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EX-32.2 - EXHIBIT 32.2 - BROADVIEW NETWORKS HOLDINGS INCbnhex322-12312016.htm
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EX-31.2 - EXHIBIT 31.2 - BROADVIEW NETWORKS HOLDINGS INCbnhex312-12312016.htm
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EX-21.1 - EXHIBIT 21.1 - BROADVIEW NETWORKS HOLDINGS INCbnhex211subsidiariesofbroa.htm
EX-12.1 - EXHIBIT 12.1 - BROADVIEW NETWORKS HOLDINGS INCbnhex121ratioofearningstof.htm

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_______________________
Form 10-K
Mark One
x
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For The Fiscal Year Ended December 31, 2016
OR
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
(State or other jurisdiction of
incorporation or organization)
 
11-3310798
(I.R.S. Employer
Identification No.)
 
 
 
800 Westchester Avenue, Suite N501
Rye Brook, NY 10573
(Address of principal executive offices)
 
 
10573
(Zip Code)
(914) 922-7000
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
NONE
Securities registered pursuant to Section 12(g) of the Act:
NONE
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No þ
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes þ No ¨
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 ¨ No ¨
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 ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. þ
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 ¨
Accelerated filer ¨
Non-accelerated filer x
Smaller reporting company ¨
 
 
(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 Act). Yes ¨ No x
State the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant’s most recently completed second fiscal quarter.
Since no public equity market exists for such shares, the aggregate market value of the common stock held by non-affiliates of the Company is not determinable.
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 April 13, 2017
Common Stock, $.01 par value per share
 
9,993,120
DOCUMENTS INCORPORATED BY REFERENCE
NONE.





TABLE OF CONTENTS
 
Page
PART I
Item 4.  Mine Safety Disclosures
PART II
PART III
PART IV
In this report, references to “Broadview,” the “Company,” “we,” “us” and “our” refer to Broadview Networks Holdings, Inc. and its subsidiaries, unless the context indicates otherwise.



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 our continuing as a going concern and 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 ability to continue as a going concern;
highly competitive nature of the communications market;
failure to anticipate and keep up with technological changes;
governmental regulatory oversight;
elimination or relaxation of certain regulatory rights and protections;
regulatory uncertainties in the communications industry;
continued industry consolidation;
failure to manage and expand operations effectively;
failure to retain and attract management and key personnel;
failure to maintain interconnection and service agreements with incumbent local exchange carriers;
difficulties in working with incumbent local exchange carriers;
reliance on a limited number of non-ILEC third party service providers;
system disruptions or the failure of our information systems to perform as expected;
ability to maintain real estate leases at switch sites;
loss of a substantial number of customers;
failure to successfully integrate future acquisitions;
claims of intellectual property infringement;
misappropriation of our intellectual property and proprietary rights;
liability for information disseminated through our network;
our history of net losses;
billing disputes with carrier vendors;
difficulties collecting payment from carrier and wholesale customers;
liability associated with periodic audits conducted by State Taxing and other Authorities;
declining prices for communications services;
impact of debt facilities on operating flexibility; and
our ability to service our substantial indebtedness.
    
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.



3


PART I

Item 1.
Business
Company Overview

We are a leading provider of cloud-based unified communication services (“UCaaS”) and information technology solutions to small and medium sized businesses (“SMB”) and enterprise customers nationwide. We offer a broad suite of cloud-based systems and services under the brand OfficeSuite® to our end-user customers nationwide. Our end-user customers have approximately 182,000 active licenses on our flagship product OfficeSuite® Phone. OfficeSuite® Phone comprises a growing percentage of our overall recurring revenue and the vast majority of our existing cloud-based revenue stream. In addition, we generate revenue from third-party service providers utilizing our technology and OfficeSuite® Phone on a white-label or wholesale basis. These third-party service providers offer services to their own end-user customers located in Canada, certain European countries and the United States with approximately 100,000 currently active licenses.
Our product portfolio provides bundled packages that include cloud-based services and network connectivity with a focus on addressing the productivity, mobility, flexibility, security and business continuity needs of end users. In addition, our growth initiatives focus sales channels on communications-intensive multi-location business customers who require multiple products and customers who are likely users of our cloud-based services. These customers generally purchase higher-margin services in multi-year contracts, resulting in higher customer retention rates and higher average monthly recurring revenue. For customers located within the footprint of 252 colocations in the Northeast and Mid-Atlantic regional markets, we offer additional IP-based and traditional communications services utilizing our network infrastructure.
We benefit from software development expertise, proprietary technology and a strong next-generation IP 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. We sell through multiple channels including a direct sales force primarily located in the Northeast and Mid-Atlantic regions, and wholesale and channel partners nationwide.
As of December 31, 2016, we provided our services to approximately 20,000 business customers nationwide. In 2016, cloud-based services, including both cloud-based computing services and cloud related access, generated 35% of total end-user voice and data revenue, up from 17% in 2012. Revenue for these services has grown at approximately a 14% compound annual growth rate (“CAGR”) since 2012. In the fourth quarter of 2016 relative to the fourth quarter of 2015, our end-user pure cloud revenue grew 20% and our end-user cloud access revenue grew 5%, resulting in overall end-user cloud revenue growth of 16%. Approximately 40% of our current cloud-based recurring revenue stream is from customers who were previously purchasing other services from us. As the benefits of cloud-based service offerings are more widely adopted by the customers we serve, we anticipate we will convert a growing percentage of our existing customers to our cloud-based service offerings.
We are investing in our cloud-based solutions, specifically by expanding the features and technology of our cloud-based unified communications system and expanding our portfolio of cloud computing services. We provide comprehensive network connectivity to our customers, utilizing our own network and the networks of other carriers through direct interconnections. Integrating cloud-based services and access enable us to offer SMB and enterprise customers unique business solutions on a cost-effective basis.

4



Recent Events
On April 12, 2017, we executed a definitive Agreement and Plan of Merger pursuant to which we will be acquired via a reverse triangular merger by Windstream Holdings, Inc. (“Windstream”) in an all cash transaction. The transaction has been unanimously approved by our Board of Directors and, following execution of the Agreement and Plan of Merger, stockholders holding a majority of the issued and outstanding shares of our capital stock entitled to vote approved the Agreement and Plan of Merger and the transactions contemplated thereby. The transaction has also been unanimously approved by the Board of Directors of Windstream and is not subject to any financing conditions or Windstream stockholder approval. Pursuant to the terms of the merger agreement, each share of Company common stock will receive $6.98 per share in cash at the closing of the transaction. It is anticipated that our existing indebtedness, including all of our outstanding 10.5% Senior Notes and all outstanding amounts under our $25 million revolving credit facility, will be repaid at closing. Closing of the transaction is anticipated to occur in the third quarter of 2017 and is subject only to regulatory approvals and customary closing conditions.
Products and Services
We provide our customers with a comprehensive array of cloud-based communications and IT products and services, including hosted UCaaS, virtual and dedicated servers or infrastructure as a service (“IaaS”), software as a service (“SaaS”), circuit-switched and IP-based voice and data communications services, as well as value-added products and professional IT services. Our business is to deliver complete solutions to our target customers, with a focus on helping them address their critical and complex infrastructure, productivity, security and business continuity needs.
The following table summarizes our product and service offerings:
CLOUD SERVICES
PROFESSIONAL IT SERVICES
NETWORK ACCESS AND OTHER SERVICES
OfficeSuite® Phone solutions
Equipment Consulting & Sales
Dedicated & Switched Access
OfficeSuite® Call Center Services
IT Project Outsourcing
Dedicated Internet Access
Video Conferencing and Collaboration
Network Design and Implementation
Ethernet Networking
Hosted Microsoft Exchange®
Network Integration
MPLS Networking
Data Backup & Recovery
Customer Service Management Portal
Dynamic IP Integrated Voice & Data
Hosted Dedicated and Virtual Servers
Managed Router
Local, Regional & Long Distance
Virtual Private Data Centers (Private Cloud)
 
Toll-free

IP Voice Services (VoIP and SIP)
 
 
Data Center & Collocation Services
 
 
Internet Policy Management
 
 
Firewall / Network Security
 
 
Online Fax Services
 
 
Virtual Private Networks
 
 
Cloud Services

Unified Communications as a Service. OfficeSuite® Phone, our easy-to-use, 100% cloud-based unified communications platform, provides customers with high-quality, easy-to-use phones and equipment, advanced voicemail, online fax services, and an unlimited calling plan. The service includes MyOfficeSuite, a powerful administrative and end-user portal that provides advanced Unified Communications (“UC”) capabilities such as presence and chat. The product also includes disaster avoidance and recovery capabilities, a converged IP network, intuitive management tools, 24×7 expert network monitoring, ongoing product upgrades and enhancements. Customers can choose from a wide range of LCD phones, cordless phones and connectivity options at various price points. Optional capabilities include: An extensive array of OfficeSuite® mobility options, including mobile softphones for Android, iPhone and iPad, mobile management, presence and chat clients, and mobile video and collaboration clients; OfficeSuite® Call Center Services, which provides robust call center capabilities, including advanced call routing, queuing, call recording, easy-to-use reporting and dashboard functionality; OfficeSuite® Dental, which integrates with a widely-used CRM solution used by dental practices; and an ever increasing array of integrations and connectors, including OfficeSuite® for Skype for Business, OfficeSuite® UC for CRMs, OfficeSuite® UC for Microsoft Office 365, OfficeSuite® Google Chrome Extension,

5


OfficeSuite® UC for Microsoft Dynamics and OfficeSuite® for Salesforce, which integrates with SalesForce.com®, a widely-used cloud-based CRM solution, as well as fully documented and modern RESTful APIs for integration
Software as a Service/Infrastructure as a Service ("SaaS/IaaS"). Our cloud computing product offerings include individual and bundled packages of subscription-based software and infrastructure services. Businesses can access cloud versions of Microsoft Exchange®. We provide packages that incorporate a robust set of mobility and remote employee features, a full suite of backup tools for desktop and server data, and both virtualized and dedicated server solutions.
Professional IT Services    
Our professional IT services provide customers with the expertise and tools needed to make the services and technology we offer work for them. We provide our customers with knowledge of current and emerging technologies, and assist them in charting a business plan to leverage those technologies to meet their business goals.
Customers can utilize our certified technicians and engineers on a project basis to help install, deploy and integrate systems. We also provide software tools and online applications that allow customers to, in real time, monitor system performance, create and view reports and make changes to their services.
Network Access and Other Services
Integrated Services. We offer integrated voice and data packages to small- and medium-sized businesses, including a variety of service options designed to accommodate our customers’ needs. Our integrated offerings result in performance and cost efficiencies, as compared to discrete services purchased from separate competing carriers. We also provide multiple products in a bundle to increase utilization of a common circuit. Services are delivered over a variety of high-bandwidth broadband access methods including high bandwidth Ethernet services, Ethernet-over Copper (“EoC”) and one or more IP-based T-1s. These integrated packages drive increased revenue per customer and higher customer retention. We offer an IP-based integrated T-1 service leveraging our MetaSwitch® IP-based call agents and media gateways and our multiprotocol label switching (“MPLS”) network to deliver highly flexible voice and data services.
Voice Services. We offer voice services over the Internet using Session-Initiation Protocol (“SIP”) or other similar protocols and our next-generation IP network in order to meet the needs of large and small customers who either use their own premises-based communications system or who have basic needs. We provide customer premises equipment where required to complete the customer solution. This includes customers who may have their own IP phone system, use a traditional fax machine or small customers with limited communications needs. We use UNE-Ls, EoC, digital T-1 lines and, in certain instances, our commercial agreements with other providers to service our customers.
Data Services. Our data service offerings are designed to provide a full range of services targeted at businesses that require single or multipoint high-speed, dedicated data connections. We provide Internet access and networking service on our networks via Switched Ethernet T-1, DS3, EoC or DSL, depending on our customer’s bandwidth and security needs, as well as via high bandwidth and broadband IP access services obtained through partners. Our MPLS and IP Virtual Private Network (“VPN”) data network services include multiple classes of service for differentiated levels of QoS, service level agreements and security. In addition, through arrangements with national IP network providers, we offer these services on a nationwide basis to those of our business customers who have locations outside of our network footprint. These services enable customers to deploy tailored, IP-based business applications for secure internal enterprise, business-to-business and business-to-customer data communications among geographically dispersed locations, while also providing high-speed access to the Internet.
Sales and Marketing
Our sales organization consists of four primary sales channels: direct sales, nationwide channel partners, inside sales and wholesale sales. Channel partners are our primary sales channel outside of the northeastern United States. We also work with organizations and individuals who refer business to Broadview through personal networking. Each channel enables us to provide a bundled product offering of cloud-based services, voice and data communications, hardware and managed network services through a consultative analysis of each customer’s specific needs. We will continue to work to help existing customers move to cloud-based services to ensure they have the tools needed to evolve their business and to further ensure loyalty.
Marketing support is provided to our sales channels in many forms, including email campaigns, marketing communications support and leads. In addition, marketing provides online and printed materials, sales promotions and vertical marketing programs.

6


We also offer services to other carriers and resellers through our Wholesale division. The Wholesale division leverages our cloud-based services expertise, next-generation technology development, network strength and our leading back office automation systems to deliver a reseller-branded suite of cloud-based voice, data, IP and integrated services for resale, where the reseller retains the customer relationship and is responsible for sales, customer care and billing.

7


Industry and Competition
Overview
The communications industry was once defined by voice services, data services (Internet access and networking) and equipment providers. As the role of information technology advances in today’s business environment, the roles of security, mobility, business continuity, software and hardware have become increasingly important for both SMB and enterprise organizations and are increasingly integrated with the communications needs of these entities.
The cloud-services market has expanded rapidly as high-speed network access has become more readily available and as new technology has allowed enterprise-grade systems (hardware and software) to be deployed inside a service provider’s network for end user availability. Many cloud service providers emerged offering various services that are “hosted” in the cloud. For example, dedicated servers have been collocated inside of provider owned facilities and rented out on a subscription basis. UC services, that combine traditional voice services with advanced services incorporating mobile, presence and chat are now hosted in the cloud and provided as a service and are known as UCaaS.
Technology advancements allowed for servers to be “virtualized” for fractional use by end-users to improve utilization of assets and to make computing resources even more cost-effective for customers whose needs didn’t demand dedicated resources.
Many service providers have adopted a “hosted” and “virtualized” approach to applications and systems to provide services. Private Branch Exchange (“PBX”) phone systems, Customer Relationship Management (“CRM”) and Enterprise Resource Management platforms, and other similar systems are now capable of being provided in a hosted cloud environment. These developments have allowed market participants to change their revenue models from typical one-time purchases of software and equipment to monthly or annual subscriptions where access to the equipment, software, technology and features is essentially rented by the customer. Economies of scale have allowed service providers to offer functionality which previously was only cost effective for larger enterprises to a larger base of small- and medium-sized customers.
Today, the market for cloud-based services is expanding rapidly as businesses look for opportunities to improve operational efficiency, accessibility and employee productivity, while reducing risk. As a cloud service provider with the infrastructure, experience and support mechanisms already developed and in place, Broadview offers a portfolio of cloud-based services that address the communications and information technology needs of SMBs and enterprise customers.
The market for communications services, particularly voice, has been historically dominated by the Incumbent Local Exchange Carriers (“ILECs”) in the United States. These carriers include Verizon Communications, Inc. (“Verizon”), AT&T, Inc. (“AT&T”), CenturyLink Inc., Frontier Communications Corporation (“Frontier”), FairPoint Communications Inc. (“Fairpoint”), and Windstream Corporation (“Windstream”). While the ILECs own the majority of the local exchange networks providing basic network access in their respective operating regions, competitive communications providers hold significant market share. In recent years, the number of competitive communications providers in the United States has been reduced by industry consolidation and the leading cable companies (“CATVs”) have entered the residential and business communications markets, thereby reducing the market share held by ILECs.
Historically, we believed that ILECs and CATVs did not adequately focus on SMB customers, which created a sustainable growth opportunity for competitive providers to service SMB customers with a broad array of services, including both traditional access services and cloud-based services. While we believe the opportunity still exists, the ILECs and CATVs are improving their ability to attract and serve our target customers.
Increased complexity in delivering communications and IT services, together with what has been a challenging economic climate has driven business customers to evaluate alternative approaches, including cloud-based products and services. As competitive pressures have commoditized more access services, we believe cloud-based services represent growth opportunities for competitive providers who are successful in tailoring cloud-based services to the needs of customers.
The cloud-based services, including UCaaS, and the access services industries are highly competitive. We believe we compete principally by offering focused customer service, greater ease of use, a powerful portal, accurate billing, a broad set of services and systems, unique technical solutions and competitive pricing. We compete with various different types of service providers, including companies focused solely on cloud-based services as well as ILECs, CATVs, internet service providers, premises-based and hosted Voice Over Internet Protocol (“VoIP”) phone system and service providers, competitive local exchange carriers (“CLECs”), wireless companies, interexchange carriers, and other market participants, including vendors, installers and communications management companies.

8


Our Strengths
Cloud-Based Product Suite. As a Cloud Service Provider, we offer SMB and enterprise customers a variety of cloud-based services that allow organizations to move infrastructure and software 100% into the cloud, for more ubiquitous, secure, ease of use and cost-effective delivery. Services include OfficeSuite® Phone, our cloud-based UCaaS system, OfficeSuite® HD Meeting, our video conferencing and collaboration solution, MyOfficeSuite, our powerful administrative and end-user portal, hosted Microsoft Exchange®, hosted virtual and dedicated servers, data backup and recovery, and archiving, compliance and eDiscovery services, as well as a full complement of cloud-based security services.
Recognized Industry Leader and Innovator. We have received industry recognition for our innovative use of technology, our product development and our customer care.
Large, Diversified Customer Base. We have approximately 20,000 SMB and enterprise customers who constitute a predictable base of recurring revenue and high quality customer relationships. We believe many of these organizations are target customers to move into the cloud with an experienced provider.
Foundation of Recurring Revenue and Visibility into Revenue and Cash Flows. Our diversified product set and our care for our customers has resulted in favorable quality of revenue trends and improving churn rates that we believe give us good forward visibility into revenue and cash flows. Our deployment of capital is largely success-based, meaning outlay is incurred incrementally only as we add new customers and new recurring revenue.
Customer Service. We closely monitor key operating and customer service performance metrics. Capturing and analyzing this information allows us to improve our internal operating functions, drive profitable revenue growth and quickly respond to changes in demographics, customer behavior and industry trends.
Software Design and Development. We have expertise in software design and development. This expertise extends through to customization and integration of commercially available software products, as well as development and enhancement of our proprietary unified cloud communications products and services. Specifically:
Proprietary Unified Communications Platform. We own the intellectual property and assets of our core 100% cloud-based UCaaS platform OfficeSuite® Phone, including the unified messaging and call center services technologies, and MyOfficeSuite, its companion administrative and end-user portal. As a result, we have direct control of the ongoing development and evolution of the services offered and the technology applied, minimizing license fees and directly controlling feature prioritization, and development schedules. This allows us to deliver unique solutions that are 100% cloud-based to our customers and target markets, including integrations with Salesforce.com®, Skype for Business® and other software and industry applications, differentiating OfficeSuite® from other service provider offerings.
Integrated OSS Infrastructure. We own and develop our internal operations and enterprise management software systems (our OSS), allowing us to continually innovate, develop and deliver automation across our product suite. Further leveraging our in-house software development expertise, we are continuing to evolve self-service tools and additional automation capabilities including integrations of the Salesforce.com® platform into our front-end sales processes. Fully developed in-house, our MyOfficeSuite portal, and its companion desktop and mobile clients, provides a single, adaptable portal for our OfficeSuite® customers to administer, operate and leverage their services from any device. Designed to be user-friendly for users and administrators alike, the MyOfficeSuite family provides full management, instantaneous changes from the online dashboard using customizable widgets and real-time presence, chat and call control.. We have further extended the MyOfficeSuite portal family to include the MyOfficeSuite Agent portal and MyOfficeSuite for white label wholesale customers, providing unprecedented visibility, management and control to our channel partners.
Facilities-Based Network Infrastructure. We own and operate an IP-based network for the development and delivery of cloud-based services. Our northeastern U.S. network topology incorporates traditional and EoC access technologies, enabling us to cost-effectively provide data services in the Northeast and nationwide utilizing partner carriers.
Experienced Management Team. Our team of senior executives and operating managers has an average of more than 25 years in the industry and expertise integrating acquired assets with existing assets. In connection with our history of mergers and acquisitions, our senior management team has successfully consolidated back-office systems and processes into a single OSS, integrated operations and cultures, and combined products, strategies and sales channels.

9


Our Markets
We target SMB and enterprise customers nationwide with cloud-based services. Previously, our focus had been solely on markets across 10 states throughout the Northeast and Mid-Atlantic United States, including the major metropolitan markets of New York, Boston, Philadelphia, Baltimore and Washington, D.C. While these markets remain important markets for us, our focus has evolved to a nationwide focus. We believe next-generation cloud- and IP-based communications services will continue to gain market share with SMB and enterprise customers. Additionally, we believe cloud-based services allow us to address a greater percentage of an SMB customer’s overall telecom and IT spending budget. As technology and network alternatives have evolved, it has become cost effective to offer our cloud-based communications services and products nationwide.
Our Revenue and Customers
Our customer base consists of SMB and enterprise customers nationwide, with a historical focus on markets across 10 states throughout the Northeast and Mid-Atlantic United States. Approximately 88% of our total revenue is generated from our end-users in a wide array of industries including professional services, health care, education, manufacturing, real estate, retail, automotive, non-profit groups and others with less than 1% coming from residential customers. Approximately 12% of total revenue is generated from wholesale, carrier access and other sources. Our wholesale line of business serves other communications providers with voice and data services including cloud-based services, data colocation and other value-added products and services. Similar to our end-user revenue, over 20% of our wholesale revenue stream consists of cloud-based services. The vast majority of revenue is under contract and is of a recurring nature.
We have been a provider of cloud-based communications services to our end-user customers in our Northeast and Mid-Atlantic markets since 2005 and have been providing these services nationwide since late 2009. The following table shows the trend of our cloud-based revenue for the years ended December 31, 2012 through December 31, 2016:
 
Year Ended December 31,
$ in millions
2012
 
2013
 
2014
 
2015
 
2016
End-user cloud-based revenue
$
50.6

 
$
57.7

 
$
63.0

 
$
72.7

 
$
84.7

% growth
20.9
%
 
14.0
%
 
9.2
%
 
15.5
%
 
16.4
%
We target larger SMB and enterprise customers, typically generating over $500 in Monthly Recurring Revenue (“MRR”) with direct and channel partner sales teams. These customers generally purchase higher margin cloud-based services in multi-year contracts resulting in higher customer retention rates and profitability. The average MRR across our entire base of business customers has increased from approximately $747 at December 31, 2012 to approximately $1,006 at December 31, 2016. The following table shows the trend in average MRR per business customer as of the last month of each period:
 
Last Month of Year Ended December 31,
 
2012
 
2013
 
2014
 
2015
 
2016
Average MRR per Business Customer
$
747

 
$
807

 
$
865

 
$
941

 
$
1,006

For the month ended December 31, 2016, 90% of our end-user revenue was generated by customers whose MRR is greater than $500, and approximately 78% was generated by customers with MRR of greater than $1,000 per month. The following table shows the five-year trend in the composition of our end-user revenue base in terms of monthly spend as of the last month of each period:
Trended MRR by Customer Size
Last Month of Year Ended December 31,
 
2012
 
2013
 
2014
 
2015
 
2016
$0 - $500
13
%
 
12
%
 
12
%
 
11
%
 
10
%
>$500 - $1000
16
%
 
15
%
 
14
%
 
13
%
 
12
%
>$1,000
71
%
 
73
%
 
74
%
 
76
%
 
78
%
 
 
 
 
 
 
 
 
 
 
 
100
%
 
100
%
 
100
%
 
100
%
 
100
%
Although we continue to focus on serving larger customers, due to our recent product additions and because we now offer our services nationwide, we are more focused on the UCaaS application portion (cloud-based services) of the potential revenue stream, in preference to the access portion (T-1 and IP voice and data circuits). Access, or last mile connectivity, is the primary

10


function and focus of the traditional telecommunications providers (ILECs, CLECs, CATVs). Although historically we focused on the access portion, we believe that as a result of technology evolution in our industry, access is increasingly commoditized and there are numerous alternatives for access services at competitive prices. As such, we focus our new sales efforts on the application portion of the revenue stream which we believe provides the greatest “value add” to the customer, often allowing the customer to choose their own method of access from a variety of access providers. This is often referred to as Bring Your Own Broadband or BYOB. Within our network footprint, we continue to also offer access services at competitive prices, providing our customers a choice of which access method works best for them.
As a result of our evolution in focus from access to UCaaS application, our average revenue per new customer and our average revenue per existing business customer is flattening and may decrease over time. In many circumstances, particularly outside of our network footprint, we anticipate being able to generate similar profitability on each new customer, but with lower revenue per customer when we do not provide the access product.
Customer Service and Retention
We improved our average monthly end-user revenue loss level from 1.7% for the year ended December 31, 2012 to 1.2% for the year ended December 31, 2016, in part due to our continued shift towards larger customers, our focus on improving customer service and our focus on cloud-based products. The following chart shows the five-year trend for each year for the years ended December 31, 2012 through 2016.
 
Year Ended December 31,
 
2012
 
2013
 
2014
 
2015
 
2016
Average Monthly Revenue Loss (1)
1.7
%
 
1.7
%
 
1.6
%
 
1.4
%
 
1.2
%
(1)     Our calculation of revenue loss is a comprehensive metric and may not be comparable to revenue loss or churn metrics reported by other companies in the industry. Our method is to include all sources of revenue loss including revenue write-down and repricing.
We service customers in a multi-tiered, multi-channel approach. Our inbound contact center, 1-800-BROADVIEW, is staffed 24 hours per day, 7 days per week, 365 days per year both internally and through a third party relationship, who handle all aspects of a customer’s questions, payments, repairs, changes of service, and new service requests. Larger customers are serviced through our dedicated support, project and sales representatives assigned to each customer.
Customers can choose to utilize our interactive voice response system for automated support, online chat, our OfficeSuite Community, and our award-winning e-Care Enterprise web-based application that provides an array of self-management tools for customers and partners.
 
Providing a superior customer experience is a major focus of our customer relationship management team. We collect statistical and direct feedback from customers through direct surveys and other methods regarding their satisfaction, after recent service experience and after disconnect, and use the information to refine and improve our processes as well as to measure the effectiveness of the organization.
Our Network
Our network architecture leverages multiple data centers and hundreds of collocations connected by IP and MPLS technologies from Juniper Networks and Cisco Systems, VoIP softswitches from MetaSwitch, including call agents and gateways, Ethernet over Copper and other broadband access, to deliver cloud-based unified communications and computing services to our customers. We reach our customers through the customer's own Internet access or by providing access on our own network or leveraging last mile connections through numerous carrier agreements. Our core network operates with 99.999% of availability and our Network Operations Center (“NOC”) monitors our network 24 hours per day, 7 days per week, 365 days per year.

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Data Centers
We operate two data centers located within our central offices, which we utilize primarily for providing space, power and services for hosting customer-owned equipment as well as for hosting our OSS and servers. In addition, we provide our cloud computing services through cloud services partners, leveraging multiple data centers in diverse geographic locations nationwide.
Fiber Network and Fiber Equipment
We operate a multi-state fiber network consisting of local metropolitan fiber rings and interstate long haul fiber systems. The fiber network consists of our owned fiber, dark fiber, Indefeasible Right of Use (“IRU”), and light-wave IRU from multiple providers. We have approximately 3,000 fiber route miles consisting of both our owned fiber and dark fiber, primarily pursuant to IRUs.
Service Agreements with Carriers
We obtain last mile access services from Verizon through state-specific interconnection agreements, commercial agreements, local wholesale tariffs and interstate contract tariffs. We also maintain agreements with a number of other carriers for the provision of network facilities, including fiber routes and high capacity loops and transport, internet service providers, and local voice and data services. These agreements often provide cost-effective alternatives for last mile connections to customers.
Integrated Operational Support Systems (“OSS”)
We have developed and continue to improve and update our integrated sales automation, order processing, service provisioning, billing, payment, collection, customer service, network surveillance, testing, repair and information systems that enable us to offer and deliver high-quality, easy-to-use, competitively priced communications services to our customers. Our software platform and business process is designed to maximize resource efficiency by ensuring single entry and flow-through of all data elements needed to provision and bill for services, from the initial sales proposal through the final order, as well as by providing self-service through online portals to customers and agents.
Sales, Order Entry and Provisioning Systems
Our sales automation, order entry and provisioning systems enable us to collect, leverage, distribute and manage sales leads, shorten the customer provisioning time cycle and reduce associated costs. The sales management toolset begins with iLead, a unified web-based customer relationship management portal built on the Salesforce.com® platform, which offers an extensive array of sales tools and capabilities. These include lead and funnel management, sales forecasting, hierarchical dashboards and reports, and full automation from proposal generation to e-signature to sales close, along with subsequent automated workflow through to design, provisioning and project management, leading to service turn-up and billing.
To support our channel partners, we created PartnerConnect, a purpose built variant of iLead. Through our iLead and PartnerConnect portals, our sales team, and channel partners can track order status, trouble reports and commissions in real-time
Customer Relationship Management System
Our CRM solutions include e-Care Enterprise and OpenCafe. e-Care Enterprise, a recipient of multiple awards for customer service and applications of business technology, allows our customers to directly monitor and manage their accounts and services online. OpenCafe, our internal CRM application, provides our customer service representatives with real time access to all information pertinent to the customer, in an organized and easy to use front-end system. In addition, OpenCafe is directly integrated with our trouble ticketing and repair tracking systems, allowing instant access to repair status and reporting. We continue to develop and implement improvements to e-Care Enterprise and OpenCafe, delivering more capabilities to our customer service representatives and customers. These CRM platforms are integrated with our MyOfficeSuite portal, which provides our customers with a high level of visibility, management and control of their OfficeSuite and related services through an intuitive user interface.
Our in-house developed billing system enables us to run multiple bill cycles with full color for the many different, tailored service packages, increasing customer satisfaction while minimizing revenue leakage and providing billing information on-line via various portals, including e-Care Enterprise and MyOfficeSuite. Our automated collections management system, integrated with our billing system, allows us to increase the efficiency of the collections process, which accelerates the collection of accounts receivable.


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Network Management Systems
Our network management systems include core licensed applications, such as TEOCO Corporation’s Netrac. With these core licensed applications, our in-house software developers have, through APIs, developed overarching control and management software applications to leverage these systems on an automated basis, and coupled the functionality to our business support applications to deliver seamless service, provisioning and billing. In addition, we have leveraged these applications to deliver Web-D, our work force management, project scheduling, assigning and tracking application, maximizing the efficiency of our field workforce.  
Intellectual Property
We rely on a combination of patent, copyright, trademark and trade secret laws, as well as licensing agreements, third party non-disclosure agreements and other contractual provisions and technical measures to protect our intellectual property rights. No individual patent, trademark or copyright is material to our business. We own a collection of patents registered in the United States, Canada and other countries relating to network design and technology for the delivery of enhanced voice services, as well as a process patent relating to our network hot-cut process. We have granted security interests in our trademarks, copyrights and patents to our lenders pursuant to the Company's $25.0 million revolving credit facility (the “Revolving Credit Facility”) and the indenture governing the $150.0 million of 10.5% Senior Secured Notes due November, 2017 (the “Notes”).
Employees
As of December 31, 2016, we had approximately 745 employees, including approximately 115 quota-bearing representatives across all sales channels. In addition, we had approximately 165 associates at December 31, 2016 working on our behalf, but employed by service partners of the Company. Our employees are not members of any labor unions. We believe that relations with our employees are good. We have not experienced any work stoppage due to labor disputes.
Available Information
All periodic and current reports, registration statements, and other filings that we file with the Securities and Exchange Commission (“SEC”), including our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 15(d) of the Securities Exchange Act of 1934, as amended, are available free of charge from the SEC’s website (http://www.sec.gov) or public reference room at 100 F. Street N.E., Washington, D.C. 20549 (1-800-SEC-0330) or through our website at http://www.broadviewnet.com. Such documents are available as soon as reasonably practicable after electronic filing of the material with the SEC. Copies of these reports (excluding exhibits) may also be obtained free of charge, upon written request to: Investor Relations, Broadview Networks Holdings, Inc., 800 Westchester Avenue, Suite N501, Rye Brook, NY 10573.
Our website address is included in this report for information purposes only. Our website and the information contained therein or connected thereto are not incorporated into this Annual Report on Form 10-K.
See also “Directors, Executive Officers and Corporate Governance - Code of Business Conduct and Ethics” for more information regarding our Code of Business Conduct and Ethics.

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REGULATION
Overview
We are subject to federal, state, local and foreign laws, regulations, and orders affecting the rates, terms, and conditions of certain of our service offerings, our costs, and other aspects of our operations, including our relations with other service providers. Regulation varies from jurisdiction to jurisdiction, and may change in response to judicial proceedings, legislative and administrative proposals, government policies, competition, and technological developments.
The Federal Communication Commission (the “FCC”) has jurisdiction over our facilities and services to the extent they are used in the provision of interstate or international communications services. State regulatory public utility commissions generally have jurisdiction over facilities and services to the extent they are used in the provision of intrastate services. Local governments may regulate aspects of our business through zoning requirements, permit or right-of-way procedures, and franchise fees. Foreign laws and regulations apply to communications that originate or terminate in a foreign country. Generally, the FCC and state public utility commissions either do not or minimally regulate Internet, video conferencing, or certain data services, although the underlying communications components of such offerings are generally regulated. Our operations also are subject to various environmental, building, safety, health, and other governmental laws and regulations.
Federal law generally preempts state statutes and regulations that restrict the provision of competitive local, long distance and enhanced services. Because of this preemption, we are generally free to provide the full range of local, long distance and data services in every state. While this federal preemption increases our potential for growth, it also increases the amount of competition to which we may be subject.
Federal Regulation
The Communications Act of 1934 (the “Communications Act”) grants the FCC authority to regulate interstate and foreign communications by wire or radio. The FCC imposes extensive regulations on common carriers that have some degree of market power such as ILECs. The FCC imposes less regulation on common carriers without market power, such as us. The FCC permits these non-dominant carriers to provide domestic interstate services (including long distance and access services) without prior authorization; but it requires carriers to receive authorization to construct and operate telecommunications facilities and to provide or resell communications services, between the United States and international points. Further, we remain subject to numerous requirements of the Communications Act, including certain provisions of Title II applicable to all common carriers which require us to offer service upon reasonable request and pursuant to just and reasonable charges and terms, and which prohibit any unjust or unreasonable discrimination in charges or terms. The FCC has authority to impose additional requirements on non-dominant carriers.
The Telecommunications Act of 1996 (the “Telecommunications Act”) amended the Communications Act to eliminate many barriers to competition in the U.S. communications industry. Under the Telecommunications Act, any entity, including cable television (“CATV”) companies and electric and gas utilities, may enter any communications market, subject to reasonable state certification requirements and regulation of safety, quality and consumer protection. The Telecommunications Act was intended to increase competition. Among other things, the Telecommunications Act opened the local exchange services market by requiring ILECs to permit competitive carriers to interconnect to their networks at any technically feasible point and required them to utilize certain parts of their networks at FCC-regulated (generally cost based) rates; it also established requirements applicable to all local exchange carriers, including competitive local exchange carriers (“CLEC”). Examples include:
Reciprocal Compensation.  Required all ILECs and CLECs to complete calls originated by competing carriers under reciprocal arrangements at prices based on a reasonable approximation of incremental cost or through mutual exchange of traffic without explicit payment.
Resale.  Required all ILECs and CLECs to permit resale of their communications services without unreasonable or discriminatory restrictions or conditions. In addition, ILECs were required to offer for resale, wholesale versions of all communications services that the ILEC provides at retail to subscribers that are not telecommunications carriers at discounted rates, based on the costs avoided by the ILEC in the wholesale offering.

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Access to Rights-of-Way.  Required all ILECs and CLECs and any other public utility that owns or controls poles, conduits, ducts, or rights-of-way used in whole or in part for wire communications, to permit competing carriers (and CATV systems) access to those poles, ducts, conduits and rights-of-way at regulated prices. CLEC rates for access to its poles, ducts, conduits and rights-of-way, however, are not regulated.
The Telecommunications Act also codified the ILECs’ equal access and nondiscrimination obligations and preempted inconsistent state regulation.
Legislation.  Congress is considering rewriting the Telecommunications Act. The prospects and timing of the potential legislative initiative remain unclear, and as such, we cannot predict the outcome of any such legislative effort.
Unbundled Network Elements.  The Telecommunications Act required ILECs to provide requesting telecommunications carriers with nondiscriminatory access to network elements on an unbundled basis at any technically feasible point on rates, terms and conditions that are just, reasonable and nondiscriminatory, in accordance with the other requirements set forth in Sections 251 and 252 of the Communications Act. The Telecommunications Act gave the FCC authority to determine which network elements must be made available to requesting carriers such as us. The FCC was required to determine whether the failure to provide access to such network elements would impair the ability of the carrier seeking access to provide the services it sought to offer. Based on this standard, the FCC developed an initial list of Regional Bell Operating Company (“RBOC”) network elements that must be unbundled on a national basis in 1996. Those initial rules were set aside by the U.S. Supreme Court and the FCC subsequently developed revised unbundling rules, which also were set aside on appeal.
In August 2003, in the Triennial Review Order (“TRO”), the FCC substantially modified its rules governing access to unbundled network elements (“UNEs”). The FCC limited requesting carrier access to certain aspects of the loop, transport, switching and signaling/databases UNEs but continued to require some unbundling of these elements. In the TRO, the FCC also determined that certain broadband elements, including “fiber-to-the-home loops” in “greenfield” situations, broadband services over fiber-to-the-home loops in overbuild situations, packet switching, and the packetized portion of hybrid loops, were not subject to unbundling obligations. On March 2, 2004, the U.S. Court of Appeals for the D.C. Circuit vacated certain portions of the TRO and remanded to the FCC for further proceedings.
In December 2004, the FCC issued an Order on Remand of the TRO (“TRRO”), which became effective on March 11, 2005. The TRRO further modified the unbundling obligations of ILECs. Under certain circumstances, the FCC removed the ILECs’ unbundling obligations with regard to high capacity local loops and dedicated transport and eliminated the obligation to provide local switching. Under the FCC’s new rules, the availability of high capacity loops and transport depends upon new tests based on the capacity of the facility, the business line density of incumbent wire centers, and the existence of colocated fiber providers in incumbent wire centers.
FCC rules implementing the local competition provisions of the Telecommunications Act permitted CLECs to lease UNEs at rates determined by state public utility commissions employing the FCC’s Total Element Long Run Incremental Cost forward-looking, cost-based pricing model. On September 15, 2003, the FCC opened a proceeding reexamining the Total Element Long Run Incremental Cost (“TELRIC”) methodology and wholesale pricing rules for communications services made available for resale by ILECs in accordance with the Telecommunications Act. This proceeding was intended to determine whether the TELRIC pricing model produced unpredictable pricing inconsistent with appropriate economic signals; failed to adequately reflect the real-world attributes of the routing and topography of an ILEC’s network; and created disincentives to investment in facilities by understating forward-looking costs in pricing RBOC network facilities and overstating efficiency assumptions.
In orders released in August 2004, the FCC extended the unbundling relief it had previously provided to fiber-to-the-home loops to “fiber-to-the-curb loops.” On October 27, 2004, the FCC issued an order granting requests by the Regional Bell Operating Companies (“RBOCs”) that the FCC forbear from enforcing the independent unbundling requirements of Section 271 of the Communications Act with regard to the broadband elements that the FCC had previously determined were not subject to unbundling obligations (fiber-to-the-home loops, fiber-to-the-curb loops, the packetized functionality of hybrid loops, and packet switching).
On September 16, 2005, the FCC partially granted a petition filed by Qwest Communications International, Inc. (“Qwest”) seeking forbearance from the application of the FCC’s dominant carrier regulation of interstate services, and Section 251(c) requirements throughout the Omaha, Nebraska Metropolitan Statistical Area (“MSA”). The FCC granted Qwest the requested relief in nine of its 24 Omaha central offices where it determined that competition from intermodal (cable) service providers was “extensive.” Although the FCC required that Qwest continue to make UNEs available in the nine specified central offices, Qwest was only required to do so at non-Total Element Long Run Incremental Cost rates. The FCC did not grant Qwest the requested relief regarding its colocation and interconnection obligations. On January 30, 2007, the FCC partially granted ACS of Anchorage, Inc.’s (“ACS”) petition seeking forbearance from the application of the FCC’s dominant carrier regulation of interstate services,

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and Section 251(c) requirements throughout the Anchorage, Alaska local exchange carrier study area. The FCC granted ACS the requested relief in five of its 11 Anchorage central offices where it determined that “competition by the local cable operator . . . ensures that market forces will protect the interests of consumers.” Although the FCC required that ACS continue to make UNEs available in the five central offices in which the requested relief was granted, it was only required to do so at commercially negotiated rates.
In December 2007, the FCC denied a Verizon petition for relief comparable to that accorded Qwest and ACS - forbearance from the application of the FCC’s dominant carrier regulation of interstate services, and Section 251(c) unbundling requirements - in six MSAs, including the New York-Northern New Jersey-Long Island, NY-NJ-PA MSA, the Philadelphia-Camden-Wilmington-Baltimore PA-NJ-DE-MD MSA and the Boston-Cambridge-Quincy, MA-NH MSA. On June 19, 2009, the D.C. Circuit remanded the Verizon forbearance decision to the FCC for further consideration and explanation. On August 20, 2009, the FCC initiated a proceeding to address the remand of the Verizon forbearance decision, as well as the remand of another order denying Qwest UNE-forbearance relief in four of its largest markets. Both Verizon and Qwest withdrew their UNE-forbearance petitions following denial by the FCC of Qwest’s Phoenix UNE-forbearance request. In denying the Qwest Phoenix UNE-forbearance petition, the FCC established a new market-power analytical framework for assessing future forbearance petitions.
On September 23, 2005, the FCC issued an order that largely deregulates “wireline broadband Internet access service.” The FCC refers to “wireline broadband Internet access service” as a service that uses existing or future wireline facilities of the telephone network to provide subscribers with access to the Internet, including by means of both next generation fiber-to-the-premises services and all digital subscriber lines. This decision by the FCC follows the decision by the United States Supreme Court in the “Brand X Case”, issued June 27, 2005, in which the Court held that cable systems are not legally required to lease access to competing providers of Internet access service. Consistent with the FCC’s previous classification of cable modem service as an information service, the FCC classified broadband Internet access service as an information service because it intertwines transmission service with information processing and is not, therefore, a “pure” transmission service such as frame relay or ATM, which remained classified as telecommunications services. The FCC required that existing transmission arrangements between broadband Internet access service providers and their customers be made available for a one-year period from the effective date of this decision. This decision did not affect CLECs’ ability to obtain UNEs, but did relieve the ILECs of any duty to offer DSL transmission services subject to regulatory oversight.
On March 19, 2006, the FCC, by inaction, granted Verizon’s Petition for Forbearance from the application of the FCC’s Computer II and Title II requirements to Verizon’s Broadband service offerings. Arguably, the grant of Verizon’s petition permitted Verizon to offer DSL, ATM, Frame Relay and T-1 services on a non-common carrier basis, free from unbundling and Total Element Long Run Incremental Cost pricing requirements, although Verizon appeared to narrow its petition to ask for far more limited relief, limiting the requested relief to a select group of service offerings. Other ILECs have sought and been granted similar relief. On October 12, 2007, the FCC agreed that AT&T’s existing packet-switched broadband telecommunications services and existing optical transmission services could be treated as non-dominant and would no longer be subject to certain regulatory requirements. Other ILECs have sought and been granted similar relief.
In June 2009, the FCC adopted new rules governing forbearance requests. These rules require, among other things, that forbearance petitions be complete when filed, state explicitly the scope of the relief requested, identify any other relevant proceedings and comply with certain format requirements. The rules also limit the petitioner’s right to withdraw the petition or narrow its scope.
In December 2015, the FCC granted in substantial part a forbearance petition filed by the U.S. Telecom Association on October 6, 2014. The FCC elected to forebear from, among other things, (i) further application to the RBOCs of Sections 271 and 272 of the Telecommunications Act and (ii) the requirement that ILECs provide a 64 kbps voice channel where copper loops have been retired. Other petitions pending before the FCC seek to reverse forbearance authority previously granted to the ILECs.
In August 2015, the FCC released a Report and Order which formally addressed the transition from networks based on Time-Division Multiplexing (“TDM”) circuit-switched voice services running on copper loops to all- Internet Protocol (“IP”) multi-media networks using copper, coaxial cable, wireless and fiber as physical infrastructure. In its Report and Order, the FCC identified the principals which should guide this transition which include competition, consumer protection, universal service, public safety and national security. The FCC concluded that while transitioning from TDM to IP, it was critical to preserve competition by maintaining wholesale access to network facilities for competitive providers. While the FCC did not impose any new wholesale access obligations on ILECs during the transition, it did strengthen its copper retirement and service discontinuation rules so that wholesale network access would remain viable.
In its 2015 “Open Internet Order,” the FCC reclassified broadband Internet access as a common-carrier service. In so doing, the FCC subjected broadband Internet access to Title II regulation under the Communications Act, although it did not apply certain Title II requirements. The FCC's 2015 Open Internet Order was upheld on appeal in June 2016.

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Special Access.  Over the past decade, the FCC has undertaken a lengthy and comprehensive review of its rules governing the pricing of special access service offered by ILECs subject to price cap regulation. Special access pricing by these carriers currently is subject to price cap rules, as well as pricing flexibility rules that permit these carriers to offer volume and term discounts and contract tariffs (“Phase I pricing flexibility”) and/or remove from price caps regulation special access service in a defined geographic area (“Phase II pricing flexibility”) based on showings of competition. In a Tariff Investigating Order and Notice of Proposed Rulemaking, issued on April 28, 2016 the FCC tentatively concluded that it would continue to permit pricing flexibility where competitive market forces would be sufficient to constrain special access prices, but undertook an examination of whether the current triggers for pricing flexibility had accurately gauged competition levels and worked as intended. The FCC has also requested comments on, amoung other things, whether certain aspects of ILEC special access tariff offerings (e.g., basing discounts on previous volumes of service; tying nonrecurring charges and termination penalties to term commitments; and imposing use restrictions in connection with discounts) are unreasonable. While the FCC would have adopted many of the pro-competitive changes proposed in its NPRM in a proposed Report in Order circulated before the November presidential election, the recent change in administrations has rendered such an outcome highly unlikely.
Interconnection Agreements.  Pursuant to FCC rules implementing the Telecommunications Act, we negotiate interconnection agreements with ILECs to obtain access to UNE services, generally on a state-by-state basis. These agreements typically have three-year terms. We currently have interconnection agreements in effect with Verizon for, among other states, New York, Massachusetts, New Jersey, Pennsylvania, Maryland, Virginia, Delaware and Rhode Island, as well as the District of Columbia. In the states of Vermont, New Hampshire and Maine, we have interconnection agreements with FairPoint following its acquisition of Verizon’s network assets in these states. We have entered into a multi-state interconnection agreement with AT&T covering its entire ILEC service area and are currently negotiating agreements with other ILECs to support our nationwide service offering outside the Verizon Northeast and Mid-Atlantic service areas.
We are in the process of renegotiating our interconnection agreement with Verizon in New York. If the negotiation process does not produce, in a timely manner, an interconnection agreement that we find acceptable, we may petition the New York public utility commission to arbitrate any disputed issues. Arbitration decisions in turn may be appealed to federal courts. As an alternative to negotiating an interconnection agreement, we may adopt, in its entirety, another carrier’s approved agreement.
Colocation.  FCC rules generally require ILECs to permit competitors to colocate equipment used for interconnection and/or access to UNEs. Changes to those rules, upheld in 2002 by the D.C. Circuit, allow competitors to colocate multifunctional equipment and require ILECs to provision cross-connects between colocated carriers.
Regulation of ISPs.  To date, the FCC has treated Internet Service Providers (“ISPs”) as enhanced service providers, which are generally exempt from federal and state regulations governing common carriers. Nevertheless, in its recently released “Open Internet Order,” the FCC recently reclassified broadband Internet access as a common-carrier service and subjected broadband Internet access providers to a number of the core consumer protection requirements of Title II of the Communications Act.
Moreover, Congress has passed a number of laws that concern the Internet and Internet users. Generally, these laws limit the application of taxes to and the potential liability of ISPs.
Network Management and Internet Neutrality. In August 2005, the FCC adopted a policy statement that outlined four principles intended to preserve and promote the open and interconnected nature of the Internet. The FCC, the Obama Administration and Congress have expressed interest in imposing these so-called “net neutrality” requirements on broadband Internet access providers, which address whether, and the extent to which, owners of network infrastructure should be permitted to engage in network management practices that prioritize data packets on their networks through commercial arrangements or based on other preferences. In its 2005 policy statement the RFCC expressed the view that consumers are entitled to access lawful Internet content and to run applications and use services of their choice, subject to the needs of law enforcement and reasonable network management. In an August 2008 decision, the FCC characterized these net neutrality principles as binding and enforceable and stated that network operators have the burden to prove that their network management techniques are reasonable. In that order, which was overturned by a court decision in April 2010, the FCC imposed sanctions on a broadband Internet access provider for managing its network by blocking or degrading some Internet transmissions and applications in a way that the FCC found to be unreasonably discriminatory. In December 2010, the FCC issued new rules to govern network management practices and prohibit unreasonable discrimination in the transmission of Internet traffic. The FCC’s decision adopting these rules was vacated and remanded to the agency for further consideration
.

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On February 26, 2015, the FCC released its “Open Internet Order,” adopting new net neutrality rules for broadband providers. In addition to reclassifying broadband internet access as a common carrier service subject to Title II of the Communication Act, the order adopts three main prohibitions: (i) no “blocking,” (ii) no “throttling” and (iii) no “paid prioritization.” As a standard of conduct, the FCC ruled that providers may not unreasonably interfere with or unreasonably disadvantage (i) end users’ ability to select, access and use broadband Internet access service or the lawful Internet content, applications, services or devices of their choice, or (ii) edge providers’ ability to make lawful content, applications, services or devices available to end users. The FCC also adopted enhanced transparency rules which apply, among other things, to price, performance characteristics and network practices. Finally, the FCC declined to forbear from application of Title II’s core consumer safeguards, but did forbear from unbundling and network access requirements such as those impose by Title II on ILECs. The FCC’s “Open Internet” rules were upheld on appeal, but are likely to be rolled back by the new Trump administration.
Long Distance Competition.  Section 271 of the Communications Act, enacted as part of the Telecommunications Act, established a process by which an RBOC could obtain authority to provide long distance service in a state within its region. Each RBOC was required to demonstrate that it had satisfied a “14-point competitive checklist” and that granting such authority would be in the public interest. All of the RBOCs have received FCC approval to provide in-state long distance service within their respective regions. Receipt of Section 271 authority by the RBOCs has resulted in increased competition in certain markets and services.
The RBOCs have a continuing obligation to comply with the 14-point competitive checklist, and are subject to continuing oversight by the FCC and state public utility commissions. Each RBOC must provide unbundled access to UNEs at just and reasonable rates and comply with state-specific Performance Assurance Plans pursuant to which a RBOC that fails to provide access to its facilities in a timely and commercially sufficient manner must provide affected CLECs compensation in the form of cash or service credits.
On November 8, 2013, the FCC released its “Rural Call Completion Order” which adopted new rules designed to strengthen its ability to ensure the provision of a reasonable and nondiscriminatory level of service to rural areas. To this end, the FCC adopted rules that require, among other things, certain originating long-distance providers to record, retain and report information on long distance call completion. The data so gathered is intended to allow the FCC to monitor service so as to ensure that the percentage delivery and service quality of calls to rural areas is comparable to the percentage delivery and service quality of calls to non-rural areas. The FCC has entered into a number of consent decrees and imposed substantial finds on large interexchange carriers (“IXCs”) whose rural call completion results failed to pass muster.
Detariffing.  The FCC has largely eliminated carriers’ obligations to file with the FCC tariffs containing prices, terms and conditions of service and has required carriers to withdraw all of their federal tariffs other than those relating to access services. Our interstate and international rates nonetheless must still be just and reasonable and nondiscriminatory. Our state tariffs generally remain in place, although an increasing number of states are following the FCC’s lead and eliminating tariffs. Detariffing precludes our ability to rely on filed rates, terms and conditions as a means of providing notice to customers of prices, terms and conditions under which we offer services, and requires us instead to rely on individually negotiated agreements with end-users. We have, however, historically relied primarily on our sales force and marketing activities to provide information to our customers regarding the rates, terms, and conditions of service and expect to continue to do so. Further, in accordance with the FCC’s orders we maintain a schedule of our rates, terms and conditions for our interstate and international services on our web site.
Intercarrier Compensation.  The FCC’s intercarrier compensation rules include rules governing access charges, which govern the payments that IXCs and wireless service providers make to local exchange carriers (“LECs”) to originate and terminate long distance calls, and reciprocal compensation rules, which generally govern the compensation between telecommunications carriers for the transport and termination of local traffic. On March 3, 2005, the FCC released a further Notice of Proposed Rulemaking seeking comment on a variety of proposals to replace the current system of intercarrier payments, under which the compensation rate depends on the type of traffic at issue, the type of carriers involved, and the end points of the communication, with a unified approach for access charges and reciprocal compensation. In connection with the FCC’s rulemaking proceeding, a number of industry groups attempted to negotiate a plan that would bring all intercarrier compensation and access charges to a unified rate over a negotiated transition period. The FCC called for public comment on one such plan designated the “Missoula Plan.” In November 2008, the FCC issued a further Notice of Proposed Rulemaking setting forth various proposals for the reform of its intercarrier compensation regime. In its “National Broadband Plan,” released on March 16, 2010, the FCC recommended that per-minute intercarrier compensation charges be eliminated over time: first, by moving intrastate switched access charges to interstate levels over a period of two to four years; second, by moving switched access charge rates to reciprocal compensation levels; and third, by phasing out per-minute intercarrier compensation rates altogether.

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In November 2011, the FCC adopted policy changes that will over time ultimately reduce carriers’ access rates applicable for all telecommunications traffic exchanged with an LEC to a uniform “bill-and-keep” framework for both intrastate and interstate access traffic. The reforms required by the FCC’s new rules are being phased in over a multi-year transition. Specifically, effective December 29, 2011, the following rates were capped: (1) all interstate access rate elements and reciprocal compensation rates; (2) for price cap carriers and CLECs operating in their areas, all intrastate access rates; and (3) for rate-of-return carriers and CLECs operating in their areas, terminating access rates only. In addition, competitive carriers were required to reduce their intrastate tariffed access charges by July 2013 to those no greater than the incumbent carriers with which they compete, as was currently required with CLEC’s interstate access charges. From 2015 through 2018, further reductions in both intrastate and interstate access charges and reciprocal compensation rates are required, with a “bill-and-keep” framework ultimately applicable for all charges. These new rules significantly alter the manner in which all carriers, including carriers such as us that use different service platforms such as wireless and VoIP, are compensated for the origination and termination of telecommunications traffic and the rates that we pay for these services. The FCC new intercarrier compensation regime was upheld on appeal in the U.S. Court of Appeals for the Tenth Circuit. While in their current form, these new rules will result in a loss of revenues for carriers such as us, the FCC has authorized carriers such as us to recover lost revenue attributable to the FCC action through price increases and charges to the end user customer.
On April 18, 2001, the FCC issued a new order regarding intercarrier compensation for ISP-bound traffic. In that Order, the FCC established a new intercarrier compensation mechanism for ISP-bound traffic with declining rates over a three-year period. In addition to establishing a new rate structure, the FCC capped the amount of ISP-bound traffic that would be “compensable” and prohibited payment of intercarrier compensation for ISP-bound traffic to carriers entering new markets. The April 2001 order was appealed to the D.C. Circuit, which ultimately found that the FCC had not provided an adequate legal basis for its ruling, and therefore remanded the matter to the FCC. In the interim, the court let the FCC’s rules stand. In November 2008, the FCC issued revised rules governing the intercarrier compensation regime that would govern ISP-bound traffic. These rules have been upheld on appeal. On October 8, 2004, the FCC issued an order in response to a July 2003 Petition for Forbearance filed by Core Communications (the “Core Petition”) asking the FCC to forbear from enforcing the rate caps, growth cap, and new market and mirroring rules of the remanded April 2001 order. The FCC granted the Core Petition with respect to the growth cap and the new market rules, but denied the Core Petition as to the rate caps and mirroring rules.
CALEA.  The Communications Assistance for Law Enforcement Act (“CALEA”) requires communications providers to provide law enforcement officials with call content and/or call identifying information under a valid electronic surveillance warrant, and to reserve a sufficient number of circuits for use by law enforcement officials in executing court-authorized electronic surveillance.
CPNI.  FCC rules protect the privacy of certain information about customers that communications carriers, including us, acquire in the course of providing communications services. CPNI includes information related to the quantity, technological configuration, type, destination and the amount of use of a communications service. The FCC’s initial CPNI rules prevented a carrier from using CPNI to market certain services without the express approval of the affected customer, referred to as an “opt-in” approach. In July 2002, the FCC revised its opt-in rules in a manner that limits our ability to use the CPNI of our subscribers without first engaging in extensive customer service processes and recordkeeping. Recently, the FCC further modified its CPNI requirements to, among other things, extend CPNI regulations to interconnected VoIP providers, require annual carrier certifications and to impose additional limitations on the release of CPNI without express customer approval. Congress has recently overturned the FCC action extending privacy rules to interconnected VoIP providers.
Universal Service.  Section 254 of the Communications Act and the FCC’s implementing rules require all communications carriers providing interstate or international communications services to periodically contribute to the Universal Service Fund (“USF”). The USF supports several programs administered by the Universal Service Administrative Company (“USAC”) with oversight from the FCC, including: (i) communications and information services for schools and libraries, (ii) communications and information services for rural health care providers, (iii) basic telephone service in regions characterized by high communications costs, (iv) basic telephone services for low-income consumers, and (v) interstate access support. Based on the total funding needs for these programs, the FCC determines a contribution factor, which it applies to each contributor’s interstate and international end-user communications revenues. We measure and report our revenues in accordance with rules adopted by the FCC. The contribution rate factors are calculated and revised quarterly and we are billed for our contribution requirements each month based on projected interstate and international end-user communications revenues, subject to periodic true-up. USF contributions may be passed through to consumers on an equitable and nondiscriminatory basis either as a component of the rate charged for communications services or as a separately invoiced line item.
In its “National Broadband Plan,” the FCC offered a series of ambitious proposals to transform the then current universal voice service mandate into one directly supporting universal access to broadband services, phasing out support for voice-only telephone services and replacing it with support for voice-enabled broadband platforms. In November 2011, the FCC expanded the USF to include broadband services as part of the Connect America Fund (“CAF”). The new fund also includes a “Mobility Fund,” making mobile broadband an independent universal service objective.

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Telephone Numbering.  The FCC oversees the administration and the assignment of local telephone numbers, an important asset to voice carriers, by NeuStar, Inc., in its capacity as North American Numbering Plan Administrator (“NANC”). Extensive FCC regulations govern telephone numbering, area code designation, and dialing procedures. Since 1996, the FCC has permitted businesses and residential customers to retain their telephone numbers when changing local telephone companies, referred to as local number portability. The availability of number portability is important to competitive carriers like us, because customers, especially businesses, may be less likely to switch to a competitive carrier if they cannot retain their existing telephone numbers.
On May 14, 2009, the FCC issued an order that requires carriers to complete simple wireline and simple intermodal number ports within one business day. The order requires the North American Numbering Council (“NANC”) to develop new process flows that take into account the shortened porting interval.
Slamming.  A customer’s choice of local or long distance communications company is encoded in the customer’s record, which is used to route the customer’s calls so that the customer is served and billed by the desired company. A customer may change service providers at any time, but the FCC and some states regulate this process and require that specific procedures be followed. Slamming occurs when these specific procedures are not followed, such as when a customer’s service provider is changed without proper authorization or as a result of fraud. The FCC has levied substantial fines for slamming.
Taxes and Regulatory Fees.  We are subject to numerous local, state and federal taxes and regulatory fees, including but not limited to a three percent federal excise tax on local service, FCC regulatory fees and public utility commission regulatory fees. We have procedures in place to ensure that we properly collect taxes and fees from our customers and remit such taxes and fees to the appropriate entity pursuant to applicable law and/or regulation.
The Internet Tax Freedom Act placed a moratorium on taxes on Internet access and multiple, discriminatory taxes on electronic commerce. Certain states have enacted various taxes on Internet access and electronic commerce, and selected states’ taxes are being contested on a variety of bases.
State Regulation
The Communications Act maintains the authority of individual states to impose their own regulation of rates, terms and conditions of intrastate services, so long as such regulation is not inconsistent with the requirements of federal law or has not been preempted. Because we provide communications services that originate and terminate within individual states, including both local service and in-state long distance toll service, we are subject to the jurisdiction of the public utility commission and other regulators in each state in which we provide such services. For instance, we must obtain a Certificate of Public Convenience and Necessity (“CPCN”) or similar authorization before we may commence the provision of communications services in a state. We are certified to provide facilities-based and resold competitive local and interexchange service throughout the contiguous United States the State of Hawaii and the District of Columbia.
In addition to requiring certification, state regulatory authorities often impose tariff and filing requirements and obligations to contribute to state universal service and other funds. State public utility commissions also regulate, to varying degrees, the rates, terms and conditions upon which we and our competitors conduct retail business. In general, state regulation of ILEC retail offerings is greater than the level of regulation applicable to CLECs. In a number of states, however, ILECs either have obtained or continue to actively seek some level of increased pricing flexibility or deregulation, either through amendment of state law or through proceedings before state public utility commissions.
We also are subject to state laws and regulations regarding slamming, cramming, and other consumer protection and disclosure regulations. States further retain the right to sanction a service provider or to revoke certification if the service provider violates relevant laws or regulations. Finally, we may be subject to requirements in some states to obtain prior approval for, or notify the state commission of, any transfers of control, sales of assets, corporate reorganizations, issuance of stock or debt instruments and related transactions.
Rates for intrastate switched access services, which we provide to IXCs to originate and terminate in-state toll calls, are subject to the jurisdiction of the state in which the call originated and/or terminated. State public utility commissions also regulate the rates ILECs charge for interconnection, access to network elements, and resale of services by competitors.
State regulators establish and enforce wholesale service quality standards that RBOCs must meet in providing network elements to CLECs like us. These plans sometimes require payments from the ILECs to the CLECs if quality standards are not met. ILECs are actively petitioning various state commissions to modify the state wholesale quality plans in ways that would reduce or eliminate certain wholesale quality standards.

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Local Regulation
Local governments may regulate aspects of our business through zoning requirements, permit or right-of-way procedures, and franchise fees. In some municipalities where we have installed facilities, we may be required to pay license or franchise fees based on a percentage of our revenues generated from within the municipal boundaries.
Regulation of VoIP
Federal and State
The use of the public Internet and private Internet protocol networks to provide voice communications services, including VoIP, has been largely unregulated within the United States. To date, the FCC has not imposed regulatory surcharges or most forms of traditional common carrier regulation upon providers of Internet communications services, although it has ruled that VoIP providers must contribute to the USF. The FCC has also imposed obligations on providers of two-way interconnected VoIP services to provide E911 service, and it has extended CALEA obligations to such VoIP providers. The FCC has also imposed on VoIP providers the obligation to “port” customers’ telephone numbers when customers switch carriers and desire to retain their numbers. Other aspects of VoIP and Internet telephony services, such as regulations relating to the confidentiality of data and communications, copyright issues and taxation of services, may be subject to federal or state regulation.
In a series of decisions issued in 2004, the FCC clarified that the FCC, not the state public utility commissions, has jurisdiction to decide the regulatory status of IP-enabled services, including VoIP. On November 12, 2004, in response to a request by Vonage Holdings Corp., a VoIP services provider, the FCC issued an order preempting traditional telephone company regulation of VoIP service by the Minnesota Public Utility Commission, finding that the service cannot be separated into interstate and intrastate communications without negating federal rules and policies. In April 2004, the FCC issued an order concluding that, under current rules, AT&T’s phone-to-phone IP telephony service is a telecommunications service upon which interstate access charges may be assessed. This decision, however, is limited to interexchange service that: (1) uses ordinary customer premises equipment with no enhanced functionality; (2) originates and terminates on the PSTN; and (3) undergoes no net protocol conversion and provides no enhanced functionality to end-users due to the provider’s use of IP technology. The FCC made no determination regarding retroactive application of its ruling, and stated that the decision does not preclude it from adopting a different approach when it resolves the IP-enabled services or intercarrier compensation rulemaking proceedings.
In November 2011, the FCC adopted intercarrier compensation rules under which all traffic, including VoIP-PSTN traffic, ultimately will be subject to a bill-and-keep framework. As of December 29, 2011, default rates for toll VoIP-PSTN traffic were required to be equal to interstate access rates applicable to non-VoIP traffic both in terms of rate level and rate structure; default rates for other VoIP-PSTN traffic were required to be reciprocal compensation rates. In addition, VoIP-PSTN traffic is subject to the same phase-down of access rates as are applied to traditional voice traffic. By a Declaratory Ruling released on February 11, 2015, the FCC clarified the applicability of the “VoIP symmetry rule” adopted in the action described above, making it clear that the VoIP symmetry rule is technology and facilities neutral and that, therefore, whether a CLEC partners with a facilities-based or an “over-the-top” VoIP provider, the CLEC is nonetheless deemed to be providing the “functional equivalent” of end office switching for access charge purposes.
Other Domestic Regulation
We are subject to a variety of federal, state, local, and foreign environmental, safety and health laws, and governmental regulations. These laws and regulations govern matters such as the generation, storage, handling, use, and transportation of hazardous materials, the emission and discharge of hazardous materials into the atmosphere, the emission of electromagnetic radiation, the protection of wetlands, historic sites, and endangered species and the health and safety of employees. We also may be subject to laws requiring the investigation and cleanup of contamination at sites we own or operate or at third-party waste disposal sites. Such laws often impose liability even if the owner or operator did not know of, or was not responsible for, the contamination.



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Item 1A.
Risk Factors
Our business faces many risks. Accordingly, existing and prospective investors and shareholders should carefully consider the risks and uncertainties described below and the other information in this report, including the consolidated financial statements and notes to consolidated financial statements. If any of the following risks or uncertainties actually occurs, our business, financial condition or results of operations would likely suffer. Additional risks and uncertainties not presently known to us or that are not currently believed to be important to you also may adversely affect our company.
Risks Related to Our Industry

The communications market in which we operate is highly competitive, and we may not be able to compete effectively against companies that have greater resources and/or different service offerings than we do, which could cause us to lose existing customers and impede our ability to attract new customers.
The communications industry is highly competitive and is affected by the introduction of new services and systems by, and the market activities of, major industry participants with substantial market shares. We have not achieved, and do not expect to achieve, a major share of any of the service, product or geographic markets we serve.
In each of our geographic markets we compete with the incumbent local exchange carrier (“ILEC”) serving that area. ILECs have the following advantages over us:
long-standing relationships and strong brand reputation with customers;
financial, technical, marketing, personnel and other resources substantially greater than ours;
more funds to deploy communications services and systems that compete with ours;
the potential to subsidize competitive services with revenue from a variety of businesses;
relaxed regulatory oversight, including increased pricing flexibility;
larger networks; and
benefits from existing regulations that favor ILECs.
We also face, and expect to continue to face, competition in the local exchange market from other existing and potential market participants, such as competitive local exchange carriers (“CLECs”), cable television (“CATV”) companies and wireless service providers. We generally target the same small and medium sized enterprises and multi-location business customers as other CLECs. CATV companies are increasingly targeting these same customers and are doing so at rates lower than we generally offer. We are also increasingly subject to competition from carriers providing voice over Internet protocol (“VoIP”) over the public Internet or private networks. VoIP providers are currently subject to substantially less regulation than traditional local telephone companies and do not pay certain taxes and regulatory charges that we are required to pay.
In the long distance market, we face competition from the ILECs, large and small interexchange carriers (“IXCs”), wireless carriers and VoIP providers. Long distance prices have decreased substantially in recent years and are expected to continue to decline in the future as a result of increased competition.
In addition, the development of new technologies continues to give rise to new competitors in our markets. For example, in the managed services and “cloud” markets, we face competition not only from communications providers, but from major software and social media providers, as well as new entrepreneurial entities.
Further information regarding competition in the communications market is included in the section entitled “Industry and Competition.”


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The communications industry is undergoing rapid technological changes, and new technologies may be superior to the technologies we use. We may fail to anticipate and keep up with such changes.
The communications industry is subject to rapid and significant changes in technology and in customer requirements and preferences. If we fail to anticipate and keep up with such changes, we could lose market share, which could reduce our revenue. We have developed our business based, in part, on traditional telephone technology. Subsequent technological developments may reduce the competitiveness of our network and require expensive unanticipated upgrades or additional communications products that could be time consuming to integrate into our business. We may be required to select one technology over another at a time when it might be impossible to predict with any certainty which technology will prove to be more economic, efficient or capable of attracting customers. In addition, even though we utilize new technologies, such as hosted VoIP and other cloud-based services, we may not be able to implement other new technologies as effectively as other companies with more experience with those new technologies. In addition, while we have deployed new technologies, including soft-switches, EoC, MPLS, SIP and core and edge routers, we may not be able to implement new technology as effectively as other companies with more experience with such technologies.
We are subject to substantial government regulation that may restrict our ability to provide, and may increase the costs we incur to provide, our services.
We are subject to varying degrees of federal, state and local regulation. Pursuant to the Communications Act of 1934 (“Communications Act”), the Federal Communications Commission (“FCC”) exercises jurisdiction over us with respect to interstate and international services. We must comply with various federal regulations, including rules regarding the content of our bills, protection of subscriber privacy, maintenance of service quality standards and other consumer protection matters. If we fail to comply with federal reporting and regulatory requirements, we may incur fines or other penalties, including loss of our authority to provide services.
State regulatory commissions also exercise jurisdiction over us to the extent we provide intrastate services. We are required to obtain regulatory authorization and/or file tariffs with regulators in many of the states in which we operate. State regulatory commissions also often regulate the rates, terms and conditions at which we offer service. We have obtained all of the certifications necessary for us to provide our services, but each state commission retains the authority to revoke our certificate to provide service in its state if it determines that we have violated any condition of our certification or if it finds that doing so would be in the public interest.
Both federal and state regulators require us to pay various fees and assessments, including contribution to federal and state Universal Service Funds (“USF”). If we fail to comply with these requirements, we may be subject to fines or potentially be asked to show cause as to why our certificates of authority to provide service should not be revoked.

A discussion of legal and regulatory developments is included in the section entitled “Business - Regulation.”
Elimination or relaxation of regulatory rights and protections could harm our business, results of operations and financial condition.
The FCC has reduced our ability to access certain elements of ILEC telecommunications platforms in ways that have affected our operations. For example, we no longer have the right to require ILECs to sell us unbundled network element platforms (“UNE-P”) and now must obtain such services pursuant to commercial agreements. Expiration or termination of such a commercial arrangement would result in a substantial increase in our cost of service. In certain central offices, we also no longer have the right to require ILECs to sell to us as unbundled network elements (“UNEs”), or have limited access rights to obtain, UNE high capacity circuits that connect our central switching office locations to our customers’ premises. We further no longer have the right to require ILECs to sell us UNE transport between our switches and ILEC switches. Still further, we have only limited or no access to UNE DS1 or DS3 transport on certain interoffice routes. Where we lose unbundled access to high capacity circuits or interoffice transport, we must either find alternative suppliers or purchase substitute circuits from the ILECs as special access, which increases our costs. Finally, our access to certain broadband elements of the ILEC network has been limited or eliminated in certain circumstances, our access to the ILEC’s copper infrastructure could be eliminated if the ILECs elect to retire their copper facilities and the requirement that ILECs provide a 64 kbps voice channel where copper loops have been retired has been eliminated. Inability to access copper facilities would eliminate or reduce our ability to provide EoC and interfere with our ability to provide cost-effective broadband service.
Section 10 of the Communications Act requires the FCC to forbear from applying individual provisions of the Communications Act or its various enabling regulations upon a showing (i) that a statutory provision or a regulation is not necessary to ensure that rates and practices remain just, reasonable and non-discriminatory or otherwise necessary to protect consumers, (ii) that forbearance would generally be in the public interest and (iii) that forbearance would promote competition. Pursuant to

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Section 10, the FCC has effectively deregulated provision of certain broadband services. Exercising its forbearance authority, the FCC has also relieved ILECs in certain markets of their obligation to provide CLECs with unbundled access to network elements at rates mandated by state regulatory commissions. Further exercise by the FCC of its forbearance authority could have an adverse impact on our business and operations.
A discussion of legal and regulatory developments is included in the section entitled “Business - Regulation.”
The communications industry faces significant regulatory uncertainties and the adverse resolution of these uncertainties could harm our business, results of operations and financial condition.
The Communications Act remains subject to judicial review and ongoing proceedings before the FCC, including proceedings relating to interconnection pricing, access to and pricing for UNEs and special access services and other issues that could result in significant changes to our business and business conditions in the communications industry generally. Decisions by the FCC have eliminated or reduced our access to certain elements of the ILEC telecommunications platforms we use to serve our customers and increased the rates that we must pay for such elements. Other FCC decisions have reduced our intercarrier compensation revenues and raised our contributions to the USF. Other proceedings are pending before the FCC that could potentially further limit our access to these network elements or further increase the rates we must pay for such elements. Likewise, proceedings before the FCC could impact the availability and price of special access facilities. Other proceedings before the FCC could result in increases in the cost of regulatory compliance. A number of states also have proceedings pending that could impact our access to and the rates we pay for network elements. Other state proceedings could limit our pricing and billing flexibility. Our business would be substantially impaired if the FCC, the courts or state commissions eliminated our access to the facilities and services we use to serve our customers, substantially increased the rates we pay for facilities and services or adversely impacted the revenues we receive from other carriers or our customers. In addition, congressional legislative efforts to rewrite the Communications Act or enact other telecommunications legislation, as well as various state legislative initiatives, may cause major industry and regulatory changes. We cannot predict the outcome of these proceedings or legislative initiatives or the effects, if any, that these proceedings or legislative initiatives may have on our business and operations.
A discussion of legal and regulatory developments is included in the section entitled “Business - Regulation.”
Continued industry consolidation could further strengthen our competitors and could adversely affect our prospects.
Consolidation in the telecommunications industry is occurring at a rapid pace. In addition to the combinations of Verizon and MCI and SBC, AT&T and BellSouth, numerous CLEC combinations have occurred, including several which directly impact our markets such as Windstream/Paetec, Paetec/Cavalier, Earthlink/ITCDeltaCom, Earthlink/One Communications and Verizon/XO Communications. This consolidation strengthens our competitors and poses increased competitive challenges for us. The ILEC/interexchange carrier combinations not only provided the ILECs with national and international networks, but eliminated the two most effective and well-financed opponents of the ILECs in federal and state legislative and regulatory forums and potentially reduced the availability of non-ILEC network facilities. The CLEC combinations provide direct competitors with greater financial, network and marketing assets.


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Risks Related to Our Business
Risks Related to Our Operations
Our success depends on the ability to manage and expand operations effectively.
Our ability to manage and expand operations effectively will depend on the ability to:
offer high-quality, reliable services at reasonable costs;
introduce new technologies;
install and operate telecommunications switches and related equipment;
lease access to suitable transmission facilities at competitive prices;
scale operations;
obtain successful outcomes in disputes and in litigation, rule-making, legislation and regulatory proceedings;
successfully negotiate, adopt or arbitrate interconnection agreements with ILECs;
acquire necessary equipment, software and facilities;
integrate existing and newly-acquired technology and facilities, such as switches and related equipment;
evaluate markets;
add products;
monitor operations;
control costs;
maintain effective quality controls;
hire, train and retain qualified personnel;
enhance operating and accounting systems;
address operating challenges;
adapt to market and regulatory developments; and
obtain and maintain required governmental authorizations.
In order for us to succeed, these objectives must be achieved in a timely manner and on a cost-effective basis. If these objectives are not achieved, we may not be able to compete in existing markets or expand into new markets.
If we are unable to retain and attract management and key personnel, we may not be able to execute our business plan.
We believe that our success is due, in part, to our experienced management team. Losing the services of one or more members of our management team could adversely affect our business and possibly prevent us from further improving our operational, financial and information management systems and controls. We do not maintain “key- man” life insurance on any of our officers.
Our ability to implement our business plan is dependent on our ability to retain and hire a large number of qualified new employees each year. The competition for qualified technical and sales personnel is intense in the communications industry and in our markets. If we are unable to hire sufficient qualified personnel, our customers could experience inadequate customer service and delays in the installation and maintenance of service, which could have a material adverse effect on our business, results of operations and financial condition.

Our ability to provide our services and systems at competitive prices is dependent on our ability to negotiate and enforce favorable interconnection and other agreements with ILECs.
Our ability to continue to obtain favorable interconnection, unbundling, service provisioning and pricing terms is dependent, in part, on maintenance of interconnection agreements with ILECs. We are party to one or more interconnection agreements in each of the contiguous 48 States, the State of Hawaii and the District of Columbia. The initial terms of all of our interconnection agreements in the Northeast and Mid-Atlantic have expired; however, each of these agreements contains an “evergreen” provision that allows the agreement to continue in effect until terminated. If we were to receive a termination notice from an ILEC, we could negotiate a new agreement or initiate an arbitration proceeding at the relevant state commission before the agreement expired. In addition, the Communications Act gives us the right to opt into interconnection agreements which have been entered into by other carriers, provided the agreement is still in effect and provided that we adopt the entire agreement. We are in the process of renegotiating the terms of our New York interconnection agreements with Verizon. We cannot assure you that we will be able to successfully renegotiate these agreements or any other interconnection agreement on terms favorable to us or at all.

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We also rely on commercial arrangements with ILECs to secure the services and facilities we use to serve our customer. For example, we acquire what would have been UNE-P service from Verizon pursuant to a Wholesale Advantage Agreement. If this agreement were to be terminated or expire, we would be required to convert all of the lines thereunder to resale, which would be substantially less favorable to us in terms of cost and service. We cannot assure you that our commercial agreement with Verizon will be renewed at the end of its term or that it will not be terminated before the end of its term.
We have also entered into interstate contract tariffs with Verizon that allow us to purchase special access facilities at discounted rates. Our new interstate contract tariff requires us to maintain certain dollar levels of purchases of Verizon services. If we were to fail to maintain these purchase levels, our contract tariff would likely be terminated, causing our cost of service to rise substantially. We cannot assure you that our contract tariff will be renewed at the end of its term or that it will not be terminated before the end of its term.
We maintain other commercial arrangements with Verizon pursuant to which we purchase unregulated network facilities. We cannot assure you that these commercial agreements with Verizon will be renewed at the end of their terms or that they will not be terminated before the end of their terms.
Our various interconnection and certain commercial agreements with Verizon contain provisions pursuant to which we could be compelled to provide letters of credit in an amount of up to two months’ anticipated billings if, in any two months of a consecutive 12-month period, we fail to timely pay undisputed amounts due Verizon and fail to promptly cure such nonpayment. The provision of such letters of credit could adversely impact our liquidity position. Our various interconnection and certain commercial agreements with Verizon also substantially limit the time period within which both we and Verizon can (i) backbill for services rendered to the other and (ii) dispute charges for services rendered to the other.
Due to their control of “last-mile” access to many of our customers, if we experience difficulties in working with ILECs, our ability to offer services on a timely and cost-effective basis could be materially and adversely affected.
Our business depends on our ability to interconnect with ILEC networks and to lease from the ILECs certain essential network elements. We obtain access to these network elements and services under terms established in interconnection agreements, contract tariffs and commercial arrangements that we have entered into with ILECs. Like many competitive communications services providers, from time to time, we have experienced difficulties in working with ILECs with respect to obtaining information about network facilities, ordering and maintaining network elements and services, interconnecting with ILEC networks and settling financial disputes. These difficulties can impair our ability to provide service to customers on a timely and competitive basis. If an ILEC refuses to cooperate or otherwise fails to support our business needs for any other reason, including labor shortages, work stoppages, cost-cutting initiatives or disruption caused by mergers, other organizational changes or terrorist attacks, our ability to offer services on a timely and cost-effective basis can be materially and adversely affected.
We depend on a limited number of non-ILEC third-party service providers for long distance, data, cloud, managed and other services, and if any of these providers were to experience significant interruptions in its business operations, or were to otherwise cease to provide such services to us, our ability to provide services to our customers could be materially and adversely affected.
We depend on a limited number of non-ILEC third-party service providers for long distance, data, cloud, managed and other services. If any of these non-ILEC third-party providers were to experience significant interruptions in their business operations, terminate their agreements with us or fail to perform the services or meet the standards of quality required under the terms of our agreements with them, our ability to provide these services to our customers could be materially and adversely affected for a period of time that we cannot predict. If we have to migrate the provision of these services to an alternative provider, we cannot assure you that we would be able to timely locate alternative providers of such services, that we could migrate such services in a short period of time without significant customer disruption so as to avoid a material loss of customers or business, or that we could do so at economical rates.
System disruptions or the failure of our information systems to perform as expected could result in increased capital expenditures, customer and vendor dissatisfaction, loss of business or the inability to add new customers or additional services.
Our success ultimately depends on providing reliable service. Our provision of services may be disrupted by problems in the network, such as equipment failures and problems with a competitor’s or vendor’s system, such as physical damage to telephone lines or power surges and outages. In addition, our engineering and operations organizations continually monitor and analyze the utilization of our network. As a result, they may develop projects to modify or eliminate network circuits that are underutilized. This ongoing process may result in limited network outages for a subset of our customers. Any disruption in our network could cause the loss of customers and result in additional expenses.

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The day-to-day operation of our business is highly dependent on our ability to protect our communications and information technology systems from damage or interruptions by events beyond our control. Sabotage, computer viruses or other infiltration by third parties could damage or disrupt our service, damage our facilities, damage our reputation and cause us to lose customers, among other things. A catastrophic event could materially harm our operating results and financial condition. Catastrophic events could include a terrorist attack in markets where we operate or a major earthquake, fire, or similar event that would affect our central offices, corporate headquarters, network operations center or network equipment.
In recent years, the Northeast and Mid-Atlantic states have been struck by multiple catastrophic storms. These storms have, in some cases, demolished the network infrastructure of our principal facilities provider in key areas. They have also caused substantial damage to our network infrastructure. Such natural disasters have, and in the future may again, materially harm our operating results and financial condition.
Certain real estate leases and agreements are important to our business and failure to maintain such leases and agreements could adversely affect us.
Our switches are housed in facilities owned by third parties. Our use of these facilities is subject to multiple real estate leases. If we were to lose one or more of these leases, the resultant relocation of one or more of our switches would be costly and disruptive to our business and customers. We cannot assure you that we will be able to maintain all of the real estate leases governing our multiple switch sites.
Our business, results of operations and financial condition could be adversely affected if our customers terminate their contracts or are migrated by sales agents to another carrier.
Customers, whether on “month-to-month” arrangements or long-term contracts, periodically terminate their contracts, with or without penalties. If a significant percentage of customers or a significant number of key customers should terminate their service agreements with us, our business, results of operations and financial condition could be adversely affected.
Also, certain of our agreements with sales agents do not expressly preclude the sales agent from migrating the customers they secured for us to other carriers. Sales agents could attempt to obtain from these customers the authorization to replace us as the customers’ service provider. If a number of customers were to be migrated away from our service by sales agents, our business, results of operations and financial condition could be adversely affected.
Our customers are impacted by conditions in the economy as a whole. If conditions in the economy worsen, our customers may experience increasing business downturns or bankruptcies. Such adverse economic impacts could result in reduced sales, higher churn and greater bad debt for us. Reduced sales and higher churn could also result from concerns that we may not be able to repay our indebtedness. Any combination of these factors could adversely impact our operating results and financial performance.
We may engage in future acquisitions that are not successful or fail to integrate acquired businesses into our operations, which may adversely affect our competitive position and growth prospects.
As part of our business strategy, we may acquire other entities that we believe are complementary to our business. We may be unable to identify suitable acquisition candidates, or if we do identify such acquisition candidates, we may not successfully complete those transactions that are commercially favorable to us or at all, which may adversely affect our competitive position and growth prospects.
If we acquire another business, we may face difficulties, including:
integrating the personnel, services, products or technologies of that business into our operations;
retaining key personnel of that business;
failing to adequately identify or assess liabilities of that business;
failing to achieve the forecasts we used to determine the purchase price of that business; and
diverting our management’s attention from the normal daily operation of our business.
These difficulties could disrupt our ongoing business and increase our expenses. As of the date of this annual report on Form 10-K, we have no agreements to enter into any material acquisition transactions.

27


In addition, our ability to complete acquisitions will depend, in part, on our ability to finance these acquisitions, including the costs of acquisition and integration. Our ability may be constrained by our cash flow, the level of our indebtedness at the time, restrictive covenants in the agreements governing our indebtedness, conditions in the securities markets, regulatory constraints and other factors, many of which are beyond our control. If we proceed with one or more acquisitions in which the consideration consists of cash, we may use a substantial portion of our available cash to complete the acquisitions. If we finance one or more acquisitions with the proceeds of indebtedness, our interest expense and debt service requirements could increase materially. The financial impact of acquisitions could materially affect our business and could cause substantial fluctuations in our quarterly and yearly operating results.
Risks Related to Our Intellectual Property
Advanced services, such as our “cloud” and hosted VoIP services, may generate claims of intellectual property infringement.
We provide a variety of advanced services, such as our “cloud” and hosted VoIP services. These services rely on patents and other intellectual property that third parties may claim infringe their intellectual property. Such claims may materially and adversely affect our ability to continue to sell or provide advanced services to retail and wholesale customers.
We license certain intellectual property to certain other carriers for the provision of hosted VoIP service. We are often contractually bound to indemnify these other carriers in the event that a third party alleges that our intellectual property infringes its intellectual property rights. If our licensees’ provision of hosted VoIP services were to be made the subject of intellectual property infringement claims, our financial position could be adversely impacted.
Misappropriation of our intellectual property and proprietary rights could impair our competitive position, and defending against intellectual property infringement and misappropriation claims could be time consuming and expensive and, if we are not successful, could cause substantial expenses and disrupt our business.
We rely on a combination of patent, copyright, trademark and trade secret laws, as well as licensing agreements, third party non-disclosure agreements, agreements with employees and other contractual provisions and technical measures to protect our intellectual property rights. There can be no assurance that these protections will be adequate to prevent our competitors from copying or reverse-engineering our hardware or software products, or that our competitors will not independently develop technologies that are substantially equivalent or superior to our technology.
In addition, we cannot be sure that the products, services, technologies and advertising we employ in our business do not or will not infringe valid patents, trademarks, copyrights or other intellectual property rights held by third parties. We may be subject to legal proceedings and claims from time to time relating to intellectual property of others in the ordinary course of our business. Defending against intellectual property infringement or misappropriation claims could be time consuming and expensive regardless of whether we are successful, and could cause substantial expenses and disrupt our business.
As an Internet access provider, we may incur liability for information disseminated through our network.
The law relating to the liability of Internet access providers and on-line services companies for information carried on or disseminated through their networks is unsettled. As the law in this area develops, the potential imposition of liability upon us for information carried on and disseminated through our network could require us to implement measures to reduce our exposure to such liability, which may require the expenditure of substantial resources or the discontinuation of certain products or service offerings. Any costs that are incurred as a result of such measures or the imposition of liability could harm our business.
Risks Related to Our Finances
We have a history of net losses and we may not be profitable in the future.
We have experienced significant net losses. We recorded net income of $2.3 million in 2016, and net losses of $9.8 million and $9.2 million in 2015 and 2014, respectively. We cannot assure you that we will become profitable in the future.
Our revenues have declined for the past several years and we can provide no assurance that we can reverse that trend of revenue declines or offset such declines with cost reductions.

28


Our current billing disputes with our vendors may cause us to pay our vendors certain amounts of money, which could materially adversely affect our business, financial condition, results of operations and cash flows and which may cause us to be unable to meet certain financial covenants related to our senior indebtedness.
We are involved in a variety of disputes with multiple carrier vendors relating to billings of approximately $12.4 million as of December 31, 2016. When we identify an error in a vendor’s bill, we dispute the amount that we believe to be incorrect and often withhold payment for that portion of the invoice. Errors we routinely identify on bills include, but are not limited to, vendors billing us for services we did not consume, vendors billing us for services we did not order, vendors billing us for services that should have been billed to another carrier, vendors billing us for services using incorrect rates or the wrong tariff, and vendors failing to provide the necessary supporting detail to allow us to bill our customers or verify the accuracy of the bill. While we hope to resolve these disputes through negotiation, we may be compelled to arbitrate or litigate these matters. The resolution of these disputes may require us to pay the vendor an amount that is greater than the amount for which we have planned or even the amount the vendor claims is owed if late payment charges are assessed, which could materially adversely affect our business, financial condition, results of operations and cash flows. 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.
For more information regarding our billing disputes, see the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operation - Liquidity and Capital Resources - Disputes.”
Difficulties we may experience with ILECs, interexchange carriers and wholesale customers over payment issues may harm our financial performance.
We have at times experienced difficulties collecting amounts due to us for services that we provide to ILECs and IXCs. These balances due to us can be material. We cannot assure you that we will be able to reach mutually acceptable settlements to collect overdue and disputed payments in the future.
Our interconnection agreements allow ILECs to decrease order processing, disconnect customers and increase our security deposit obligations for delinquent payments. If an ILEC makes an enforceable demand for an increased security deposit, we could have less cash available for other expenses. If an ILEC were to cease order processing or disconnect customers, our business and operations would be materially and adversely affected.
Periodically, our wholesale customers experience financial difficulties. To the extent that the credit quality of our wholesale customers deteriorates or they seek bankruptcy protection, we may have difficulty collecting amounts due for services that we have provided to them. While we maintain security deposits and often retain the right to solicit end-user customers, we cannot assure you that such mechanisms will provide us adequate protection.
We periodically have disagreements with ILECs and interexchange carriers regarding the interpretation and application of laws, rules, regulations, tariffs and agreements. Adverse resolution of these disagreements may impact our revenues and our costs of service, both prospectively and retroactively. Some of the disagreements can be quantified and are included among our outstanding billing disputes with Verizon and other carriers (see the risk factor entitled “Our current billing disputes with our vendors may cause us to pay our vendors certain amounts of money, which could materially adversely affect our business, financial condition, results of operations and cash flows and which may cause us to be unable to meet certain financial covenants related to our senior indebtedness”), while others cannot be quantified because their resolution will depend upon public policy determinations not yet made by the FCC. If one or more of such disagreements were resolved through litigation or arbitration against us, such adverse resolution could require us to pay more for services than we had planned.
Periodic audits conducted by State Taxing and other Authorities may result in imposition on us of additional liabilities.
We are required to collect from our customers and remit to various State Taxing Authorities numerous local, state and federal taxes and to pay to federal and state regulatory authorities various regulatory fees and assessments. Moreover, we are required to contribute to the Universal Service Administration Company and are subject to state escheat laws. State Taxing and other Governmental Authorities periodically conduct audits of our compliance with taxing, regulatory, USF and escheat payment obligations. While we have put in place procedures to ensure that we properly collect taxes and fees from our customers and remit such taxes and fees to the appropriate entity pursuant to applicable law and/or regulation, if our collection procedures prove to be insufficient or if a taxing, regulatory, USF or escheat authority determines that our remittances were inadequate, we could be required to make additional payments, which could have a material adverse effect on our business, financial condition and results of operations.

29


Declining prices for communications services could reduce our revenues and profitability.
We may fail to achieve acceptable profits due to pricing. Prices in telecommunication services have declined substantially in recent years, a trend which continues. Accordingly, we cannot predict to what extent we may need to reduce our prices to remain competitive or whether we will be able to sustain future pricing levels as our competitors introduce competing services or similar services at lower prices. Our ability to meet price competition may depend on our ability to operate at costs equal to or lower than those of our competitors or potential competitors.

Risks Associated with Our Notes

Uncertainty surrounding our ability to refinance our existing indebtedness raises significant doubt about our ability to continue as a going concern. 
As of December 31, 2016, our outstanding indebtedness consisted of $150.0 million (face value), 10.5% senior secured notes due on November 15, 2017 and $11.5 million under our Revolving Credit Facility due on October 1, 2017. We cannot assure you that we will be able to refinance our notes or our Revolving Credit Facility on or prior to their respective maturity dates, nor can we assure you that if we are able to refinance all or a part of our indebtedness, we will be able to do so on commercially reasonable terms. In the event an infusion of capital or a refinancing does not occur, management does not believe that we will have the necessary cash to repay the principal of our senior secured notes when due. Our inability to repay the senior secured notes upon maturity without refinancing raises substantial doubt about our ability to continue as a going concern. See Note 17 to our consolidated financial statements contained in this Annual Report on Form 10-K for the fiscal year ended December 31, 2016 for more information.

Our substantial indebtedness may restrict our operating flexibility, could adversely affect our financial health and could prevent us from fulfilling our financial obligations.
Our substantial indebtedness may restrict our operating flexibility, which could adversely affect our financial health and could prevent us from fulfilling our financial obligations. The indenture governing our Notes and the credit agreement governing our Revolving Credit Facility contain covenants that, among other things, restrict our ability to take specific actions, even if we believe them to be in our best interest, including restrictions on our ability to:

incur or guarantee additional indebtedness or issue preferred stock;
pay dividends or distributions on, or redeem or repurchase, capital stock;
create liens with respect to our assets;
make investments, loans or advances;
prepay subordinated indebtedness;
 enter into transactions with affiliates;
merge, consolidate or sell our assets; and
engage in any business other than activities related or complementary to communications.

As of December 31, 2016, we had $161.9 million of total outstanding indebtedness. Our indebtedness could significantly affect our financial health and our ability to fulfill our financial obligations. For example, a high level of indebtedness could:

make it more difficult for us to satisfy our current and future debt obligations;
make it more difficult for us to obtain additional financing for working capital, capital expenditures, acquisitions or general corporate purposes;
require us to dedicate a substantial portion of our cash flows from operating activities to the payment of principal and interest on our indebtedness, thereby reducing the funds available to us for our operations and other purposes, including investments in service development, capital spending and acquisitions;
place us at a competitive disadvantage to our competitors who are not as highly leveraged as we are;
make us vulnerable to interest rate fluctuations, if we incur any indebtedness that bears interest at variable rates;
impair our ability to adjust to changing industry and market conditions; and
make us more vulnerable in the event of a further downturn in general economic conditions or in our business or changing market conditions and regulations.
We cannot assure you that we will be able to meet these requirements or satisfy these covenants in future. If we fail to do so, our indebtedness under our Notes and our Revolving Credit Facility could become accelerated and payable at a time when we are unable to pay such indebtedness. Such acceleration could adversely affect our ability to carry out our business plan and would have a negative effect on our financial condition.

30



Although the indenture governing the Notes and the credit agreement governing our Revolving Credit Facility will limit our ability and the ability of our subsidiaries to incur additional indebtedness, these restrictions are subject to a number of qualifications and exceptions and, under certain circumstances, debt incurred in compliance with these restrictions could be substantial. In addition, the indenture governing the Notes and the credit agreement governing our Revolving Credit Facility will not prevent us from incurring obligations that do not constitute indebtedness. See the section entitled, “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources.” To the extent that we incur additional indebtedness or such other obligations, the risks associated with our substantial leverage, including our possible inability to service our debt, would increase.

Our outstanding indebtedness of $150.0 million (face value) in the form of 10.5% senior secured notes are due on November 15, 2017 and outstanding indebtedness of $11.5 million in the form of our Revolving Credit Facility is due on October 1, 2017. We cannot assure you that we will be able to refinance or repay these notes or this facility on or prior to their respective maturity dates, which may affect our ability to continue as a going concern. See Note 17 to our consolidated financial statements contained in this Annual Report on Form 10-K for the fiscal year ended December 31, 2016 for more information.

To service our indebtedness, we will require a significant amount of cash. The ability to generate cash depends on many factors beyond our control.
Our ability to repay or to refinance obligations with respect to our indebtedness, including our Notes, our Revolving Credit Facility and the funding of planned capital expenditures, depends on our future financial and operating performance. This, to a certain extent, is subject to general economic, financial, competitive, business, legislative, regulatory and other factors that are beyond our control. These factors could include operating difficulties, diminished access to necessary network facilities, increased operating costs, significant customer churn, pricing pressures, the response of competitors, regulatory developments and delays in implementing strategic initiatives.
As of December 31, 2016, we held cash and cash equivalents in the amount of $24.7 million and we had drawn $11.5 million on our Revolving Credit Facility.
There can be no assurance that our business will generate sufficient cash flow from operations or that future borrowings will be available in an amount sufficient to enable us to pay our indebtedness or to fund other liquidity needs. As of December 31, 2016, we required approximately $15.8 million in cash to service the interest due on our Notes, which mature in November 2017, throughout their remaining life. We may need to refinance all or a portion of our indebtedness, including our Notes and our Revolving Credit Facility, at or before maturity. There can be no assurances that we will be able to refinance any of our indebtedness, including our Notes and our Revolving Credit Facility, on commercially reasonable terms or at all.

For more information regarding our liquidity, see the section entitled, “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources.”

Item 1B.
Unresolved Staff Comments
None.

31


Item 2.
Properties
Our corporate headquarters is located in Rye Brook, New York. We do not own any facilities. The table below lists our current material leased facilities.
Location
 
Lease Expiration
 
Approximate Square Footage
 
 
 
 
 
Offices:
 
 
 
 

King of Prussia, PA
 
January 2022
 
57,209

New York, NY
 
June 2019
 
28,567

Rye Brook, NY
 
April 2019
 
27,088

Ottawa, CN
 
June 2018
 
10,824

Melville, NY
 
October 2018
 
9,348

Switches:
 
 
 
 

New York, NY
 
December 2022
 
38,500

Philadelphia, PA
 
July 2023
 
16,617

Long Island City, NY
 
October 2019
 
14,941

Charlestown, MA
 
April 2020
 
10,464

Philadelphia, PA
 
Month to month
 
21,000

Syracuse, NY
 
October 2019
 
8,000

Philadelphia, PA
 
January 2023
 
5,928

Herndon, VA
 
June 2020
 
5,000

Item 3.
Legal Proceedings
We are 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 regarding our contractual disputes with our vendors, see the sections entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Risk Factors - Our current billing disputes with our vendors may cause us to pay our vendors certain amounts of money, which could materially adversely affect our business, financial condition, results of operations and cash flows and which may cause us to be unable to meet certain financial covenants related to our senior indebtedness” and “Risk Factors - Our ability to provide our services and systems at competitive prices is dependent on our ability to negotiate and enforce favorable interconnection and other agreements.”

Item 4.
Mine Safety Disclosures
Not Applicable.

32


PART II
Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
There is no established public trading market for our common stock. We have not declared or paid cash dividends for the past two fiscal years and we do not anticipate that we will pay any dividends to holders of our common stock in the foreseeable future, and our ability to pay dividends is restricted by the instruments governing our outstanding indebtedness. Any payment of cash dividends on our common stock in the future will be at the discretion of our board of directors and will depend upon our results of operations, earnings, capital requirements, financial condition, future prospects, contractual restrictions and other factors deemed relevant by our board of directors. The following table lists the number of record holders by each class of stock as of April 10, 2017:
Class of Equity Security
 
Holders of Record
Common stock
 
152

See Item 12 “Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters, Securities authorized for issuance under equity compensation plans” for information regarding our equity compensation plans.
Item 6.
Selected Financial Data
The following tables set forth our selected consolidated financial data for the periods indicated. The selected consolidated financial data for the years ended December 31, 2016, 2015 and 2014 and as of December 31, 2016 and 2015 have been derived from our audited consolidated financial statements included elsewhere in this report. The selected consolidated financial data for the years ended December 31, 2013 and 2012 and as of December 31, 2014, 2013 and 2012 have been derived from our audited consolidated financial statements not included elsewhere in this report.
The following financial information is qualified by reference to and should be read in conjunction with the section of this report entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the Consolidated Financial Statements and Notes to Consolidated Financial Statements. All dollar amounts are in thousands.


33


 
Year Ended December 31,
 
2016
 
2015
 
2014
 
2013
 
2012
Statements of operations data:
 
 
 
 
 
 
 
 
 
Revenues
$
288,755

 
$
291,109

 
$
300,469

 
$
315,363

 
$
340,907

Operating expenses:
 
 
 
 
 
 
 
 
 
Cost of revenues (1)
122,063

 
129,977

 
139,412

 
147,505

 
164,232

Selling, general and administrative
118,222

 
123,667

 
122,354

 
124,001

 
130,777

Depreciation and amortization
28,258

 
29,440

 
29,831

 
32,839

 
36,382

Total operating expenses
268,543

 
283,084

 
291,597

 
304,345

 
331,391

Income from operations
20,212

 
8,025

 
8,872

 
11,018

 
9,516

Reorganization items

 

 

 
(1,072
)
 
(8,415
)
Interest expense
(16,598
)
 
(16,485
)
 
(16,790
)
 
(17,196
)
 
(35,200
)
Interest income
40

 
26

 
23

 
33

 
50

Income (loss) before provision for income taxes
3,654

 
(8,434
)
 
(7,895
)
 
(7,217
)
 
(34,049
)
Provision for income taxes
(1,390
)
 
(1,358
)
 
(1,332
)
 
(1,264
)
 
(1,224
)
Net income (loss)
$
2,264

 
$
(9,792
)
 
$
(9,227
)
 
$
(8,481
)
 
$
(35,273
)
 
 
 
 
 
 
 
 
 
 
Statements of cash flow data:
 
 
 
 
 
 
 
 
 
Cash flows provided by (used in):
 
 
 
 
 
 
 
 
 
Operating activities
$
32,093

 
$
22,671

 
$
19,984

 
$
22,898

 
$
12,760

Investing activities
(21,467
)
 
(24,479
)
 
(23,172
)
 
(22,545
)
 
(6,631
)
Financing activities
(1,091
)
 
2,524

 
9,502

 
(1,946
)
 
(19,317
)
 
 
 
 
 
 
 
 
 
 
 
December 31,
 
2016
 
2015
 
2014
 
2013
 
2012
Balance Sheet data:
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
$
24,708

 
$
15,173

 
$
14,457

 
$
8,143

 
$
9,736

Property and equipment, net
48,641

 
54,125

 
57,011

 
61,070

 
68,381

Goodwill
98,238

 
98,238

 
98,238

 
98,238

 
98,238

Total assets
204,319

 
202,877

 
209,004

 
209,222

 
226,411

Total debt, including current portion
161,895

 
162,978

 
160,454

 
150,952

 
152,898

Total stockholders’ equity (deficiency)
(8,551
)
 
(10,807
)
 
(1,015
)
 
8,212

 
16,693

___________________________


(1)
Exclusive of depreciation and amortization.




34


Item 7.
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 “Selected Financial Data” and the “Consolidated Financial Statements and Notes to Consolidated Financial Statements” included elsewhere in this report. Certain information contained in the discussion and analysis set forth below and elsewhere in this 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 report that could cause results to differ materially from those expressed in such forward-looking statements, including matters set forth in the section entitled “Risk Factors”. 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 provider of cloud-based unified communication services (“UCaaS”) and information technology solutions to small and medium sized businesses (“SMB”) and enterprise customers nationwide. We offer a broad suite of cloud-based systems and services under the brand OfficeSuite® to our end-user customers nationwide. Our end-user customers have approximately 182,000 active licenses on our flagship product OfficeSuite® Phone. OfficeSuite® Phone comprises a growing percentage of our overall recurring revenue and the vast majority of our existing cloud-based revenue stream. In addition, we generate revenue from third-party service providers utilizing our technology and OfficeSuite® Phone on a white-label or wholesale basis. These third-party service providers offer services to their own end-user customers located in Canada, certain European countries and the United States with approximately 100,000 currently active licenses.
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. Previously, 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 sales efforts focused on these markets. We sell through multiple channels including our direct sales force, our channel partners which offers all of our end-user products in the Northeast and Mid-Atlantic regions and our cloud products nationwide, our inside sales channel, and our wholesale channel which provides our services to other carriers and resellers.
As of December 31, 2016, we provided our services to approximately 20,000 business customers nationwide. For the year ended December 31, 2016, approximately 88% of our total revenue was generated from 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 year ended December 31, 2016, we generated revenues of $288.8 million, and Adjusted EBITDA of $49.2 million. For more information, see the “Adjusted EBITDA Presentation” later in this section.
For the years ended December 31, 2016, 2015 and 2014, we recorded operating income of $20.2 million, $8.0 million and $8.9 million, respectively. For the year ended December 31, 2016 we recorded net income of $2.3 million and for the years ended December 31, 2015 and 2014, net losses of $9.8 million and $9.2 million, respectively. 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 being sold through new and existing sales channels that are growing, which may increase revenues and gross margin.         
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 selling, general and administrative (“SG&A”) costs, and by the achievement of certain operating efficiencies throughout the organization.

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As of December 31, 2016, we had approximately 155 sales, sales management and sales support employees, including approximately 115 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 channel partners, VARs/MSPs/ nationwide distributors/strategic partners and web channels.
We focus our sales efforts on selling cloud-based services to communications intensive business customers who purchase multiple products, many of whom have multiple locations. 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 year ended December 31, 2016, revenue from customers purchasing T-1- and IP-based products and cloud-based services, including cloud-based computing services and cloud related access, represented 84% of our end-user revenue with the remaining 16% of end-user revenue coming from customers purchasing only traditional services. Of the 84% of end-user revenue from customers purchasing T-1- and IP-based products and cloud-based services, 35% of end-user revenue was generated by cloud-based services, 34% of end-user revenue was generated by other T-1- and IP-based products, and 15% of end-user 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 88% of new end-user sales, with typical incremental gross profit margins in excess of 60%. Sales of cloud-based services, including sales of both cloud-based computing services and cloud related access, represented approximately 66% of new end-user sales while other T-1- and IP-based products represented 22% of new end-user sales. Since 2012, cloud-based products and services have grown at a 14% compound annual growth rate (“CAGR”). In the fourth quarter of 2016 relative to the fourth quarter of 2015, our end-user pure cloud revenue grew 20% and our end-user cloud access grew 5%, resulting in overall end-user cloud revenue growth of 16%.
Our facilities-based network encompasses approximately 3,000 route miles of metro and long-haul fiber including both owned and dark fiber, primarily pursuant to Indefeasible Right of Use (“IRU”) and 252 colocations. Our network architecture pairs the strength of a traditional infrastructure with IP and 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 Network (“VPN”) and complex multi-location services, on a cost effective basis. Our network topology incorporates metro Ethernet over Copper (“EoC”) 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 multiprotocol label switching (“MPLS”)-based infrastructure, which enhances the performance of our network.
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 Voice Over Internet Protocol (“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.
As a result of these initiatives, our recent levels of new customers, sales, activations, backlog pending activation and customer and revenue retention have improved. Because of these and other factors, we believe we are in a period of relative revenue and EBITDA stability, and will continue to focus on further accelerating the growth of our cloud revenue stream. However, during the transition to improving results, we may continue to experience some volatility due to several factors, including but not limited to our ongoing growth investments and the occurrence of certain non-recurring items that affect our results.

36



Ability to Continue as a Going Concern
In accordance with Financial Accounting Standards Board, or the FASB, ASU No. 2014-15, Presentation of Financial Statements - Going Concern (Subtopic 205-40), management evaluated whether there are conditions or events, considered in aggregate, that raise substantial doubt about the Company’s ability to continue as a going concern within one year after the date the financial statements are issued. Management believes we will have sufficient cash to repay the outstanding principal of $11,500 on our $25,000 Senior Revolving Credit Facility (“Credit Facility”) at its October 1, 2017 maturity date. However, management does not believe we will have sufficient cash to repay the principal of $150,000 on our New Notes at its November 15, 2017 maturity date. Accordingly, we may need to raise additional funds. Therefore, the Company has retained financial and legal counsel to pursue and evaluate various strategic alternatives, including a potential sale of all or part of the Company, and both long-term and short-term financing alternatives. We may seek to raise such capital through debt financings, bank borrowings, public or private equity financings, strategic disposition of assets, the business or portions of the business. Any future strategic options or other significant unplanned costs or cash requirements may also require that we raise additional funds through the issuance of debt or equity. Although we have had positive cash flows from operations in each of the last several years, there is uncertainty surrounding our refinancing or strategic plans. This uncertainty, coupled with management's belief we will not have sufficient cash to repay the principal on our New Notes at its maturity date, raises substantial doubt about our ability to continue as a going concern.
Our auditors have included a paragraph in this report which raises substantial doubt about our ability to continue as a going concern.  There is no assurance that we will be able to accomplish all or any of these items. See the section entitled “- Liquidity and Capital Resources”.  Our consolidated financial statements included in this report have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business.  The financial statements do not include any adjustments relating to the recoverability of the recorded assets or the classification of liabilities that may be necessary should it be determined that we are unable to continue as a going concern. We are currently pursuing strategic and refinancing alternatives and anticipate conducting our business consistent with past practices during this process. See Note 17 to our consolidated financial statements contained in this Annual Report on Form 10-K for the fiscal year ended December 31, 2016 for more information.

37


Results of Operations
The following table sets forth, for the periods indicated, certain financial data as a percentage of total revenues.
 
Year Ended December 31,
 
2016
 
2015
 
2014
Revenues:
 
 
 
 
 
Voice and data services:
 
 
 
 
 
     Cloud
29.3
 %
 
25.0
 %
 
21.0
 %
     NonCloud
55.4
 %
 
59.9
 %
 
64.0
 %
     Ancillary
3.2
 %
 
2.8
 %
 
2.8
 %
Voice and data services
87.9
 %
 
87.7
 %
 
87.8
 %
Wholesale
9.2
 %
 
9.0
 %
 
8.5
 %
Carrier access
2.1
 %
 
2.0
 %
 
2.3
 %
Total network services
99.2
 %
 
98.7
 %
 
98.6
 %
Other
0.8
 %
 
1.3
 %
 
1.4
 %
Total revenues
100.0
 %
 
100.0
 %
 
100.0
 %
Operating expenses:
 
 
 
 
 
Network services
41.9
 %
 
43.9
 %
 
45.6
 %
Other cost of revenues
0.4
 %
 
0.7
 %
 
0.8
 %
Selling, general and administrative
40.9
 %
 
42.5
 %
 
40.7
 %
Depreciation and amortization
9.8
 %
 
10.1
 %
 
9.9
 %
Total operating expenses
93.0
 %
 
97.2
 %
 
97.0
 %
Income from operations
7.0
 %
 
2.8
 %
 
3.0
 %
Interest expense
(5.7
)%
 
(5.7
)%
 
(5.6
)%
Income (loss) before provision for income taxes
1.3
 %
 
(2.9
)%
 
(2.6
)%
Provision for income taxes
(0.5
)%
 
(0.5
)%
 
(0.5
)%
Net income (loss)
0.8
 %
 
(3.4
)%
 
(3.1
)%
Key Components of Results of Operations
Revenues
    
Our revenues, as detailed in the table above, consist primarily of network services revenues, which consists 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 end-user 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 end-user and wholesale customers.

For the year ended December 31, 2016 approximately 88% of our total revenue was generated from end-user 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”). Our cloud-based revenues have grown from 2012 to 2016 at a 14% 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 significantly over the past several years. We expect our voice and data revenue will continue to be characterized by significant growth in our end-user cloud revenue offsetting most, if not all, of the decline in our traditional revenue streams. Our cloud-based products and services comprised approximately 35% of our end-user revenue and approximately 66% of new end-user sales in 2016. 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 usage in product offerings.

38



Cost of Revenues (exclusive of depreciation and amortization)
Our cost of revenues consists primarily of both the cost of operating our network facilities and the costs related to providing last mile facilities to our customers. Determining our cost of revenues requires significant estimates. The network components for our facilities-based business include the cost of:
leasing local voice grade loops and digital 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 cost of revenues consists in part of amounts that we pay to Verizon, Frontier Communications Corporation ("Frontier"), Fairpoint Communications, Inc. (“FairPoint”) and AT&T, Inc. (“AT&T”) pursuant to commercial agreements we have with each of 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. Our Verizon commercial agreement expires in 2019.  The Frontier & AT&T agreements expire in October 2017 after which both agreements continue on a month to month basis.
We have also entered into multiple tariffed agreements with Verizon under which we purchase special access services as well as an associated commercial agreement pursuant to which we take a variety of high-bandwith services; these agreements have substantial cost commitments.  These tariffed agreements and associated commercial agreement expire at the end of 2017. 
Our cost of revenues also include fees we pay for long distance, data and other services. We have entered into long-term wholesale purchasing agreements for these services with a variety of partners. Some of these agreements contain significant termination penalties and/or minimum volume commitments.
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:
 
Year Ended December 31,
 
2016
 
2015
 
2014
Income from operations
$
20,212

 
$
8,025

 
$
8,872

Add back non-gross profit items included in income from operations:
 

 
 

 
 

Depreciation and amortization
28,258

 
29,440

 
29,831

Selling, general and administrative
118,222

 
123,667

 
122,354

 
 
 
 
 
 
Gross profit (exclusive of depreciation and amortization)
$
166,692

 
$
161,132

 
$
161,057

Percentage of total revenue
57.7
%
 
55.4
%
 
53.6
%
    

39


Gross profit as used by the Company is not a financial measurement prepared in accordance with GAAP. Gross profit is a measure of the general efficiency of our network costs in comparison to our revenue. As we expense the current cost of our network against current period revenue, we use this measure as a tool to monitor our progress with regard to network optimization and other operating metrics.
Our management also uses gross profit to evaluate performance relative to that of our competitors. This financial measure permits a comparative assessment of operating performance, relative to our performance based on our GAAP results, while isolating the effects of certain items that vary from period to period without any correlation to core operating performance or that vary widely among similar companies. Our management believes that gross profit is a particularly useful comparative measure within our industry.
We provide information relating to our gross profit so that analysts, investors and other interested persons have the same data that management uses to assess our operating performance, which permits them to obtain a better understanding of our operating performance and to evaluate the efficacy of the methodology and information used by our management to evaluate and measure such performance on a standalone and a comparative basis.
Our gross profit may not be directly comparable to similarly titled measures reported by other companies due to differences in accounting policies and items excluded or included in the adjustments, which limits its usefulness as a comparative measure. In addition, gross profit has other limitations as an analytical financial measure. These limitations include the following:
gross profit does not reflect our capital expenditures or future requirements for capital expenditures;
gross profit does not reflect the interest expense, or the cash requirements necessary to service interest or principal payments, associated with our indebtedness;
 
although depreciation and amortization are non-cash charges, the assets being depreciated and amortized will likely have to be replaced in the future, and gross profit does not reflect any cash requirements for such replacements; and
gross profit does not reflect the SG&A expenses necessary to run our ongoing operations.
Our management compensates for these limitations by relying primarily on our GAAP results to evaluate our operating performance and by considering independently the economic effects of the foregoing items that are or are not reflected in gross profit. As a result of these limitations, gross profit should not be considered as an alternative to income from operations, as calculated in accordance with GAAP, as a measure of operating performance.
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.

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 Voice Over Internet Protocol (“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.
Depreciation and Amortization
Our depreciation and amortization expense 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.

40


Adjusted EBITDA Presentation
Adjusted EBITDA as presented in this Management’s Discussion and Analysis of Financial Condition and Results of Operations represents net income (loss) before depreciation and amortization, interest income and expense, provision for income taxes, and other non-recurring 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 income (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 income (loss) as net income (loss) is calculated in accordance with GAAP:
 
Year Ended December 31,
 
2016
 
2015
 
2014
Net income (loss)
$
2,264

 
$
(9,792
)
 
$
(9,227
)
Add back non-EBITDA items included in net income (loss):
 
 
 
 
 
Depreciation and amortization
28,258

 
29,440

 
29,831

Interest expense, net of interest income
16,558

 
16,459

 
16,767

Provision for income taxes
1,390

 
1,358

 
1,332

 
 
 
 
 
 
EBITDA
48,470

 
37,465

 
38,703

Severance and related separation costs

 
193

 
562

Professional fees related to strategic initiatives
592

 
696

 

Costs associated with early termination of lease, net

91

 

 

Cost associated with settlements

 
1,268

 

Adjusted EBITDA
$
49,153

 
$
39,622

 
$
39,265

Percentage of total revenues
17.0
%
 
13.6
%
 
13.1
%
Management uses Adjusted EBITDA to enhance its understanding of our operating performance, which represents management’s views concerning our performance in the ordinary, ongoing and customary course of operations. Management historically has found it helpful, and believes that investors have found it helpful, to consider an operating measure that excludes items that are not reflective of our core operations. Accordingly, the exclusion of these items in our non-GAAP presentation should not be interpreted as implying that these items are non-recurring, infrequent or unusual. Management believes that, for the reasons discussed below, our use of a supplemental financial measure, which excludes these expenses, facilitates an assessment of our fundamental operating trends and addresses concerns of management and of our investors that these expenses may obscure such underlying trends. Management notes that each of these expenses is presented in our financial statements and discussed in the management’s discussion and analysis section of our reports filed with the SEC, so that investors have complete information about the expenses.

41


The information about our operating performance provided by this financial measure is used by management for a variety of purposes. Management regularly communicates Adjusted EBITDA results to our board of directors and discusses with the board management’s interpretation of such results. Management also compares our Adjusted EBITDA performance against internal targets as a key factor in determining cash bonus compensation for executives and other employees, primarily because management believes that this measure is indicative of how the business is performing and is being managed. In addition, our management uses Adjusted EBITDA to evaluate our performance relative to that of our competitors. This financial measure permits a comparative assessment of operating performance, relative to our performance based on our GAAP results, while isolating the effects of certain items that vary from period to period without any correlation to operating performance.
Our management believes that Adjusted EBITDA is a particularly useful comparative measurement within our industry. The communications industry has experienced recent trends of increased merger and acquisition activity and financial restructurings. These activities have led to significant charges to earnings, such as those resulting from integration costs and debt restructurings, and to significant variations among companies with respect to capital structures and cost of capital (which affect interest expense) and differences in taxation and book depreciation of facilities and equipment (which affect relative depreciation expense), including significant differences in the depreciable lives of similar assets among various companies. Adjusted EBITDA facilitates company-to-company comparisons in the communications industry by eliminating some of the foregoing variations. By permitting investors to review both the GAAP and non-GAAP measures, companies that customarily use similar non-GAAP measures facilitate an enhanced understanding of historical financial results and enable investors to make more meaningful company-to-company comparisons.
We provide information relating to our Adjusted EBITDA so that analysts, investors and other interested persons have the same data that management uses to assess our operating performance, which permits these analysts, investors and other interested persons to obtain a better understanding of our operating performance and to evaluate the efficacy of the methodology and information used by our management to evaluate and measure such performance both on a standalone and a comparative basis. Management believes that Adjusted EBITDA should be viewed only as a supplement to the GAAP financial information.
Our Adjusted EBITDA may not be directly comparable to similarly titled measures reported by other companies due to differences in accounting policies and items excluded or included in the adjustments, which limits its usefulness as a comparative measure. In addition, Adjusted EBITDA has other limitations as an analytical financial measure. These limitations include the following:
Adjusted EBITDA does not reflect our capital expenditures, future requirements for capital expenditures or contractual commitments to purchase capital equipment;
Adjusted EBITDA does not reflect the interest expense, or the cash requirements necessary to service interest or principal payments, associated with our indebtedness;
although depreciation and amortization are non-cash charges, the assets being depreciated will likely have to be replaced in the future, and Adjusted EBITDA does not reflect any cash requirements for such replacements; and
Adjusted EBITDA does not reflect the effect of earnings or charges resulting from matters that management considers not indicative of our ongoing operations.
Our management compensates for these limitations by relying primarily on our GAAP results to evaluate operating performance and by considering independently the economic effects of the foregoing items that are or are not reflected in Adjusted EBITDA. As a result of these limitations, Adjusted EBITDA should not be considered as an alternative to net income (loss) as calculated in accordance with GAAP, as a measure of operating performance or as an alternative to any other GAAP measure of operating performance.


42


Year Ended December 31, 2016 Compared to the Year Ended December 31, 2015
Set forth below is a discussion and analysis of our results of operations for the years ended December 31, 2016 and 2015.
The following table provides a breakdown of components of our gross profit for the years ended December 31, 2016 and 2015:
 
Year Ended December 31,
 
 
 
2016
 
2015
 
 
 
Amount
 
% of Total
Revenues
 
Amount
 
% of Total
Revenues
 
% Change
Revenues:
 
 
 
 
 
 
 
 
 
Network services
$
286,360

 
99.2
%
 
$
287,379

 
98.7
%
 
(0.4
)%
Other
2,395

 
0.8
%
 
3,730

 
1.3
%
 
(35.8
)%
Total revenues
$
288,755

 
100.0
%
 
$
291,109

 
100.0
%
 
(0.8
)%
 
 
 
 
 
 
 
 
 
 
Cost of revenues:
 
 
 
 
 
 
 
 
 
Network services
$
120,774

 
41.9
%
 
$
127,869

 
43.9
%
 
(5.5
)%
Other
1,289

 
0.4
%
 
2,108

 
0.7
%
 
(38.9
)%
Total cost of revenues
$
122,063

 
42.3
%
 
$
129,977

 
44.6
%
 
(6.1
)%
 
 
 
 
 
 
 
 
 
 
Gross profit:
 
 
 
 
 
 
 
 
 
Network services
$
165,586

 
57.3
%
 
$
159,510

 
54.8
%
 
3.8
 %
Other
1,106

 
0.4
%
 
1,622

 
0.6
%
 
(31.8
)%
Total gross profit (exclusive of depreciation and amortization)
$
166,692

 
57.7
%
 
$
161,132

 
55.4
%
 
3.5
 %
Revenues
Revenues for the years ended December 31, 2016 and 2015 were as follows:
 
Year Ended December 31,
 
 
 
2016
 
2015
 
 
 
Amount
 
% of Total
Revenues
 
Amount
 
% of Total
Revenues
 
% Change
Revenues:
 
 
 
 
 
 
 
 
 
Voice and data services:
 
 
 
 
 
 
 
 
 
       Cloud
$
84,669

 
29.3
%
 
$
72,729

 
25.0
%
 
16.4
 %
       NonCloud
160,078

 
55.4
%
 
174,629

 
59.9
%
 
(8.3
)%
       Ancillary
8,976

 
3.2
%
 
7,994

 
2.8
%
 
12.3
 %
Voice and data services
253,723

 
87.9
%
 
255,352

 
87.7
%
 
(0.6
)%
Wholesale
26,708

 
9.2
%
 
26,084

 
9.0
%
 
2.4
 %
Carrier access
5,929

 
2.1
%
 
5,943

 
2.0
%
 
(0.2
)%
Total network services
286,360

 
99.2
%
 
287,379

 
98.7
%
 
(0.4
)%
Other
2,395

 
0.8
%
 
3,730

 
1.3
%
 
(35.8
)%
Total revenues
$
288,755

 
100.0
%
 
$
291,109

 
100.0
%
 
(0.8
)%

Revenues from voice and data services decreased $1.6 million or 0.6% between 2015 and 2016. Within voice and data services, revenues from cloud-based services increased $11.9 million, or 16.4%. This increase is due to our expanded efforts on selling our cloud-based services. Revenues from core voice and data services, excluding cloud-based services, decreased $14.6 million, or 8.3% due to: i) a lower number of lines and customers, ii) lower usage revenue per customer and iii) lower prices per unit for certain traditional services. Ancillary voice and data revenues increased $1.0 million primarily due to nonrecurring revenue. Wholesale revenues increased $0.6 million or 2.4%, driven by increased sales of certain products including cloud-based services. Carrier access revenues, which includes a net negative change in non-recurring amounts, decreased by 0.2%. Excluding the non-

43


recurring revenue, core access increased due to several factors, including: increasing levels of traffic to which access charges are applicable, offset by lower per-minute rates charged to carriers as a result of Federal Communications Commission-mandated rate decreases. Our other revenues decreased $1.3 million or 35.8% between 2015 and 2016 as a result of a reduction in certain non-ancillary revenues associated with our contracting traditional revenue stream.
 
Cost of Revenues (exclusive of depreciation and amortization)
 
Cost of revenues were $122.1 million for the year ended December 31, 2016, a decrease of 6.1% from $130.0 million for the same period in 2015. The decrease is primarily due to the increased proportion of cloud-based services, 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 42.3% in 2016 from 44.6% in 2015.
Gross Profit (exclusive of depreciation and amortization)
 
Gross profit was $166.7 million for the year ended December 31, 2016, an increase of 3.5% from $161.1 million for the same period in 2015. As a percentage of revenues, gross profit increased to 57.7% in 2016 from 55.4% in 2015. We are focusing sales initiatives towards increasing the amount of cloud-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 continue to improve over time.

Selling, General and Administrative
SG&A expenses were $118.2 million for the year ended December 31, 2016, a decrease of 4.4% from $123.7 million for the same period in 2015. As a percentage of revenues, SG&A expenses decreased to 40.9% in 2016 from 42.5% in 2015. The decrease is primarily due to i) employee related costs resulting from lower headcount and related expense, ii) repairs & contract maintenance and service maintenance as a result of cost saving initiatives in various categories,

Depreciation and Amortization
Depreciation and amortization costs were $28.3 million for the year ended December 31, 2016, a decrease of 3.7% from $29.4 million. This decrease in depreciation and amortization expense is primarily the result of property and equipment becoming fully depreciated during 2015.
Interest
Interest expense was $16.6 million for the year ended December 31, 2016, a slight increase from $16.5 million in 2015. Our effective annual interest rates for the year ended December 31, 2016 and 2015 are as follows:
 
Year Ended December 31,
 
2016
 
2015
Interest expense
$
16,598

 
$
16,485

Weighted average debt outstanding
$
162,003

 
$
160,799

Effective interest rate (1)
10.25
%
 
10.25
%
(1) The effective interest rate was 10.36% for the year ended December 31, 2016, excluding a non-debt related interest adjustment.

44


Year Ended December 31, 2015 Compared to the Year Ended December 31, 2014
Set forth below is a discussion and analysis of our results of operations for the years ended December 31, 2015 and 2014.
The following table provides a breakdown of components of our gross profit for the years ended December 31, 2015 and 2014:
 
Year Ended December 31,
 
 
 
2015
 
2014
 
 
 
Amount
 
% of Total
Revenues
 
Amount
 
% of Total
Revenues
 
% Change
Revenues:
 
 
 
 
 
 
 
 
 
Network services
$
287,379

 
98.7
%
 
$
296,244

 
98.6
%
 
(3.0
)%
Other
3,730

 
1.3
%
 
4,225

 
1.4
%
 
(11.7
)%
Total revenues
$
291,109

 
100.0
%
 
$
300,469

 
100.0
%
 
(3.1
)%
 
 
 
 
 
 
 
 
 
 
Cost of revenues:
 
 
 
 
 
 
 
 
 
Network services
$
127,869

 
43.9
%
 
$
137,158

 
45.6
%
 
(6.8
)%
Other
2,108

 
0.7
%
 
2,254

 
0.8
%
 
(6.5
)%
Total cost of revenues
$
129,977

 
44.6
%
 
$
139,412

 
46.4
%
 
(6.8
)%
 
 
 
 
 
 
 
 
 
 
Gross profit:
 
 
 
 
 
 
 
 
 
Network services
$
159,510

 
54.8
%
 
$
159,086

 
53.0
%
 
0.3
 %
Other
1,622

 
0.6
%
 
1,971

 
0.6
%
 
(17.7
)%
Total gross profit (exclusive of depreciation and amortization)
$
161,132

 
55.4
%
 
$
161,057

 
53.6
%
 
 %
Revenues
Revenues for the years ended December 31, 2015 and 2014 were as follows:
 
Year Ended December 31,
 
 
 
2015
 
2014
 
 
 
Amount
 
% of Total
Revenues
 
Amount
 
% of Total
Revenues
 
% Change
Revenues:
 
 
 
 
 
 
 
 
 
Voice and data services:
 
 
 
 
 
 
 
 
 
       Cloud
$
72,729

 
25.0
%
 
$
62,995

 
21.0
%
 
15.5
 %
       NonCloud
174,629

 
59.9
%
 
192,351

 
64.0
%
 
(9.2
)%
       Ancillary
7,994

 
2.8
%
 
8,494

 
2.8
%
 
(5.9
)%
Voice and data services
255,352

 
87.7
%
 
263,840

 
87.8
%
 
(3.2
)%
Wholesale
26,084

 
9.0
%
 
25,633

 
8.5
%
 
1.8
 %
Carrier access
5,943

 
2.0
%
 
6,771

 
2.3
%
 
(12.2
)%
Total network services
287,379

 
98.7
%
 
296,244

 
98.6
%
 
(3.0
)%
Other
3,730

 
1.3
%
 
4,225

 
1.4
%
 
(11.7
)%
Total revenues
$
291,109

 
100.0
%
 
$
300,469

 
100.0
%
 
(3.1
)%

Revenues from voice and data services decreased $8.5 million or 3.2% between 2014 and 2015. Within voice and data services, revenues from cloud-based services increased $9.7 million, or 15.5%. This increase is due to our expanded efforts on selling our cloud-based services. Revenues from core voice and data services, excluding cloud-based services, decreased $17.7 million, or 9.2%, and ancillary voice and data revenues decreased by $0.5 million.  The decrease in non-cloud core services was due to: i) a lower number of lines and customers, ii) lower usage revenue per customer and iii) lower prices per unit for certain traditional services. Wholesale revenues increased $0.5 million or 1.8%. The increase is attributable to growth from new customers. Carrier access revenues decreased $0.8 million or 12.2% which includes a net positive change in non-recurring amounts. Excluding

45


the non-recurring revenue, core access revenues decreased due to several factors, including: i) decreasing levels of traffic to which access charges are applicable, including decreases in end-user voice customer traffic, and ii) lower per-minute rates charged to carriers as a result of Federal Communications Commission-mandated rate decreases. Our other revenues decreased $0.5 million or 11.7% between 2014 and 2015.
 
Cost of Revenues (exclusive of depreciation and amortization)
 
Cost of revenues were $130.0 million for the year ended December 31, 2015, a decrease of 6.8% from $139.4 million for the same period in 2014 primarily due to the 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 44.6% in 2015 from 46.4% in 2014.
Gross Profit (exclusive of depreciation and amortization)
 
Gross profit was $161.1 million for the year ended December 31, 2015, unchanged from the same period in 2014. As a percentage of revenues, gross profit increased to 55.4% in 2015 from 53.6% in 2014. 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 continue to improve over time.

Selling, General and Administrative
SG&A expenses were $123.7 million for the year ended December 31, 2015, an increase of 1.1% from $122.4 million for the same period in 2014. As a percentage of revenues, SG&A expenses increased to 42.5% in 2015 from 40.7% in 2014. The increase as a percentage of revenues is primarily due to the decrease in revenues in 2015, as we continue to invest in growth initiatives.

Depreciation and Amortization
Depreciation and amortization costs were $29.4 million for the year ended December 31, 2015, a decrease of 1.3% from $29.8 million.
Interest
Interest expense was $16.5 million for the year ended December 31, 2015, a decrease of 1.8% from $16.8 million for the same period in 2014. Our effective annual interest rates for the year ended December 31, 2015 and 2014 are as follows:
 
Year Ended December 31,
 
2015
 
2014
Interest expense
$
16,485

 
$
16,790

Weighted average debt outstanding
$
160,799

 
$
153,736

Effective interest rate
10.25
%
 
10.92
%

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.
      

46


Liquidity and Capital Resources
Sources and uses of liquidity
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 and is due on October 1, 2017. Any outstanding amounts under the revolving credit facility are subject to a borrowing base limitation based on an advance rate of 85% of the amount of eligible receivables, as defined. Our borrowing base has limited our availability to $17.6 million, of which $11.5 million was outstanding as of December 31, 2016. In addition to our normal operating requirements, our short-term liquidity needs consist of interest on the Notes, which are due in November 15, 2017, capital expenditures and working capital. As of December 31, 2016, our $24.7 million of cash and cash equivalents was being held in several large financial institutions, although most of our balances exceed the Federal Deposit Insurance Corporation insurance limits.
As of December 31, 2016, we will require approximately $15.8 million in cash to service the interest due on the Notes throughout the remaining life of the Notes. For the year ended December 31, 2016, the Company incurred capital expenditures of $21.5 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 expected new revenue.
As of December 31, 2016, we had cash and cash equivalents of $24,708. We cannot assure you that we will be able to refinance any of our indebtedness, including the notes and our credit facility, on commercially reasonable terms or at all. However, we continuously evaluate and consider all strategic and financing opportunities. Any future strategic options or other significant unplanned costs or cash requirements may also require that we raise additional funds through the issuance of debt or equity. In the event refinancing does not occur, we believe we will have sufficient cash to repay the principal on the Revolving Credit Facility at its October 1, 2017 maturity date. However, we do not believe we will have the necessary cash to repay the principal of our notes due November 15, 2017. Although we have had positive cash flows from operations in each of the last several years, there is uncertainty surrounding the refinancing. Our inability to repay our notes upon maturity without refinancing raises substantial doubt about our ability to continue as a going concern. Our independent auditors included an explanatory paragraph in their report on the accompanying consolidated financial statements regarding concerns about our ability to continue as a going concern. See Note 17 to our consolidated financial statements contained in this Annual Report on Form 10-K for the fiscal year ended December 31, 2016 for more information.
Disputes
We continue to be involved in a variety of disputes with multiple carrier vendors relating to billings of approximately $12.4 million as of December 31, 2016. 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.



47


Year Ended December 31, 2016 Compared to Year Ended December 31, 2015
Cash Flows from Operating Activities
Cash provided by operating activities was $32.1 million for the year ended December 31, 2016, compared to $22.7 million for the same period in 2015. This increase in cash flow from operating activities is primarily due to higher consolidated earnings and an increase in net operating assets.
Cash Flows from Investing Activities
Cash used in investing activities was $21.5 million for the year ended December 31, 2016, compared to $24.5 million for the same period in 2015. The change in cash flow from investing activities was primarily due to a decrease in capital expenditures of $3.3 million.
Cash Flows from Financing Activities
Cash used in financing activities was $1.1 million for the year ended December 31, 2016, compared to cash provided by financing activities of $2.5 million for the same period in 2015. The change in cash flows from financing activities was primarily due to the net change in activities on our revolving credit facility.
Year Ended December 31, 2015 Compared to the Year Ended December 31, 2014
Cash Flows from Operating Activities
Cash provided by operating activities was $22.7 million for the year ended December 31, 2015, compared to $20.0 million for the same period in 2014. This increase 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 $24.5 million for the year ended December 31, 2015, compared to $23.2 million for the same period in 2014. The change in cash flow from investing activities was primarily due to an increase in capital expenditures of $1.0 million.
Cash Flows from Financing Activities
Cash provided by financing activities was $2.5 million for the year ended December 31, 2015, compared to $9.5 million for the same period in 2014. The change in cash flows from financing activities was primarily due to the net effect of i) net lower borrowings on our revolving credit facility of $7.5 million and ii) net lower repayments on our capital lease financings of $0.5 million.
Contractual Obligations
The following table summarizes our future contractual cash obligations as of December 31, 2016. The following numbers are presented in thousands.
 
Total
 
Less Than 1 Year
 
1-3 Years
 
3-5 Years
 
More Than 5
Years
10.5% senior secured notes due 2017
$
150,000

 
$
150,000

 
$

 
$

 
$

Cash interest for notes
15,750

 
15,750

 

 

 

Revolving Credit Facility due 2017
11,500

 
11,500

 

 

 

Cash interest for Revolving Credit Facility at current rate of 5.5%
539

 
539

 

 

 

Capital lease obligations
395

 
167

 
209

 
19

 

Operating leases
33,761

 
7,605

 
13,853

 
8,861

 
3,442

Total contractual obligations
$
211,945

 
$
185,561

 
$
14,062

 
$
8,880

 
$
3,442


48


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 audited Consolidated Financial Statements and Notes to audited 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. We believe our critical accounting policies represent the more significant judgments and estimates used in the preparation of our audited Consolidated Financial Statements herein.
Revenue Recognition
Our revenues consist primarily of network services revenues, which primarily include voice and data services, wholesale services and access services. Our network services revenues are derived primarily from subscriber usage and fixed monthly recurring fees. Such revenue is recognized in the month the actual services and other charges are provided. Revenues for charges that are billed in advance of services being rendered are deferred. Services rendered for which the customer has not been billed are recorded as unbilled revenues until the period such billings are provided. Revenues from carrier interconnection and access are recognized in the month in which the service is provided, but subject to our conclusion that realization of that revenue is reasonably assured. Revenues and direct costs related to up-front service installation fees are deferred and amortized over four years, which is based on the estimated expected life of our customer base. The estimate of the expected life of our customer base was based in part on an analysis of customer turnover from which it was determined that our monthly turnover was approximately 2% along with our decision to extend our customers’ minimum contract term beyond two years. The effect of changing the estimated expected life of our customer base by one year would result in a change in the amount of revenue recognized on an annual basis of between $0.5 million and $0.8 million.
Accounts Receivable and Allowance for Doubtful Accounts
Accounts receivable are reported at their outstanding unpaid balances reduced by an allowance for doubtful accounts. We estimate doubtful accounts based on historical bad debts, factors related to the specific customers’ ability to pay, percentages of aged receivables and current economic trends. For example, inactive customer balances are reserved at 50%. The aggregate reserve balance is re-evaluated at each balance sheet date. A hypothetical increase in our aggregate reserve balance of 10% would result in an increase to our bad debt expense of $0.7 million. We reflect all carrier related receivables on our consolidated balance sheet at the amount we expect to realize in cash.
Impairment of Long-Lived Assets
We review our long-lived assets, including definite-lived intangible assets, for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. In analyzing potential impairments, projections of future cash flows are used to estimate fair value and are compared to the carrying amount of the asset. There is inherent subjectivity involved in estimating future cash flows, which can have a material impact on the amount of potential impairments.
Goodwill
We perform an impairment test at least annually on goodwill, which is conducted at the reporting unit level. We have one reporting unit. Goodwill is tested for impairment using a consistent measurement date, which for us is the fourth quarter of each year, or more frequently if impairment indicators arise. The evaluation of goodwill for impairment is primarily based on a discounted cash flow model, which includes estimates of future cash flows, along with an analysis of comparable recent mergers and acquisitions and publicly quoted market prices. There is inherent subjectivity involved in estimating future cash flows, which can have a material impact on the amount of any potential impairment. Based on the goodwill impairment test we conducted, the fair value of our reporting unit exceeded its carrying value.

49


Disputes
We are, in the ordinary course of business, billed certain charges from other carriers that we believe are erroneous. We carefully review our vendor invoices and frequently dispute inaccurate or inappropriate charges. In cases where we dispute certain charges, we frequently pay only undisputed amounts on vendor invoices. The amount of disputed charges may remain outstanding for some time pending resolution or compromise.
Management does not believe a payment of the entire amount of disputed charges will occur. We therefore account for our disputed billings from carriers based on the estimated settlement amount of disputed balances. The settlement estimate is based on a number of factors including historical results of prior dispute settlements. We consistently review the outstanding disputes and reassess the likelihood of success in the event of the resolution of these disputes. We believe we have accrued an amount appropriate to settle all remaining disputed charges. However, it is possible that the actual settlement of any remaining disputes may differ from our reserves and that we may settle at amounts greater than the estimates.

Item 7A.
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 rates and the Revolving Credit Facility with a variable 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.
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 December 31, 2016 was approximately $147.5 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. For more information, see Note 14 to Consolidated Financial Statements.
  



50


Item 8.
Financial Statements and Supplementary Data
Index to Consolidated Financial Statements
 
 
 
 
Consolidated Balance Sheets at December 31, 2016 and 2015
 
 
Consolidated Statements of Operations and Comprehensive Income (Loss) for the years ended December 31, 2016, 2015 and 2014
 
 
Consolidated Statements of Stockholders’ Deficiency for the years ended December 31, 2016, 2015 and 2014
 
 
Consolidated Statements of Cash Flows for the years ended December 31, 2016, 2015 and 2014
 
 
 
 
 
 


51


MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Our management is responsible for establishing and maintaining adequate internal control over financial reporting. In connection with the preparation of our annual consolidated financial statements, management has conducted an assessment of the effectiveness of our internal control over financial reporting based on the framework set forth in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework). Management’s assessment included an evaluation of the design of our internal control over financial reporting and testing of the operational effectiveness of those controls. Based on this evaluation and testing, we have concluded that, as of December 31, 2016, our internal control over financial reporting was effective to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles.

52


eylogo2016a01a03.jpg
Report of Independent Registered Public Accounting Firm

The Board of Directors and Stockholders of

Broadview Networks Holdings, Inc. and Subsidiaries

We have audited the accompanying consolidated balance sheets of Broadview Networks Holdings, Inc. and subsidiaries as of December 31, 2016 and 2015, and the related consolidated statements of operations and comprehensive income (loss), stockholders’ deficiency and cash flows for each of the three years in the period ended December 31, 2016. Our audits also included the financial statement schedule listed in the Index at Item 15(a). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.
We conducted our December 31, 2016 audit in accordance with the standards of the Public Company Accounting Oversight Board (United States) and in accordance with auditing standards generally accepted in the United States of America. We conducted our December 31, 2015 and 2014 audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. We were not engaged to perform an audit of the Company’s internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Broadview Networks Holdings, Inc. and subsidiaries as of December 31, 2016 and 2015, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2016 in conformity with U.S. generally accepted accounting principles.
Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 3 to the consolidated financial statements, the Company does not have sufficient funds to repay its $150 million of “New Notes” when they mature in November 2017. In addition, the Company has incurred historical net losses and has a stockholders' deficiency. These conditions raise substantial doubt about its ability to continue as a going concern. Management's plans in regard to these matters are also described in Note 3. The 2016 consolidated financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the outcome of this uncertainty.

/s/ Ernst & Young LLP

April 13, 2017

53


BROADVIEW NETWORKS HOLDINGS, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(in thousands, except share amounts)
 
December 31,
 
2016
 
2015
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
24,708

 
$
15,173

Certificates of deposit
1,022

 
1,022

Accounts receivable, less allowance for doubtful accounts of $6,798 and $7,967
21,200

 
23,225

Other current assets
6,689

 
6,460

Total current assets
53,619

 
45,880

Property and equipment, net
48,641

 
54,125

Goodwill
98,238

 
98,238

Intangible assets, net
574

 
1,376

Other assets
3,247

 
3,258

Total assets
$
204,319

 
$
202,877

LIABILITIES AND STOCKHOLDERS’ DEFICIENCY
 
 
 
Current liabilities:
 
 
 
10.5% senior secured notes
$
150,000

 
$

Revolving credit facility
11,500

 

Accounts payable
6,409

 
4,714

Accrued expenses and other current liabilities
14,005

 
15,809

Taxes payable
6,174

 
4,752

Deferred revenues
8,908

 
9,175

Current portion of capital lease obligations
167

 
253

Total current liabilities
197,163

 
34,703

10.5% senior secured notes

 
150,000

Revolving credit facility

 
12,500

Deferred rent payable
4,076

 
4,626

Deferred revenues
915

 
899

Capital lease obligations, net of current portion
228

 
225

Deferred income taxes payable
9,825

 
8,856

Other
663

 
1,875

Total liabilities
212,870

 
213,684

Stockholders’ equity deficiency:
 
 
 
Common stock — $.01 par value; authorized 19,000,000 shares, issued and outstanding 9,993,120 and 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
306,784

 
306,792

Accumulated deficit
(315,435
)
 
(317,699
)
Total stockholders’ deficiency
(8,551
)
 
(10,807
)
Total liabilities and stockholders’ deficiency
$
204,319

 
$
202,877

See notes to consolidated financial statements.

54


BROADVIEW NETWORKS HOLDINGS, INC. AND SUBSIDIARIES

Consolidated Statements of Operations and Comprehensive Income (Loss)
(in thousands)
 
Year Ended December 31,
 
2016
 
2015
 
2014
Revenues
$
288,755

 
$
291,109

 
$
300,469

Operating expenses:
 
 
 
 
 
Cost of revenues (exclusive of depreciation and amortization)
122,063

 
129,977

 
139,412

Selling, general and administrative
118,222

 
123,667

 
122,354

Depreciation and amortization
28,258

 
29,440

 
29,831

Total operating expenses
268,543

 
283,084

 
291,597

Income from operations
20,212

 
8,025

 
8,872

Interest expense
(16,598
)
 
(16,485
)
 
(16,790
)
Interest income
40

 
26

 
23

Income (loss) before provision for income taxes
3,654

 
(8,434
)
 
(7,895
)
Provision for income taxes
(1,390
)
 
(1,358