BROADVIEW NETWORKS HOLDINGS INC - FORM 10-Q - November 5, 2014

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EX-32.2 - EXHIBIT 32.2 - BROADVIEW NETWORKS HOLDINGS INCbnhex322-9302014.htm
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
Mark One
þ
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For The Quarterly Period Ended September 30, 2014
o
 
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Transition Period from                      to                     
Commission File Number 333-142946
Broadview Networks Holdings, Inc.
(Exact name of registrant as specified in its charter)
Delaware
 
11-3310798
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
 
 
 
800 Westchester Avenue,
 
 
Suite N501 Rye Brook, NY 10573
 
10573
(Address of principal executive offices)
 
(Zip code)
(914) 922-7000
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes o No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer o
 
Accelerated filer o
 
Non-accelerated filer þ
 
Smaller reporting company o
 
 
 
 
(Do not check if a smaller reporting company)
 
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ
Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes o No o
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
Class
 
Outstanding at November 5, 2014
Common Stock, $.01 par value per share
 
9,999,945


TABLE OF CONTENTS

 
 
 
 
 
Condensed Consolidated Balance Sheets as of September 30, 2014 (unaudited) and December 31, 2013
 
 
Unaudited Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2014 and 2013
 
 
Unaudited Condensed Consolidated Statements of Cash Flows for the three and nine months ended September 30, 2014 and 2013
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 4. Mine Safety Disclosures
 
 
 
 
 
 
 
 
 Exhibit 31.1
 Exhibit 31.2
 Exhibit 32.1
 Exhibit 32.2
 Exhibit 101.INS
 Exhibit 101.SCH
 Exhibit 101.CAL
 Exhibit 101.LAB
 Exhibit 101.PRE
 Exhibit 101.DEF

2

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
This report contains both historical and forward-looking statements. All statements other than statements of historical fact included in this report that address activities, events or developments that we expect, believe or anticipate will or may occur in the future are forward-looking statements including, in particular, the statements about our plans, objectives, strategies and prospects regarding, among other things, our financial condition, results of operations and business. We have identified some of these forward-looking statements with words like “believe,” “may,” “will,” “should,” “expect,” “intend,” “plan,” “predict,” “anticipate,” “estimate” or “continue” and other words and terms of similar meaning. These forward-looking statements may be contained throughout this report, including but not limited to statements under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” These forward-looking statements are based on current expectations about future events affecting us and are subject to uncertainties and factors relating to our operations and business environment, all of which are difficult to predict and many of which are beyond our control and could cause our actual results to differ materially from those matters expressed or implied by forward-looking statements. Many factors mentioned in our discussion in this report will be important in determining future results. Although we believe that the expectations reflected in these forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. Our plans and objectives are based, in part, on assumptions involving the execution of our stated business plan and objectives. Forward-looking statements (including oral representations) are only predictions or statements of current plans, which we review and update regularly. They can be affected by inaccurate assumptions we might make or by known or unknown risks and uncertainties, including, among other things, risks associated with:

•
our history of net losses;
•
the elimination or relaxation of certain regulatory rights and protections;
•
billing and other disputes with vendors;
•
failure to maintain interconnection and service agreements with incumbent local exchange and other carriers;
•
the loss of customers in an adverse economic environment;
•
regulatory uncertainties in the communications industry;
•
system disruptions or the failure of our information systems to perform as expected;
•
the failure to anticipate and keep up with technological changes;
•
inability to provide services and systems at competitive prices;
•
difficulties associated with collecting payment from incumbent local exchange carriers, interexchange carriers and wholesale customers;
•
the highly competitive nature of the communications market in which we operate including competition from incumbents, cable operators and other new market entrants, and declining prices for communications services;
•
continued industry consolidation;
•
restrictions in connection with our indenture governing the notes and credit agreement governing our revolving credit facility;
•
our ability to service our substantial indebtedness;
•
government regulation;
•
increased regulation of Internet-protocol-based service providers;
•
vendor bills related to past periods;
•
the ability to maintain certain real estate leases and agreements;
•
interruptions in the business operations of third party service providers, including but not limited to work stoppages;
•
the financial difficulties faced by others in our industry;
•
the failure to retain and attract management and key personnel;
•
the failure to manage and expand operations effectively;
•
the failure to successfully integrate future acquisitions, if any;
•
misappropriation of our intellectual property and proprietary rights;
•
protection of and access to intellectual property essential to our network and products;
•
the possibility of incurring liability for information disseminated through our network;
•
service network disruptions due to software or hardware bugs of the network equipment;
•
fraudulent usage of our network and services; and
•
the failure to maintain effective internal control over financial reporting.

3

Because our actual results, performance or achievements could differ materially from those expressed in, or implied by, these forward-looking statements, we cannot give any assurance that any of the events anticipated by these forward-looking statements will occur or, if any of them do, what impact they will have on our business, results of operations and financial condition. You are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this report. We do not undertake any obligation to update these forward-looking statements to reflect new information, future events or otherwise, except as may be required under federal securities laws.




4

PART I — FINANCIAL INFORMATION

Item 1.
Financial Statements

Broadview Networks Holdings, Inc.
Condensed Consolidated Balance Sheets
(dollars in thousands, except par value)
 
September 30,
2014
 
December 31,
2013
 
(Unaudited)
 
 
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
9,574

 
$
8,143

Certificates of deposit
1,272

 
1,820

Accounts receivable, less allowance for doubtful accounts of $5,113 and $6,037
23,270

 
24,450

Other current assets
8,584

 
7,753

Total current assets
42,700

 
42,166

Property and equipment, net
58,562

 
61,070

Goodwill
98,238

 
98,238

Intangible assets, net
2,891

 
4,068

Other assets
3,704

 
3,680

Total assets
$
206,095

 
$
209,222

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
3,955

 
$
4,749

Accrued expenses and other current liabilities
20,434

 
14,442

Taxes payable
6,009

 
7,413

Deferred revenues
9,574

 
10,100

Current portion of capital lease obligations
244

 
676

Total current liabilities
40,216

 
37,380

101/2% Senior secured notes
150,000

 
150,000

Deferred rent payable
4,844

 
4,879

Deferred revenues
1,014

 
1,103

Capital lease obligations, net of current portion
276

 
276

Deferred income taxes payable
7,644

 
6,917

Other
455

 
455

Total liabilities
204,449

 
201,010

Stockholders’ equity:
 
 
 
Common stock - $.01 par value; authorized 19,000,000 shares, issued and outstanding 9,999,945 shares
100

 
100

Preferred stock — $.01 par value; authorized 1,000,000 shares, issued and outstanding no shares
—

 
—

Additional paid-in capital
306,792

 
306,792

Accumulated deficit
(305,246
)
 
(298,680
)
Total stockholders’ equity
1,646

 
8,212

Total liabilities and stockholders’ equity
$
206,095

 
$
209,222

See notes to unaudited condensed consolidated financial statements.

5

Broadview Networks Holdings, Inc.
Unaudited Condensed Consolidated Statements of Operations
(dollars in thousands)

 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2014
 
2013
 
2014
 
2013
Revenues
$
73,720

 
$
78,589

 
$
227,742

 
$
239,850

Operating expenses:
 
 
 
 
 
 
 
Cost of revenues (exclusive of depreciation and amortization)
34,058

 
36,693

 
105,517

 
111,779

Selling, general and administrative
30,002

 
30,569

 
92,741

 
92,579

Depreciation and amortization
7,478

 
8,175

 
22,295

 
24,795

Total operating expenses
71,538

 
75,437

 
220,553

 
229,153

Income from operations
2,182

 
3,152

 
7,189

 
10,697

Reorganization items
—

 
(327
)
 
—

 
(1,072
)
Interest expense
(4,248
)
 
(3,945
)
 
(12,719
)
 
(12,913
)
Interest income
4

 
10

 
15

 
25

Loss before provision for income taxes
(2,062
)
 
(1,110
)
 
(5,515
)
 
(3,263
)
Provision for income taxes
(298
)
 
(295
)
 
(1,051
)
 
(1,026
)
Net loss
$
(2,360
)
 
$
(1,405
)
 
$
(6,566
)
 
$
(4,289
)

See notes to unaudited condensed consolidated financial statements.

6

Broadview Networks Holdings, Inc.
Unaudited Condensed Consolidated Statements of Cash Flows
(dollars in thousands)

 
Nine Months Ended
September 30,
 
2014
 
2013
Cash flows from operating activities
 
 
 
Net loss
$
(6,566
)
 
$
(4,289
)
Adjustments to reconcile net loss to net cash provided by operating activities:
 
 
 
Depreciation
21,118

 
23,150

Amortization of intangible assets
1,177

 
1,645

Provision for doubtful accounts
514

 
1,122

Deferred income taxes
727

 
727

Other
—

 
(339
)
Changes in operating assets and liabilities exclusive of assets and liabilities acquired:
 
 
 
Accounts receivable
666

 
3,004

Other current assets
(831
)
 
1,977

Other assets
(24
)
 
101

Accounts payable
(794
)
 
575

Accrued expenses, other current liabilities and taxes payable
4,588

 
(3,351
)
Deferred revenues
(615
)
 
(613
)
Deferred rent payable
(35
)
 
(4
)
Net cash provided by operating activities
19,925

 
23,705

 
 
 
 
Cash flows from investing activities
 

 
 
Purchases of property and equipment
(18,610
)
 
(16,743
)
Cash paid to acquire the assets of Common Voices
—

 
(765
)
Other
548

 
(14
)
Net cash used in investing activities
(18,062
)
 
(17,522
)
 
 
 
 
Cash flows from financing activities
 
 
 
Proceeds from revolving credit facility
5,000

 
5,000

Repayments of revolving credit facility
(5,000
)
 
(5,000
)
Proceeds from capital lease financing
255

 
155

Payments on capital lease obligations
(687
)
 
(1,496
)
Net cash used in financing activities
(432
)
 
(1,341
)
 
 
 
 
Net increase in cash and cash equivalents
1,431

 
4,842

Cash and cash equivalents at beginning of period
8,143

 
9,736

Cash and cash equivalents at end of period
$
9,574

 
$
14,578


See notes to unaudited condensed consolidated financial statements.

7

Broadview Networks Holdings, Inc.
Notes to Unaudited Condensed Consolidated Financial Statements
(dollars in thousands)

1.
Organization and Description of Business
Broadview Networks Holdings, Inc. (the “Company”) is a leading cloud-based service provider of communications and information technology solutions to small and medium sized business and enterprise customers nationwide. After several years of development, the Company began providing cloud-based unified communication services in 2005 and later introduced into its product portfolio a variety of cloud-based computing solutions. Today, the Company offers a full suite of cloud-based systems and services under the brand OfficeSuite® to customers nationwide. The Company has one reportable segment.
The accompanying unaudited condensed consolidated financial statements have been prepared based upon Securities and Exchange Commission (“SEC”) rules that permit reduced disclosure for interim periods. These financial statements reflect all adjustments necessary for a fair presentation of the results of operations and financial condition for the interim periods shown, including normal recurring accruals and other items. The results for interim periods are not necessarily indicative of results for the full year. For a more complete discussion of significant accounting policies and certain other information, the Company’s interim unaudited financial statements should be read in conjunction with its audited financial statements as of and for the year ended December 31, 2013 contained in the Company’s Form 10-K filed with the SEC on March 31, 2014. The condensed consolidated interim financial statements include both the Company’s accounts and the accounts of its wholly-owned subsidiaries. All significant intercompany transactions have been eliminated in consolidation. The Company has evaluated the impact of subsequent events through the date the condensed consolidated financial statements were filed with the SEC.
The preparation of the 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 disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements and the reported amount of revenues and expenses during the reporting period. Management periodically reviews such estimates and assumptions as circumstances dictate. Actual results could differ from those estimates.
    
2.
Fair Value of Financial Instruments
The Company’s financial instruments include cash and cash equivalents, certificates of deposit, trade accounts receivable, accounts payable and long-term debt. The Company’s available cash balances are invested on a short-term basis (generally overnight) and, accordingly, are not subject to significant risks associated with changes in interest rates. All of the Company’s cash flows are derived from operations within the United States and are not subject to market risk associated with changes in foreign exchanges rates. The carrying amounts of the Company’s cash and cash equivalents, certificates of deposit, trade accounts receivable and accounts payable reported in the consolidated balance sheets as of September 30, 2014 and December 31, 2013 are deemed to approximate fair value because of their liquidity and short-term nature.
The fair value of the Company’s 10.5% Senior Secured Notes due 2017 (the “Notes”) was $145,575 and $146,588 at September 30, 2014 and December 31, 2013, respectively, which was based on the most recent publicly quoted prices of the Notes as of such dates. These are considered to be Level 1 inputs.    



8
Broadview Networks Holdings, Inc.
Notes to Unaudited Condensed Consolidated Financial Statements (continued)
(dollars in thousands)



3. Recent Accounting Pronouncements
In May 2014, a comprehensive update on the accounting standard for revenue recognition was issued. This update affects any entity that enters into contracts with customers to transfer goods or services. Under this new guidance, an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. This update is effective for annual periods beginning on or after December 15, 2016. Early adoption is not permitted. The Company is currently evaluating the potential impact of adopting this standard and cannot yet determine the impact of its adoption on its operating results and financial position. Nor has the Company determined its method of adoption, either full retrospective approach or the modified retrospective approach.
In August 2014, the accounting standard which provides guidance on determining when and how to disclose going-concern uncertainties in the financial statements was updated. The new standard requires management to perform interim and annual assessments of an entity’s ability to continue as a going concern within one year of the date the financial statements are issued. An entity must provide certain disclosures if conditions or events raise substantial doubt about the entity’s ability to continue as a going concern. The update applies to all entities and is effective for annual periods ending after December 15, 2016. Early adoption is permitted. The adoption of this standard is not expected to have any impact on the Company’s operating results and financial position.

4.
Commitments and Contingencies
The Company has employment agreements with certain key executives as of September 30, 2014. These agreements provide for base salaries and performance bonuses over periods ranging from one to two years. These employment agreements also provide for severance compensation ranging from 6 to 24 months after termination.
The Company has standby letters of credit outstanding of $1,110, which are fully collateralized by domestic certificates of deposit.
The Company has, in the ordinary course of its business, engaged in certain billing disputes with carriers and has recorded the estimated settlement amount of the disputed balances. The settlement estimate is based on various factors, including historical results of prior dispute settlements. The amount of such charges in dispute at September 30, 2014 was $7,335. The Company believes that the ultimate settlement of these disputes will be at amounts less than the amount disputed and has accrued the estimated settlement in accrued expenses and other current liabilities at September 30, 2014. It is possible that actual settlements of such disputes may differ from these estimates and the Company may settle at amounts greater than the estimates.
The Company has entered into a commercial agreement with its principal vendor under which it purchases certain services that it had previously leased under the unbundled network platform provisions of the Telecommunications Act of 1996. During 2013, the Company entered into an extension of this commercial agreement which expires in 2016. The Company has also entered into multiple tariffed agreements with its principal vendor under which it purchases special access services. As these tariffed agreements are set to expire at the end of this year, the Company is in the process of negotiating extensions for these agreements.  The Company does not expect the extensions to materially impact our future financial condition, results of operations, or cash flows.
The Company is, in the ordinary course of business, under audit with several state and local taxing authorities. Any estimated liabilities are included in taxes payable at September 30, 2014. It is possible that actual settlements may differ from these estimates and the Company may settle at amounts greater than the estimates. The Company does not believe that the ultimate outcome of any such audits will result in any liability that would have a material adverse effect on its financial condition, results of operations or cash flows.


9
Broadview Networks Holdings, Inc.
Notes to Unaudited Condensed Consolidated Financial Statements (continued)
(dollars in thousands)


5.
Debt
    The $150,000 Notes due 2017 that were issued in connection with the 2012 restructuring are fully, unconditionally and irrevocably guaranteed on a senior secured basis, jointly and severally, by each of the Company’s existing and future domestic restricted subsidiaries. The Notes and the guarantees rank senior in right of payment to all existing and future subordinated indebtedness of the Company and its subsidiary guarantors, as applicable, and equal in right of payment with all existing and future senior indebtedness of the Company and of such subsidiaries.
The Notes and the guarantees are secured by a lien on substantially all of the Company’s assets provided, however, that pursuant to the terms of the intercreditor agreement, the security interest in those assets consisting of receivables, inventory, deposit accounts, securities accounts and certain other assets that secure the Notes and the guarantees are contractually subordinated to a lien thereon that secures the Company’s revolving credit facility with an aggregate principal amount of $25,000 and certain other permitted indebtedness. There were no outstanding borrowings under this credit facility at September 30, 2014.


6.
Income Taxes
At September 30, 2014, the Company had net operating loss carryforwards (“NOLs”) available totaling approximately $174,884 which begin to expire in 2019. The Company has provided a full valuation allowance against its net deferred tax assets, of which the NOLs are the primary component, because management does not believe it is more likely than not that this asset will be realized. If the Company achieves profitability, the net deferred tax assets may be available to offset future income tax liabilities.


10

Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the Unaudited Condensed Consolidated Financial Statements and Notes to the Unaudited Condensed Consolidated Financial Statements included elsewhere in this quarterly report and our Form 10-K for the year ended December 31, 2013 filed with the Securities and Exchange Commission (the “SEC”). Certain information contained in the discussion and analysis set forth below and elsewhere in this quarterly report, including information with respect to our plans and strategies for our business and related financing, includes forward-looking statements that involve risk and uncertainties. In evaluating such statements, existing and prospective investors should specifically consider the various factors identified in this quarterly report that could cause results to differ materially from those expressed in such forward-looking statements, including matters set forth in our Form 10-K for the year ended December 31, 2013 filed with the SEC. Many of the amounts and percentages presented in this discussion and analysis have been rounded for convenience of presentation, and all amounts included in tables are presented in thousands.

Overview
    
We are a leading cloud-based service provider of communications and information technology solutions to small and medium sized businesses (“SMB”) and enterprise customers nationwide. After several years of development, we began providing cloud-based unified communication services (“UCaaS”) in 2005 and later introduced into our product portfolio a variety of cloud-based computing solutions. Today, we offer a full suite of cloud-based systems and services under the brand OfficeSuite® to customers nationwide and have more than 100,000 active licenses on our flagship product OfficeSuite® Phone and additional licenses for services delivered through third-party service providers utilizing our proprietary software and technology. OfficeSuite® Phone comprises a growing percentage of our overall recurring revenue and the vast majority of our existing cloud-based revenue stream.
We benefit from software development expertise, proprietary technology and a strong next-generation network infrastructure. This allows us to offer our customers more than just cloud-based services, but additionally products that include advanced, converged communications services and network access by leveraging our network infrastructure, on a cost-effective basis. We have provided cloud-based services in the Northeast and Mid-Atlantic United States since 2005 and offered cloud-based services nationwide since late 2009. Prior to 2009, our focus had been solely on markets across 10 states, including the major metropolitan markets of New York, Boston, Philadelphia, Baltimore and Washington, D.C. These markets remain important markets for us and we have the majority of our direct sales efforts focused on these markets. We distribute our products through quota-bearing sales representatives, including a direct sales force primarily based in the Northeast and Mid-Atlantic United States, sales agents nationwide, and by our expanded efforts in wholesale, web marketing, Value Added Resellers ("VAR's") and nationwide distributor channels.
As of September 30, 2014, we provided our services to approximately 25,000 business customers nationwide. For the nine months ended September 30, 2014, approximately 88% of our total revenue was generated from retail end users in a wide array of industries, including professional services, health care, education, manufacturing, real estate, retail, automotive, non-profit groups and others. For the same period, approximately 12% of our total revenue was generated from wholesale, carrier access and other market channels. For the nine months ended September 30, 2014, we generated revenues of $227.7 million and Adjusted EBITDA of $30.0 million. For more information, see the “Adjusted EBITDA Presentation” later in this section.
    
For the nine months ended September 30, 2014, and the years ended December 31, 2013 and 2012, we recorded operating income of $7.2 million, $11.0 million and $9.5 million, respectively. For the nine months ended September 30, 2014, and the years ended December 31, 2013 and 2012, we recorded net losses of $6.6 million, $8.5 million and $35.3 million, respectively. Although we expect to have net losses for the foreseeable future, we continue to search for ways of increasing operating efficiencies that could potentially offset continued pressures on revenue and margin. We have also developed new technology and products that are growing rapidly that are being sold through new and existing sales channels.
Our business is subject to several macro trends, some of which negatively affect our operating performance. Among these negative trends are lower wireline voice usage per customer, which translates into less usage-based revenue and lower unit pricing for certain services. In addition, we continue to face other industry-wide trends including rapid technology changes and overall increases in competition from existing large competitors such as Verizon Communications, Inc. (“Verizon”) and established cable operators, competitive local exchange carriers and newer entrants such as cloud, wireless and other service providers. These factors are partially mitigated by several positive factors.  These include a more stable customer base, increasing revenue per customer due to the trend of customers buying more products from us as we deploy new technology and expand our offerings, higher contribution margins for our cloud services, a focus on larger customers and an overall increase in demand for data, managed and cloud-based services.  Although our overall revenue has declined, we have partially mitigated the impact of the revenue decline on our overall operating results by various price increases, revenue assurance efforts, reducing costs of revenue and certain of our

11

selling, general and administrative (“SG&A”) costs, by the achievement of certain operating efficiencies throughout the organization and the reduced interest on the Notes.
As of September 30, 2014, we had approximately 200 sales, sales management and sales support employees, including approximately 150 quota-bearing representatives in all sales channels, the majority of whom target SMB and enterprise customers in the Northeast and Mid-Atlantic regions. We also offer our OfficeSuite® cloud-based solutions, including our OfficeSuite® Phone product, on a nationwide basis, where we sell through our agents, VARs/nationwide distributors/strategic partners and web channels.
We focus our sales efforts on selling cloud-based services to communications intensive multi-location business customers who purchase multiple products. These customers generally purchase higher margin services in multi-year contracts, and consequently maintain higher retention rates. Historically, our focus was on providing T-1- and IP-based products as well as our cloud-based services.
For the nine months ended September 30, 2014, revenue from customers purchasing T-1- and IP-based products and cloud-based services represented 80% of our retail revenue with the remaining 20% of retail revenue coming from customers purchasing only traditional services. Of the 80% of retail revenue from customers purchasing T-1- and IP-based products and cloud-based services, 24% of retail revenue was generated by cloud-based services, 41% of retail revenue was generated by other T-1- and IP-based products, and 15% of retail revenue was generated by traditional voice services provided to those customers purchasing T-1- and IP-based products and cloud-based services. For the same period, T-1- and IP-based products and cloud-based services represented approximately 85% of new retail sales, with typical incremental gross profit margins in excess of 60%. Cloud-based services, including cloud-based computing services, represented approximately 49% of new retail sales while other T-1- and IP-based products represented 36% of new retail sales. Since 2010, cloud-based products and services have grown at an 18% compounded annual growth rate (“CAGR”).
Our facilities-based network encompasses approximately 3,000 route miles of metro and long-haul fiber and approximately 260 colocations. Our network architecture pairs the strength of a traditional infrastructure with IP and Multiprotocol Label Switching (“MPLS”) platforms. These platforms, in conjunction with our software development expertise and proprietary technology, allow us to offer a product line that includes advanced, converged services, such as our cloud-based solutions, virtual private networks and complex multi-location services, on a cost effective basis. Our network topology incorporates metro Ethernet over Copper access technology, enabling us to provide multi-megabit data services through copper loops to customers from selected major metropolitan colocations, resulting in lower costs and higher margins. In addition, we are able to deliver our cloud-based communications services nationwide utilizing partner carriers for last-mile access and via customer provided access, (i.e. bring your own broadband). A significant portion of our customer base has been migrated to our IP- and MPLS-based infrastructure, which enhances the performance of our network. As of September 30, 2014, approximately 77% of our total installed lines were provisioned on-net.
Following the restructuring of our balance sheet in the third quarter of 2012, we began making incremental investments in various organic revenue growth initiatives, including enhancements to our direct sales force and channel partners programs, marketing support, product development and software development for our hosted VoIP product offering. The total cost of these initiatives is substantial, representing several million dollars of incremental spending. These investments are likely to continue as we maintain our focus on potential growth initiatives.
After several quarters of revenue and EBITDA declines, we believe that these initiatives have begun to have a positive impact on our operations. Although the first and second quarters of 2014 showed relatively flat revenue and EBITDA compared to the last two quarters of 2013, we had anticipated some volatility in our results as we transition from declining to increasing revenue and EBITDA. This is due to several factors, including our continuing investment in growth initiatives and the occurrence of certain non-recurring items that affect our results. While the current quarter experienced a decline in revenue and a modest decline in EBITDA, we continue to experience improving levels of new sales, customer activations and a growing backlog of revenue pending activation. Based on these and other operating metrics, we believe that we are entering a period of relative revenue and EBITDA stability, although during this transition period we do expect some modest volatility in our results. 



12

Results of Operations
The following table sets forth, for the periods indicated, certain financial data as a percentage of total revenues.
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2014
 
2013
 
2014
 
2013
Revenues:
 
 
 
 
 
 
 
Voice and data services:
 
 
 
 
 
 
 
     Cloud
21.6
 %
 
18.7
 %
 
20.5
 %
 
17.9
 %
     NonCloud
63.8
 %
 
67.5
 %
 
64.7
 %
 
68.8
 %
     Ancillary
2.7
 %
 
2.7
 %
 
2.7
 %
 
2.5
 %
Voice and data services
88.1
 %
 
88.9
 %
 
87.9
 %
 
89.2
 %
Wholesale
8.6
 %
 
7.4
 %
 
8.4
 %
 
7.2
 %
Access
2.0
 %
 
2.0
 %
 
2.3
 %
 
2.2
 %
Total network services
98.7
 %
 
98.3
 %
 
98.6
 %
 
98.6
 %
Other
1.3
 %
 
1.7
 %
 
1.4
 %
 
1.4
 %
Total revenues
100.0
 %
 
100.0
 %
 
100.0
 %
 
100.0
 %
Operating expenses:
 
 
 
 
 
 
 
Network services
45.9
 %
 
46.1
 %
 
45.9
 %
 
46.2
 %
Other cost of revenues
0.3
 %
 
0.6
 %
 
0.4
 %
 
0.4
 %
Selling, general and administrative
40.7
 %
 
38.9
 %
 
40.7
 %
 
38.6
 %
Depreciation and amortization
10.1
 %
 
10.4
 %
 
9.8
 %
 
10.3
 %
Total operating expenses
97.0
 %
 
96.0
 %
 
96.8
 %
 
95.5
 %
 
 
 
 
 
 
 
 
Income from operations
3.0
 %
 
4.0
 %
 
3.2
 %
 
4.5
 %
Reorganization items
—
 %
 
(0.4
)%
 
—
 %
 
(0.4
)%
Interest expense, net of interest income
(5.8
)%
 
(5.0
)%
 
(5.6
)%
 
(5.5
)%
Loss before provision for income taxes
(2.8
)%
 
(1.4
)%
 
(2.4
)%
 
(1.4
)%
Provision for income taxes
(0.4
)%
 
(0.4
)%
 
(0.5
)%
 
(0.4
)%
 
 
 
 
 
 
 
 
Net loss
(3.2
)%
 
(1.8
)%
 
(2.9
)%
 
(1.8
)%

Key Components of Results of Operations
Revenues
    
Our revenues, as detailed in the table above, consist primarily of network services revenues, which consist primarily of voice and data managed and cloud-based services, wholesale services and access services. Voice and data services consist of local dial tone, long distance and data services, as well as managed and cloud-based services. Wholesale services consist of voice and data services, cloud-based services, and transport services provided to other carriers, as well as data colocation services provided to end users and other carriers. Similar to our retail revenue, greater than 20% of our wholesale revenue stream consists of cloud-based services. Carrier access services include carrier access and reciprocal compensation revenue, which consists primarily of usage charges that we bill to other carriers to originate and terminate their calls from and to our customers. Network services revenues represents a predominantly recurring revenue stream linked to our retail and wholesale customers.
For the nine months ended September 30, 2014 approximately 88% of our total revenue was generated from retail customer voice and data products and services. Revenue from data and integrated voice/data products, including cloud-based services and T-1/T-3 and other managed services has been trending to an increasing percentage of our overall revenue over the past several years, while voice revenues have been declining primarily due to the decline in revenue from traditional voice services, or Plain Old Telephone Services (“POTS”). In recent quarters, we have experienced a reduction in the quarterly rate of decline of our POTS revenues. Since June 30, 2010, our average quarterly rate of decline has been 3.3% as compared to the 5.7% average quarterly rate of decline experienced during the periods from April 1, 2009 to June 30, 2010, when the combined effects of the recession and our shift in product focus most impacted our results. Our cloud-based revenues have grown from 2010 to 2014 at an 18% CAGR. As a result, the average quarterly decline in our core voice and data revenue, which excludes certain ancillary voice and data revenue components, has improved since 2009, with an average quarterly decrease of $1.2 million in the four quarters ended September 30, 2014 as compared to a peak sequential decrease of $4.7 million in the quarter ended June 30, 2009. Our cloud-

13

based products and services comprised approximately 24% of our retail revenue and approximately 49% of new retail sales in the nine months ended September 30, 2014. We continue to focus on cloud-based, data and managed services as growth opportunities as we expect the industry to trend toward lower usage components of legacy products such as long distance and local usage. This lower usage is primarily driven by trends toward customers using more online and wireless communications and bundling of minutes of use in product offerings.
Cost of Revenues (exclusive of depreciation and amortization)
Our network services cost of revenues consists primarily of both the cost of operating our network facilities and the costs related to our off-net customers. Determining our cost of revenues requires numerous estimates. The network components for our facilities-based business include the cost of:
•
leasing local loops and digital T-1 lines which connect our customers to our network;
•
leasing high capacity digital lines that connect our switching equipment to our colocations;
•
leasing high capacity digital lines and related trunking that interconnect our network with the Incumbent Local Exchange Carriers (“ILECs”) and other carrier partners;
•
leasing space, power and terminal connections in the ILEC central offices for colocating our equipment;
•
signaling system network connectivity;
•
leasing space and purchasing power to support our various switch site locations; and
•
Internet transit and peering, which is the cost of delivering Internet traffic from our customers to the public Internet.
The costs to obtain local loops, digital lines and high capacity digital interoffice transport facilities from the ILECs vary by carrier and state, are governed by our various ILEC interconnection agreements and other ILEC contracts and tariffs and are regulated under federal and state laws. Within our footprint we often obtain local loops, T-1 lines and interoffice transport capacity from the ILECs. We also obtain interoffice facilities from carriers other than the ILECs, where possible, in order to lower costs and improve network redundancy; however, in many cases, the ILECs are our only source for local loops and T-1 lines. We have entered into agreements with cable providers as another alternative for local loops.
Our off-net network services cost of revenues consists of amounts we pay to Verizon, Fairpoint Communications, Inc. (“Fairpoint”) and AT&T, Inc. (“AT&T”) pursuant to our commercial agreements with them. Rates for such services are prescribed in the commercial agreements and available for the term of the agreements. The FairPoint commercial agreement operates on a month-to-month basis. During 2013, we entered into an extension of our Verizon commercial agreement, which expires in 2016.  We have also entered into multiple tariffed agreements with Verizon under which we purchase special access services. These tariffed agreements expire at the end of the year.  The AT&T commercial agreement is being bifurcated into two separate agreements. One of the agreements, which covers the Connecticut territory, has been extended and now expires in October 2017. We are currently negotiating an extension for the second agreement, which covers the remainder of the AT&T territory and is set to expire in December 2014. We do not expect the extension to materially impact our future financial condition, results of operations, or cash flows.
Our network services cost of revenues also include the fees we pay for long distance, data and other services. We have entered into long-term wholesale purchasing agreements for these services. Some of these agreements contain significant termination penalties and/or minimum volume commitments.

14

Gross Profit (exclusive of depreciation and amortization)
Gross profit (exclusive of depreciation and amortization), referred to herein as “gross profit”, as presented in this Management’s Discussion and Analysis of Financial Condition and Results of Operations, represents income from operations, before depreciation and amortization and SG&A. Gross profit is a non-GAAP financial measure used by our management, together with financial measures prepared in accordance with GAAP such as revenue, cost of revenue, and income from operations to assess our historical and prospective operating performance.
The following table sets forth, for the periods indicated, a reconciliation of gross profit to income from operations as income from operations is calculated in accordance with GAAP:

 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2014

 
2013

 
2014

 
2013

Income from operations
$
2,182

 
$
3,152

 
$
7,189

 
$
10,697

Depreciation and amortization
7,478

 
8,175

 
22,295

 
24,795

Selling, general and administrative
30,002

 
30,569

 
92,741

 
92,579

Gross profit
$
39,662

 
$
41,896

 
$
122,225

 
$
128,071

Percentage of total revenue
53.8
%
 
53.3
%
 
53.7
%
 
53.4
%
Gross profit is not a financial measurement prepared in accordance with GAAP. See “Management's Discussion and Analysis of Financial Condition and Results of Operations — Key Components of Result of Operations — Gross Profit (exclusive of depreciation and amortization)” in our Form 10-K for the year ended December 31, 2013 for our reasons for including gross profit data in this quarterly report and for material limitations with respect to the usefulness of this measurement.
Selling, General and Administrative
SG&A is comprised primarily of salaries and related expenses, software development expenses, occupancy costs, sales and marketing expenses, commission expenses, bad debt expense, billing expenses, professional services expenses, and insurance expenses.
Determining our allowance for doubtful accounts receivable requires significant estimates. In determining the proper level for the allowance we consider factors such as historical collections experience, the aging of the accounts receivable portfolio and economic conditions. We perform a credit review process on each new significant customer that involves reviewing the customer’s current service provider bill and payment history, matching customers with national databases for delinquent customers and, in some cases, requesting credit reviews through Dun & Bradstreet Corporation.
    
During the latter part of 2012, and continuing at an increasing level throughout 2013 and 2014, we launched several new initiatives directed at supporting our revenue growth initiatives.  These included recruiting expenses for new sales personnel, new quota bearing sales personnel and sales management, purchasing lead generation data bases, increasing support for channel sales, increasing software and systems development teams for OfficeSuite® and costs associated with a new sales and customer relationship management software package implementation.
Depreciation and Amortization
Our depreciation and amortization expense currently includes depreciation for network related voice and data equipment, fiber, back-office systems, third party conversion costs, furniture, fixtures, leasehold improvements, office equipment and computers and amortization of intangibles associated with mergers, acquisitions and software development costs.
Reorganization Items
Our expenses that resulted from the Chapter 11 reorganization activities were reported as reorganization items in our consolidated statements of operations. Our reorganization expenses consisted entirely of professional fees associated with the Restructuring, including the preparation of the Registration Statement and subsequent amendments on Form S-1 filed with the SEC in 2013.

15

Adjusted EBITDA Presentation
Adjusted EBITDA as presented in this Management’s Discussion and Analysis of Financial Condition and Results of Operations represents net loss before depreciation and amortization, interest income and expense, provision for income taxes, and other non-operational items described in the table below that are not part of our core operations. Adjusted EBITDA is not a measure of financial performance under GAAP. Adjusted EBITDA is a non-GAAP financial measure used by our management, together with financial measures prepared in accordance with GAAP such as net loss, income from operations and revenues, to assess our historical and prospective operating performance.
The following table sets forth, for the periods indicated, a reconciliation of adjusted EBITDA to net loss as net loss is calculated in accordance with GAAP:
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2014
 
2013
 
2014
 
2013
Net loss
$
(2,360
)
 
$
(1,405
)
 
$
(6,566
)
 
$
(4,289
)
Add back non-EBITDA items included in net loss:
 
 
 
 
 
 
 
Depreciation and amortization
7,478

 
8,175

 
22,295

 
24,795

Interest expense, net of interest income
4,244

 
3,935

 
12,704

 
12,888

  Provision for income taxes
298

 
295

 
1,051

 
1,026

 
 
 
 
 
 
 
 
EBITDA
9,660

 
11,000

 
29,484

 
34,420

Severance and related separation costs
—

 
—

 
562

 
241

Reorganization items
—

 
327

 
—

 
1,072

Adjusted EBITDA
$
9,660

 
$
11,327

 
$
30,046

 
$
35,733

Percentage of total revenues
13.1
%
 
14.4
%
 
13.2
%
 
14.9
%
    
For more information regarding Adjusted EBITDA data, and for material limitations with respect to the usefulness of this measurement, see the section of the form 10-K for the year ended December 31, 2013 entitled “Management's Discussion and Analysis of Financial Condition and Results of Operations — Key Components of Results of Operations — Adjusted EBITDA Presentation”.

16

Three Months Ended September 30, 2014 Compared to Three Months Ended September 30, 2013
Set forth below is a discussion and analysis of our results of operations for the three months ended September 30, 2014 and 2013.
The following table provides a breakdown of components of our gross profit for the three months ended September 30, 2014 and 2013:
 
Three Months Ended September 30,
 
 
 
2014
 
2013
 
 
 
Amount
 
% of Total
Revenues
 
Amount
 
% of Total
Revenues
 
% Change
Revenues:
 
 
 
 
 
 
 
 
 
Network services
$
72,767

 
98.7
%
 
$
77,279

 
98.3
%
 
(5.8
)%
Other
953

 
1.3
%
 
1,310

 
1.7
%
 
(27.3
)%
Total revenues
73,720

 
100.0
%
 
78,589

 
100.0
%
 
(6.2
)%
Cost of revenues:
 
 
 
 
 
 
 
 
 
Network services
33,825

 
45.9
%
 
36,258

 
46.1
%
 
(6.7
)%
Other
233

 
0.3
%
 
435

 
0.6
%
 
(46.4
)%
Total cost of revenues
34,058

 
46.2
%
 
36,693

 
46.7
%
 
(7.2
)%
Gross profit:
 
 
 
 
 
 
 
 
 
Network services
38,942

 
52.8
%
 
41,021

 
52.2
%
 
(5.1
)%
Other
720

 
1.0
%
 
875

 
1.1
%
 
(17.7
)%
Total gross profit
$
39,662

 
53.8
%
 
$
41,896

 
53.3
%
 
(5.3
)%

Revenues
Revenues for the three months ended September 30, 2014 and 2013 were as follows:
 
Three Months Ended September 30,
 
 
 
2014
 
2013
 
 
 
Amount
 
% of Total
Revenues
 
Amount
 
% of Total
Revenues
 
% Change
Revenues:
 
 
 
 
 
 
 
 
 
Voice and data services:
 
 
 
 
 
 
 
 
 
     Cloud
$
15,927

 
21.6
%
 
$
14,657

 
18.7
%
 
8.7
 %
     NonCloud
47,035

 
63.8
%
 
53,040

 
67.5
%
 
(11.3
)%
     Ancillary
1,988

 
2.7
%
 
2,137

 
2.7
%
 
(7.0
)%
Voice and data services
64,950

 
88.1
%
 
69,834

 
88.9
%
 
(7.0
)%
Wholesale
6,326

 
8.6
%
 
5,842

 
7.4
%
 
8.3
 %
Access
1,491

 
2.0
%
 
1,603

 
2.0
%
 
(7.0
)%
Total network services
72,767

 
98.7
%
 
77,279

 
98.3
%
 
(5.8
)%
Other
953

 
1.3
%
 
1,310

 
1.7
%
 
(27.3
)%
Total revenues
$
73,720

 
100.0
%
 
$
78,589

 
100.0
%
 
(6.2
)%

Revenues from voice and data services decreased $4.9 million or 7.0% between 2013 and 2014. Within voice and data services, revenues from cloud-based services increased $1.3 million, or 8.7%; revenues from core voice and data services, excluding cloud-based services decreased $6.0 million, or 11.3%; and ancillary voice and data revenues decreased $0.1 million.  The decrease in non-cloud core services was due to: i) line churn which exceeded line additions, ii) lower usage revenue per customer, iii) lower prices per unit for certain traditional services and iv) a lower number of lines and customers.  Wholesale revenues increased by $0.5 million or 8.3%. The increase is attributable to growth from new customers. Access revenues decreased by $0.1 million or 7.0% and other revenues decreased $0.4 million or 27.3% between 2013 and 2014.



17


Cost of Revenues (exclusive of depreciation and amortization)

Cost of revenues were $34.1 million for the three months ended September 30, 2014, a decrease of 7.2% from $36.7 million for the same period in 2013, primarily due to our overall decline in revenue. The decrease is also due to the identification and elimination of inefficiencies in our operating platforms and negotiations of lower costs from our vendors. As a percentage of revenues, cost of revenues decreased modestly to 46.2% in 2014 from 46.7% in 2013. Our costs consist primarily of those incurred from other providers and those incurred from the cost of our network. Costs where we purchased services or products from third party providers comprised $25.6 million or 75.3% of our total cost of revenues for the three months ended September 30, 2014 compared to $27.9 million, or 75.9%, for the three months ended September 30, 2013. The most significant components of our costs purchased from third party providers consist of costs related to our Verizon commercial contract, unbundled network element loop costs and T-1 costs, which totaled $5.0 million, $2.7 million and $9.3 million, respectively, for the three months ended September 30, 2014. Combined, these costs decreased by 10.1% between 2013 and 2014. These costs totaled $5.9 million, $3.5 million and $9.6 million, respectively, for the three months ended September 30, 2013.
Gross Profit (exclusive of depreciation and amortization)

Gross profit was $39.7 million for the three months ended September 30, 2014, a decrease of 5.3% from $41.9 million for the same period in 2013. The decrease in gross profit is primarily due to the decline in revenue. As a percentage of revenues, gross profit increased modestly to 53.8% in 2014 from 53.3% in 2013. We are focusing sales initiatives towards increasing the amount of cloud-based services and T-1-based services, as we believe that these initiatives will produce incrementally higher margins than those currently reported from traditional voice services. In addition, as we continue to drive additional cost saving initiatives, including provisioning customers to our on-net facilities, identifying additional inaccuracies in billing from existing carriers, renegotiating existing agreements and executing new agreements with additional vendors, we believe that our gross profit as a percentage of revenue will improve.

Selling, General and Administrative

SG&A expenses were $30.0 million, 40.7% of revenues, for the three months ended September 30, 2014, a decrease of 1.9% from $30.6 million, 38.9% of revenues, for the same period in 2013. This decrease is primarily due to the net result of a $1.0 million decrease in headcount related costs, offset by modest fluctuations of several other expenses.

We continue to look for additional cost savings in various categories including, but not limited to, headcount and professional services.
Depreciation and Amortization

Depreciation and amortization expense was $7.5 million for the three months ended September 30, 2014, a decrease of 8.5% from $8.2 million for the same period in 2013. This decrease in depreciation and amortization expense is primarily the result of property and equipment becoming fully depreciated during the latter part of 2013.
Interest

Interest expense was $4.2 million for the three months ended September 30, 2014, an increase of 7.7% from $3.9 million for the same period in 2013. This increase is primarily due to increases in interest expense associated with tax related liabilities, net of reduced capital lease obligations. Our effective annual interest rates for the three months ended September 30, 2014 and 2013 are as follows:
 
Three Months Ended
September 30,
 
2014
 
2013
Interest expense
$
4,248

 
$
3,945

Weighted average debt outstanding
$
150,557

 
$
151,817

Effective interest rate
11.29
%
 
10.39
%




18


Nine Months Ended September 30, 2014 Compared to Nine Months Ended September 30, 2013
Set forth below is a discussion and analysis of our results of operations for the nine months ended September 30, 2014 and 2013.
The following table provides a breakdown of components of our statements of operations for the nine months ended September 30, 2014 and 2013:

 
Nine Months Ended September 30,
 
 
 
2014
 
2013
 
 
 
Amount
 
% of Total
Revenues
 
Amount
 
% of Total
Revenues
 
% Change
Revenues:
 
 
 
 
 
 
 
 
 
Network services
$
224,616

 
98.6
%
 
$
236,399

 
98.6
%
 
(5.0
)%
Other
3,126

 
1.4
%
 
3,451

 
1.4
%
 
(9.4
)%
Total revenues
227,742

 
100.0
%
 
239,850

 
100.0
%
 
(5.0
)%
Cost of revenues:
 
 
 
 
 
 
 
 
 
Network services
104,602

 
45.9
%
 
110,851

 
46.2
%
 
(5.6
)%
Other
915

 
0.4
%
 
928

 
0.4
%
 
(1.4
)%
Total cost of revenues
105,517

 
46.3
%
 
111,779

 
46.6
%
 
(5.6
)%
Gross profit:
 
 
 
 
 
 
 
 
 
Network services
120,014

 
52.7
%
 
125,548

 
52.4
%
 
(4.4
)%
Other
2,211

 
1.0
%
 
2,523

 
1.0
%
 
(12.4
)%
Total gross profit
$
122,225

 
53.7
%
 
$
128,071

 
53.4
%
 
(4.6
)%

Revenues
Revenues for the nine months ended September 30, 2014 and 2013 were as follows:
 
Nine Months Ended September 30,
 
 
 
2014
 
2013
 
 
 
Amount
 
% of Total
Revenues
 
Amount
 
% of Total
Revenues
 
% Change
Revenues:
 
 
 
 
 
 
 
 
 
Voice and data services:
 
 
 
 
 
 
 
 
 
     Cloud
$
46,600

 
20.5
%
 
$
43,001

 
17.9
%
 
8.4
 %
     NonCloud
147,349

 
64.7
%
 
164,790

 
68.8
%
 
(10.6
)%
     Ancillary
6,234

 
2.7
%
 
6,218

 
2.5
%
 
0.3
 %
Voice and data services
200,183

 
87.9
%
 
214,009

 
89.2
%
 
(6.5
)%
Wholesale
19,133

 
8.4
%
 
17,104

 
7.2
%
 
11.9
 %
Access
5,300

 
2.3
%
 
5,286

 
2.2
%
 
0.3
 %
Total network services
224,616

 
98.6
%
 
236,399

 
98.6
%
 
(5.0
)%
Other
3,126

 
1.4
%
 
3,451

 
1.4
%
 
(9.4
)%
Total revenues
$
227,742

 
100.0
%
 
$
239,850

 
100.0
%
 
(5.0
)%

Revenues from voice and data services have decreased $13.8 million or 6.5% between 2013 and 2014. Within voice and data services, revenues from cloud-based services increased $3.6 million, or 8.4%; revenues from core voice and data services, excluding cloud-based services decreased $17.4 million, or 10.6%; and ancillary voice and data revenues were unchanged.  The decrease in non-cloud core services was due to: i) line churn which exceeded line additions, ii) lower usage revenue per customer, iii) lower prices per unit for certain traditional services and iv) a lower number of lines and customers. Wholesale revenues increased by $2.0 million or 11.9%. The increase is attributable to growth from new customers and included some non-recurring revenue. Carrier access revenues were unchanged. Other revenues decreased $0.3 million between 2013 and 2014.


19

Cost of Revenues (exclusive of depreciation and amortization)

Cost of revenues were $105.5 million for the nine months ended September 30, 2014, a decrease of 5.6% from $111.8 million for the same period in 2013 primarily due to our overall decline in revenue. The decrease is also due to the identification and elimination of certain inefficiencies in our operating platforms and negotiations of lower costs from our vendors. As a percentage of revenues, cost of revenues decreased to 46.3% in 2014 from 46.6% in 2013. Our costs consist primarily of those incurred from other providers and those incurred from the cost of our network. Costs where we purchased services or products from third party providers comprised $80.3 million, or 76.1%, of our total cost of revenues for the nine months ended September 30, 2014 and $84.8 million, or 75.9%, in the nine months ended September 30, 2013. The most significant components of our costs purchased from third party providers consist of costs related to our Verizon wholesale advantage contract, UNE-L costs and T-1 costs, which totaled $15.8 million, $8.4 million and $27.9 million, respectively, for the nine months ended September 30, 2014. Combined, these costs decreased by 10.9% between 2013 and 2014. These costs totaled $18.5 million, $10.7 million and $29.4 million, respectively, for the nine months ended September 30, 2013.
Gross Profit (exclusive of depreciation and amortization)

Gross profit was $122.2 million for the nine months ended September 30, 2014, a decrease of 4.6% from $128.1 million for the same period in 2013. The decrease in gross profit is primarily due to the decline in revenue. As a percentage of revenues, gross profit increased modestly to 53.7% in 2014 from 53.4% in 2013. We are focusing sales initiatives towards increasing the amount of cloud-based services and T-1-based services, as we believe that these initiatives will produce incrementally higher margins than those currently reported from traditional voice services. In addition, as we continue to drive additional cost saving initiatives, including provisioning customers to our on-net facilities, identifying additional inaccuracies in billing from existing carriers, renegotiating existing agreements and executing new agreements with additional vendors, we believe that our gross profit as a percentage of revenue will improve over time.

Selling, General and Administrative

SG&A expenses were $92.7 million, 40.7% of revenues, for the nine months ended September 30, 2014, an increase of 0.2% from $92.6 million, 38.6% of revenues, for the same period in 2013. This increase is primarily due to the net effect of modest fluctuations of several expenses.
Depreciation and Amortization
Depreciation and amortization costs were $22.3 million for the nine months ended September 30, 2014, a decrease of 10.1% from $24.8 million for the same period in 2013. This decrease in depreciation and amortization expense is primarily the result of property and equipment becoming fully depreciated during the latter part of 2013.
Interest
Interest expense was $12.7 million for the nine months ended September 30, 2014, a decrease of 1.5% from $12.9 million for the same period in 2013. This decrease is primarily the result of the reduced principal and related interest on our capital lease line. Our effective annual interest rates for the nine months ended September 30, 2014 and 2013 are as follows:

 
Nine Months Ended
September 30,
 
2014
 
2013
Interest expense
$
12,719

 
$
12,913

Weighted average debt outstanding
$
150,537

 
$
152,263

Effective interest rate
11.27
%
 
11.31
%




20

Off-Balance Sheet Arrangements
We have no special purpose or limited purpose entities that provide off-balance sheet financing, liquidity, or market or credit risk support, and we do not currently engage in hedging, research and development services, or other relationships that expose us to any liabilities that are not reflected on the face of our financial statements.


Liquidity and Capital Resources
Our principal sources of liquidity are cash from operations, cash and cash equivalents on hand and a revolving credit facility. Our revolving credit facility has a current maximum availability of $25.0 million subject to certain borrowing base limitations. This facility was undrawn as of September 30, 2014. In addition to our normal operating requirements, our short-term liquidity needs consist of interest on the Notes, capital expenditures and working capital. Our cash and cash equivalents are being held in several large financial institutions, although most of our balances exceed the Federal Deposit Insurance Corporation insurance limits.
As of September 30, 2014, we will require approximately $55.1 million in cash to service the interest due on the Notes throughout the remaining life of the Notes. For the nine months ended September 30, 2014, the Company incurred capital expenditures of $18.6 million. Fixed and success-based capital expenditures will continue to be a significant use of liquidity and capital resources. A majority of our planned capital expenditures are “success-based” expenditures, meaning that they are directly linked to new revenue.
Disputes
We continue to be involved in a variety of disputes with multiple carrier vendors relating to billings of approximately $7.3 million as of  September 30, 2014. While we hope to resolve these disputes through negotiation, we may be compelled to arbitrate these matters. We believe we have accrued an amount appropriate to settle all outstanding disputed charges. However, it is possible that the actual settlement of any outstanding disputes may differ from our reserves and that we may settle at amounts greater than the estimates. We believe we will have sufficient cash on hand to fund any differences between our expected and actual settlement amounts. In the event that disputes are not resolved in our favor and we are unable to pay the vendor charges in a timely manner, the vendor may deny us access to the network facilities that we require to serve our customers. If the vendor notifies us of an impending “embargo” of this nature, we may be required to notify our customers of a potential loss of service, which may cause a substantial loss of customers. It is not possible at this time to predict the outcome of these disputes.
Nine Months Ended September 30, 2014 Compared to Nine Months Ended September 30, 2013
Cash Flows from Operating Activities
Cash provided by operating activities was $19.9 million for the nine months ended September 30, 2014, compared to $23.7 million for the same period in 2013. This decrease in cash flow from operating activities is primarily due to the timing of ordinary business operating activities.
Cash Flows from Investing Activities
Cash used in investing activities was $18.1 million for the nine months ended September 30, 2014, compared to $17.5 million for the same period in 2013. The change in cash flow from investing activities was due to the net of: i) an increase in capital expenditures of $1.9 million, ii) the redemption of certificate of deposit for $0.6 million in 2014, and iii) cash paid of $0.8 million for the acquisition of Common Voices, Inc., in 2013.
Cash Flows from Financing Activities
Cash flows used in financing activities was $0.4 million for the nine months ended September 30, 2014, compared to $1.3 million for the same period in 2013. The change in cash flows from financing activities was due to the net of the repayments on our capital lease financings.



21

Application of Critical Accounting Policies and Estimates
The preparation of the consolidated financial statements in accordance with GAAP requires us to make judgments, estimates and assumptions regarding uncertainties that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities and the reported amounts of revenues and expenses. We use historical experience and all available information to make these judgments and estimates and actual results could differ from those estimates and assumptions that are used to prepare our financial statements at any given time. Despite these inherent limitations, management believes that Management’s Discussion and Analysis of Financial Condition and Results of Operations and the accompanying Unaudited Condensed Consolidated Financial Statements and Notes to Unaudited Condensed Consolidated Financial Statements provide a meaningful and fair perspective of our financial condition and our operating results.
We consider an accounting estimate to be critical if it requires assumptions to be made that were uncertain at the time the estimate was made and changes in the estimate or different estimates that could have been selected could have a material impact on our consolidated results of operations or financial condition.
For more information, see the section of our Form 10-K for the year ended December 31, 2013 entitled “Management's Discussion and Analysis of Financial Condition and Results of Operations — Application of Critical Accounting Policies and Estimates”.

Other Matters
At September 30, 2014, we had NOLs available totaling approximately $174.9 million, which begin to expire in 2019. As of September 30, 2014, we have provided a full valuation allowance against the net deferred tax asset, of which the NOLs are the primary component, because we do not believe it is more likely than not that this asset will be realized. If we achieve profitability, the net deferred tax assets may be available to offset future income tax liabilities.


22

Item 3.
Quantitative and Qualitative Disclosures About Market Risk
In the normal course of business, our financial position is subject to a variety of risks, such as the collectability of our accounts receivable and the recoverability of the carrying values of our long-term assets. Our debt obligations consist primarily of the Notes with a fixed interest rate. We are not exposed to market risks from changes in foreign currency exchange rates or commodity prices. We do not hold any derivative financial instruments nor do we hold any securities for trading or speculative purposes.
We continually monitor the collectability of our accounts receivable and have not noted any significant changes in our collections as a result of current economic and market conditions. We believe that our allowance for doubtful accounts is adequate as of September 30, 2014. Should the market conditions worsen or should our customers’ ability to pay decrease, we may be required to increase our allowance for doubtful accounts, which would result in a charge to our SG&A expenses.
Our available cash balances are invested on a short-term basis (generally overnight) and, accordingly, are not subject to significant risks associated with changes in interest rates. Substantially all of our cash flows are derived from our operations within the United States and we are not subject to market risk associated with changes in foreign exchange rates.
The fair value of the Notes at September 30, 2014, was approximately $145.6 million and was based on publicly quoted market prices. The Notes, like all fixed rate securities, are subject to interest rate risk and will fall in value if market interest rates increase.

Item 4.
Controls and Procedures
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports filed under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow for timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.
As of the end of the period covered by this report, our management carried out an evaluation, under the supervision and with the participation of our Chief Executive Officer and our Chief Financial Officer, of the effectiveness of our disclosure controls and procedures pursuant to Exchange Act Rules 13a-15 and 15d-15. Based on the foregoing, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of September 30, 2014. For information regarding the Company's annual assessment of the effectiveness of internal control over financial reporting, see our Form 10-K for the year ended December 31, 2013.
Changes in Internal Control Over Financial Reporting
There have been no changes in our internal control over financial reporting during the quarter ended September 30, 2014 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.



23

PART II — OTHER INFORMATION

Item 1.
Legal Proceedings
We are not currently a party to any material legal action. We are, however, party to certain legal actions arising in the ordinary course of business. We are also involved in certain billing and contractual disputes with our vendors. We do not believe that the ultimate outcome of any of the foregoing actions will result in any liability that would have a material adverse effect on our financial condition, results of operations or cash flows.
For more information, see the section entitled “Management's Discussion and Analysis of Financial Condition and Results of Operations” and our Form 10-K for the year ended December 31, 2013.

Item 1A.
Risk Factors
There have been no material changes in our risk factors from those set forth in our Form 10-K for the year ended December 31, 2013, which should be read in conjunction with this report.
These risks are not the only risks that we face.  Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition or results of operations.

Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
None.

Item 3.
Defaults Upon Senior Securities
None.

Item 4.
Mine Safety Disclosures
Not Applicable.

Item 5.
Other Information
None.


24

Item 6.
Exhibits
The following exhibits are filed herewith:

Exhibit
No.
 
Description
31.1
 
Certification of the Company’s Chief Executive Officer pursuant to Exchange Act Rules 13a-14(a)/15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
 
 
31.2
 
Certification of the Company’s Chief Financial Officer pursuant to Exchange Act Rules 13a-14(a)/15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
 
 
32.1
 
Certification of the Company’s Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
 
 
32.2
 
Certification of the Company’s Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
 
 
101.INS
 
XBRL INSTANCE DOCUMENT
 
 
 
101.SCH
 
SCHEMA DOCUMENT
 
 
 
101.CAL
 
CALCULATION LINKBASE DOCUMENT
 
 
 
101.LAB
 
LABELS LINKBASE DOCUMENT
 
 
 
101.PRE
 
PRESENTATION LINKBASE DOCUMENT
 
 
 
101.DEF
 
DEFINITION LINKBASE DOCUMENT

25

SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on November 5, 2014.

 
BROADVIEW NETWORKS HOLDINGS, INC. 
 
 
 
 
 
 
By:  
/s/ Michael K. Robinson  
 
 
 
Name:  
Michael K. Robinson 
 
 
 
Title:  
Chief Executive Officer, President and Director 
 
 
 
 
 
 
 
By:  
/s/ Corey Rinker  
 
 
 
Name:  
Corey Rinker 
 
 
 
Title:  
Chief Financial Officer, Executive Vice President, Treasurer and
Assistant Secretary 
 

26

EXHIBIT INDEX

Exhibit
No.
 
Description
31.1
 
Certification of the Company’s Chief Executive Officer pursuant to Exchange Act Rules 13a-14(a)/15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
 
 
31.2
 
Certification of the Company’s Chief Financial Officer pursuant to Exchange Act Rules 13a-14(a)/15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
 
 
32.1
 
Certification of the Company’s Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
 
 
32.2
 
Certification of the Company’s Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
 
 
101.INS
 
XBRL INSTANCE DOCUMENT
 
 
 
101.SCH
 
SCHEMA DOCUMENT
 
 
 
101.CAL
 
CALCULATION LINKBASE DOCUMENT
 
 
 
101.LAB
 
LABELS LINKBASE DOCUMENT
 
 
 
101.PRE
 
PRESENTATION LINKBASE DOCUMENT
 
 
 
101.DEF
 
DEFINITION LINKBASE DOCUMENT

27

BROADVIEW NETWORKS HOLDINGS INC Reports