Costs
|
|
Principal
|
|
Unamortized Discount and Debt Issuance Costs
|
Credit Facility
|
|
$
|
330,613
|
|
$
|
2,266
|
|
$
|
340,385
|
|
$
|
3,283
|
8% Notes
|
|
|
150,000
|
|
|
23,960
|
|
|
150,000
|
|
|
26,529
|
Capital lease obligations
|
|
|
7,465
|
|
|
-
|
|
|
7,842
|
|
|
-
|
Long-term debt
|
|
|
488,078
|
|
|
26,226
|
|
|
498,227
|
|
|
29,812
|
Less: Current portion of long-term debt
|
|
|
73,825
|
|
|
-
|
|
|
13,530
|
|
|
-
|
Long-term debt, excluding current portion
|
|
$
|
414,253
|
|
$
|
26,226
|
|
$
|
484,697
|
|
$
|
29,812
|
Credit Facility
On April 30, 2013, Lumos Networks Operating Company, a wholly-owned subsidiary of the Company, entered into a $425 million credit facility (the “Credit Facility”). The Credit Facility consists of a $100 million senior secured five-year term loan (“Term Loan A”), a $275 million senior secured six-year term loan (“Term Loan B”); a $28 million senior secured incremental term loan, which was added through an amendment to the Credit Facility dated January 2, 2015, (“Term Loan C”); and a $50 million senior secured five-year revolving credit facility (the “Revolver”). The proceeds from Term Loan A and Term Loan B were used to retire the prior first lien credit facility outstanding amount of approximately $311 million and to pay closing costs and other expenses related to the transaction, with the remaining proceeds available for normal course capital expenditures and working capital purposes. The Company
used
the net proceeds from Term Loan C to fund new FTTC projects. As of
September 30, 2017
, no borrowings were outstanding under the Revolver.
On August 6, 2015, the Company prepaid $40.0 million of the outstanding principal of the Credit Facility, which was allocated ratably to Term Loans A, B and C. The Company used proceeds from the issuance of the 8% Notes, discussed below, to fund these prepayments.
Pricing of the amended Credit Facility is LIBOR plus 3.00% for the Revolver and Term Loan A and LIBOR plus 3.25% for Term Loan B and C. The Credit Facility does not require a minimum LIBOR rate. Term Loan A matures in
September
2018 with quarterly payments of 2.50%
per annum
. Term Loan B matures in 2019 with quarterly payments of 1% per annum. Term Loan C matures in 2019 with quarterly payments of 1% per annum. The Revolver matures in full in
September
2018. The Credit Facility is secured by a first priority pledge of substantially all property and assets of Lumos Networks Operating Company and all material subsidiaries, as guarantors, excluding the RLECs.
The amended Credit Facility includes various restrictions and conditions, including a maximum leverage ratio of
4.50
:1.00 through December 31, 2017, 4.25:1.00 through December 31, 2018, and 4.00:1.00 thereafter. The amended Credit Facility also sets a minimum interest coverage ratio of 3.25:1.00. At
September 30, 2017
, the Company’s leverage ratio was
3.
48
:
1.00 and its interest coverage ratio was
7.00
:1.00. The Company was in compliance with its debt covenants as of
September 30, 2017
.
The Company’s effective interest rate on its Credit Facility for the
nine months ended September 30, 2017
was 4.
28
%.
8% Notes due 2022
On August 6, 2015, the Company issued $150 million in unsecured promissory notes (the “8% Notes”) to an affiliate of Pamplona Capital Management LLC (“Pamplona”). The net proceeds of the
8%
Notes, after a $1.5 million purchasers discount and payment of $7.1 million of closing costs, were used to prepay $40.0 million of the Company’s existing Credit Facility with the remainder to be used for general corporate purposes, including to fund future growth opportunities. The
8%
Notes bear interest at an annual fixed rate of 8.00% and mature on August 15, 2022. Interest is payable in arrears on a quarterly basis on August 15, November 15, February 15, and May 15 of each year. Interest is payable in cash or, at the election of the Company, through the issuance of additional notes or by adding the amount of the accrued interest to the unpaid principal amount of the
8%
Notes outstanding at that time. The
8%
Notes were also issued with
5,500,000
warrants for no additional consideration to purchase shares of the Company’s common stock (the “Warrants”). The Company allocated the net proceeds received from the debt issuance to the 8% Notes and the equity-classified Warrants based on the relative fair value of the instruments. As a result, the Company recognized a total discount on the 8% Notes of $24.8 million of which $23.5 million represents the value assigned to the Warrants, and $1.3 million represents the allocated portion of the aforementioned $1.5 million purchasers discount. The discount on the 8% Notes is being amortized to interest expense over the life of the debt using the effective interest method. See Note 1
2
for additional details regarding the Warrants.
The Company’s effective interest rate on the 8% Notes for the
nine
months ended
September 30, 2017
was 12.55%, which represents the contractual rate adjusted for discount and deferred debt issuance costs.
Debt Issuance Costs
In connection with the issuance of the 8% Notes in August 2015 and the Term Loan C financing in January 2015, the Company deferred an additional $6.0 million and $0.9 million, respectively, in debt issuance costs. Total
u
namortized debt issuance costs associated with the 8% Notes and Credit Facility are included in the table above, which amounts are included as a reduction of long-term debt in the condensed consolidated ba
lance sheets in accordance with
ASU
2015-03,
Simplifying the Presentation of Debt Issuance Costs
. These costs are being amortized to interest expense over the life of the debt using the effective interest method. Amortization of debt issuance costs
was
$
1.
2
million and $
1
.
1
million for the three months ended
September 30, 2017
and 201
6
, respectively
,
and $
3
.
6
million and $
3.3
million for the
nine months ended September 30, 2017 and 2016
, respectively
.
Co
B
ank Patronage Credits
The Company receives patronage credits from CoBank and certain other of the Farm Credit System lending institutions (collectively referred to as “patronage banks”) which are not reflected in the interest rates above. The patronage banks hold a portion of the credit facility and are cooperative banks that are required to distribute their profits to their members. Patronage credits are calculated based on the patronage banks’ ownership percentage of the credit facility and are received by the Company as either a cash distribution or as equity in the patronage banks. These credits are recorded in the condensed consolidated statements of
operations
as an offset to interest expense. The Patronage credits were
$0.2
million and
$0.3
million
for the
three months ended
September 30, 2017
and 2
01
6
, respectivel
y, and
$0.7 million and $0.8 million
for the
nine months ended September 30, 2017 and 2016
, respectively.
Debt Maturities
The aggregate maturities of Term Loan A, Term Loan B and Term Loan C under the Credit Facility are $
3
.
2
million in the remainder of 201
7
, $
70.9
million in 201
8
and
$
256.5
million in 201
9
. The Revolver under the Credit Facility, under which no borrowings are outstanding as of
September 30, 2017
, matures in full in 2018. The 8% Notes mature for $150.0 million in 2022.
Capital lease obligations
In addition to the long-term debt discussed above, the Company has capital leases on vehicles with original lease terms of four to five years. The Company also has
a
fiber
indefeasible right of use (“IRU”)
classified as a capital lease
, which wa
s entered into in January 2016.
The IRU network capacity arrangement extends through 2035 with payments due monthly.
As of
September 30, 2017
, the combined total net present value of the Company’s future minimum lease payments is $
7
.
5
million and the principal portion of these
capital lease obligations is due as follows: $
0.
1
million in the remainder of 201
7
, $0.5 million in 201
8
, $0.
5
million in 201
9
, $0.4 million in 20
20
, $0.4 million in 202
1
and $
5
.
6
million thereafter.
The historical cost and accumulated amortization for each of the related assets associated with the capital leases is as follows as of
September 30, 2017
:
|
|
|
|
|
|
|
|
|
September 30, 2017
|
(In thousands)
|
|
Historical Cost
|
|
Accumulated Amortization
|
Vehicles
|
|
$
|
2,657
|
|
$
|
(1,945)
|
Network capacity IRU
|
|
|
8,871
|
|
|
(776)
|
Total
|
|
$
|
11,528
|
|
$
|
(2,721)
|
Note
8
. Supplementary Disclosures of Cash Flow Information
The following information is presented as supplementary disclosures for the
condensed
consolidated statements of cash flows for the
nine months ended September 30, 2017 and 2016
:
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30,
|
(In thousands)
|
|
|
2017
|
|
|
2016
|
Cash payments for:
|
|
|
|
|
|
|
Interest (net of amounts capitalized)
|
|
$
|
19,222
|
|
$
|
17,634
|
Income taxes
|
|
|
-
|
|
|
304
|
Cash receipts for:
|
|
|
|
|
|
|
Income tax refunds
|
|
|
283
|
|
|
-
|
Supplemental investing and financing activities:
|
|
|
|
|
|
|
Additions to property, plant and equipment included in accounts payable
|
|
|
1,130
|
|
|
2,930
|
Obligations incurred under capital leases
|
|
|
-
|
|
|
7,936
|
Cash payments for interest for the
nine months ended September 30, 2017
and 2016
in the table above
are
net of
$0.7
million and
$0.
8
million
, respectively,
of cash received from CoBank for patronage credits (Note
7
).
The amount of interest capitalized was
$
0.
4
million and
$0.
8
million
for the
nine months ended September 30, 2017 and 2016
, respectively
.
Note 9. Fair Value of Financial Instruments
The Company’s financial instruments consist of cash and cash equivalents, marketable securities, accounts receivable, accounts payable, capital lease obligations (including the current portion), accrued liabilities, contingent consideration obligations, the Credit Facility (including the current portion) and the 8% Notes as of
September 30, 2017
and December 31, 2016. The carrying values of cash and cash equivalents, accounts receivable, accounts payable, capital lease obligations and accrued liabilities approximated their fair values at
September 30, 2017
and December 31, 2016. Marketable securities are recorded in the condensed consolidated balance sheets at fair value (see Note 5).
The following tables present the placement in the fair value hierarchy of financial assets and liabilities that are measured at fair value on a recurring basis at
September 30, 2017
and December 31, 2016:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair Value Measurements at
September 30, 2017
|
|
|
|
(In thousands)
|
|
Level 1
|
|
Level 2
|
|
Level 3
|
|
Total Fair Value
|
Financial Liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Contingent consideration obligations
|
|
$
|
-
|
|
$
|
-
|
|
$
|
10,200
|
|
$
|
10,200
|
Total financial liabilities
|
|
$
|
-
|
|
$
|
-
|
|
$
|
10,200
|
|
$
|
10,200
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair Value Measurements at
December 31, 2016
|
|
|
|
(In thousands)
|
|
Level 1
|
|
Level 2
|
|
Level 3
|
|
Total Fair Value
|
Financial Assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash equivalents:
|
|
|
|
|
|
|
|
|
|
|
|
|
Money market mutual funds
|
|
$
|
6,742
|
|
$
|
-
|
|
$
|
-
|
|
$
|
6,742
|
Corporate debt securities
|
|
|
-
|
|
|
413
|
|
|
-
|
|
|
413
|
Total cash equivalents
|
|
|
6,742
|
|
|
413
|
|
|
-
|
|
|
7,155
|
Marketable securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Variable rate demand notes
|
|
|
-
|
|
|
13,995
|
|
|
-
|
|
|
13,995
|
Commercial paper
|
|
|
-
|
|
|
7,370
|
|
|
-
|
|
|
7,370
|
Corporate debt securities
|
|
|
-
|
|
|
16,716
|
|
|
-
|
|
|
16,716
|
Total marketable securities
|
|
|
-
|
|
|
38,081
|
|
|
-
|
|
|
38,081
|
Total financial assets
|
|
$
|
6,742
|
|
$
|
38,494
|
|
$
|
-
|
|
$
|
45,236
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The fair value of commercial paper, variable rate demand notes and corporate, municipal and U.S. government debt securities are provided by a third-party pricing service and are estimated using pricing models. The underlying inputs to the pricing models are directly observable from active markets.
However, the pricing models used do entail a certain amount of subjectivity and therefore differing judgments in how the underlying inputs are modeled could result in different estimates of fair value. As such, the Company classifies these fair value measurements as Level 2 within the fair value hierarchy.
Additionally, through the business acquisitions of Clarity and DC74, the Company recognized contingent consideration obligations associated with the earnout provisions contained in the agreements. The fair value of the contingent consideration obligations was estimated using a discounted cash flow analysis that schedules out probability-weighted cash flows and adjusts for other factors such as estimated changes in market conditions and credit risk. The fair values of the contingent consideration obligations as of
September 30, 2017
for Clarity and DC74 were $
5
.
0
million and $5.
2
million, respectively. The fair value technique applied utilizes certain Level 3 inputs.
The following table summarizes the carrying amounts and estimated fair values of the components included in the Company’s long-term debt, including the current portion.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2017
|
|
December 31, 2016
|
(In thousands)
|
|
Carrying Value
|
|
Fair Value
(Level 2)
|
|
Carrying Value
|
|
Fair Value
(Level 2)
|
Credit Facility
|
|
$
|
328,347
|
|
$
|
297,196
|
|
$
|
337,102
|
|
$
|
304,571
|
8% Notes
|
|
|
126,040
|
|
|
135,556
|
|
|
123,471
|
|
|
133,965
|
Capital Lease Obligations
|
|
|
7,465
|
|
|
7,465
|
|
|
7,842
|
|
|
7,842
|
The respective fair values of the Credit Facility and the 8% Notes were estimated based on an internal discounted cash flows analysis that schedules out the estimated cash flows for the future debt and interest repayments and applies a discount factor that is adjusted to reflect estimated changes in market conditions and credit factors.
The Company also has certain non-marketable long-term investments for which it is not practicable to estimate fair value with total carrying values of $1.6 million and $1.5 million as of
September 30, 2017
and December 31, 2016, respectively of which $1.5 million and $1.4 million, respectively, represents the Company’s investment in CoBank. This investment is primarily related to patronage distributions of restricted equity and is a required investment related to the portion of the Credit Facility held by CoBank. This investment is carried under the cost method.
Note
10
. Equity
Below is a summary of the activity and status of equity as of and for the
nine months ended September 30, 2017
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(In thousands, except per share amounts)
|
Common Shares
|
|
Treasury Shares
|
|
Common Stock
|
|
Additional Paid-in Capital
|
|
Treasury Stock
|
|
Accumulated
Deficit
|
|
Accumulated Other Comprehensive Loss, net of tax
|
|
Total Lumos Networks Corp. Stockholders' Equity
|
|
Noncontrolling Interests
|
|
Total Equity
|
Balance, December 31, 2016
|
23,607
|
|
2
|
|
$
|
236
|
|
$
|
175,008
|
|
$
|
(2)
|
|
$
|
(29,064)
|
|
$
|
(11,004)
|
|
$
|
135,174
|
|
$
|
886
|
|
$
|
136,060
|
Cumulative effect adjustment
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
of adoption of ASU 2016-09
|
-
|
|
-
|
|
|
-
|
|
|
329
|
|
|
-
|
|
|
1,579
|
|
|
-
|
|
|
1,908
|
|
|
-
|
|
|
1,908
|
Balance, January 1, 2017
|
23,607
|
|
2
|
|
|
236
|
|
|
175,337
|
|
|
(2)
|
|
|
(27,485)
|
|
|
(11,004)
|
|
|
137,082
|
|
|
886
|
|
|
137,968
|
Net loss attributable to
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Lumos Networks Corp.
|
-
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
(5,240)
|
|
|
-
|
|
|
(5,240)
|
|
|
-
|
|
|
(5,240)
|
Other comprehensive income,
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
net of tax
|
-
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
605
|
|
|
605
|
|
|
-
|
|
|
605
|
Equity-based compensation expense
|
-
|
|
-
|
|
|
-
|
|
|
9,152
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
9,152
|
|
|
-
|
|
|
9,152
|
Restricted shares issued, shares
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
issued through the employee
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
stock purchase plan and
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
401(k) matching contributions
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(net of shares reacquired
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
through restricted stock forfeits
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
and settlement of tax withholding
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
obligations on vesting of shares)
|
410
|
|
162
|
|
|
5
|
|
|
101
|
|
|
(2,872)
|
|
|
-
|
|
|
-
|
|
|
(2,766)
|
|
|
-
|
|
|
(2,766)
|
Stock option exercises
|
42
|
|
(41)
|
|
|
-
|
|
|
340
|
|
|
696
|
|
|
-
|
|
|
-
|
|
|
1,036
|
|
|
-
|
|
|
1,036
|
Net income attributable to
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
noncontrolling interests
|
-
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
39
|
|
|
39
|
Balance, September 30, 2017
|
24,059
|
|
123
|
|
$
|
241
|
|
$
|
184,930
|
|
$
|
(2,178)
|
|
$
|
(32,725)
|
|
$
|
(10,399)
|
|
$
|
139,869
|
|
$
|
925
|
|
$
|
140,794
|
Note
1
1
. Earnings
(Loss)
per Share
The Company computes basic earnings (loss) per share by dividing net income (loss) attributable to Lumos Networks Corp. applicable to common shares by the weighted average number of common shares outstanding during the period. The impact on earnings (loss) per share of nonvested restricted shares outstanding that contain a non-forfeitable right to receive dividends on a one-to-one per share ratio to common shares is included in the computation of basic earnings per share pursuant to the two-class method. The Company issues restricted shares from time to time with vesting terms that are based on achievement of certain stock price performance conditions. These nonvested restricted shares are excluded from the computation of basic and diluted weighted average shares until the period in which the applicable performance or market conditions are attained.
The Company uses the treasury stock method to determine the number of potentially dilutive common shares from stock options and nonvested restricted shares during the period.
T
he computations of basic and diluted earnings
(loss)
per share for the
three and nine months ended September 30, 2017
and 201
6
are detailed in the following table.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
Nine Months Ended September 30,
|
(In thousands, except per share amounts)
|
|
2017
|
|
2016
|
|
2017
|
|
2016
|
Numerator:
|
|
|
|
|
|
|
|
|
|
|
|
|
Net (loss) income attributable to Lumos Networks Corp.
|
|
$
|
(453)
|
|
$
|
1,023
|
|
$
|
(5,240)
|
|
$
|
(627)
|
Less: net income attributable to Lumos Networks Corp. allocable to participating securities
|
|
|
-
|
|
|
(36)
|
|
|
-
|
|
|
-
|
Numerator for basic and diluted (loss) earnings per common share
|
|
|
(453)
|
|
|
987
|
|
|
(5,240)
|
|
|
(627)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Denominator:
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average basic shares outstanding
|
|
|
23,940
|
|
|
23,463
|
|
|
23,723
|
|
|
23,300
|
Less: weighted average participating securities and nonvested performance-based restricted shares
|
|
|
(751)
|
|
|
(846)
|
|
|
(803)
|
|
|
(804)
|
Denominator for basic (loss) earnings per common share
|
|
|
23,189
|
|
|
22,617
|
|
|
22,920
|
|
|
22,496
|
Plus: potentially dilutive restricted shares and stock options
|
|
|
-
|
|
|
237
|
|
|
-
|
|
|
-
|
Denominator for diluted (loss) earnings per common share
|
|
|
23,189
|
|
|
22,854
|
|
|
22,920
|
|
|
22,496
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic and diluted (loss) earnings per share
|
|
$
|
(0.02)
|
|
$
|
0.04
|
|
$
|
(0.23)
|
|
$
|
(0.03)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the three and nine months ended September 30, 2017 and the nine months ended 2016, the denominator for diluted
loss per common share is equivalent to the denominator for basic loss per common share because the addition of stock options and unvested restricted stock would be antidil
utive for the period
s
.
For the three months ended September 30, 2017, the denominator for diluted loss per common share excluded 4
99,442
and 5
30
,99
1
shares, related to stock options and nonvested r
estricted stock, respectively.
T
he earnings per share calculation for the
three months ended September 30, 2016
exclude
d 772,146 and 345,439 shares, related to stock options and nonvested restricted stock, respectively.
For the
nine months ended September 30, 2017 and 2016
, the denominator for diluted loss per common share excluded
478,767
and
515,995
and
1,
0
0
8,
939
and
469,509
shares, resp
ectively,
related to stock options and nonveste
d restricted stock, respectively
.
The denominator for diluted
loss
per share for the three
and nine
months ended
September
30, 2017 also
excluded
1,
202,464
and 1,097,281
shares
, respectively,
associated with the 8% Notes warrants, which are
anti-
dilutive for
each
period.
The earnings (loss) per share calculations for the three and nine months ended September 30, 2016 exclude
the
5,500,000
outstanding stock warrants described in Note
1
2
as they would be antidilutive for
each
period.
Note 12
. Stock Options, Restricted Stock and Stock Warrants
Stock Options and Restricted Stock
The Company has an Equity and Cash Incentive Plan administered by the Compensation Committee of the Company’s board of directors, which permits the grant of long-term incentives to employees and non-employee directors, including stock options, stock appreciation rights, restricted stock awards, restricted stock units, incentive awards, other stock-based awards and dividend equivalents. As of
September 30, 2017
, the maximum number of shares of common stock available for awards under the Equity and Cash Incentive Plan was 5,500,000
and
5
33
,
114
securities
remained available for issuance under the plan. Upon the exercise of stock options or upon the grant of restricted stock under the Equity and Cash Incentive Plan, new common shares are issued or treasury stock is reissued.
The Company issued
no
stock options
and
89,
067
shares of restricted stock under the Equity and Cash Incentive Plan during the
nine
months ended
September 30, 2017
. Restricted shares generally cliff vest on the third anniversary of the grant date for employees and generally cliff vest on the first anniversary of the grant date for non-employee directors. Some of the outstanding restricted stock awards vest on a graded vesting schedule over a five year period.
A summary of the
activity
and status of the Company’s stock options for the
nine months ended September 30, 2017
,
is as follows:
|
|
|
|
|
|
|
|
|
|
(In thousands, except per share amounts)
|
Shares
|
|
Weighted-Average Exercise Price per Share
|
|
Weighted-Average Remaining Contractual Term
|
|
Aggregate Intrinsic Value
|
Stock options outstanding at December 31, 2016
|
1,749
|
|
$
|
12.35
|
|
|
|
|
|
Granted during the period
|
-
|
|
|
-
|
|
|
|
|
|
Exercised during the period
|
(105)
|
|
|
13.66
|
|
|
|
|
|
Forfeited during the period
|
-
|
|
|
-
|
|
|
|
|
|
Expired during the period
|
(29)
|
|
|
19.44
|
|
|
|
|
|
Stock options outstanding at September 30, 2017
|
1,615
|
|
$
|
12.14
|
|
4.8 years
|
|
$
|
9,451
|
|
|
|
|
|
|
|
|
|
|
Stock options exercisable at September 30, 2017
|
1,280
|
|
$
|
11.98
|
|
4.7 years
|
|
$
|
7,707
|
Total stock options outstanding, vested and expected to vest at September 30, 2017
|
1,615
|
|
$
|
12.14
|
|
|
|
$
|
9,451
|
The total fair value of options that vested during the
nine
months ended
September 30, 2017
was $
0.
4
million.
As of
September 30, 2017
, there was $
0
.
4
million of total unrecognized compensation cost related to unvested stock options, which is expected to be recognized over a weighted-average period of
0
.
8
years.
A summary of the activity and status of the Company’s restricted stock for the
nine months ended September 30, 2017
, is as follows:
|
|
|
|
|
(In thousands, except per share amounts)
|
Shares
|
|
|
Weighted-Average Grant Date Fair Value per Share
|
Restricted stock outstanding at December 31, 2016
|
849
|
|
$
|
13.85
|
Granted during the period
|
89
|
|
|
16.43
|
Vested during the period
|
(202)
|
|
|
13.57
|
Forfeited during the period
|
-
|
|
|
-
|
Restricted stock outstanding at September 30, 2017
|
736
|
|
$
|
14.24
|
As of
September 30, 2017
, there was $
3
.
4
million of total unrecognized compensation cost related to unvested restricted stock awards, which is expected to be recognized over a weighted-average period of
1.
4
years.
Immediately prior to the effective time of the
EQT
Merger, the Company’s outstanding stock options (whether or not vested and exercisable) will automatically vest and be cancelled and entitle the option holder to receive an amount in cash equal to the product of (i) the total number of shares subject to the option and (ii) the amount, if any, of excess of $18.00 and the applicable exercise price per share underlying the option (less any applicable withholding taxes). Additionally, immediately prior to the effective time of the Merger, the Company’s outstanding restricted stock will automatically vest and the restrictions thereon will lapse and entitle the holder of such share of Company restricted stock to receive $18.00 in cash (less any applicable withholding taxes).
Stock Warrants
A summary of the activity and status of the Company’s stock warrants for the
nine
months ended
September 30, 2017
, is as follows:
|
|
|
|
|
(In thousands, except per share amounts)
|
Shares
|
|
|
Weighted Average Exercise Price per Share
|
Stock warrants outstanding at December 31, 2016
|
5,500
|
|
$
|
13.99
|
Granted during the period
|
-
|
|
|
-
|
Exercised during the period
|
-
|
|
|
-
|
Expired during the period
|
-
|
|
|
-
|
Stock warrants outstanding at September 30, 2017
|
5,500
|
|
$
|
13.99
|
Outstanding warrants consist of those issued on August 6, 2015 in conjunction with the 8% Notes issuance discussed in Note
7
(the “Warrants”). The Warrants are fully vested and exercisable and may be net-share settled on a cashless basis only until they expire on August 6, 2022. A portion of the net proceeds from the 8% Notes issuance was allocated to the equity-classified Warrants based on the relative fair value of the instruments.
Lumos Investment Holdings, Ltd., an affiliate of Pamplona Capital Management, the holder of the Warrants has agreed, subject to the effectiveness of the
EQT
Merger, to exercise the Warrant. Upon exercise, Pamplona will receive 1,225,278 shares of common stock that will be exchanged for $18.00
per share
in cash in the
EQT
Merger.
Note
1
3
. Income Taxes
Income tax
expense
for the
three months ended September 30, 2017
and 2016
was
$0.
3
million
and
$
1.0
million, respectively
,
income tax benefit for the
nine
months ended
September
30, 2017 was $
1
.
8
million and income tax expense for the
n
ine
months ended
September
30, 2016 was $
1
.7 million,
which represents the federal statutory ta
x rate applied to pre-tax
income (l
oss
)
a
nd the effects of state income taxes and certain non-deductible charges for each period
.
The Company
’s
recurring non-deductible expenses relate primarily to certain non-cash
equity
-based compensation
and
non-deductible interest on the 8% Notes, which are treated as applicable high yield discount obligations (“AHYDO”) within the meaning of Section 163(i)(1) of the Internal Revenue Code, as amended.
The Company also incurred certain transaction costs during the
three and nine months ended September 30, 2017 and 2016
that would be considered capitalized costs for income tax purposes
, primarily associated with the Merger
.
While
management
believes
the Company
has adequately provided for all
significant
tax positions, amounts asserted by taxing authorities could be greater than its accrued position. Accordingly, additional provisions could be recorded in the future as revised estimates are made or the underlying matters are settled or ot
herwise resolved. In general,
tax year
s
201
3
and thereafter
remain open and subject to federal and state audit examinations.
Note 14
. Related Party Transactions
Valley
Net, an equity method investee of the Company, resells capacity on the Company’s fiber network under an operating lease agreement. Facility lease revenue from ValleyNet was approximately $1.
0
million
and $1.
3
million
for
three months ended September 30, 2017 and 2016
,
respectively
,
and $
3
.1
million and $
3
.
7
million for the
nine months ended September 30, 2017 and 2016
, respectively,
which is presented in the Company’s data segment revenues.
T
he Company had accounts receivable
from Valley
Net of
$0.
3
million
and $0.4 million
at
September 30, 2017
and December 31, 201
6
, respectively
. The Company also leases and resells capacity from ValleyNet. The total
lease expense was
$0.
2
mill
ion
and $0.3 million
for
the
three months ended September 30, 2017 and 2016
, respectively,
a
nd $
0.
8
million and $0.
9
million for the
nine months ended September 30, 2017 and 2016
, respectively
.
Note 15. Restructuring Charges
In 2016, the Company completed an employee reduction-in-force and
incurred
restructuring costs, consisting of employee severance and termination benefits
.
The
Company incurred
less than $0.1 million of
restructuring costs during the
three and
nine months ended September 30, 2017
.
Restructuring costs
of $1.8 million were recognized during the nine months ended September 30, 2016. This amount is net of an adjustment of $0.4 million recorded
as income
in the three months ended September 30, 2016 to reduce previously accrued amounts to reflect changes in estimated severance obligations.
A liability for restructuri
ng charges in the amount of $0.1
million is included in the Company’s condensed consolidated balance sheet as of
September 30, 2017
, related to employee termination costs accrued, but not yet paid. Below is a summary of the restructuring liability balance as of
September 30, 2017
:
|
|
|
|
|
|
|
(In thousands)
|
|
|
Employee
Severance and
Termination
Benefits
|
|
|
Total
|
Beginning balance at December 31, 2016
|
|
$
|
398
|
|
$
|
398
|
Additions, net of adjustments
|
|
|
34
|
|
|
34
|
Payments
|
|
|
(379)
|
|
|
(379)
|
Ending balance at September 30, 2017
|
|
$
|
53
|
|
$
|
53
|
Note 1
6
. Commitments and Contingencies
Customer Disputes and Routine Matters
The Company periodically makes claims or receives disputes and is involved in legal actions related to billings to other carriers for access to the Company’s network. The Company does not recognize revenue related to such matters until
collection of the claims is reasonably assured
. In addition to this, the Company periodically disputes access charges that are assessed by other companies with which the Company interconnects and is involved in other disputes and legal and tax proceedings and filings arising from normal business activities.
T
he Company is involved in routine litigation and disputes in the ordinary course of its business. While the
results of litigation and disputes are inherently unpredictable
, management does not expect that the ultimate costs to resolve these matters will have a material adverse effect on the Company’s consolidated 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 condensed consolidated financial statements.
The Company has purchase commitments relating to capital
projects
totaling $
1
.
1
million as of
September 30, 2017
, which are expected to be satisfied during
the remainder of
201
7
.
Litigation Related to the
EQT
Merger
On April 4, 2017 and April 11, 2017, two putative class action lawsuits were filed in the United States District Court for the District of Delaware (the “Court”) against the Company’s directors, EQT Partners Inc., Parent and Merger Sub. The plaintiffs in the actions alleged that the Company’s disclosures in its preliminary proxy statement filed by the Company with the SEC on March 31, 2017 contained false and misleading statements and omitted material information and further that the individual defendants are liable for those alleged misstatements and omissions. The actions sought, among other things, to enjoin the Merger or, if the Merger has been consummated, to rescind the Merger or an award of damages, and an award of attorneys’ and experts’ fees and costs. Following the Company’s filing of its definitive proxy, the plaintiffs in the actions filed stipulations of voluntary dismissal asserting that their claims had been rendered moot. On June 12, 2017
,
the Court issued a Stipulation of Dismissal and Withdrawal Order for each action, in which the Court retained jurisdiction over the action solely for purposes of further proceedings related to the adjudication of the plaintiffs’ fee and expense application. Subsequently, the parties reached agreement with respect to payment of plaintiff’s fees and expenses and on August 29, 2017 the Court issued Orders closing and terminating each action. The Company’s fees and expenses relating to these actions were immaterial
.
Item 2
. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The following sections provide an overview of our business strategy
, our financial condition
and results of operations and highlight key trends and uncertainties in our business
and should be read
in conjunction with our consolidated financial statements and the related notes included elsewhere in this report
. Any statements contained in this
Management’s Discussion and Analysis of Financial Condition and Results of Operations
that are not
statements of historical fact, including statements about our beliefs and expectations, are forward-looking statements and should be evaluated as such. The words “anticipates,” “believes,” “expects,” “intends,” “plans,” “estimates,” “targets,” “projects,” “should,” “may,” “will” and similar words and expressions are intended to identify forward-looking statements.
See "Forward-Looking Statements" at the end of this discussion for additional factors relating to such statements
, and see “Risk Factors” in
Part II, Item A of this Quarterly Report on Form 10-Q and in
Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 201
6
.
Overview
Lumos Networks Corp. (“Lumos Networks,” the “Company,” “we,” “us,” or “our”) is a fiber-based bandwidth infrastructure and service provider in the Mid-Atlantic region. We provide services to carrier and enterprise
customers, including healthcare providers, local government agencies, financial institutions and educational institutions, over our
approximately
11,
0
00
route-mile fiber optic network. Our principal products and services include Multiprotocol Label Switching (“MPLS”) based Ethernet, Metro Ethernet (“Metro E”), Fiber to the Cell site (“FTTC”) wireless backhaul and data transport services, wavelength transport services and IP services.
Our overall strategy is to transition into a pure-play fiber bandwidth infrastructure company through pursuit of expansion opportunities, both organic and inorganic. To achieve organic growth, our objective is to leverage and expand our fiber assets to capture the growing demand for data and mobility services among our carrier and enterprise customers in our marketplace. Our operating strategy is to (i)
monetize our approximatel
y 1
1,0
00 rout
e-mile fiber optic network by selling bandwidth infrastructure services to new and existing carriers and enterprise customers while maintaining our ratio of data revenue from on-net traffic at or above 80%; (ii) use our “expansion” and "edge-out” strategies to enter into new markets and extend into markets adjacent to our existing footprint to increase our addressable market size; (iii) leverage our growing fiber network to expand to new fiber to the cell opportunities under long term contracts; (iv) proactively manage our churn through several initiatives including upgrading existing customers from legacy technologies to carrier Ethernet services and continually improving network and operational performance; (v) focus on managing resources from the declining legacy voice products into our faster growing and more profitable data products; and (vi) execute our success-based investment strategy in both organic and inorganic opportunities to grow our data business while maintaining our capital efficiency
and expanding margins.
EQT
Merger
On February 18, 2017, we entered into a definitive agreement (“Merger Agreement”) by and among the Company, MTN Infrastructure TopCo, Inc. (“Parent”) and MTN Infrastructure BidCo, Inc. (“Merger Sub”), pursuant to which we will be acquired by EQT Infrastructure investment strategy (“EQT Infrastructure”), subject to regulatory approval and other customary closing conditions
(
“the Merger” or
“EQT Merger”)
. Pursuant to the Merger Agreement, each outstanding share of common stock of the Company prior to the effective time of the Merger shall be automatically converted into the r
ight to receive $18.00 in cash.
T
he EQ
T Merger is expected to close before the end of
November 2017.
For further information refer to Note 3. EQT Merger in the Notes to Unaudited Condensed Consolidated Financial Statements included in this quarterly report. Also refer to the Current Reports filed on Form 8-K on Febru
ary 21, 2017, F
ebruary 22, 2017 and
May 24, 2017
and our definitive proxy statement filed on April 21, 2017.
Business Segments and Strategy
Our operating segments generally align with our major product and service offerings and coincide with the way that our chief operating decision makers measure performance and allocate resources. Our current reportable operating segments are data, residential and small business (“R&SB”) and RLEC access.
In January 2017, we completed the business acquisitions of Clarity Communications, LLC (“Clarity”) and DC74, LLC (“DC74”)
, results of which
are presented
wholly
within the data segment of our business
, specifically, within the enterprise data and transport product lines for Clarity and within the enterprise data product line for DC74
.
Our data segment
provided
64.7%
and
60.6
%
of our total
revenue for the
three months ended September 30, 2017 and 2016
, respectively
, and 63.
6
% and
59.3
% in the respective
nine
month periods
. Revenue
for our data segment
increased
15.4%
for
the
nine months ended September 30, 2017
, as compared
to the respective period
in 201
6
.
This segment, which includes our enterprise data,
transport
and
FTTC product groups, represents the main growth opportunity and
is
the key focal point of our strategy. We market and sell these services primarily to carrier
and enterprise customers, including healthcare providers,
state and
local government agencies,
financial institutions and educational institutions.
Our data product lines are growing at a pace that significantly exceeds
the decline
in
our legacy product lines
,
and in
the
aggregate, due to
our focus on on-net customers,
they also provide a
higher gross margin
. A
significant
majority of our capital expenditures and sales force are dedicated to
increasing
revenue and profit from our data
segment
. We believe that a balanced split between
enterprise and carrier
revenue results in the most effective capital allocation and resulting profitability. Our ability to
sustain or accelerate revenue growth in our data segment depends on our ability to obtain and effectively deploy capital to upgrade and expand our fiber network and implement our expansion and edge-out strategies in a timely and disciplined manner, attract new customers and successfully manage churn downwards through customer retention programs, including upgrading existing customers from legacy technologies to carrier Ethernet services.
The
15.4%
year-over-year growth in our data segment revenues for 201
7
was achieved primarily through
the business acquisitions of Clarity and DC74
as well as organic growth in our enterprise data business
.
Specifically
, the
organic
growth is
attributable to
improving enterprise penetration within
our existing and new markets,
providing greater Ethernet bandwidth to enterprise customers
and bandwidth upgrades on existing FTTC contracts and the addition of second tenants at existing towers
.
Our marketing and sales efforts are focused on taking advantage of increased carrier bandwidth demand, particularly for long-term FTTC contracts from wireless carriers that are deploying long-term evolution (“LTE”) data services, selling into our expansion and edge out markets (with an emphasis on targeting large enterprise customers in our expansion markets of Richmond, VA and Norfolk, VA), maximizing the use of our carrier end user distribution channel, providing connection to data centers for our enterprise customers and improving penetration in existing markets.
As of
September 30, 2017
, we had 1,3
10
cell towers a
nd
2,
230
buildings connected to our fiber network, including
4
4
data centers. Our FTTC revenue increased
$
2.1
million, or
7.7
%
, for the
nine
months ended September 30, 2017
as a result of
bandwidth upgrades on existing towers,
the additio
n of second tenants and
to a lesser extent, the growth in connected towers.
Revenues from our enterprise data products increased
$13.8
million, or
35.8%
,
for the
nine
months ended
September
30, 2017 as compared to the respective period in 2016
due to the business acquisitions of Clarity and DC74 and growth in our metro Ethernet and dedicated Internet product lines
.
The growth in FTTC and enterprise data revenues was partially offset by the year-over-year decline in our revenue from data transport products, which have been negatively impacted by network grooming as existing customers redesign their networks and upgrade from time division multiplexing (“TDM”) technology to Ethernet products to improve efficiency. As we continue to implement our data growth strategy, which includes monetizing our recently expanded fiber optic network in the key Virginia markets of Richmond and Norfolk, we believe that the effect of churn on legacy product lines will continue to be more than offset by revenues from carrier Ethernet products, including long-term FTTC contracts, new enterprise customers and expanded bandwidth services with existing customers.
Our R&SB segment provided
26.3%
and
3
0
.
6
%
of
our total
revenue for the three months ended
September 30, 2017
and 201
6
, respectively
, and
27.
2
% a
nd 3
0
.
9
% for the respective
nine
month periods
. This segment includes legacy voice and
IP services products targeted at
our residential and small business customers. Re
venue decl
ined approximately
5.3
% for the first
nine
months of 201
7
as compared to 201
6
primarily due to the decline in revenues from legacy voice products. This decline is attributable to voice line loss resulting from residential wireless substitution, technology changes and product replacement by competitive voice service offerings from cable operators in our markets. We expect aggregate revenue from these businesses will continue to decline.
Our RLEC access segment provided approximately
9.0%
and 9.2
%
of our
total
revenue
for the
three and nine months ended September 30, 2017
, respectively,
as compared to approximately
8.8%
and 9.8%
for the respective period
s
in 201
6
.
This decline is attributable to voice line loss and regulatory actions taken to reduce intra-state tariffs by applicable regulatory authorities, principally the FCC and the Virginia SCC. In 2011, the FCC released an order comprehensively reforming its Universal Service Fund (“USF”) and intercarrier compensation systems. In the order, the FCC determined that interstate and intrastate access charges, as well as local reciprocal compensation, should be eliminated entirely over time. These FCC pricing reductions commenced on July 1, 2012 and continue through July 1, 2020. A portion of the access revenue previously received by our RLECs from carriers is being recovered through payments from the FCC’s “Connect America Fund” (“CAF”) and from increases in charges to end user subscribers in the form of rate increases and the FCC’s “Access Recovery Charge”. These new payments and revenues were also effective July 1, 2012.
Our total revenues derived from cost recovery mechanisms
,
including the USF and the CAF, were $
4
.
8
million
and $4.2 million for
the three months ended
September 30, 2017
and 201
6
,
respectively,
and $
1
5.0
million and $
14.3
million for the
nine months ended September 30, 2017 and 2016
,
respectively
.
Our
R&SB and RLEC
access
segments require limited incremental capital to maintain the underlying assets and deliver reasonably predictable cash flows. Despite declining
revenues
, we expect cash flows from these legacy businesses to continue to significantly contribute to funding the capital investment in our growing data segment.
Our operating
income
margin w
as
13.7%
for the three months ended
September 30, 2017
as compared to
17.8
%
for the respective period in
201
6
.
Our operating
income
margin
s
for the
nine months ended September 30, 2017 and 2016
were
9.0%
and
14.2
%, respectively.
The
de
crease
in our operating income margins
for the thre
e
month period
was primarily
due
to increases in selling, general and administrative expenses and depreciation and amortization, partially
offset by
increases in gross profit
. The decrease in our operating income margins for the
nine
month period was primarily due to the aforementioned reasons, but was also partially offset by lower restructuring costs
as compared to the same period in 201
6
.
Our
Contribution Margin ratios, as
defined below, were
75.3%
and 74.7%
for the
three months ended September 30, 2017 and
2016
, respectively,
a
nd
7
5.0
%
and
74.5
%
for the
nine months ended
September 30, 2017 and 2016
, respectively
.
Our Adjusted EBITDA margins
, as defined below,
were
43.8%
and
46.9
%
for the three months ended
September 30, 2017
and 201
6
, respectively
, and
44.2
%
and 45.
9
% for the
nine months ended September 30, 2017 and 2016
, respectively
.
Operating Revenues
Our revenues are generated from the following segments:
|
·
|
|
Data, which includes the following products: enterprise data (
metro
Ethernet, dedicated internet, VoIP, private line
, data center
and wavelength
), transport, and FTTC
;
|
|
·
|
|
R&SB, which includes legacy voice products (local lines, PRI, long distance, toll and directory services and other voice services) and IP services (integrated access, DSL,
fiber-to-the-premise
broadband XL and IP-based video). This segment also includes revenues from switched access and reciprocal compensation services provided to other carrier
s in our competitive markets; and
|
|
·
|
|
RLEC access, which primarily includes switched access provided to other carriers in our RLEC markets.
|
Operating Expenses
Our operating expenses are incurred
from the following categories:
|
·
|
|
Cost of r
evenue, excl
usive of d
epr
e
ciation and
a
mortization, including usage-based access charges, long distance, directory, operator services and other direct costs incurred in accessing other telecommunications providers' networks in order to provide telecommunication services to our end-user customers and leased facility expenses for connection to other carriers;
|
|
·
|
|
Selling, general and administrative,
exclusive of depreciation and amortization,
including:
|
|
o
|
|
D
irect operating
and selling costs
,
which include
salaries, wages and benefits of
field
personnel,
subscriber based third party
licensing and maintenance fees, sales commissions and property taxes,
repair and maintenance
and utilities
necessary to own
and operate customer equipment
,
|
|
o
|
|
I
ndirect operating costs
,
which include salaries, wages and benefits of network operations, customer care, engineering, program management, sales, warehousing, product management and service delivery personnel and costs to maintai
n and operate our core network
, and
|
|
o
|
|
Corporate general and administrative
costs
,
which includes
billing, bad debt expenses, taxes other than income
and property taxes allocable to categories above
, executive services, accounting, legal, purchasing, information technology, human resources and other
corporate
general and administrative expenses, including earned bonuses and equity-based compensation expense related to stock and option instruments held by employees and non-employee directors and amortization of actuarial losses and other gains or losses related to retirement plans;
|
|
·
|
|
Depreciation and amortization, including depreciable long-lived property, plant and equipment and amortization of intangible assets where applicable;
|
|
·
|
|
Accretion of a
sset retirement obligations;
|
|
·
|
|
Restructuring charges; and
|
|
·
|
|
C
hanges in f
air value of c
ontingent
consideration obligations
.
|
Contribution Margin
Contribution Margin
,
as defined by us, is net income
or loss
attributable to Lumos Networks Corp. before interest, income taxes, depreciation and amortization, accretion of asset retirement obligations, net income
or loss
attributable to noncontrolling interests, other (income) expenses, net,
restructuring charges,
changes in fair value of contingent consideration obligations,
corporate
general and administrative
costs
(as defined above)
, inclusive of equity-based compensation,
transaction related
charges
and amortization of actuarial gains or losses
and indirect operating
costs
(as defined above)
. Contribution Margin
ratio
is calculated as Contribution Margin
over
operating revenues.
Contribution Margin is a non-GAAP financial performance measure. It should not be considered in isolation, as an alternative to, or more meaningful than measures of financial performance determined in accordance with GAAP. Management believes that Contribution Margin is a
meaningful measure
related to the incremental cash flow delivered by new billings
that
provides relevant and useful information to investors for comparing performance period to period
against peer companies
and for comparing
profitability
of
the
Company’s
businesses
. Management utilizes Contribution Margin internally to assess the profitability of the Company
’s product
groups
and for capital allocation decision-making.
Management also uses Contribution Margin for budget planning purposes and for
other
strategic planning in
i
tiatives.
See a reconciliation of net
(loss)
income
attributable to Lumos Networks C
orp.
to Contribution Margin, as defined by the Company, on a consolidated basis for the
three and nine months ended September 30, 2017 and 2016
, as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
Nine Months Ended September 30,
|
(In thousands)
|
|
|
2017
|
|
2016
|
|
2017
|
|
2016
|
Net (Loss) Income Attributable to Lumos Networks Corp.
|
|
|
$
|
(453)
|
|
$
|
1,023
|
|
$
|
(5,240)
|
|
$
|
(627)
|
Net (Loss) Income Attributable to Noncontrolling Interests
|
|
|
|
(29)
|
|
|
46
|
|
|
39
|
|
|
137
|
Net (Loss) Income
|
|
|
|
(482)
|
|
|
1,069
|
|
|
(5,201)
|
|
|
(490)
|
Income tax expense (benefit)
|
|
|
|
335
|
|
|
1,046
|
|
|
(1,838)
|
|
|
1,712
|
Interest expense
|
|
|
|
7,771
|
|
|
7,164
|
|
|
22,756
|
|
|
21,165
|
Other income, net
|
|
|
|
(8)
|
|
|
(48)
|
|
|
(647)
|
|
|
(320)
|
Operating income
|
|
|
|
7,616
|
|
|
9,231
|
|
|
15,070
|
|
|
22,067
|
Depreciation and amortization and accretion of asset retirement obligations
|
|
|
|
14,483
|
|
|
12,762
|
|
|
43,716
|
|
|
37,119
|
Restructuring charges
|
|
|
|
-
|
|
|
(384)
|
|
|
34
|
|
|
1,823
|
Changes in fair value of contingent consideration obligations
|
|
|
|
100
|
|
|
-
|
|
|
700
|
|
|
-
|
Indirect operating costs
|
|
|
|
10,239
|
|
|
9,121
|
|
|
31,184
|
|
|
26,657
|
Corporate general and administrative costs, including equity-based compensation and transaction related charges
|
|
|
|
9,430
|
|
|
7,968
|
|
|
34,461
|
|
|
27,798
|
Contribution Margin
|
|
|
$
|
41,868
|
|
$
|
38,698
|
|
$
|
125,165
|
|
$
|
115,464
|
Adjusted EBITDA
Adjusted EBITDA, as defined by us, is net
income
or loss
attributable to Lumos Networks Corp. before interest, income taxes, depreciation and amortization, accretion of asset retirement obligations, net income
or loss
attributable to noncontrolling interests, other (income) expenses, net, equity-based compensation, amortization of actuarial gains or losses, restr
ucturing charges
,
transaction related
charges
and
changes in the fair value of contingent consideration
obligations
. Adjusted EBITDA margin is calculated as
the ratio of Adjusted EBITDA
to operating revenues.
Adjusted EBITDA is a non-GAAP financial performance measure. It should not be considered in isolation, as an alternative to, or more meaningful than measures of financial performance determined in accordance with GAAP. Management believes that Adjusted EBITDA is a standard measure of operating performance and liquidity that is commonly reported in the telecommunications and high speed data transport industry and provides relevant and useful information to investors for comparing performance period to period and for comparing financial performance of similar companies. Management utilizes Adjusted EBITDA internally to assess
business performance, the
ability to meet future capital expenditure and working capital requirements, to incur indebtedness if necessary, and to fund continued growth. Management also uses Adjusted EBITDA for budget planning purposes and as factors in the Company’s employee compensation programs.
The following table provide
s a reconciliation of net
(loss) income
attributable to Lumos Networks Corp. to Adjusted EBITDA, as defined by the Company, on a consolidated basis for the
three and nine months ended September 30, 2017 and 2016
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
Nine Months Ended September 30,
|
(In thousands)
|
|
2017
|
|
2016
|
|
|
2017
|
2016
|
Net (Loss) Income Attributable to Lumos Networks Corp.
|
|
$
|
(453)
|
|
$
|
1,023
|
|
$
|
(5,240)
|
|
$
|
(627)
|
Net (Loss) Income Attributable to Noncontrolling Interests
|
|
|
(29)
|
|
|
46
|
|
|
39
|
|
|
137
|
Net (Loss) Income
|
|
|
(482)
|
|
|
1,069
|
|
|
(5,201)
|
|
|
(490)
|
Income tax expense (benefit)
|
|
|
335
|
|
|
1,046
|
|
|
(1,838)
|
|
|
1,712
|
Interest expense
|
|
|
7,771
|
|
|
7,164
|
|
|
22,756
|
|
|
21,165
|
Other income, net
|
|
|
(8)
|
|
|
(48)
|
|
|
(647)
|
|
|
(320)
|
Operating income
|
|
|
7,616
|
|
|
9,231
|
|
|
15,070
|
|
|
22,067
|
Depreciation and amortization and accretion of asset retirement obligations
|
|
|
14,483
|
|
|
12,762
|
|
|
43,716
|
|
|
37,119
|
Amortization of actuarial losses
|
|
|
326
|
|
|
338
|
|
|
977
|
|
|
1,013
|
Equity-based compensation
|
|
|
1,156
|
|
|
1,661
|
|
|
9,152
|
|
|
8,477
|
Restructuring charges
|
|
|
-
|
|
|
(384)
|
|
|
34
|
|
|
1,823
|
Changes in fair value of contingent consideration obligations
|
|
|
100
|
|
|
-
|
|
|
700
|
|
|
-
|
Transaction related charges
|
|
|
691
|
|
|
652
|
|
|
4,086
|
|
|
652
|
Adjusted EBITDA
|
|
$
|
24,372
|
|
$
|
24,260
|
|
$
|
73,735
|
|
$
|
71,151
|
Other Income (Expenses)
Our other income (expenses) are generated (incurred) from
interest expense on debt instruments and capital lease obligations
, including amortization of debt issuance costs
and debt discounts
and
other income or expense, which includes interest income and fees, expenses related to our senior secured credit facility and, as appropriate under the circumstances, secondary public offering and stock registration costs and write-off of unamortized debt issuance costs
.
Income Taxes
Our income tax
expense (benefit)
and effective tax rate increases or decreases based upon changes in a number of factors, including primarily the amount of our pre-tax income or loss, state minimum tax assessments, and non-deductible expenses.
Nonc
ontrolling Interests in
Earnings of Subsidiaries
We have a partnership through our RLEC
s
with a 46.3% noncontrolling interest that owns certain signaling equipment and provides service to a number of small RLECs and to TNS
(an inter-operability solution provider)
.
Results of Operations
Three and nine months ended September 30, 2017
compared to
three and nine months ended September 30, 2016
Operating revenues
in
creas
ed $
3.8
million, or
7.4
%, from the
three months ended September 30, 2016
to the
three months ended September 30, 2017
primarily due to
increases in data revenues of $
4.6
million
and RLEC access revenues of $0.4 million
, partially offset
by
a
decrease in R&SB revenues
of
$1.2
million.
For the three months
ended
September 30, 2017
, data
revenues represented
64.7%
of our total revenue, compared to
60.6%
for the prior year comparative perio
d.
Operating revenues increased
$11.9
million, or
7.7%
,
from the
nine
months ended September 30, 2016 to the nine months ended September 30, 2017 primarily due to increases in data revenues of $14.2 million
and RLEC access revenues of $0.2 million, partially offset by a decrease in R&SB revenues of $2.5 million
.
For further details regarding thes
e revenue fluctuations, see “Operating Revenues” below.
Operating income
de
creased
$1.6
million from
$9.
2
million for
the
three months ended September 30, 2016
to
$
7.6
million for
the
three months ended September 30, 2017
due to
a $2
.
9
million increase in selling, general and administrative expenses, a $
1
.
7
million increase i
n depreciation and amortization,
a $0.
4
million increase in cost of r
evenue
,
a $0.
1
million change in fair value of contingent consideration obligations
and changes in restructuring charges
, partially offset by a $3
.
8
million increase in revenue.
Operating income decreased $
7
.
0
million
from
$22.1 million for
the
nine months ended September 30, 2016
to
$15.1 million for
the
nine months ended September 30, 2017
due to
a $12.3 million increase in selling, general and administrative expenses, a $6.6 million increase in depreciation and amortization, a $1.0 million
increase in cost of revenue and
a $0.7 million change in fair value of contingent consideration obligations, partially offset by a
n
$11.9 million increase in revenue and decreases in restructuring charges.
For further d
etails regarding these operating expense fluctuations, see “Operating Expenses” section below.
Net
loss
attributable to Lumos Networks
was $0.5 million for the three months ended September 30, 2017, which decreased
$1.5
million from net income of $1.0 million for the three months ended September 30, 2016. The decrease was
primarily a result of the
aforementioned
$1.6
million d
ecrease in operating income and a $0.6 million increase in interest expense, partially offset by a decrease in income taxes
o
f $0.7
million
.
Net
loss
attributable to Lumos Networks
in
crea
s
ed
$4.
6
mill
ion from
a net loss of $0.6 million for
the
nine
months ended September 30, 2016
to
a
net loss of $5.2 million for
the
nine months ended September 30, 201
7
primarily
as a result of the
aforementioned
$7
.0
million
d
ecrease in operating
income and
increases in interest expense
,
offset
by
an income tax benefit during the nine months ended September 30, 2017
.
Cont
ribution Margin
increased $
3.
2
million
and $
9
.
7
million
from
the
three and nine months ended September 30, 201
6 to the three and nine months ended September 30, 2017, respectively,
due to the revenue increases discussed above.
Adjusted EBITDA was
$24.4
million
and
$24.3
million
for
the
three months ended September 30, 2017 and 2016
,
respectively
, and $
73.7
million and $
71.2
million for the
nine months ended September 30, 2017
and 2016,
respe
ctively
.
Adjusted EBITDA
increased due to
the
increase
s
in
revenue
discussed above
, partially offset by increases in selling, general and administrative expenses
.
OPERATING REVENUES
The following table identifies our external operating revenues by business segment and major product group for the
three and nine months ended September 30, 2017 and 2016
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
|
|
|
|
|
Dollars in thousands
|
|
2017
|
|
2016
|
|
$ Variance
|
|
% Variance
|
Operating Revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
Enterprise data
|
|
$
|
18,111
|
|
$
|
13,549
|
|
$
|
4,562
|
|
33.7
|
%
|
Transport
|
|
|
8,135
|
|
|
8,499
|
|
|
(364)
|
|
(4.3)
|
%
|
FTTC
|
|
|
9,752
|
|
|
9,325
|
|
|
427
|
|
4.6
|
%
|
Total Data
|
|
|
35,998
|
|
|
31,373
|
|
|
4,625
|
|
14.7
|
%
|
R&SB:
|
|
|
|
|
|
|
|
|
|
|
|
|
Legacy voice
|
|
|
9,232
|
|
|
10,340
|
|
|
(1,108)
|
|
(10.7)
|
%
|
IP services
|
|
|
4,601
|
|
|
4,399
|
|
|
202
|
|
4.6
|
%
|
CLEC access
|
|
|
799
|
|
|
1,124
|
|
|
(325)
|
|
(28.9)
|
%
|
Total R&SB
|
|
|
14,632
|
|
|
15,863
|
|
|
(1,231)
|
|
(7.8)
|
%
|
RLEC access
|
|
|
4,980
|
|
|
4,535
|
|
|
445
|
|
9.8
|
%
|
Total operating revenues
|
|
$
|
55,610
|
|
$
|
51,771
|
|
$
|
3,839
|
|
7.4
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30,
|
|
|
|
|
|
|
Dollars in thousands
|
|
2017
|
|
2016
|
|
$ Variance
|
|
% Variance
|
Operating Revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
Enterprise data
|
|
$
|
52,188
|
|
$
|
38,428
|
|
$
|
13,760
|
|
35.8
|
%
|
Transport
|
|
|
24,810
|
|
|
26,500
|
|
|
(1,690)
|
|
(6.4)
|
%
|
FTTC
|
|
|
29,121
|
|
|
27,030
|
|
|
2,091
|
|
7.7
|
%
|
Total Data
|
|
|
106,119
|
|
|
91,958
|
|
|
14,161
|
|
15.4
|
%
|
R&SB:
|
|
|
|
|
|
|
|
|
|
|
|
|
Legacy voice
|
|
|
28,876
|
|
|
31,285
|
|
|
(2,409)
|
|
(7.7)
|
%
|
IP services
|
|
|
13,576
|
|
|
13,028
|
|
|
548
|
|
4.2
|
%
|
CLEC access
|
|
|
2,875
|
|
|
3,527
|
|
|
(652)
|
|
(18.5)
|
%
|
Total R&SB
|
|
|
45,327
|
|
|
47,840
|
|
|
(2,513)
|
|
(5.3)
|
%
|
RLEC access
|
|
|
15,446
|
|
|
15,215
|
|
|
231
|
|
1.5
|
%
|
Total operating revenues
|
|
$
|
166,892
|
|
$
|
155,013
|
|
$
|
11,879
|
|
7.7
|
%
|
|
·
|
|
D
ata.
Data revenues for the
three months ended September 30, 2017
increas
ed
$4.6
million, or
14.7%
, over the comparative period in 201
6
and data revenues for the
nine months ended September 30, 2017
increased
$14.2 million, or 15.4%
,
over the comparative period in 2016
.
The overall increase in data revenues is
primarily
due to
the acquisitions of Clarity and DC74,
in addition to
growth in
enterprise data revenues and in
FTTC site services
,
partially offset by churn in data transport revenues due to network grooming activities as described below.
|
|
o
|
|
Enterprise Data
– Enterprise data
revenues increased
33.7
%
and 35.8%
fo
r the
three and nine months ended September 30, 2017
as compared to the
respective period
s
in 201
6
.
The business acquisitions of Clarity and DC7
4 increased enterprise data revenues
in the aggregate
$
2.9
million
and $
7.9
million
during the
three and nine months ended September 30, 2017
, respectively
. Additionally, w
e
were
connected to
2,
230
on
-net buildings as of
September 30, 2017
, as compared to
1,
984
as of
September 30, 2016
. Metro Ethernet and dedicated Internet
also contributed
to revenue growth in this segment, which growth was partially attributable to increased
installation of services
sold
through our carrier end user distribution channel. Growth in
these product lines
was partially offset by declines in private line and other legacy enterprise data products as a result of churn from competitio
n from national carriers and cable operators in our markets and to a lesser extent due to customers upgrading from TDM to Ethernet products.
|
|
o
|
|
Transport
– T
ransport revenues
decreased 4.3
% and
6.
4
%
for the
three and nine months ended September 30, 2017
, respectively,
as compared to the respective period
s
in 201
6
. These decreases were
primarily attributable to
continued
network grooming
activities by carriers
as TDM technology is replaced by Ethernet
, partially offset by the acquisition of Clarity
,
which added $0.
4
million
and $1.
5
million
of transport revenue during the
three and nine months ended September 30, 2017
, respectively
.
|
|
o
|
|
FTTC
–
Revenues from o
ur FTTC contracts grew
4.6%
and 7.7%
for the
three and nine months ended September 30, 2017
,
respectively,
as comp
a
red to the respective period
s
in 201
6
. This growth is attributable to
increased bandwi
dth to existing connected cell towers i
n addition to
slight incre
a
ses
in our fiber connections to wireless
cell sites
and the addition of second tenants to existing cell sites.
|
|
·
|
|
R&SB
.
Revenue from residential and small business
products declined
7.8%
and
5
.
3
%
for the
three and nine months ended September 30, 2017
, respectively,
as compared to the
respective period
s
in 201
6
. This decline was primarily driven by decreases in revenue from legacy voice products due to the increasing use of wireless devices and competition from cable operators in our markets as
well as our shift in focus to voice over IP (which is included in data segment revenues). As of
September 30, 2017
, we operated approximately
2
1,501
RLEC telephone access lines and
58,089
competitive voice lines, compared to approximately
2
3
,
381
and
68,084
as of
September 30, 2016
, respectively. This represents a
n
8
.
0
%
year-over-year decline in
RL
EC telephone access lines and a
1
4
.
7
%
year-over-year decline in competitive voice lines.
Declines in revenue from legacy DSL products were partially offset by g
rowth in fiber-to-the-premise products within our IP services product group such as Broadband XL and IP video. Our total
Broadband XL
subscribers
increased
14.2
%
over the last twelve months from
8,307
at
September 30, 2016
to
9,485
at
September 30, 2017
.
|
|
·
|
|
RLEC Access.
The
9.8%
in
crease in RLEC access revenues from the
three months ended September 30, 2016
to the
three months ended September 30, 2017
is primarily a result of
increases in
USF funding
and
certain adjustments during the three months ended September 30, 2016
. T
he 1.5% increase from the nine months ended September 30, 2016 to the nine months ended September 30, 2017
is primarily
the
result
of
the aforementioned
increases
, partially offset by
the intrastate access rate reductions mandated by regulatory reform and a step-down
in
the recovery
amounts
of certain intrastate access charges from the
CAF program
discussed in the overview section above
and a decrease in RLEC telephone access lines
.
|
OPERATING EXPENSES
The following table identifies
our operating expenses for the
three and nine months ended September 30, 2017 and 2016
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
|
|
|
|
|
Dollars in thousands
|
|
2017
|
|
2016
|
|
$ Variance
|
|
%Variance
|
Operating Expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of Revenue, exclusive of depreciation and amortization shown separately below
|
|
$
|
10,042
|
|
$
|
9,657
|
|
$
|
385
|
|
4.0
|
%
|
Selling, general and administrative, exclusive of depreciation and amortization shown separately below
|
|
|
23,369
|
|
|
20,505
|
|
|
2,864
|
|
14.0
|
%
|
Depreciation and amortization
|
|
|
14,456
|
|
|
12,739
|
|
|
1,717
|
|
13.5
|
%
|
Accretion of asset retirement obligations
|
|
|
27
|
|
|
23
|
|
|
4
|
|
17.4
|
%
|
Restructuring charges
|
|
|
-
|
|
|
(384)
|
|
|
384
|
|
N/M
|
|
Change in fair value of contingent consideration obligations
|
|
|
100
|
|
|
-
|
|
|
100
|
|
N/M
|
|
Total operating expenses
|
|
$
|
47,994
|
|
$
|
42,540
|
|
$
|
5,454
|
|
12.8
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30,
|
|
|
|
|
|
|
Dollars in thousands
|
|
2017
|
|
2016
|
|
$ Variance
|
|
%Variance
|
Operating Expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of Revenue, exclusive of depreciation and amortization shown separately below
|
|
$
|
30,978
|
|
$
|
29,948
|
|
$
|
1,030
|
|
3.4
|
%
|
Selling, general and administrative, exclusive of depreciation and amortization shown separately below
|
|
|
76,394
|
|
|
64,056
|
|
|
12,338
|
|
19.3
|
%
|
Depreciation and amortization
|
|
|
43,640
|
|
|
37,028
|
|
|
6,612
|
|
17.9
|
%
|
Accretion of asset retirement obligations
|
|
|
76
|
|
|
91
|
|
|
(15)
|
|
(16.5)
|
%
|
Restructuring charges
|
|
|
34
|
|
|
1,823
|
|
|
(1,789)
|
|
(98.1)
|
%
|
Change in fair value of contingent consideration obligations
|
|
|
700
|
|
|
-
|
|
|
700
|
|
N/M
|
|
Total operating expenses
|
|
$
|
151,822
|
|
$
|
132,946
|
|
$
|
18,876
|
|
14.2
|
%
|
N/M
-
Not
Meaningful
Cost of Revenue, exclusive of Depreciation and Amortization
.
Cost of r
evenue
in
creased
$0.4
million, or
4.0%
, for the
three months ended September 30, 2017
and $1.0 million, or 3.4%
,
for the nine months ended September 30, 2017
as compared to the
respective 2016 periods
,
which is primarily attributable to increased customer access colocation costs from the business acquisitions, partially offset by decreases due to the overall decrease in voice access lines.
Selling, General and Administrative
, exclusive of Depreciation and Amortization
.
Selling, general and administrative expenses
increased
$2.9
million, or
14.0%
,
for the
three months ended September 30, 2017
as
compared to the same period in the prior
year
primarily as a r
esult of
$
0
.
7
million of
transaction
related charges
incurred
,
increases in salaries, wages and benefits
of $
2.2
million
primarily due to the business acquisitions as well as increased sales commissions
and increases in network maintenance and operating costs
. Selling, general and administrative expenses
increased $
12.3
million, or
19.3
%,
for the
nine
months ended
September
30, 2017 as compared to the same period in the prior year primarily as a result of a $
6.3
million increase in salaries, wages and benefits and equity-based compensation, primarily due to the business acquisitions as well as an increase in the
annual employee bonus paid in
the form of
immediately vested shares
and increased sales commissions
,
$
4
.
1
million of
transaction related
charges incurred
and
increases in network maintenance and operating costs
.
Depreciation and Amortization.
Depreciati
on and amortization
increased
$1.7
million, or
13.5%
,
for the
three months ended September 30, 2017
as compared to
the same period in the prior year due
to
a
$
1
.
1
million
increase in depreciation costs
and an increas
e in amortization expense of $
0.
6
million.
Depreciation and amortization
increased $
6
.
6
million, or
17
.
9
%,
for the
nine months ended September 30, 2017
as compared to the same period in the prior year due
to a $
5
.
0
million increase in depreciation costs and an increase in amortization expense of $1.
6
million.
The increase
s in depreciation costs are
a result of the year-over-year increase in our depreciable base of assets primarily from capital investment in our
fiber
network including infrastructure upgrades and FTTC
site installations. The in
crease
s in amortization cost are
attributable to
the
amortization for
customer
relationship and trade name
intangible assets
acquired during the Clarity and DC74 acquisitions. We use an accelerated
amortization method based on these assets’ estimated patterns of benefit.
Change in F
air
V
alue of
Contingent C
onsideration
Obligations
.
We recognized certain contingent consideration obligations in connection with the acquisitions of Clarity and DC74 due to the earnout provisions in the acquisition agreements. The change in the fair value of the liabilit
ies
is
due primarily to the
accretion
of the discount and
changes in
probability assumptions on the projected cash flows is reported through earnings.
OTHER INCOME (EXPENSES) AND INCOME TAXES
The following table summarizes our other income (expenses) and income taxes for the
three
and nine
months ended September 30, 2017 and 2016
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
|
|
|
|
|
(Dollars in thousands)
|
|
2017
|
|
2016
|
|
$ Variance
|
|
%Variance
|
Interest expense
|
|
$
|
(7,771)
|
|
$
|
(7,164)
|
|
$
|
(607)
|
|
8.5
|
%
|
Other income, net
|
|
|
8
|
|
|
48
|
|
|
(40)
|
|
(83.3)
|
%
|
Total other expenses, net
|
|
$
|
(7,763)
|
|
$
|
(7,116)
|
|
$
|
(647)
|
|
9.1
|
%
|
Income tax expense
|
|
$
|
335
|
|
$
|
1,046
|
|
$
|
(711)
|
|
(68.0)
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30,
|
|
|
|
|
|
|
(Dollars in thousands)
|
|
2017
|
|
2016
|
|
$ Variance
|
|
%Variance
|
Interest expense
|
|
$
|
(22,756)
|
|
$
|
(21,165)
|
|
$
|
(1,591)
|
|
7.5
|
%
|
Other income, net
|
|
|
647
|
|
|
320
|
|
|
327
|
|
102.2
|
%
|
Total other expenses, net
|
|
$
|
(22,109)
|
|
$
|
(20,845)
|
|
$
|
(1,264)
|
|
6.1
|
%
|
Income tax (benefit) expense
|
|
$
|
(1,838)
|
|
$
|
1,712
|
|
$
|
(3,550)
|
|
(207.4)
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest Expense.
Interest expense for the
three
and nine
months ended September 30, 2017 and 2016
primarily consists of incurred costs associated with our Credit Facility as well as amortization of debt issuance costs
and
interest incurred on the 8% Notes
,
as well as amortization of
associated
debt discounts and debt issuance costs. The year-over-year increase in interest expense is primarily attributable to
a decrease in
i
nterest capitalization due to de
creased
capital expenditure activity
and changes in ba
nk patronage credits (see Note 7
of the Notes
to Unaudited Condensed Consolidated Financial Statements).
Other Income (Expenses).
Other
income
primarily consists of
interest income earned on marketable securities
for the
three and
nine
months ended
September
30, 2017. The nine months ended September 30, 2017 also include
s
the write-off of certain accrued secondary
public offering
costs
, for which the likelihood of payment was deemed remote
.
Income Tax Expense
(Benefit)
.
Income tax
expense
for the three months ended
September 30, 2017
and 201
6
was
$0.
3
million
and
$1
.0
million, re
spectively
. Income tax benefit for the
nine
months ended
September
30, 2017 was
$
1
.
8
million and
i
ncome tax expense for the
nine
months ended
September
30, 2016 was
$
1
.7 million,
which represents the federal statutory tax rate applied to pre-tax
income (
loss
)
and the effects of state income taxes and certain non-deductible
charges
for each period.
The in
crease in income tax
benefit
and
changes
in
our
effective tax rate were primarily due to the changes in
loss
before taxes and the effect of
certain permanent book and tax differences.
Our recurring
non-deductible
expenses relate primarily
to the 8% Notes issued in August 2015, which are subject to the AHYDO interest limitation.
O
ther
recurring non-deductible expenses
include
non-cash equity-based compensation
and certain transaction costs that are expected to be capitalized for income tax purposes.
Liquidity and Capital Resources
For the
nine months ended September 30, 2017 and 2016
, our cash flows from operations totaled approximately
$54.
3
million and
$45.8
million, respectively. Our cash flows from operations are primarily generated by payments received from customers for da
ta and voice communication services and carrier access to our network offset by payments to other carriers, payments to our employees, payments for interest and taxes and payments for other network operating costs and other selling, general and administrative expenses. Our cash on hand, which
is
generally available for operations and to fund long-term FTTC contracts, may also be used to repay debt obligations or fund other capital expenditures.
As of
September 30, 2017
, we had
$505.
3
million
in aggregate long-term liabilities, consisting of
$388.0
million in
long-term debt, net
of
$2
6
.
2
million in debt discounts and deferred issuance
costs
and
$117.
3
million in other l
ong-term liabilities, inclusive
of deferred income tax liabilities of
$93.
6
million, pension a
nd other postretirement obligations of
$15.2
mi
llion and o
ther long-term liabilities of
$8.
5
million. Our Credit Facility includes a revolving credit facility of $50 million (the “Revolver”),
all of
which was available for our working capital
requirements and other general corporate purposes as of
September 30, 2017
.
Mandatory prepayments include an excess cash flow sweep equal to 50% of Excess Cash Flow, as
defined under the Credit Agreement, for each fiscal year commencing in 2013 for so long as the leverage ratio exceeds 3.25:1.00.
Under the Credit Agreement,
certain of our subsidiaries
are also bound by certain financial covenants. Noncompliance with any one or more of the debt covenants may have an adverse effect on our financial condition or liquidity in the event such noncompliance cannot be cured or should we be unable to obtain a waiver from the lenders of the Credit Facility.
As of
September 30, 2017
, we were in compliance with all of our debt covenants, a
nd our ratios were as follows:
|
|
|
|
Actual
|
Covenant Requirement at
September
30
, 2017
|
Total debt outstanding to EBITDA (as defined in the Credit Agreement)
|
3
.48
|
Not more than
4.
50
|
Minimum interest coverage ratio
|
7.00
|
Not less than 3.25
|
On January 2, 2015,
we
entered into a $28 million senior secured incremental term loan facility under the existing Credit Facility
(
“Term Loan C”
)
and amended certain terms of the Credit Facility
(the “Amended Credit Facility”)
.
We
used
the net proceeds from Term Loan C to fund
capital expenditures fo
r customer builds related to
new FTTC site contracts.
Term Loan C will mature in 2019 with quarterly payments of 1% per annum. The Amended Credit Facility sets a maximum leverage ratio of 4.50:1.00 through December 31, 2017, 4.25:1.00 through December 31, 2018
and 4.00:1.00 thereafter.
On August
6
, 2015
, we closed on the issuance of unsecured promissory notes in an
aggregate principal amount of
$150 m
illion
(the “
8%
Note
s
”)
to
an affiliate of
Pamplona Capital Management LLC (
“Pamplona”
).
N
et proceeds of the
8%
Note
s
, afte
r payment of closing costs,
were
used to pay off
$40 million
of our existing Credit Facility
,
with the remainder to be used
for general corporate purposes, including to fund future growth opportunities.
The
8%
Notes bear interest at an annual fixed rate of 8.00% and mature on August 15, 2022. Interest is payable in arrears on a quarterly basis on August 15, November 15, February 15 and May 15 of each year, beginning on November 15, 2015. Interest is payable in cash or, at our election, through the issuance of additional notes or by adding the amount of the accrued interest to the unpaid principal amount of the
8%
Notes outstanding at that time.
All interest to date has been paid in cash and
we
currently intend to continue to pay the interest in cash.
We also
have capital leases on vehicles with original le
ase terms of four to five years and an IRU
network capacity
a
rrangement
that are included
as a component of
long-term
debt on the conden
sed consolidated balance sheet
as
September 30, 2017
.
As of
September 30, 2017
, the combined total net present value of
our
future minimum lease payments was $
7.
5
million.
The following table presents a summary of our cash flow activity for the
nine
months ended September 30, 2017 and 2016
:
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30,
|
(In thousands)
|
|
2017
|
|
2016
|
Net cash provided by operating activities
|
|
$
|
54,333
|
|
$
|
45,787
|
Net cash used in investing activities
|
|
|
(32,340)
|
|
|
(15,347)
|
Net cash used in financing activities
|
|
|
(11,986)
|
|
|
(10,531)
|
Increase in cash and cash equivalents
|
|
$
|
10,007
|
|
$
|
19,909
|
Operating.
The in
crease in cash
flows from operations is primarily due to changes in working capital largely due to timing of payments to vendors and cash collections from customers.
Investing.
The
change
in cash
used in
investing activities is primarily
due
to
the acquisitions of Clarity and DC74, $10.0 million and $23.5 million, respectively. In addition to a decrease in
purchases of marketable securities, net of sales and maturities, of $
11
.8
million
and
a decrease
in
purchases of property
,
p
lant and equipment of $
2
8
.
3
million
. Capital expenditures for the
n
i
ne
months ended September 30, 2017
were comprised of (i) $
30
.
7
million for success-based customer projects, network expansion and infrastructure upgrades, (ii) $
5
.
3
million for network maintenance, (iii) $
3
.
4
million for information technology and facility related projects, and
less
(iv) $
2
.
5
million for
de
creases in inventory on hand for capital projec
ts in the preceding categories.
Through
September 30, 2017
, we have developed and acquired a fiber network of
approximately 1
1,0
00 route
miles, of which
approximately
4
2
% is owned by us and has been
accumulated through our capital investment in fiber builds and strategic acquisitions over the past several years with the remaining approximately
5
8
%
of our network under IRU agreements. We intend to continue to invest in our fiber infrastructure.
We currently expect to incur
capital expenditures
during the remainder of
2017
associated with
enterprise and carrier installations, data network enhancements and, to a lesser
extent, to fund essential network
facility upgrades and fiber-to-the-premise deployments for our R&SB segment.
Financing.
The net cash
used in
financing activities for the
nine months ended September 30, 2017
consisted
of common stock repurchased
for a total of
$2.
9
million to cover tax withholding obligations on
employee stock awards
and
the repayment of principal on the Credit Facility and payments under capital lease obligations totaling $
10
.
2
million, partially offset by proceeds from stock
option exercises of $
1
.
1
million
.
As of
September 30, 2017
, we had approximately
$
43
.
6
million in cash all of which
is
available for current operations.
We expect that the cash we generate from operations combined with our cash on hand will be sufficient to satisfy our working capital requirements, capital expenditures and debt service requirements
until September 2018
. Additionally, we have access to the Revolver, which is currently undrawn. However, if our assumptions prove incorrect or if there are other factors that increase our need for additional liquidity, such as material unanticipated losses, loss of customers or a significant reduction in demand for our services or other factors, or if we are successful in obtaining additi
onal major FTTC contracts or we m
ake additional acquisitions, we would expect to seek additional sources of funds through refinancing or other means including additional equity financing.
Additionally,
if the EQT Merger is not completed we will need to refinance our Term Loan A and our Revolver, both of
which mature in September 2018. T
here is no assurance
that we could obtain
any such
additional financing on acceptable terms, if at all. If available, additional equity financing may dilute our stockholders and debt financing may restrict our ability to raise future capital.
As discussed previously in this Management’s Discussion and Analysis, events and actions taken by the FCC are projected to have a significant negative impact on our future cash flows from the RLEC access products, partially offset by the Connect America Fund (“CAF”) payments to us.
On March 4, 2015, our board of directors
terminated
our quarterly dividend in favor of allocating capital to growth opportunities.
Off Balance Sheet Arrangements
We do not have any off balance sheet arrangements or financing activities with special purpose entities.
Recent Accounting Pronouncements
In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers
(Topic 606)
(“ASU 2014-09”), which will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective. ASU 2014-09 requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. In August 2015, the FASB issued ASU 2015-14, Revenue from Contracts with Customers (Topic 606) - Deferral of the Effective Date, which defers the effective date of ASU 2014-09 for public business entities from annual reporting periods beginning after December 15, 2016, to annual reporting periods beginning after December 15, 2017. Early application is permitted only as of annual reporting periods beginning after December 15, 2016. ASU 2014-09 permits the use of either the retrospective or cumulative effect transition method. In March 2016, the FASB issued ASU 2016-08, Revenue from Contracts with Customers (Topic 606) – Principal versus Agent Considerations (Reporting Gross versus Net) (“ASU 2016-08”), which clarifies implementation guidance on principal versus agent considerations. In April 2016, the FASB issued ASU 2016-10, Revenue from Contracts with Customers (Topic 606) – Identifying Performance Obligations and Licensing (“ASU 2016-10”), which clarifies guidance related to identifying performance obligations and licensing implementation guidance contained in ASU 2014-09. In May 2016, the FASB issued ASU 2016-12, Revenue from Contracts with Customers (Topic 606) – Narrow-Scope Improvements and Practical Expedients (“ASU 2016-12”), which addresses narrow-scope improvements to the guidance on collectability, noncash consideration, and completed contracts at transition. Additionally, the amendments in ASU 2016-12 provide a practical expedient for contract modifications at transition and an accounting policy election related to the presentation of sales taxes and other similar taxes collected from customers. Finally, in December 2016, the FASB issued ASU 2016-20, Technical Corrections and Improvements to Topic 606, Revenue from Contracts with customers, which makes minor corrections or improvements to ASU 2014-09.
We have
complete
d
our initial
impact assessment
and are
in the process of
develop
ing
an implementation plan to include any potential process or system changes
.
Although the full assessment of the impact to
our
results of operations, financial position and cash flows as a result of this guidance is ongoing,
we
expect that changes in the timing of and method of recognition for certain non-recurring charges received from customers and allocations of certain contract revenues to products and services may result in additional contract assets and liabilities in the consolidated balance sheet. In addition, the requirement to defer incremental contract acquisition costs, including sales commissions, and recognize such costs over the contract period or expected customer life may result in the recognition of a deferred charge within our consolidated balance sheets and could have the impact of deferring operating expenses
.
We
will
adopt this new standard as of January 1, 2018 and currently expect to apply the modified retrospective method, which may result in a cumulative effect adjustment as of the date of adoption. Both our initial assessment and our selected transition method may change depending on the results of our final assessment of the impact to our
consolidated
financial statements
and disclosures
.
In January 2016, the FASB issued ASU 2016-01, Financial Instruments - Overall (Topic 825): Recognition and Measurement of Financial Assets and Financial Liabilities (“ASU 2016-01”). The standard addresses certain aspects of recognition, measurement, presentation and disclosure of financial instruments. ASU 2016-01 is effective for public business entities for fiscal years, and interim periods within those years, beginning after December 15, 2017, and early adoption is not permitted. We do not expect the future adoption of ASU 2016-01 to have a material impact on our consolidated financial statements and disclosures.
In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842) (“ASU 2016-02”), which will replace most existing lease guidance in U.S. GAAP when it becomes effective. ASU 2016-02 requires an entity to recognize most leases, including operating leases, on the consolidated balance sheet
s
of the lessee. ASU 2016-02 is effective for public business entities for annual reporting periods beginning after December 15, 2018, with early adoption permitted. ASU 2016-02 requires the use of a modified retrospective transition method with elective reliefs. We are still evaluating the effect that ASU 2016-02 will have on our consolidated financial statements and disclosures.
In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows – Classification of Certain Cash Receipts and Cash Payments (Topic 230) (“ASU 2016-15”), which addresses the following eight classification issues related to the statement of cash flows presentation, with the objective of reducing diversity in practice: 1) debt prepayment or debt extinguishment costs; 2) settlement of zero-coupon debt instruments; 3) contingent consideration payments made after a business combination; 4) proceeds from the settlement of insurance claims; 5) proceeds from the settlement of corporate-owned life insurance policies, including bank-owned life insurance policies; 6) distributions received from equity method investees; 7) beneficial interests in securitization transactions; and 8) separately identifiable cash flows and application of the predominance principle. ASU 2016-15 is effective for public business entities for annual reporting periods beginning after December 31, 2017, with early adoption permitted. Although we are still evaluating the effect that ASU 2016-15 will have on our statement of cash flow and disclosures, we expect the standard will primarily impact the presentation of the earnouts associated with the business acquisitions completed in January 2017.
Under ASU 2016-15, the earnouts would be presented in the statement of cash flows as cash outflows for financing activities up to the amount of the original contingent consideration liability and the excess would be classified as cash outflows for operating activities.
In January 2017, the FASB issued ASU 2017-04, Intangibles – Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment (“ASU 2017-04”), which simplifies the accounting for goodwill impairment by eliminating Step 2 of the goodwill impairment test, which requires a hypothetical purchase price allocation. Under
ASU
2017-04, goodwill will be measured using the difference between the fair value and carrying value of the reporting unit. ASU 2017-04 is effective for public business entities for annual and interim reporting periods beginning after December 31, 2019, with early adoption permitted for goodwill impairment tests with measurement dates after January 1, 2017. We do not expect the future adoption of ASU 2017-04 to have a material impact on
our
consolidated financial statements and disclosures.
In Marc
h 2017, the FASB issued ASU 2017-07, Compensation – Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Periodic Postretirement Benefit Cost (“ASU 2017-07”), which requires the service cost component of net benefit cost to be reported in the same line item as compensation cost on the consolidated statements of operations. Under 2017-07 all other components of net benefit cost will be reported outside of operating income. ASU 2017-
0
7 is effective for public business entities for annual and interim reporting periods beginning after December 15, 2017 and r
etrospective application of the change in income statement presentation is required
.
Based on current actuarial estimates, we estimate the future adoption
of
ASU 2017-07
would increase operating income by
less than
$0.5 million for the annual
period.
However, the calculation of post retirement benefit cost
is
subject to
significant
estimates and assumptions and changes in these estimates could
result in changes to the
impact of ASU 2017-07 on
the our
operating income when adopted.
In May 2017, the FASB issued ASU 2017-09, Compensation – Stock Compensation (Topic 718): Scope of Modification Accounting (“ASU 2017-09”), which amends the scope of modification accounting for share-based payment arrangements and requires that a description of significant modifications for each period for which an income statement is presented along with the related increase or decrease in expense due to these modifications. ASU 2017-09 is effective for all public business entities for annual and interim periods beginning after December 15, 2017 and early adoption is permitted at the beginning of an annual period for which interim or annual financial statements have not been issued.
We do
not expect the future adoption of ASU 2017-09 to have a material impact on
our
consolidated financial statements
and disclosures
.
Forward-Looking Statements
This Management’s Discussion and Analysis of Financial Condition and Results of Operations includes certain forward-looking statements.
Such forward-looking statements reflect, among other things, our current expectations, plans and strategies, and anticipated financial results, all of which are subject to known and unknown risks, uncertainties and factors that may cause our actual results to differ materially from those expressed or implied by these forward-looking statements. Many of these risks are beyond our ability to control or predict. Because of these risks, uncertainties and assumptions, you should not place undue reliance on these forward-looking statements.
Furthermore, forward-looking statements speak only as of the date they are made. We do not undertake any obligation to update or review any forward-looking information, whether as a result of new information, future events or otherwise. Important factors with respect to any such forward-looking statements, including certain risks and uncertainties that could cause actual results to differ from those contained in the forward-looking statements, include, but are not limited to: the successful closing of the announced
EQT Merger
, including satisfying closing conditions; the timing to consummate the proposed
Merger
; any disruption from the
proposed
Merger
making it more difficult to maintain relationships with customers, employees or suppliers; the diversion of management time on
Merger
-related issues; the
Merger
may involve unexpected costs, liabilities or delays; the outcome of any legal proceedings related to the
Merger
, the failure by EQT Infrastructure to obtain the necessary financing arrangement set forth in commitment letters received in connection with th
e M
erger; the impact of our previous acquisitions of Clarity and DC74 on our operations; rapid development and intense competition with resulting pricing pressure in the telecommunications and high speed data transport industry; our ability to grow our
data business on an organic or inorganic basis in order to offset expected revenue declines in legacy voice and access products; our ability to obtain new carrier contracts or expand services under existing carrier contracts at competitive pricing levels to offset churn and achieve revenue growth from our carrier businesses; our ability to separate our legacy business on a timely basis; our ability to effectively allocate capital and timely implement network expansion plans necessary to accommodate organic growth initiatives; our ability to
complete customer installations in a timely manner; adverse economic conditions; operating and financial restrictions imposed by our senior credit facility and our unsecured debt obligations; our cash and capital requirements; our ability to maintain and enhance our network; the potential to experience a high rate of customer turnover; federal and state regulatory fees, requirements and developments; our reliance on certain suppliers and vendors; and other unforeseen difficulties that may occur. These risks and uncertainties are not intended to represent a complete list of all risks and uncertainties inherent in our business, and should be read in conjunction with the more detailed cautionary statements and risk factors included
in
our SEC filings, including this Quarterly Report on Form 10-Q and our
A
nnual Report filed on Form 10-K
for the year ended December 31, 201
6
.