10-K 1 broadviewnetworksholdingdo.htm 10-K Broadview Networks Holding Document 2013 10K
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, 2013
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 March 31, 2014
Common Stock, $.01 par value per share
 
9,999,945
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.



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

our history of net losses;
the elimination or relaxation of certain regulatory rights and protections;
billing and other disputes with vendors;
failure to maintain interconnection and service agreements with incumbent local exchange and other carriers;
the loss of customers in an adverse economic environment;
regulatory uncertainties in the communications industry;
system disruptions or the failure of our information systems to perform as expected;
the failure to anticipate and keep up with technological changes;
inability to provide services and systems at competitive prices;
difficulties associated with collecting payment from incumbent local exchange carriers, interexchange carriers and wholesale customers;
the highly competitive nature of the communications market in which we operate including competition from incumbents, cable operators and other new market entrants, and declining prices for communications services;
continued industry consolidation;
restrictions in connection with our indenture governing the 10.5% Senior Secured Notes due 2017 (the “Notes”) and credit agreement governing our revolving credit facility;
our ability to service our substantial indebtedness;
government regulation;
increased regulation of Internet-protocol-based service providers;
vendor bills related to past periods;
the ability to maintain certain real estate leases and agreements;
interruptions in the business operations of third party service providers, including but not limited to work stoppages;
the financial difficulties faced by others in our industry;
the failure to retain and attract management and key personnel;
the failure to manage and expand operations effectively;
the failure to successfully integrate future acquisitions, if any;
misappropriation of our intellectual property and proprietary rights;
protection of and access to intellectual property essential to our network and products;
the possibility of incurring liability for information disseminated through our network;
service network disruptions due to software or hardware bugs of the network equipment;
fraudulent usage of our network and services; and
the failure to maintain effective internal control over financial reporting.




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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.



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PART I

Item 1.
Business
Company Overview

We are a leading cloud-based service provider of communications and information technology solutions to small and medium sized business (“SMB”) and enterprise customers nationwide. After several years of development, we began providing cloud-based unified communication services (“UCaaS”) in 2005 and later introduced into our product portfolio a variety of cloud-based computing solutions. Today, we offer a full suite of cloud-based systems and services under the brand OfficeSuite® to customers nationwide and have more than 100,000 active licenses on our flagship product OfficeSuite® Phone and an additional 80,000 licenses sold through other service providers. OfficeSuite® Phone comprises a growing percentage of our overall recurring revenue and the vast majority of our existing cloud-based revenue stream.
Our product portfolio provides bundled packages that include cloud-based services and network connectivity with a focus on addressing the productivity, flexibility, security and business continuity needs of end users. In addition, our growth initiatives focus direct sales efforts 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 our approximately 260 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. For the year ended December 31, 2013, approximately 82% of all new revenue installed during the period was provisioned on our next-generation IP network.
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, sales agents nationwide, and expanded efforts in wholesale and web marketing. We have strategic partnerships under the RCA brand and other nationwide distributors who market and sell technology to thousands of Value Added Resellers.
As of December 31, 2013, we provided our services to approximately 25,000 business customers nationwide. In 2013, cloud-based services, including bundled and standalone services, generated 21% of total retail voice and data revenue, up from 7% in 2009. Revenue for these services has grown at approximately a 20% compound annual growth rate (“CAGR”) since 2009. Approximately 50% 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.
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”), hosted virtual desktop, 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 solve their critical and complex infrastructure, productivity, security and business continuity needs through a combination of products and services.



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The following table summarizes our product and service offerings:
CLOUD SERVICES
PROFESSIONAL IT SERVICES
T-1 BASED & TRADITIONAL OFFERINGS
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
Application Virtualization
Managed Router
Local, Regional & Long Distance
Hosted Dedicated and Virtual Servers
 
Audio Conferencing
Hosted Virtual Desktops
 
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 cloud-based unified communications platform, provides customers with high-quality, easy-to-use phones and equipment, advanced voicemail, online fax services, an unlimited calling plan and customer website for easy administration. The product 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 and connectivity options at various price points. An optional capability, OfficeSuite® Call Center Services, provides robust call center capabilities, including advanced call routing, queuing, call recording, easy-to-use reporting and dashboard functionality.
Software as a Service/Infrastructure as a Service/Hosted Virtual Desktop. Our cloud-based computing product offerings include individual and bundled packages of subscription-based software and infrastructure services. Businesses can access cloud-based versions of Microsoft Exchange®, Microsoft Office® and other Microsoft products and thousands of other business applications. 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. 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.
T-1 Based & Traditional 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 MPLS network to deliver highly flexible voice and data services.


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Voice Services. We offer voice services over the Internet and our next-generation IP network to customers with or without customer premise equipment, 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. 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. Our multiprotocol label switching (“MPLS”) and IP 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 retail sales organization consists of five separate sales channels: direct sales, agent partners, VARs/nationwide distributors/strategic partnerships, web marketing and customer care operations. 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 marketing communications support and leads. In addition, marketing provides online and printed materials, sales promotions and vertical marketing programs.
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.
Industry and Competition
Overview
The communications industry was once defined by voice services (local, regional and long-distance); 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, 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. 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 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 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.

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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 local 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.
While the ILECs provide a broad range of communications services, we believe that they have largely neglected the SMB segment due to an increased focus on the global enterprise business segments of the market, increased competitive pressures in the residential market, and the focus required to integrate recent mergers and acquisitions. In addition, with limited network footprint in business parks, CATV providers have been focused on delivering basic voice and data access services primarily to smaller businesses within and surrounding residential communities.
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 and the access services industries are highly competitive. We believe we compete principally by offering focused customer service, accurate billing, a broad set of services and systems 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.
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 into the cloud, for more ubiquitous, secure and cost-effective delivery. Services include OfficeSuite® Phone, our cloud-based unified communications system, hosted Microsoft Exchange®, hosted Microsoft SharePoint®, hosted virtual desktops, 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 25,000 SMB and enterprise customers who constitute a predictable base of recurring revenue and high quality customer relationships. We believe many of these organizations are looking 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.

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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 cloud-based communications service platform OfficeSuite® Phone, including the unified messaging and call center services technologies. 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 schedules and priorities. This allows us to deliver unique solutions to our customers and target markets, including integrations with Salesforce.com®, Advatel 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. At the end of 2013, our in-house development team delivered an entirely new and fully automated customer purchasing and service delivery portal, in association with the introduction of our new OfficeSuite Simplicity™ product, targeted at the small business customer.
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.
Our Markets
We currently 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. Market research estimates that the U.S. cloud service market is expected to grow from $22.8 billion in 2012 to $43.2 billion by 2016. 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 89% of our total revenue is generated from retail end users in a wide array of industries including professional services, health care, education, manufacturing, real estate, retail, automotive, non-profit groups and others with less than 2% coming from residential customers. Approximately 11% 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 retail revenue, approximately 20% of our wholesale revenue stream consists of cloud-based services.
We have been a provider of cloud-based communications services to our retail 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, 2009 through December 31, 2013:
 
Year Ended December 31,
$ in millions
2009
 
2010
 
2011
 
2012
 
2013
Retail cloud-based revenue
$27.5
 
$33.0
 
$41.9
 
$50.6
 
$57.7
% growth
 
 
20.2%
 
26.8%
 
20.9%
 
14.0%

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We target larger SMB and enterprise customers, typically generating over $500 in Monthly Recurring Revenue (“MRR”), with direct and agent sales forces and through strategic partnerships. 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 $553 at December 31, 2009 to approximately $807 at December 31, 2013. The following table shows the trend in average MRR per business customer as of the last month of each period:
 
Year Ended December 31,
 
2009
 
2010
 
2011
 
2012
 
2013
Average MRR per Business Customer
$553
 
$610
 
$674
 
$747
 
$807
For the month of December 31, 2013, 88% of our retail revenue was generated by customers whose MRR is greater than $500, and approximately 73% 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 retail revenue base in terms of monthly spend as of the last month of each period:
Trended MRR by Customer Size
Year Ended December 31,
 
2009
 
2010
 
2011
 
2012
 
2013
$0 - $500
19
%
 
16
%
 
14
%
 
13
%
 
12
%
>$500 - $1000
17
%
 
18
%
 
17
%
 
16
%
 
15
%
>$1,000
64
%
 
66
%
 
69
%
 
71
%
 
73
%
 
 
 
 
 
 
 
 
 
 
 
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 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 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. Within our network footprint, we continue to offer access services at competitive prices.  In late 2013, we launched OfficeSuite Simplicity™ to target smaller businesses who require Unified Communications services. We sell and deliver these services in a highly automated fashion, often without any customer to Broadview employee contact during much of the sales and installation process. This level of automation allows us to cost-effectively serve smaller, lower revenue potential customers at similar profitability levels as the larger customers we target.
As a result of our evolution in focus from access to application and the introduction of the OfficeSuite Simplicity™ product, our average revenue per new customer and our average revenue per existing business customer may flatten or decrease. In many circumstances, particularly outside of our network footprint, we anticipate being able to generate similar profitability on each new customer, albeit at lower revenue per customer when we do not capture the access revenue stream. The application portion of the targeted revenue streams offers higher percentage margins and therefore similar profitability on the new revenue we generate from the customers we target.

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Customer Service and Retention
We have been able to improve our average monthly revenue loss level from 2.3% for the year ended December 31, 2009 to 1.7% for the year ended December 31, 2013, 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, 2009 through 2013.
 
Year Ended December 31,
 
2009
 
2010
 
2011
 
2012
 
2013
Average Monthly Revenue Loss (1)
2.3%
 
2.1%
 
1.8%
 
1.7%
 
1.7%
(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.
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 agency, 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 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 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 softswitch from MetaSwitch, call agents and gateways, EoC and other broadband access, to deliver cloud-based unified communications and computing services to our customers. We reach our customers through the customers own Internet access or by providing access on our own network or leveraging last mile connections thorough carrier agreements.
Data Centers
We operate three 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 to enable last mile connections to customers.
For more information, see the section entitled “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.”

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Integrated 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, competitively priced communications services to our customers.
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 based on the Salesforce.com® platform, which offers an extensive array of sales tools and capabilities, including lead and funnel management, sales forecasting, hierarchical dashboards and reports, and full automation from proposal generation to e-signature to sales close.
To support our indirect sales forces, we created AgentTrak, a purpose built variant of iLead. Through our iLead and AgentTrak portals, our sales team, agents and other indirect sales teams 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 coupled 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.
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 our e-Care Enterprise website. 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.
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 outstanding Notes.
Employees
As of December 31, 2013, we had approximately 815 employees, including approximately 150 quota-bearing representatives in all sales channels. In addition, we had approximately 200 associates at December 31, 2013 working on our behalf, but employed by a service partner to 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.

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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. We cannot predict what impact, if any, such changes or proceedings may have on our business, financial condition or results of operations, and we cannot guarantee that regulatory authorities will not raise material issues regarding our compliance with applicable regulations.
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 do not regulate Internet, video conferencing, or certain data services, although the underlying communications components of such offerings may be 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 greatly increases our potential for growth, it also increases the amount of competition to which we may be subject. In addition, the cost of enforcing federal preemption against certain state policies and programs may be large and may involve considerable delay.
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 an 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 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. Because aspects of the Telecommunications Act remain subject to numerous federal and state policy rulemaking proceedings and judicial review, there is still ongoing uncertainty as to the ultimate impact it will have on us. 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. 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.
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 cable television 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.

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The Telecommunications Act also codified the ILECs’ equal access and nondiscrimination obligations and preempted inconsistent state regulation.
Legislation. Congress is considering various measures that would impact telecom laws in the United States. The prospects and timing of potential legislation remain unclear, and as such, we cannot predict the outcome of any such legislation upon our business.
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 Telecommunications 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 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, are not subject to unbundling obligations. On March 2, 2004, the U.S. Court of Appeals for the District of Columbia Circuit (“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. Subsequent to the release of the TRRO, we entered into commercial agreements with Verizon, under which we continued to have access to local switching from Verizon during the terms of the agreements. We have replaced delisted UNE-Ls and transport with special access, generally at prices significantly higher than UNE rates, unless we have been able to find alternative suppliers offering more favorable rates.
FCC rules implementing the local competition provisions of the Telecommunications Act permit 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, which is ongoing, will consider whether the TELRIC pricing model produces unpredictable pricing inconsistent with appropriate economic signals; fails to adequately reflect the real-world attributes of the routing and topography of an ILEC’s network; and creates 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. On October 27, 2004, the FCC issued an order granting requests by the Regional Bell Operating Companies 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).

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On September 16, 2005, the FCC partially granted Qwest’s petition 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. 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 (9) specified central offices, Qwest will only have 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 petition seeking forbearance from the application of the FCC’s dominant carrier regulation of interstate services, 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 (5) central offices in which the requested relief was granted, ACS will only have to do so at commercially negotiated rates. Because we do not operate in either the Omaha, Nebraska or Anchorage, Alaska Metropolitan Statistical Areas, these decisions did not have a direct impact on us.
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 Metropolitan Statistical Areas, including the New York-Northern New Jersey-Long Island, NY-NJ-PA Metropolitan Statistical Area, the Philadelphia-Camden-Wilmington-Baltimore PA-NJ-DE-MD Metropolitan Statistical Area and the Boston-Cambridge-Quincy, MA-NH Metropolitan Statistical Area - three of our largest markets. 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. Qwest has appealed the FCC’s denial of its Phoenix UNE-forbearance petition.
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 remain classified as communications 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 does 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 permits 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. Through various ex parte filings, however, Verizon appeared to narrow its petition to ask for far more limited relief, arguably 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. The 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.

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The FCC is currently evaluating a number of additional forbearance petitions or forbearance-like petitions. AT&T and the National Telephone Cooperative Association have requested that the FCC initiate a proceeding to guide the transition of the public switched telephone network from TDM to IP technology, offering proposals that could jeopardize CLEC access to network interconnection and last mile access. The U.S. Telecom Association has requested that the FCC forebear from, among other things, a large number of reporting, structural separation and network interconnection requirements, as well as declare the ILECs “nondominant” in the provision of switched access services, an action which would relieve the ILECs of their tariffing obligations, among other requirements. Not all new petitions, however, have sought further forbearance or other relief from existing regulations. The FCC is also currently considering a petition filed by multiple carriers asking that the forbearance granted, in FCC action to Verizon from the application of the FCC’s Computer II and Title II requirements to Verizon’s Broadband service offerings be reversed and a petition by a competitive carrier seeking reversal of a prior Commission order denying CLECs unbundled access to the packetized bandwidth of hybrid fiber-copper loops, fiber-to-the-home loops and fiber-to-the-curb loops at the same rates that incumbent LECs charge their own retail customers, for the purpose of serving small business customers. And the FCC is considering a petition filed by a number of competitive carriers seeking access to all of Section 271’s “Checklist Elements.” Finally, the FCC has announced the formation of an agency-wide “Technology Transitions Policy Task Force” to empower and protect consumers, promote competition, and ensure network resiliency and reliability.
Special Access. The FCC has undertaken a comprehensive review of 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 Notice of Proposed Rulemaking (“NPRM”), 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 have accurately gauged competition levels and worked as intended. The FCC also requested comments on 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. By public notice dated July 9, 2007, the FCC invited parties to update the record in its special access rulemaking to address, among other things, the impact of industry consolidation on the availability of alternative facilities. In the summer of 2012, the FCC suspended its special access pricing flexibility rules and committed to undertake an extensive analysis of the special access market. As part of this market analysis, has proposed to engage in a comprehensive data collection process.
The FCC is also considering a petition filed by large corporate users and competitive carriers seeking to reverse the forbearance from dominant carrier regulation and certain Computer Inquiry requirements granted to Verizon, AT&T, legacy Embarq, Frontier, and legacy Qwest in their provision of non-TDM-based special access services.
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 others, New York, Massachusetts, New Jersey, Pennsylvania, Maryland, Virginia, Delaware, Rhode Island and Washington, D.C. 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 and are currently negotiating agreements with other ILECs to support our nationwide service offering outside the Northeast and Mid-Atlantic service areas. Our agreements will be amended to reflect recent FCC orders, but whether these changes will be affected by state public utility commission order, tariff, negotiation or arbitration is uncertain.
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. We cannot predict how successful we will be in negotiating terms critical to our provision of local network services in New York, and we may be forced to arbitrate certain provisions of our New York agreements. Interconnection agreement arbitration proceedings before other state commissions may result in decisions that could affect our business, but we cannot predict the extent of any such. 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 crossconnects between colocated carriers.

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Regulation of ISPs. To date, the FCC has treated ISPs as enhanced service providers, which are generally exempt from federal and state regulations governing common carriers. Nevertheless, regulations governing the disclosure of confidential communications, copyright, excise tax and other requirements may apply to our Internet access services. In addition, the FCC released an NPRM in September 2005 seeking comment on a broad array of consumer protection regulations for broadband Internet access services, including rules regarding the protection of Customer Proprietary Network Information (“CPNI”), slamming, truth in billing, network outage reporting, service discontinuance notices, and rate-averaging requirements.
Moreover, Congress has passed a number of laws that concern the Internet and Internet users. Generally, these laws limit the potential liability of ISPs and hosting companies that do not knowingly engage in unlawful activity. We expect that Congress will continue to consider various bills concerning the Internet and Internet users, some of which, if signed into law, could impose additional obligations on us.
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. The FCC in 2005 adopted a policy statement expressing its 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. It is not possible to determine what specific broadband network management techniques or related business arrangements may be deemed reasonable or unreasonable in the future.
Long Distance Competition. Section 271 of the Communications Act, enacted as part of the Telecommunications Act, established a process by which a 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 to affected CLECs compensation in the form of cash or service credits. Our ability to obtain adequate interconnection and access to UNEs on a timely basis and at cost effective rates could be adversely affected by an RBOC’s failure to comply with its Section 271 obligations.
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 remain in place. 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 domestic and international private line services on our web site.

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Intercarrier Compensation. The FCC’s intercarrier compensation rules include rules governing access charges, which govern the payments that interexchange carriers and commercial mobile radio service providers make to local exchange carriers 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. We purchase long distance service on a wholesale basis from interexchange carriers who pay access fees to local exchange carriers for the origination and termination of our long distance communications traffic. Historically, intrastate access charges have been higher than interstate access charges. Therefore, to the degree access charges increase or a greater percentage of our long distance traffic is intrastate our costs of providing long distance services will increase. As a local exchange provider, we bill long distance providers access charges for the origination and termination of those providers’ long distance calls. Accordingly, in contrast with our long distance operations, our local exchange business benefits from the receipt of intrastate and interstate long distance traffic. As an entity that collects and remits access charges, we must properly track and record the jurisdiction of our communications traffic and remit or collect access charges accordingly.
The FCC has stated that existing intercarrier compensation rules constitute transitional regimes and has promised to reform them. On March 3, 2005, the FCC released a further NPRM 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 NPRM, 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.
In November 2011, the FCC adopted policy changes that over time will reduce carriers’ access rates. Under the FCC’s intercarrier compensation regime, a uniform “bill-and-keep” framework for both intrastate and interstate access traffic will be applicable for all telecommunications traffic exchanged with a local exchange carrier. The reforms required by the FCC’s new rules will be 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 must reduce their intrastate tariffed access charges by July 2013 to those no greater than the incumbent carriers with which they compete, as is currently required with CLEC’s interstate access charges. From 2013 through 2018, further reductions in both intrastate and interstate access charges and reciprocal compensation rates are required, with a “bill-and-keep” framework 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 is currently under appeal in the U.S. Court of Appeals for the Tenth Circuit. In their current form, these new rules will result in a loss of revenues and could potentially increase our volume of carrier disputes. However, 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. On May 3, 2002, the D.C. Circuit 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. Because we provide facilities-based services, we incur costs in meeting these requirements. Noncompliance with these requirements could result in substantial fines.

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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 initially 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. We use our subscribers’ CPNI in accordance with applicable regulatory requirements. However, if a federal or state regulatory body determines that we have implemented those guidelines incorrectly, we could be subject to fines or penalties. In addition, correcting our internal customer systems and CPNI processes could generate significant administrative expenses.
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 USF (“USF”). The USF supports several programs administered by the Universal Service Administrative Company 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 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. To accomplish this, the FCC proposes to replace the USF with a new Connect America Fund (“CAF”) over the next ten years and to fund the CAF by broadening the universal service contribution base. The FCC has recently issued an NPRM by which it proposes to effect these changes. We cannot predict the outcome of any of these initiatives or their impact on our business.
In November 2011, the FCC expanded the USF to include broadband services as part of the CAF. The new fund also includes a Mobility Fund, making mobile broadband an independent universal service objective. Further, FCC reform of the USF contribution methodology is expected to be addressed in 2012. The application and effect of these changes, and similar state requirements, on the telecommunications industry generally and on certain of our business activities cannot be predicted.
The application and effect of changes to the USF contribution requirements and similar state requirements on the communications industry generally and on certain of our business activities cannot be predicted. If our collection procedures result in over collection, we could be required to make reimbursements of such over collection and be subject to penalty, which could have a material adverse affect on our business, financial condition and results of operations. If a federal or state regulatory body determines that we have incorrectly calculated or remitted any USF contribution, we could be subject to the assessment and collection of past due remittances as well as interest and penalties thereon.
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. 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.
AT&T and Verizon have asked the FCC to revise the system by which the costs of implementing local number portability (“LNP”) are recovered. Generally, these carriers have asked the FCC to move from a system in which cost recovery is allocated according to a carrier’s proportion of overall industry revenue to a cost recovery mechanism based on usage. If adopted, the modifications could increase our LNP charges.

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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. Once NANC releases the new process flows, large carriers will have nine months and small carriers will have fifteen months to implement the new procedures. In a related NPRM, the FCC requested comment on whether it should modify the definition of a simple port.
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. The risk of financial damage from Slamming, in the form of fines, penalties, legal fees and costs and loss of business reputation is significant. We maintain internal procedures designed to ensure that our new subscribers are switched to us and billed in accordance with federal and state regulations. Because of the volume of service orders that we may process, it is possible that some carrier changes inadvertently may be processed without authorization. Therefore, we cannot guarantee that we will not be subject to slamming complaints in the future.
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, 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. If our collection procedures prove to be insufficient or if a taxing or regulatory 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.
The Internet Tax Non-Discrimination Act, which is in effect through November 2014, places 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. If these state tax laws are not successfully contested, or if future state and federal laws imposing taxes or other regulations on Internet access and electronic commerce are adopted, our cost of providing Internet access services could be increased and our business could be adversely affected.
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 calls, 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 have obtained CPCNs to provide facilities-based service and have resold competitive local and interexchange service throughout the Northeast and Mid-Atlantic service areas. We are currently engaged in an initiative to obtain authority to provide competitive local and interexchange service throughout the contiguous United States and have secured authority in all but a handful of states.
In addition to requiring certification, state regulatory authorities may 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, Verizon either has obtained or is actively seeking some level of increased pricing flexibility or deregulation, either through amendment of state law or through proceedings before state public utility commissions. Such increased pricing flexibility could have an adverse effect on our competitive position in those states because it could allow Verizon to reduce retail rates to customers while wholesale rates that we pay to it stay the same or increase.
We also are subject to state laws and regulations regarding slamming, cramming, and other consumer protection and disclosure regulations. These rules could substantially increase the cost of doing business in any particular state. State commissions have issued or proposed substantial fines against CLECs for slamming or cramming. The risk of financial damage from slamming, in the form of fines, penalties, legal fees and costs and loss of business reputation is significant. A slamming complaint before a state commission could generate substantial litigation expenses. In addition, state law enforcement authorities may use their consumer protection authority against us if we fail to meet applicable state law requirements.

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States also retain the right to sanction a service provider or to revoke certification if a service provider violates relevant laws or regulations. If any regulatory agency were to conclude that we are or were providing intrastate services without the appropriate authority or otherwise in violation of law, the agency could initiate enforcement actions, which could include the imposition of fines, a requirement to disgorge revenues, or refusal to grant regulatory authority necessary for the future provision of intrastate services. 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 long-distance companies to originate and terminate in-state toll calls, are subject to the jurisdiction of the state in which the call originated and/or terminated. Such regulation by states could have a material adverse affect on our revenues and business opportunities within that state. State public utility commissions also regulate the rates ILECs charge for interconnection, access to network elements, and resale of services by competitors. State public utility commissions may initiate cost cases to re-price UNEs and to establish rates for wholesale services that are no longer required to be provided as UNEs under the TRRO. Any such proceedings may affect the rates, terms, and conditions contained in our interconnection agreements or in other wholesale agreements with ILECs. We cannot predict the outcome of these proceedings. The pricing, terms and conditions under which the ILECs in each of the states in which we currently operate offers such services may preclude or reduce our ability to offer a competitively viable and profitable product within these and other states on a going forward basis.
State regulators establish and enforce wholesale service quality standards that Regional Bell Operating Companies 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. Verizon is asking various state commissions in states where we operate to modify the state wholesale quality plans in ways that would reduce or eliminate certain wholesale quality standards. Changes in performance standards could result in a diminution of the service quality we receive.
Local Regulation
In some municipalities where we have installed facilities, we are required to pay license or franchise fees based on a percentage of our revenues generated from within the municipal boundaries. We cannot guarantee that fees will remain at their current levels following the expiration of existing franchises or that other local jurisdictions will not impose similar fees.
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. As a provider of interconnected VoIP services, we will bear costs as a result of these various mandates.
On February 12, 2004, the FCC adopted an NPRM to address, in a comprehensive manner, the future regulation of services and applications making use of Internet protocols, including VoIP. In the absence of federal legislation, we expect that through this proceeding, which is still pending, the FCC will resolve certain regulatory issues relating to VoIP services and develop a regulatory framework that is unique to IP telephony providers or that subjects VoIP providers to minimal regulatory requirements. We cannot predict when, or if, the FCC may take such actions. The FCC may determine that certain types of Internet telephony should be regulated like basic interstate communications services. The FCC’s pending review of intercarrier compensation policies (discussed above) also may have an adverse impact on enhanced service providers.

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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.
Other aspects of VoIP and Internet telephony services, such as regulations relating to the confidentiality of data and communications, copyright issues, taxation of services, and licensing, may be subject to federal or state regulation. Similarly, changes in the legal and regulatory environment relating to the Internet connectivity market, including regulatory changes that affect communications costs or that may increase the likelihood of competition from RBOCs or other communications companies could increase our costs of providing service.
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. Effective as of December 29, 2011, default rates for toll VoIP-PSTN traffic will 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 will be reciprocal compensation rates. In addition, VoIP-PSTN traffic will be subject to the same phase-down of access rates as will be applied to traditional voice traffic, as discussed below. We expect these new rules to result in a loss of revenues and to potentially increase our volume of carrier disputes. In addition, because the new rules regarding payment obligations for VoIP traffic are prospective only and do not address any intercarrier compensation payment obligations for VoIP traffic for any prior periods, we cannot predict how existing disputes regarding treatment of this traffic for prior periods will be resolved. The FCC also issued a further NPRM which asks for further input on many of the issues, including IP-to-IP interconnection. While the FCC states an “expectation that parties will negotiate in good faith” toward IP-to-IP interconnection agreements, questions have been raised regarding under what legal framework these interconnection arrangements should proceed, which creates uncertainty regarding whether these arrangements will be economically viable.
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. We operate numerous sites in connection with our operations. We are not aware of any liability or alleged liability at any operated sites or third-party waste disposal sites that would be expected to have a material adverse effect on our business, financial condition or results of operations. Although we monitor our compliance with environmental, safety and health laws and regulations, we cannot give assurances that we have been or will be in complete compliance with these laws and regulations. We may be subject to fines or other sanctions by federal, state and local governmental authorities if we fail to obtain required permits or violate applicable laws and regulations.
Federal and state governments have adopted consumer protection laws and undertaken enforcement actions to address advertising and user privacy. As part of these efforts, the Federal Trade Commission (“FTC”) and certain state Attorneys General have conducted investigations into the privacy practices of companies that collect information about individuals using the Internet. The FTC and various state agencies, as well as individuals, have investigated and asserted claims against, or instituted inquiries into, ISPs in connection with marketing, billing, customer retention, cancellation and disclosure practices.






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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.

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 losses of $8.5 million, $35.3 million, and $12.2 million in 2013, 2012 and 2011, respectively. We expect to continue to have losses for the foreseeable future. We cannot assure you that our revenues will grow or 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.
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 $5.1 million as of December 31, 2013. 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 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.”
Elimination or relaxation of regulatory rights and protections could harm our business, results of operations and financial condition.
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 that a statutory provision or a regulation is unnecessary to ensure that rates and practices remain just, reasonable and non-discriminatory and to otherwise protect consumers and that forbearance is generally in the public interest and would promote competition. Pursuant to Section 10, the FCC has effectively deregulated Verizon provision of certain broadband services provided to enterprise customers and has extended similar relief to other ILECs. Exercising its forbearance authority, the FCC has also relieved certain ILECs in certain markets of their obligation to provide CLECs with unbundled access to network elements at rates mandated by state regulatory commissions. Although we do not provide service in any of the impacted markets and hence are not directly affected by these latter rulings, Verizon has sought, albeit without success, forbearance from the application of the FCC’s dominant carrier regulation of interstate services, and Section 251(c) unbundling requirements in six Metropolitan Statistical Areas, including the New York-Northern New Jersey-Long Island, NY-NJ-PA Metropolitan Statistical Area, the Philadelphia-Camden-Wilmington PA-NJ-DE-MD Metropolitan Statistical Area and the Boston-Cambridge-Quincy, MA-NH Metropolitan Statistical Area - three of our largest markets. A number of other petitions seeking relaxation or elimination of regulatory requirements are currently pending at the FCC, grant of any of which could have an adverse impact on our business and operations.

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FCC rules currently allow Verizon and other ILECs to unilaterally retire copper loop facilities that provide the “last-mile” connection to certain customers with limited regulatory oversight. Verizon has filed hundreds of notices of copper plant retirement with the FCC and has announced its intention to retire its copper network over the next several years. While we, in conjunction with CLECs, have petitioned the FCC to strengthen the rules governing copper plant retirement, there are no assurances that we will be successful in this effort. Because it would limit the availability of facilities necessary to provide certain services to our customers, including EoC, and would substantially impact our cost of service, wide scale retirement of copper loops by Verizon 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 market in which we operate is highly competitive, and we may not be able to compete effectively against companies that have significantly greater resources than we do, which could cause us to lose 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. We have not achieved, and do not expect to achieve, a major share of the local access lines for any of the communications services we offer. In each of our markets we compete with the ILEC serving that area. Large competitors 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;
anticipated increased pricing flexibility and relaxed regulatory oversight;
larger networks; and
benefits from existing regulations that favor the ILECs.
We also face, and expect to continue to face, competition from other existing and potential market participants, such as CLECs, cable television companies, wireless service providers and electric utility companies. While many CLECs have always targeted small and medium sized enterprises and multi-location customers, cable television companies are increasingly targeting these customers and are doing so at rates lower than we generally offer. We are also increasingly subject to competition from providers using 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 addition, the development of new technologies could give rise to significant new competitors in the local market.
In the long distance communications market, we face competition from the ILECs, large and small interexchange carriers, wireless carriers and IP-based service 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. If this trend continues, we anticipate that revenues from our network services and other service offerings will likely be subject to significant price pressure.
 

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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.
Disruptions caused by security breaches, terrorism or for other reasons, could harm our future operating results. 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, including Hurricanes Sandy and Irene and the recent Noreaster Nemo. 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.

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.
Our ability to continue to obtain favorable interconnection, unbundling, service provisioning and pricing terms, and the time and expense involved in negotiating interconnection agreements and amendments, can be adversely affected by ongoing legal and regulatory activity. All of our interconnection agreements provide either that a party is entitled to demand renegotiation of particular provisions or of the entire agreement based on intervening changes in law resulting from ongoing legal and regulatory activity, or that a change of law is immediately effective in the agreement and that a dispute resolution process will be implemented if the parties do not agree upon the change of law. The initial terms of all of our interconnection agreements with ILECs have expired; however, each of our 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 may be able to negotiate a new agreement or initiate an arbitration proceeding at the relevant state commission before the agreement expired. In addition, the Telecommunications 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.

During 2013, we amended and extended our commercial agreement with Verizon pursuant to which we will continue to purchase a product called Verizon Wholesale Advantage Service at UNE-P rates.
 
If our commercial 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 high capacity loops and transport at discounted rates. Our current contract tariffs will all expire at the end of this year. Our interstate contract tariffs require us to maintain a certain number of channel terminations on a “take-or-pay” basis. We have entered into five- and seven-year interstate contract tariffs for Verizon’s southern and northern territories, as well as an additional five-year interstate contract tariff, which further incentivizes our use of Verizon special access services. If we fail to maintain the requisite number of channel terminations under our contract tariffs, we could be penalized a substantial amount of money. Moreover, if our contract tariff were to be terminated or expire, our cost of service could rise substantially. We cannot assure you that we will execute a new contract tariff with Verizon or that any new contract tariff, once executed, 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 a commercial agreement with AT&T, pursuant to which we serve a significant percentage of our customers in Connecticut, as well as customers in other AT&T ILEC markets. This agreement will expire at the end of 2014. If our AT&T commercial agreement were to expire, we would be required to convert all of the lines thereunder to resale, which

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would likely be incrementally less favorable to us. We cannot assure you that our commercial agreement with AT&T will be renewed at the end of its term.
We have entered into amendments of our various interconnection and commercial agreements with Verizon, which provide for assurance of timely payment. Under these amendments, 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 pay when due undisputed amounts that in total exceed 5% of the total amount invoiced by Verizon during the month and fail to cure such nonpayment within five business days of Verizon’s written notice of nonpayment. The provision of such letters of credit could adversely impact our liquidity position. The amendments 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.
We are also currently involved in a variety of disputes with vendors relating to billings of approximately $5.1 million as of December 31, 2013. For more information, 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.”
If the incumbent local exchange carriers with which we have interconnection agreements engage in anticompetitive practices or we experience difficulties in working with the incumbent local exchange carriers, our ability to offer services on a timely and cost-effective basis will be materially and adversely affected.
Our business depends on our ability to interconnect with ILEC networks and to lease from them certain essential network elements. We obtain access to these network elements and services under terms established in interconnection agreements 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 local 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 will be materially and adversely affected.
 
We are subject to substantial government regulation that may restrict our ability to provide local services and may increase the costs we incur to provide these services.
We are subject to varying degrees of federal, state and local regulation. Pursuant to the Communications Act, the FCC exercises jurisdiction over us with respect to interstate and international services. We must comply with various federal regulations, such as the duty to contribute to the USF and other subsidies. 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.
The FCC’s Triennial Review Order, subsequent Triennial Review Remand Order and related decisions have reduced our ability to access certain elements of ILEC telecommunications platforms in several ways that have affected our operations. First, we no longer have the right to require ILECs to sell us unbundled network platforms. Because of this, we entered into commercial agreements with Verizon to purchase a product called Verizon Wholesale Advantage Services at UNE-P rates subject to a surcharge, which increased over time. We are currently party to a commercial agreement with Verizon pursuant to which we will continue to purchase Verizon Wholesale Advantage Service at UNE-P rates.. Expiration or termination of our current amended and restated commercial agreement would result in a substantial increase in our cost of service. Second, in certain central offices, we no longer have the right to require ILECs to sell to us as UNEs, or have limited access rights to UNE high capacity circuits that connect our central switching office locations to customers’ premises. Third, we no longer have the right to require ILECs to sell to us UNE transport between our switches and ILEC switches. Fourth, we have only limited or no access to UNE DS1 or DS3 transport on certain interoffice routes. Petitions currently pending before the FCC could, if granted, further reduce our access to UNE-Ls and transport. In these instances where we lose unbundled access to high capacity circuits or interoffice transport, we must either find alternative suppliers or purchase substitute circuits from the ILEC 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 and our access to the ILEC’s copper infrastructure could be eliminated if the ILECs elect to retire their copper facilities. 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.

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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 most 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 the necessary certifications to provide service, but each commission retains the authority to revoke our certificate if that commission determines that we have violated any condition of our certification or if it finds that doing so would be in the public interest. While we believe we are in compliance with regulatory requirements, our interpretation of our obligations may differ from those of regulatory authorities.
Both federal and state regulators require us to pay various fees and assessments, file periodic reports and comply with various rules regarding the contents of our bills, protection of subscriber privacy, service quality and similar consumer protection matters on an ongoing basis. 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 certificate of authority to provide service should not be revoked.

A discussion of legal and regulatory developments is included in the section entitled “Business - Regulation.”
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 interexchange carriers. 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 have a material adverse effect on our business, results of operations and financial condition.
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 and Earthlink/One Communications. This consolidation strengthens our competitors and poses increased competitive challenges for us. The ILEC/interexchange carrier combinations not only provide the ILECs with national and international networks, but eliminate the two most effective and well financed opponents of the ILECs in federal and state legislative and regulatory forums and potentially reduce the availability of non-ILEC network facilities. The CLEC combinations will provide direct competitors with greater financial, network and marketing assets.

28


Advanced services, such as our “cloud” and hosted IP services, may generate claims of intellectual property infringement.
We provide a variety of advanced services, such as our “cloud” and hosted IP services. These services rely on patents and other intellectual property that third parties may claim infringes 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 IP 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 IP services were the subject of intellectual property infringement claims, our financial position could be adversely impacted.
The communications industry faces significant regulatory uncertainties and the adverse resolution of these uncertainties could harm our business, results of operations and financial condition.
If current or future regulations change, we cannot assure you that the FCC or state regulators will grant us any required regulatory authorization or refrain from taking action against us if we are found to have provided services without obtaining the necessary authorizations, or to have violated other requirements of their rules and orders. Delays in receiving required regulatory approvals or the enactment of new adverse regulations or regulatory requirements may slow our growth and have a material adverse effect upon our business, results of operations and financial condition. The Telecommunications Act remains subject to judicial review and ongoing proceedings before the FCC and state regulators, 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. Recent decisions by the FCC have eliminated or reduced our access to certain elements of ILEC telecommunications platforms that we use to serve our customers and increased the rates that we pay for such elements. Other recent 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 Telecommunications 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.
The FCC has recently revamped its intercarrier compensation mechanism and its USF program. The changes implemented by the FCC in its intercarrier compensation mechanism could reduce our high margin carrier revenue and limit or eliminate our ability to provide and charge for certain access services. The changes implemented by the FCC in its USF program could increase our program costs.
A discussion of legal and regulatory developments is included in the section entitled “Business - Regulation.”
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.
 
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 various 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.

29


We depend on a limited number of third party service providers for long distance 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 third party service providers for long distance, data and other services. If any of these 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.
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 migrated away from our service, 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.
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 and could cause us to lose customers and impede our ability to attract new customers. 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 VoIP, we may not be able to implement them as effectively as other companies with more experience with those new technologies. In addition, while we have recently purchased and deployed new technology, including VoIP softswitches, EoC and MPLS, core and edge routers, we may not be able to implement new technology as effectively as other companies with more experience with new technology.
The financial difficulties faced by others in our industry could adversely affect our public image and our financial results.
Certain competitive communications services providers, long distance carriers and other communications providers have experienced substantial financial difficulties over the past few years. To the extent that carriers in financial difficulties purchase services from us, we may not be paid in full or at all for services we have rendered. Further, the perception of instability of companies in our industry may diminish our ability to obtain further capital and may adversely affect the willingness of potential customers to purchase their communications services from us.

30


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 our expansion efforts, 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 telecommunications 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 access lines, which could have a material adverse effect on our business, results of operations and financial condition.
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 other carriers;
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.

31


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 seek to expand through the acquisition of other businesses that we believe are complementary to our business. We may be unable to identify suitable acquisition candidates, or if we do identify suitable 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 that business’s personnel, services, products or technologies into our operations;
retaining key personnel of the acquired 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 transaction.
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.
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 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.

32


If we fail to maintain effective internal controls, our financial reporting could be inaccurate.
Internal control systems are intended to provide reasonable assurance regarding the preparation and fair presentation of published financial statements. During 2012, we identified a material weakness in our internal control over financial reporting with respect to our historical methodology for calculating deferred revenue and concluded that our internal control over financial reporting was not effective as of December 31, 2012. We have recorded appropriate adjustments so that the Consolidated Financial Statements appearing in this report present fairly, in all material respects, our financial position, results of operations and cash flows for the periods presented. In addition, we have taken appropriate actions to remediate the identified material weakness in order to improve our internal controls over financial reporting. We cannot assure you that our actions will be effective or that we will not discover other material weaknesses in our controls. If we fail to maintain effective internal control over financial reporting, the accuracy and timing of our financial reporting may be adversely affected, our business and financial condition could be harmed, and investors may lose confidence in our reported financial information. For more information, see Notes 4 and 17 in the Notes to Consolidated Financial Statements.
Our substantial indebtedness may restrict our operating flexibility as the indenture governing the Notes and the credit agreement governing the Revolving Credit Facility contain certain restrictive covenants.
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 the Notes and the credit agreement governing the 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.
We cannot assure you that we will be able to meet these requirements or satisfy these covenants in the future. If we fail to do so, our indebtedness thereunder could become accelerated and payable at a time when we are unable to pay such indebtedness. This could adversely affect our ability to carry out our business plan and would have a negative effect on our financial condition.
While the “pre-packaged” plan (On August 22, 2012 (the “Petition Date”), the Company, and each of its direct and indirect subsidiaries, filed voluntary petitions for reorganization under Chapter 11 of title 11 (“Chapter 11”) of the U.S. Bankruptcy Code (the “Code”) in the U.S. Bankruptcy court for the Southern District of New York (the “Court”) with respect to a “pre-packaged” plan (the “Plan”)) has substantially de-levered us, we will still have significant long-term debt obligations. At December 31, 2013, we had $151.0 million of total outstanding indebtedness. Our substantial indebtedness could:
make it more difficult for us to satisfy 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 cash flows from operating activities to the payment of principal and interest on the indebtedness, thereby reducing the funds available to us for 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 it incurs 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 downturn in general economic conditions or in our business or changing market conditions and regulations.

33


Although the credit agreement governing the Revolving Credit Facility and the indenture governing the Notes limits our ability to incur additional indebtedness, these restrictions will be 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 credit agreement governing the Revolving Credit Facility and the indenture governing the Notes will not prevent us from incurring obligations that do not constitute indebtedness. For more information, 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 the possible inability to service our debt, would increase.
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 the Notes, the 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.
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, 2013, we required approximately $63.0 million in cash to service the interest due on the Notes throughout their remaining life. We may need to refinance all or a portion of our indebtedness, including the Notes and the Revolving Credit Facility, at or before maturity. There can be no assurances that we will be able to refinance any of our indebtedness, including the Notes and the Revolving Credit Facility, on commercially reasonable terms or at all.

Item 1B.
Unresolved Staff Comments
None.

34


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
 
September 2019
 
28,567

Rye Brook, NY
 
April 2019
 
22,680

New York, NY
 
April 2015
 
21,111

Quincy, MA
 
October 2018
 
10,811

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
 
12,144

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.

35


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 March 31, 2014:
Class of Equity Security
 
Holders of Record
Common stock
 
221

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, 2013, 2012 and 2011 and as of December 31, 2013 and 2012 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, 2010 and 2009 and as of December 31, 2011, 2010 and 2009 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. For more information regarding securities authorized for issuance under equity compensation plans, see Item 12 “Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.”



36


 
Year Ended December 31,
 
2013
 
2012
 
2011
 
2010
 
2009
Statements of operations data:
 
 
 
 
 
 
 
 
 
Revenues
$
315,363

 
$
340,907

 
$
377,989

 
$
407,740

 
$
455,298

Operating expenses:
 
 
 
 
 
 
 
 
 
Cost of revenues (1)
147,505

 
164,232

 
178,292

 
193,842

 
226,233

Selling, general and administrative (2)
124,001

 
130,777

 
132,997

 
149,245

 
154,513

Depreciation and amortization
32,839

 
36,382

 
39,508

 
43,938

 
49,922

Total operating expenses
304,345

 
331,391

 
350,797

 
387,025

 
430,668

Income from operations
11,018

 
9,516

 
27,192

 
20,715

 
24,630

Reorganization items (3)
(1,072
)
 
(8,415
)
 

 

 

Interest expense
(17,196
)
 
(35,200
)
 
(38,302
)
 
(38,379
)
 
(39,853
)
Interest income
33

 
50

 
70

 
73

 
112

Other income

 

 
183

 

 
16

Loss before provision for income taxes
(7,217
)
 
(34,049
)
 
(10,857
)
 
(17,591
)
 
(15,095
)
Provision for income taxes
(1,264
)
 
(1,224
)
 
(1,347
)
 
(1,288
)
 
(1,179
)
Net loss
$
(8,481
)
 
$
(35,273
)
 
(12,204
)
 
$
(18,879
)
 
$
(16,274
)
 
 
 
 
 
 
 
 
 
 
Statements of cash flow data:
 
 
 
 
 
 
 
 
 
Cash flows provided by (used in):
 
 
 
 
 
 
 
 
 
Operating activities
$
22,898

 
$
12,760

 
$
27,907

 
$
30,369

 
$
37,211

Investing activities
(22,545
)
 
(6,631
)
 
(29,800
)
 
(20,886
)
 
(33,238
)
Financing activities
(1,946
)
 
(19,317
)
 
(387
)
 
(6,254
)
 
(4,175
)
 
 
 
 
 
 
 
 
 
 
 
December 31,
 
2013
 
2012
 
2011
 
2010
 
2009
Balance Sheet data:
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
$
8,143

 
$
9,736

 
$
22,924

 
$
25,204

 
$
21,975

Investment securities

 

 
13,567

 
13,554

 
23,549

Property and equipment, net
61,070

 
68,381

 
80,488

 
85,144

 
86,219

Goodwill
98,238

 
98,238

 
98,238

 
98,238

 
98,238

Total assets
209,222

 
226,411

 
276,588

 
294,442

 
326,810

Total debt, including current portion
150,952

 
152,898

 
322,555

 
324,088

 
331,366

Total stockholders’ equity (deficiency)
8,212

 
16,693

 
(114,177
)
 
(101,973
)
 
(83,153
)
___________________________


(1)
Exclusive of depreciation and amortization.
(2)
Includes share-based compensation of zero for each of the years ended December 31, 2013, 2012, and 2011, and $59 and $233 for the years ended December 31, 2010 and 2009, respectively.
(3)
Expenses that result from reorganization activities and restructuring are reported as reorganization items in our consolidated statement of operations for the years ended December 31, 2013 and 2012.



37


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 cloud-based service provider of communications and information technology solutions to SMB and enterprise customers nationwide. After several years of development, we began providing cloud-based UCaaS in 2005 and later introduced into our product portfolio a variety of cloud-based computing solutions. Today, we offer a full suite of cloud-based systems and services under the brand OfficeSuite® to customers nationwide and have more than 100,000 active licenses on our flagship product OfficeSuite® Phone and an additional 80,000 licenses sold through other service providers. OfficeSuite® Phone comprises a growing percentage of our overall recurring revenue and the vast majority of our existing cloud-based revenue stream.
We benefit from software development expertise, proprietary technology and a strong next-generation network infrastructure. This allows us to offer our customers more than just cloud-based services, but additionally products that include advanced, converged communications services and network access by leveraging our network infrastructure, on a cost-effective basis. We have provided cloud-based services in the Northeast and Mid-Atlantic United States since 2005 and offered cloud-based services nationwide since late 2009. Prior to 2009, our focus had been solely on markets across 10 states, including the major metropolitan markets of New York, Boston, Philadelphia, Baltimore and Washington, D.C. These markets remain important markets for us and we have the majority of our direct sales efforts focused on these markets. We distribute our products through quota-bearing sales representatives, including a direct sales force primarily based in the Northeast and Mid-Atlantic United States, sales agents nationwide, and by our expanded efforts in wholesale, web marketing, Value Added Resellers, and nationwide distributor channels.
As of December 31, 2013, we provided our services to approximately 25,000 business customers nationwide. For the year ended December 31, 2013, approximately 89% of our total revenue was generated from retail end users in a wide array of industries, including professional services, health care, education, manufacturing, real estate, retail, automotive, non-profit groups and others. For the same period, approximately 11% of our total revenue was generated from wholesale, carrier access and other market channels. For the year ended December 31, 2013, we generated revenues of $315.4 million, and Adjusted EBITDA of $44.1 million. For more information, see the “Adjusted EBITDA Presentation” later in this section.
        
For the years ended December 31, 2013, 2012 and 2011, we recorded operating income of $11.0 million, $9.5 million and $27.2 million, respectively. For the years ended December 31, 2013, 2012 and 2011, we recorded net losses of $8.5 million, $35.3 million and $12.2 million, respectively. The reduction in operating income and larger net loss in 2012 was primarily the result of approximately $18.2 million of expenses incurred in connection with the restructuring and refinancing of our indebtedness and equity. Although we expect to have net losses for the foreseeable future, we continue to search for ways of increasing operating efficiencies that could potentially offset continued pressures on revenue and margin. We have also developed new technology and products that are being sold through new and existing sales channels that are growing, which may increase revenues and gross margin.

    

38


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 and established cable operators CLECs 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 selling, general and administrative (“SG&A”) costs, by the achievement of certain operating efficiencies throughout the organization and the reduced interest on the Notes.
As of December 31, 2013, we had approximately 190 sales, sales management and sales support employees, including approximately 150 quota-bearing representatives in all sales channels, the majority of whom target SMB and enterprise customers in the Northeast and Mid-Atlantic regions. We also offer our OfficeSuite® cloud-based solutions, including our OfficeSuite® Phone product, on a nationwide basis, where we sell through our agents, VARs/nationwide distributors/strategic partners and web channels.
We focus our sales efforts on selling cloud-based services to communications intensive multi-location business customers who purchase multiple products. These customers generally purchase higher margin services in multi-year contracts, and consequently maintain higher retention rates.
For the year ended December 31, 2013, revenue from these products and services represented 78% of our retail revenue with 21% of retail revenue generated by cloud-based communications services, 42% of retail revenue generated by other T-1- and IP-based products, and 15% of retail revenue generated by traditional voice services provided to those T-1- and IP-based accounts. For the same period, T-1- and IP-based products represented approximately 83% of new retail sales, with typical incremental gross profit margins in excess of 60%. Cloud-based services, including cloud-based computing services, represented approximately 44% of new retail sales while other T-1- and IP-based products represented 39% of new retail sales. Since 2009, cloud-based products and services have grown at a 20% CAGR.
Our facilities-based network encompasses approximately 3,000 route miles of metro and long-haul fiber and approximately 260 colocations. Our network architecture pairs the strength of a traditional infrastructure with IP and 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, VPNs and complex multi-location services, on a cost effective basis. Our network topology incorporates metro 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 MPLS-based infrastructure, which enhances the performance of our network. As of December 31, 2013, approximately 77% of our total installed lines were provisioned on-net.
In August 2012, we filed for reorganization under Chapter 11 of the Code in the Court in order to effectuate a pre-packaged financial restructuring (the “Restructuring”). In accordance with the plan of reorganization, we issued the Notes in an aggregate principal amount of $150.0 million and canceled approximately $316.2 million of our 11 3/8% notes, including accrued interest. In addition, holders of our then outstanding 11 3/8% notes received their pro rata share of (i) 97.5% of 9,999,945 shares of newly issued common stock (subject to dilution by the exercise of warrants and equity pursuant to a future management incentive plan and board compensation) and (ii) the Notes. Holders of our then-existing preferred stock received their pro rata share of (i) 2.5% of 9,999,945 shares of newly issued common stock (subject to dilution by the exercise of warrants and equity pursuant to a future management incentive plan and board compensation) and (ii) two tranches of eight-year warrants to acquire shares of newly issued common stock representing, in the aggregate, up to 15.0% of the Company’s outstanding capital stock following the Restructuring. Under the Plan, general unsecured creditors, vendors, customers and employees were not negatively impacted and our obligations to these groups were paid in full in accordance with their original terms. We successfully concluded the bankruptcy and emerged from Chapter 11 on November 13, 2012.
Company projections prior to the reorganization assumed that we would have limited excess liquidity and financial flexibility to invest in new growth initiatives. The final result of the Restructuring provided additional liquidity and we are investing in various revenue growth initiatives, including our direct sales force, channel partners and software development for our hosted VoIP product offering. The total cost of these initiatives in 2013 compared to 2012 is substantial and represents several million dollars of incremental spending. These investments and others commenced in a more significant manner in early 2013 and will continue to accelerate for the foreseeable future as we focus on various growth initiatives. In addition, we have a history of non-organic initiatives including mergers and acquisitions, and continue to evaluate these options.

39




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,
 
2013
 
2012
 
2011
Revenues:
 
 
 
 
 
Voice and data services:
 
 
 
 
 
     Cloud
18.3
 %
 
14.8
 %
 
11.1
 %
     NonCloud
68.2
 %
 
71.7
 %
 
73.6
 %
     Ancillary
2.7
 %
 
2.4
 %
 
1.9
 %
Voice and data services
89.2
 %
 
88.9
 %
 
86.6
 %
Wholesale
7.3
 %
 
6.8
 %
 
6.1
 %
Carrier access
2.1
 %
 
2.4
 %
 
5.2
 %
Total network services
98.6
 %
 
98.1
 %
 
97.9
 %
Other
1.4
 %
 
1.9
 %
 
2.1
 %
Total revenues
100.0
 %
 
100.0
 %
 
100.0
 %
Operating expenses:
 
 
 
 
 
Network services
46.3
 %
 
47.5
 %
 
46.3
 %
Other cost of revenues
0.5
 %
 
0.6
 %
 
0.8
 %
Selling, general and administrative
39.3
 %
 
38.4
 %
 
35.2
 %
Depreciation and amortization
10.4
 %
 
10.7
 %
 
10.5
 %
Total operating expenses
96.5
 %
 
97.2
 %
 
92.8
 %
Income from operations
3.5
 %
 
2.8
 %
 
7.2
 %
     Reorganization items
(0.3
)%
 
(2.5
)%
 
 %
Interest expense
(5.5
)%
 
(10.3
)%
 
(10.1
)%
Loss before provision for income taxes
(2.3
)%
 
(10.0
)%
 
(2.9
)%
Provision for income taxes
(0.4
)%
 
(0.3
)%
 
(0.3
)%
Net loss
(2.7
)%
 
(10.3
)%
 
(3.2
)%
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 retail revenue, approximately 20% of our wholesale revenue stream consists of cloud-based services. Carrier access services include carrier access and reciprocal compensation revenue, which consists primarily of usage charges that we bill to other carriers to originate and terminate their calls from and to our customers. Network services revenues represents a predominantly recurring revenue stream linked to our retail and wholesale customers.

For the year ended December 31, 2013 approximately 89% of our total revenue was generated from retail customer voice and data products and services. Revenue from data and integrated voice/data products, including cloud-based services and T-1/T-3 and other managed services has been trending to an increasing percentage of our overall revenue over the past several years, while voice revenues have been declining primarily due to the decline in revenue from traditional voice services, or Plain Old Telephone Services (“POTS”). In recent quarters, we have experienced a reduction in the quarterly rate of decline of our POTS revenues. Since June 30, 2010, our average quarterly rate of decline has been 3.6% as compared to the 5.7% average quarterly rate of decline experienced during the periods from April 1, 2009 to June 30, 2010, when the combined effects of the recession and our shift in product focus most impacted our results. Our cloud-based revenues have grown from 2009 to 2013 at a 20% CAGR. As a result, the average quarterly decline in our core voice and data revenue, which excludes certain ancillary voice and data revenue components, has improved since 2009, with an average quarterly decrease of $1.6 million in 2013 as compared to a

40


peak sequential decrease of $4.7 million in the quarter ended June 30, 2009. Our cloud-based products and services comprised approximately 21% of our retail revenue and approximately 44% of new retail sales in 2013. 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.
Cost of Revenues (exclusive of depreciation and amortization)
Our network services cost of revenues consists primarily of both the cost of operating our network facilities and the costs related to our off-net customers. Determining our cost of revenues requires 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 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 agreement with cable providers as another alternative for local loops
Our off-net network services cost of revenues consists of amounts we pay to Verizon, Fairpoint and AT&T pursuant to our commercial agreements with them. Rates for such services are prescribed in the commercial agreements and available for the term of the agreements. The FairPoint commercial agreement operates on a month-to-month basis. During 2013, we entered into an extension of our Verizon commercial agreement which expires in 2016. Our AT&T commercial agreement expires in December 2014.
Our network services cost of revenues also include the fees we pay for long distance, data and other services. We have entered into long-term wholesale purchasing agreements for these services. Some of these agreements contain significant termination penalties and/or minimum volume commitments.
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 (loss) from operations as income from operations is calculated in accordance with GAAP:
 
Year Ended December 31,
 
2013
 
2012
 
2011
Income from operations
$
11,018

 
$
9,516

 
$
27,192

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

 
 

 
 

Depreciation and amortization
32,839

 
36,382

 
39,508

Selling, general and administrative
124,001

 
130,777

 
132,997

 
 
 
 
 
 
Gross profit
$
167,858

 
$
176,675

 
$
199,697

Percentage of total revenue
53.2
%
 
51.8
%
 
52.8
%
    

41


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.
During the latter part of 2012, and continuing at an increasing level in 2013, we launched several new initiatives directed at supporting our revenue growth initiatives. These included recruiting expenses for new sales personnel, new quota-bearing sales personnel and sales management, purchasing lead generation data bases, increasing support for channel sales, increasing software and systems development teams for OfficeSuite® and costs associated with a new sales and customer relationship management software package implementation.
Depreciation and Amortization
Our depreciation and amortization expense currently includes depreciation for network related voice and data equipment, fiber, back-office systems, third party conversion costs, furniture, fixtures, leasehold improvements, office equipment and computers and amortization of intangibles associated with mergers, acquisitions and software development costs.
Reorganization Items
Our expenses that result from Chapter 11 reorganization activities and Restructuring are reported as reorganization items in our consolidated statements of operations. Our reorganization expenses consisted entirely of a transaction bonus and professional fees associated with the Restructuring, including the preparation of the Registration Statement and subsequent amendments on Form S-1 filed with the Commission in 2013.


42




Adjusted EBITDA Presentation
Adjusted EBITDA as presented in this Management’s Discussion and Analysis of Financial Condition and Results of Operations represents net loss before depreciation and amortization, interest income and expense, provision for income taxes, and other non-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 loss, income from operations and revenues, to assess our historical and prospective operating performance.
 
The following table sets forth, for the periods indicated, a reconciliation of Adjusted EBITDA to net loss as net loss is calculated in accordance with GAAP:
 
Year Ended December 31,
 
2013
 
2012
 
2011
Net loss
$
(8,481
)
 
$
(35,273
)
 
$
(12,204
)
Add back non-EBITDA items included in net loss:
 
 
 
 
 
Depreciation and amortization
32,839

 
36,382

 
39,508

Interest expense, net of interest income
17,163

 
35,150

 
38,232

Provision for income taxes
1,264

 
1,224

 
1,347

 
 
 
 
 
 
EBITDA
42,785

 
37,483

 
66,883

Costs associated with early termination of lease

 

 
1,656

Severance and related separation costs
241

 
376

 
295

Professional fees related to strategic initiatives(1)

 
9,787

 
595

Reorganization items (1)
1,072

 
8,415

 

Costs associated with carrier settlement

 
2,800

 

Costs associated with legal settlement

 
400

 

Costs associated with Hurricane Sandy

 
914

 

Other income

 

 
(183
)
Adjusted EBITDA
$
44,098

 
$
60,175

 
$
69,246

Percentage of total revenues
14.0
%
 
17.7
%
 
18.3
%
(1)     During 2012, management determined that costs associated with refinancing efforts should be written off. These costs, totaling $1,630, were included in other assets on our consolidated balance sheet at December 31, 2011. The remaining $8,157 represents professional fees incurred in connection with the reorganization prior to the Petition Date. The reorganization items in 2012 and 2013 represent professional fees incurred in connection with the reorganization after the Petition Date. The total costs incurred in connection with the restructuring and refinancing of indebtedness and equity were approximately $19.3 million.
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.

43


The information about our operating performance provided by this financial measure is used by management for a variety of purposes. Management regularly communicates its 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. Management believes that because of the variety of equity awards used by companies, the varying methodologies for determining share-based compensation among companies and from period to period, and the subjective assumptions involved in those determinations, excluding share-based compensation from Adjusted EBITDA enhances company-to-company comparisons over multiple fiscal periods. 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 and amortized will likely have to be replaced in the future, and Adjusted EBITDA does not reflect any cash requirements for such replacements;
Adjusted EBITDA does not reflect the cost of equity awards to employees; 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 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.


44


Year Ended December 31, 2013 Compared to the Year Ended December 31, 2012
Set forth below is a discussion and analysis of our results of operations for the years ended December 31, 2013 and 2012.
The following table provides a breakdown of components of our gross profit for the years ended December 31, 2013 and 2012:
 
Year Ended December 31,
 
 
 
2013
 
2012
 
 
 
Amount
 
% of Total
Revenues
 
Amount
 
% of Total
Revenues
 
% Change
Revenues:
 
 
 
 
 
 
 
 
 
Network services
$
310,916

 
98.6
%
 
$
334,476

 
98.1
%
 
(7.0
)%
Other
4,447

 
1.4
%
 
6,431

 
1.9
%
 
(30.9
)%
Total revenues
$
315,363

 
100.0
%
 
$
340,907

 
100.0
%
 
(7.5
)%
 
 
 
 
 
 
 
 
 
 
Cost of revenues:
 
 
 
 
 
 
 
 
 
Network services
$
145,981

 
46.3
%
 
$
161,993

 
47.5
%
 
(9.9
)%
Other
1,524

 
0.5
%
 
2,239

 
0.7
%
 
(31.9
)%
Total cost of revenues
$
147,505

 
46.8
%
 
$
164,232

 
48.2
%
 
(10.2
)%
 
 
 
 
 
 
 
 
 
 
Gross profit:
 
 
 
 
 
 
 
 
 
Network services
$
164,935

 
52.3
%
 
$
172,483

 
50.6
%
 
(4.4
)%
Other
2,923

 
0.9
%
 
4,192

 
1.2
%
 
(30.3
)%
Total gross profit
$
167,858

 
53.2
%
 
$
176,675

 
51.8
%
 
(5.0
)%
Revenues
Revenues for the years ended December 31, 2013 and 2012 were as follows:
 
Year Ended December 31,
 
 
 
2013
 
2012
 
 
 
Amount
 
% of Total
Revenues
 
Amount
 
% of Total
Revenues
 
% Change
Revenues:
 
 
 
 
 
 
 
 
 
Voice and data services:
 
 
 
 
 
 
 
 
 
       Cloud
$
57,697

 
18.3
%
 
$
50,602

 
14.8
%
 
14.0
 %
       NonCloud
215,073

 
68.2
%
 
244,289

 
71.7
%
 
(12.0
)%
       Ancillary
8,417

 
2.7
%
 
8,019

 
2.4
%
 
5.0
 %
Voice and data services
281,187

 
89.2
%
 
302,910

 
88.9
%
 
(7.2
)%
Wholesale
22,977

 
7.3
%
 
23,033

 
6.8
%
 
(0.2
)%
Carrier access
6,752

 
2.1
%
 
8,533

 
2.5
%
 
(20.9
)%
Total network services
310,916

 
98.6
%
 
334,476

 
98.1
%
 
(7.0
)%
Other
4,447

 
1.4
%
 
6,431

 
1.9
%
 
(30.9
)%
Total revenues
$
315,363

 
100.0
%
 
$
340,907

 
100.0
%
 
(7.5
)%

Revenues from voice and data services decreased $21.7 million or 7.2% between 2012 and 2013. Within voice and data services, revenues from cloud-based services increased $7.1 million, or 14.0%; revenues from core voice and data services, excluding cloud-based services, decreased $29.2 million, or 12%; and ancillary voice and data revenues increased by $0.4 million.  The decrease in non-cloud core services was due to: i) line churn which exceeded line additions, ii) lower usage revenue per customer, iii) lower prices per unit for certain traditional services and iv) a lower number of lines and customers.  Wholesale revenues were virtually unchanged. Carrier access revenues decreased $1.8 million or 20.9%, which reflects a one-time settlement that occurred in 2012. Excluding the nonrecurring access settlement, carrier access revenues decreased due to several factors, including: decreasing levels of traffic to which access charges are applicable, including decreases in retail voice customer traffic,

45


lower average per-minute rates charged to carriers as a result of FCC-mandated rate decreases and traffic jurisdiction classifications. Our other revenues decreased $2.0 million or 30.8% between 2012 and 2013. Other revenues include data cabling, service installation and wiring and phone systems sales and installation, which continued to decline due to the economic environment.
 
Cost of Revenues (exclusive of depreciation and amortization)
 
Cost of revenues were $147.5 million for the year ended December 31, 2013, a decrease of 10.2% from $164.2 million for the same period in 2012 primarily due to the overall decline in revenue. The decrease is also due to the identification and elimination of inefficiencies in our operating platforms and negotiations of lower costs from our vendors. Our costs consist primarily of those incurred from other providers and those incurred from the cost of our network. Costs where we purchased services or products from third party providers comprised $112.0 million, or 75.9% of our total cost of revenues for the year ended December 31, 2013 and $125.6 million, or 76.4%, in the year ended December 31, 2012. The most significant components of our costs purchased from third party providers consist of costs related to our Verizon commercial contract, UNE-L costs and T-1 costs, which totaled $24.2 million, $13.9 million and $38.9 million, respectively, for the year ended December 31, 2013. Combined, these costs decreased by 11.5% between 2012 and 2013. These costs totaled $27.4 million, $16.2 million and $43.2 million, respectively, for the year ended December 31, 2012.
Gross Profit (exclusive of depreciation and amortization)
 
Gross profit was $167.9 million for the year ended December 31, 2013, a decrease of 5.0% from $176.7 million for the same period in 2012. The decrease in gross profit is primarily due to the decline in revenue. As a percentage of revenues, gross profit increased to 53.2% in 2013 from 51.8% in 2012. This increase in gross profit as a percentage of revenue in 2013 is partially due to a settlement of disputed access revenue that occurred in 2012 that resulted in lower revenue without a corresponding reduction in cost of revenue. The impact of the settlement reduced gross profit by 0.5% in 2012. The increase is also due to a shift toward T-1 and cloud-based services and our focus on customer and network optimization. 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 $124.0 million, 39.3% of revenues, for the year ended December 31, 2013, a decrease of $6.8 million, or 5.2% from $130.8 million, 38.4% of revenues, for the same period in 2012. This decrease is primarily due to the net effect of i) decreased professional fees in connection with the restructuring of $9.8 million, $1.6 million of which consisted of write-offs of discontinued refinancing costs and $8.2 million of other professional fees incurred in connection with the ongoing restructuring in 2012, ii) increased expenses in 2013 due to a one time settlement of a tax audit of $1.0 million covering the years 2004 through 2012, and iii) increased expenses in 2013 for several new initiatives directed at supporting our revenue growth initiatives.

We continue to look for additional cost savings in various categories.

Depreciation and Amortization
Depreciation and amortization costs were $32.8 million for the year ended December 31, 2013, a decrease of 9.9% from $36.4 million for the same period in 2012. This decrease in depreciation and amortization expense is the result of certain property and equipment fully depreciating during 2013 and a reduction in the monthly amortization expense of our customer base assets. Amortization expense included in our results of operations for customer base intangible assets for the year ended December 31, 2013 was $2.2 million, a decrease of $1.3 million from $3.5 million during the same period in 2012.

46


Interest
Interest expense was $17.2 million for the year ended December 31, 2013, a decrease of 51.1% from $35.2 million for the same period in 2012. This decrease is primarily the result of the reduced principal and related interest on the Notes. Our effective annual interest rates for the year ended December 31, 2013 and 2012 are as follows:
 
Year Ended December 31,
 
2013
 
2012
Interest expense
$
17,196

 
$
35,200

Weighted average debt outstanding
$
152,011

 
$
308,138

Effective interest rate
11.3
%
 
11.4
%

47


Year Ended December 31, 2012 Compared to the Year Ended December 31, 2011
Set forth below is a discussion and analysis of our results of operations for the years ended December 31, 2012 and 2011.
The following table provides a breakdown of components of our gross profit for the years ended December 31, 2012 and 2011:
 
Year Ended December 31,
 
 
 
2012
 
2011
 
 
 
Amount
 
% of Total
Revenues
 
Amount
 
% of Total
Revenues
 
% Change
Revenues:
 
 
 
 
 
 
 
 
 
Network services
$
334,476

 
98.1
%
 
$
369,966

 
97.9
%
 
(9.6
)%
Other
6,431

 
1.9
%
 
8,023

 
2.1
%
 
(19.8
)%
Total revenues
$
340,907

 
100.0
%
 
$
377,989

 
100.0
%
 
(9.8
)%
 
 
 
 
 
 
 
 
 
 
Cost of revenues:
 
 
 
 
 
 
 
 
 
Network services
$
161,993

 
47.5
%
 
$
175,198

 
46.4
%
 
(7.5
)%
Other
2,239

 
0.7
%
 
3,094

 
0.8
%
 
(27.6
)%
Total cost of revenues
$
164,232

 
48.2
%
 
$
178,292

 
47.2
%
 
(7.9
)%
 
 
 
 
 
 
 
 
 
 
Gross profit:
 
 
 
 
 
 
 
 
 
Network services
$
172,483

 
50.6
%
 
$
194,768

 
51.5
%
 
(11.4
)%
Other
4,192

 
1.2
%
 
4,929

 
1.4
%
 
(15.0
)%
Total gross profit
$
176,675

 
51.8
%
 
$
199,697

 
52.9
%
 
(11.5
)%
Revenues
Revenues for the years ended December 31, 2012 and 2011 were as follows:
 
Year Ended December 31,
 
 
 
2012
 
2011
 
 
 
Amount
 
% of Total
Revenues
 
Amount
 
% of Total
Revenues
 
% Change
Revenues:
 
 
 
 
 
 
 
 
 
Voice and data services:
 
 
 
 
 
 
 
 
 
       Cloud
50,602

 
14.8
%
 
41,864

 
11.1
%
 
20.9
 %
       NonCloud
244,289

 
71.7
%
 
278,306

 
73.6
%
 
(12.2
)%
       Ancillary
8,019

 
2.4
%
 
7,192

 
1.9
%
 
11.5
 %
Voice and data services
$
302,910

 
88.9
%
 
$
327,362

 
86.6
%
 
(7.5
)%
Wholesale
23,033

 
6.8
%
 
23,046

 
6.1
%
 
(0.1
)%
Carrier access
8,533

 
2.5
%
 
19,558

 
5.2
%
 
(56.4
)%
Total network services
334,476

 
98.1
%
 
369,966

 
97.9
%
 
(9.6
)%
Other
6,431

 
1.9
%
 
8,023

 
2.1
%
 
(19.8
)%
Total revenues
$
340,907

 
100.0
%
 
$
377,989

 
100.0
%
 
(9.8
)%
Revenues from voice and data services decreased $24.5 million or 7.5% between 2011 and 2012. Within voice and data services, revenues from cloud-based services increased $8.7 million, or 20.9%; revenues from core voice and data services, excluding cloud-based services, decreased $34.0 million, or 12.2%; and ancillary voice and data revenues increased by $0.8 million. The decrease in non-cloud core services was due to: i) line churn which, while improving in recent quarters, still exceeds line additions, ii) lower usage revenue per customer, iii) lower prices per unit for certain traditional services and iv) a lower number of lines and customers. Wholesale revenues were virtually unchanged. Carrier access revenues decreased $11.0 million or 56.4%, which is partially due to one-time settlements that occurred in 2012 and 2011. In addition, carrier access revenues decreased due to several factors, including decreasing levels of traffic to which access charges are applicable, including decreases in retail voice

48


customer traffic; and lower per-minute revenue rates charged to carriers as a result of FCC-mandated rate decreases and traffic jurisdiction classifications. Our other revenues decreased $1.6 million or 19.8% between 2011 and 2012. Other revenues include data cabling, service installation and wiring and phone systems sales and installation, which continued to decline due to the economic environment.
Cost of Revenues (exclusive of depreciation and amortization)
Cost of revenues were $164.2 million for the year ended December 31, 2012, a decrease of 7.9% from $178.3 million for the same period in 2011 primarily due to the overall decline in revenue. The decrease is also due to the identification and elimination of inefficiencies in our operating platforms and negotiations of lower costs from our vendors. Our costs consist primarily of those incurred from other providers and those incurred from the cost of our network. Costs where we purchased services or products from third party providers comprised $125.6 million, or 76.5% of our total cost of revenues for the year ended December 31, 2012 and $137.2 million, or 76.9%, in the year ended December 31, 2011. The most significant components of our costs purchased from third party providers consist of costs related to our Verizon commercial contract, UNE-L costs and T-1 costs, which totaled $27.4 million, $16.2 million and $43.2 million, respectively, for the year ended December 31, 2012. Combined, these costs decreased by 11.1% between 2011 and 2012. These costs totaled $31.1 million, $18.4 million and $48.3 million, respectively, for the year ended December 31, 2011
Gross Profit (exclusive of depreciation and amortization)
Gross profit was $176.7 million for the year ended December 31, 2012, a decrease of 11.5% from $199.7 million for the same period in 2011. The decrease in gross profit is primarily due to the decline in revenue. As a percentage of revenues, gross profit decreased to 51.8% in 2012 from 52.8% in 2011. This decrease in gross profit as a percentage of revenue in 2012 is primarily due to the decrease in carrier access revenues. The overall carrier access revenue decrease is partially due to a settlement of access revenue that occurred in 2012 that resulted in lower revenue and a settlement of access revenue that occurred in 2011 that resulted in additional revenue, neither of which had a corresponding impact on cost of revenue. The impact of the settlement in 2011 increased gross profit by 0.2%. 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 anticipate that our gross profit as a percentage of revenue will improve over time.

Selling, General and Administrative
SG&A expenses were $130.8 million, 38.4% of revenues, for the year ended December 31, 2012, a decrease of $2.2 million, or 1.7% from $133.0 million, 35.2% of revenues, for the same period in 2011. This decrease is primarily due to the net effect of i) increased professional fees of $9.3 million, which includes $1.6 million of non-recurring write-offs of discontinued refinancing costs and $8.2 million of other professional fees incurred in connection with the Restructuring, ii) decreased employee costs of $5.4 million that is primarily a result of reduced employee headcount compared to the same period in 2011, and iii) decreased commissions of $2.8 million that is a result of reduced quota-bearing representatives and decreased new sales activity.
Depreciation and Amortization
Depreciation and amortization costs were $36.4 million for the year ended December 31, 2012, a decrease of 7.8% from $39.5 million for the same period in 2011. This decrease in depreciation and amortization expense is a result of network equipment fully depreciating at the end of 2011 and a reduction in the monthly amortization expense of our customer base assets. Amortization expense included in our results of operations for customer base intangible assets for the year ended December 31, 2012 was $3.5 million, a decrease of $1.6 million from $5.1 million during the same period in 2011.







49



Interest
Interest expense was $35.2 million for the year ended December 31, 2012, a decrease of 8.1% from $38.3 million for the same period in 2011. The decrease was due to lower debt outstanding and a reduced rate of interest on the 11 3/8% Senior Secured Notes due 2012 (the “Old Notes”). Upon entering into Chapter 11, we incurred interest on our notes at a rate of 10.5% rather than at the historical rate of 11.375%. The Notes bear interest at 10.5%. Our effective annual interest rates for the years ended December 31, 2012 and 2011 are as follows:
 
Year Ended December 31,
 
2012
 
2011
Interest expense
$
35,200

 
$
38,302

Weighted average debt outstanding
$
308,138

 
$
321,924

Effective interest rate
11.4
%
 
11.9
%

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.
We previously maintained standby letters of credit under our former Revolving Credit Facility. During 2012, we collateralized those letters of credit with cash.
      
Liquidity and Capital Resources
Sources and uses of liquidity
Our principal sources of liquidity are cash from operations, cash and cash equivalents on hand, our capital lease line and a revolving credit facility. Our Revolving Credit Facility has a current maximum availability of $25.0 million subject to certain borrowing base limitations. This facility was undrawn as of December 31, 2013. In addition to our normal operating requirements, our short-term liquidity needs consist of interest on the Notes, capital expenditures and working capital. As of December 31, 2013 we had $0.6 million of capital lease obligations outstanding under our capital lease lines. Our cash and cash equivalents are being held in several large financial institutions, although most of our balances exceed the Federal Deposit Insurance Corporation insurance limits.
As of December 31, 2013, we will require approximately $63.0 million in cash to service the interest due on the Notes throughout the remaining life of the Notes. For the year ended December 31, 2013, the Company incurred capital expenditures of $22.4 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.
Disputes
We continue to be involved in a variety of disputes with multiple carrier vendors relating to billings of approximately $5.1 million as of December 31, 2013. 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.


50


Credit Facility

On November 13, 2012, we entered into our new $25,000 Revolving Credit Facility. 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. The borrowing base eligibility calculation exceeds the amount required to draw on the entire Revolving Credit Facility; therefore the remaining availability under the Revolving Credit Facility and the letter of credit sublimit are fully available for borrowing to the extent they have not already been drawn upon. In addition, we are subject to an unused line fee equal to the applicable percentage, as defined, on the average daily unused portion of the revolving credit commitment, as defined. The loans bear interest on a base rate method or LIBOR method, in each case plus an applicable margin percentage, at our option. Interest on the LIBOR loans is paid at the end of the applicable LIBOR interest period, and, in any event, at least every three months; interest on the base rate loans is paid on a quarterly basis. At December 31, 2013, we had no outstanding borrowings or letters of credit under our revolving credit facility.
The Revolving Credit Facility is subject to certain specified mandatory reductions in the event future of debt issuances, asset dispositions, and insurance or condemnation events as a result of theft or destruction to our property and assets. The Revolving Credit Facility includes a number of affirmative and negative covenants, which could restrict our operations. If we were to be in default the lenders could accelerate our obligation to pay all outstanding amounts.
 
We are required to pay certain on-going fees in connection with the Revolving Credit Facility, including letter of credit fees on any letters of credit issued under the facility at a per annum rate of 3.00% of the average undrawn amount of such letter of credit, including issuance fees in respect thereof and commitment fees on the unused revolving commitments at a per annum rate of 0.75%. In the event that the Revolving Credit Facility is completely terminated or availability thereunder is permanently reduced prior to the maturity date, with respect to LIBOR loans, we are restricted as to timing to such reductions or terminations and are required to cover any costs in connection with the termination, reduction or repayment of such LIBOR or base rate commitment.
Subject to the terms of an intercreditor agreement, indebtedness under the Revolving Credit Facility is guaranteed by all of our direct and indirect domestic subsidiaries (other than certain immaterial subsidiaries) that are not borrowers thereunder and is secured by a security interest in all of our domestic subsidiaries’ tangible and intangible assets (including, without limitation, intellectual property, real property, licenses, permits and all of our and our subsidiaries’ capital stock (other than voting capital stock of our subsidiaries that exceeds 65% of such voting capital stock) and all funds and investment property on deposit therein or credited thereto and certain other excluded assets.
The Revolving Credit Facility contains financial, affirmative and negative covenants and requirements affecting us and our subsidiaries. In general, the financial covenants provide for, among other things, delivery of financial statements and other financial information to the lenders and notice to the lenders upon the occurrence of certain events. The affirmative covenants include, among other things, standard covenants relating to our operations and our subsidiaries’ businesses and compliance with all applicable laws, material applicable provisions of ERISA and material agreements. The Revolving Credit Facility contains negative covenants and restrictions on our actions and our subsidiaries, including, without limitation, incurrence of additional indebtedness, restrictions on dividends and other restricted payments, prepayments of debt, liens, sale-leaseback transactions, loans and investments, hedging arrangements, mergers, transactions with affiliates, changes in business and restrictions on our ability to amend the indenture governing the Notes.
The Revolving Credit Facility contains customary representations and warranties and events of default, including, without limitation, payment defaults, cross-payment defaults and cross events of default, covenant defaults, certain events of bankruptcy, certain events under ERISA, loss of assets, loss or expiry of license, failure to comply with certain rules and regulations, material judgments, actual or asserted invalidity of the guarantees, change in nature of business and change in control. Upon the occurrence of an event of default, the Revolving Credit Facility may be terminated, any amounts due thereunder may be automatically due and payable and the borrowers shall deposit in a cash collateral account an amount equal to 105% of the aggregate then undrawn and unexpired amount of all outstanding letters of credit.
As of December 31, 2013, we were in compliance with all restrictive covenants set forth in the credit agreement governing the Revolving Credit Facility.

51


Notes
In connection with the Plan, on November 13, 2012, we issued Notes with an aggregate principal amount of $150 million. Under the Notes, interest accrues at 10.5% per annum, calculated using a 360-day year, and is payable semi-annually in cash in arrears on May 15 and November 15 of each year, beginning on May 15, 2013. We are required to pay interest on overdue principal at 2% per annum in excess of the rate per annum set forth in the Notes, and also pay interest on overdue installments of interest at the same rate to the extent lawful.
The Notes are fully, unconditionally and irrevocably guaranteed on a senior secured basis, jointly and severally, by each of our existing and future domestic restricted subsidiaries. The Notes and the guarantees rank senior in right of payment to all existing and future subordinated indebtedness of us and our subsidiary guarantors, as applicable, and equal in right of payment with all existing and future senior indebtedness of ours and our subsidiaries.
 
The Notes and the guarantees are secured by a lien on substantially all of our assets provided, however, that pursuant to the terms of an intercreditor agreement, the security interest in those assets consisting of receivables, inventory, deposit accounts, securities accounts and certain other assets that secure the notes and the guarantees are contractually subordinated to a lien thereon that secures the our Revolving Credit Facility and certain other permitted indebtedness.
We may redeem the Notes, at our option, in whole or in part at any time prior to November 15, 2017, upon not less than 30 days or more than 60 days’ notice, at the following redemption prices (expressed as percentages of the principal amount thereof) set forth below:
Period
 
Percentage
Prior to six months following the Issue Date
 
100
%
Six months to 18 months following the Issue Date
 
105
%
18 months to 30 months following the Issue Date
 
104
%
30 months to 42 months following the Issue Date
 
103
%
42 months to 54 months following the Issue Date
 
102
%
54 months to 60 months following the Issue Date
 
100
%
In addition, we must pay accrued and unpaid interest on the aggregate principal amount of the Notes redeemed.
The indenture governing the Notes contains covenants limiting our ability to, among other things: incur or guarantee additional indebtedness or issue certain preferred stock; pay dividends; redeem or purchase equity interests; redeem or purchase subordinated debt; make certain acquisitions or investments; create liens; enter into transactions with affiliates; merge or consolidate; make certain restricted payments; and transfer or sell assets, including equity interests of existing and future restricted subsidiaries. If an event of default shall occur and be continuing and has not been waived, The Bank of New York Mellon, as trustee, or the holders of at least 25% in principal amount of outstanding Notes may declare the principal of and premium, if any, and accrued interest on all of the Notes to be due and payable. We were in compliance with all covenants at December 31, 2013 .

52


Year Ended December 31, 2013 Compared to Year Ended December 31, 2012
Cash Flows from Operating Activities
Cash provided by operating activities was $22.9 million for the year ended December 31, 2013, compared to $12.8 million for the same period in 2012. Our increase in cash flow from operating activities was primarily due to lower interest costs associated with the Notes along with improvement in ordinary business operating activities.
Cash Flows from Investing Activities
Cash used in investing activities was $22.5 million for the year ended December 31, 2013, compared to $6.6 million for the same period in 2012. The change in cash flow from investing activities was due to: i) cash paid of $0.9 million for the acquisition of Common Voices, Inc., ii) an increase in capital expenditures of $1.6 million and iii) the redemption of $13.7 million of investment securities converted into cash and cash equivalents for the same period in 2012. In addition, during 2012 we collateralized several letters of credit with cash that were previously maintained as standby letters of credit under our former revolving credit facility
Cash Flows from Financing Activities
Cash used in financing activities was $1.9 million for the year ended December 31, 2013, compared to $19.3 million for the same period in 2012. The change in cash flows from financing activities was primarily due to repayments on the Revolving Credit Facility, net of borrowings under our former Senior Revolving Debtor in Possession Credit Facility, of $17.1 million, which occurred during 2012.
Year Ended December 31, 2012 Compared to the Year Ended December 31, 2011
Cash Flows from Operating Activities
Cash provided by operating activities was $12.8 million for the year ended December 31, 2012, compared to $27.9 million for the same period in 2011. Our decline in cash flow from operating activities was due to a reduction in our revenues and higher costs incurred in connection with the restructuring, offset by lower interest costs. During the year ended December 31, 2012, we paid $24.3 million in interest expense on our senior notes compared to $34.1 million during the same period in 2011.
Cash Flows from Investing Activities
Cash used in investing activities was $6.6 million for the year ended December 31, 2012, compared to $29.8 million for the same period in 2011. The $23.2 million change in cash flow from investing activities was due to the $13.7 million decrease in activities of buying and selling investment securities and a $9.5 million decrease in the purchases of capital equipment.
Cash Flows from Financing Activities
Cash used in financing activities was $19.3 million and $0.4 million for the years ended December 31, 2012 and 2011, respectively. The change in cash flows from financing activities was primarily due to repayments of $17.1 million on the Revolving Credit Facility and net repayments of $1.7 million on our capital lease financings in 2012.

Contractual Obligations
The following table summarizes our future contractual cash obligations as of December 31, 2013. The following numbers are presented in thousands.
 
Total
 
Less Than 1 Year
 
1-3 Years
 
3-5 Years
 
More Than 5
Years
10 1/2 senior secured notes due 2017
$
150,000

 
$

 
$

 
$
150,000

 
$

Cash interest for notes
63,000

 
15,750

 
31,500

 
15,750

 

Capital lease obligations
951

 
676

 
233

 
43

 

Operating leases
52,244

 
7,370

 
13,880

 
13,949

 
17,045

Total contractual obligations
$
266,196

 
$
23,796

 
$
45,613

 
$
179,742

 
$
17,045


53


New Accounting Standards
In July 2013, the FASB issued ASU 2013-11, Income Taxes (Topic 740): Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists.  Under this new guidance, companies must present this unrecognized tax benefit in the consolidated financial statements as a reduction to deferred tax assets created by net operating losses or other tax credits from prior periods that occur in the same taxing jurisdiction. If the unrecognized tax benefit exceeds such credits it should be presented in the consolidated financial statements as a liability. This update is effective for annual and interim reporting periods for fiscal years beginning after December 15, 2013. The adoption of this standard is not expected to have any impact on the Company’s operating results and financial position.
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 $0.4 million and $0.6 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 $0.6 million. We reflect all carrier related receivables on our consolidated balance sheet at the amount we expect to realize in cash.
Depreciation
Depreciation is computed using the straight-line method over the estimated useful lives of the assets. The estimated useful life is three years for computer and office equipment, five years for furniture and fixtures, and generally seven years for network equipment. Leasehold improvements are amortized on a straight-line basis over the shorter of their estimated useful lives or the related lease term. Capitalized software costs are amortized on a straight-line basis over the estimated useful life of two years. Internal labor costs capitalized in connection with expanding our network are amortized over seven years.


54


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 and Other Intangible Assets
We perform impairment tests at least annually on all goodwill and indefinite-lived intangible assets, which are conducted at the reporting unit level. We have one reporting unit. Goodwill and indefinite-lived intangible assets are 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 and indefinite-lived intangibles for impairment is primarily based on a discounted cash flow model that includes estimates of future cash flows. 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.
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.
Income Taxes
We recognize deferred income taxes using the asset and liability method of accounting for income taxes. Under the asset and liability method, deferred income taxes are recognized for differences between the financial reporting and tax bases of assets and liabilities at enacted statutory tax rates in effect for the years in which the differences are expected to reverse. The effect on deferred taxes of a change in tax rates is recognized in income in the period that includes the enactment date. In addition, valuation allowances are established when necessary to reduce deferred tax assets to the amounts expected to be realized. At December 31, 2013, we had net operating loss carryforwards (“NOLs”) available totaling approximately$167.0 million which will begin to expire in 2019. We have provided a full valuation allowance against the net deferred tax asset as of December 31, 2013 because we do not believe it is more likely than not that this asset will be realized. To the extent that our ability to use these NOLs against any future taxable income is limited, our cash flow available for operations and debt service would be reduced. If we achieve profitability, the net deferred tax assets may be available to offset future income tax liabilities.
Reorganizations
For the period subsequent to the Petition Date, our consolidated financial statements have been prepared in accordance with Accounting Standards Codification (“ASC”) 852, “Reorganizations.” ASC 852 requires that our pre-petition liabilities that are subject to compromise be reported separately on the balance sheet as an estimate of the amount that will ultimately be allowed by the Court.
Pursuant to ASC 852, the objective of financial statements issued by an entity in Chapter 11 is to reflect its financial evolution during the proceeding. For that purpose, the financial statements for periods including and subsequent to filing the Chapter 11 petition should distinguish transactions and events that are directly associated with the reorganization from the ongoing operations of the business. Certain expenses, realized gains and losses and provisions for losses not directly related to ongoing operations are reflected separately as reorganization items in the consolidated statements of operations. Cash used for reorganization items is disclosed separately in the consolidated statements of cash flows. Additionally, pre-petition debt that is subject to compromise must be recorded at the allowed claim amount.
 

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In accordance with ASC 852, we did not adopt fresh-start accounting as of the effective date of the Plan. Fresh-start accounting requires that the reporting entity allocate the reorganization value to its assets and liabilities in relation to their fair values upon emergence from Chapter 11 if (i) the value of the assets of the emerging entity immediately before the date of confirmation is less than the total of all post-petition liabilities and allowed claims; and (ii) holders of existing voting shares immediately before confirmation receive less than 50% of the voting shares of the emerging entity. We did not qualify for fresh start reporting under ASC 852 as upon emergence from Chapter 11 the value of our assets was greater than the total of all post-petition liabilities and allowed claims. Reorganization items are expense items that were incurred or realized as a result of the bankruptcy and are presented separately in the accompanying consolidated statements of operations. These expenses include professional fees and transaction bonuses incurred and directly related to the bankruptcy filing. We have not recorded any income from reorganization activities.

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.
We continually monitor the collectability of our accounts receivable and have not noted any significant changes in our collections as a result of the Restructuring or the current economic and market conditions. We believe that our allowance for doubtful accounts is adequate as of December 31, 2013. Should the market conditions worsen or should our customers’ ability to pay decrease, we may be required to increase our allowance for doubtful accounts, which would result in a charge to our SG&A expenses.
Our available cash balances are invested on a short-term basis (generally overnight) and, accordingly, are not subject to significant risks associated with changes in interest rates. Substantially all of our cash flows are derived from our operations within the United States and we are not subject to market risk associated with changes in foreign exchange rates.
The fair value of the Notes at December 31, 2013 was approximately $146.6 million and was based on publicly quoted market prices. The Notes, like all fixed rate securities are subject to interest rate risk and will fall in value if market interest rates increase. For more information, see Note 15 to Consolidated Financial Statements.
  



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Item 8.
Financial Statements and Supplementary Data
Index to Consolidated Financial Statements


57


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. 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, 2013, 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.

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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, 2013 and 2012, and the related consolidated statements of operations, stockholders’ equity (deficiency) and cash flows for each of the three years in the period ended December 31, 2013. Our audits also included the financial statement schedule listed in the Index to Consolidated Financial Statements. 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 audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. 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 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 at December 31, 2013 and 2012, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2013, 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.
/s/ Ernst & Young LLP
New York, NY
March 31, 2014


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BROADVIEW NETWORKS HOLDINGS, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(in thousands, except share amounts)
 
December 31,
 
2013
 
2012
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
8,143

 
$
9,736

Certificates of deposit
1,820

 
1,805

Accounts receivable, less allowance for doubtful accounts of $6,037 and $7,460
24,450

 
28,811

Other current assets
7,753

 
9,300

Total current assets
42,166

 
49,652

Property and equipment, net
61,070

 
68,381

Goodwill
98,238

 
98,238

Intangible assets, net
4,068

 
6,261

Other assets
3,680

 
3,879

Total assets
$
209,222

 
$
226,411

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
4,749

 
$
4,433

Accrued expenses and other current liabilities
14,442

 
20,361

Taxes payable
7,413

 
8,820

Deferred revenues
10,100

 
10,567

Current portion of capital lease obligations
676

 
1,818

Total current liabilities
37,380

 
45,999

10.5% senior secured notes
150,000

 
150,000

Deferred rent payable
4,879

 
4,822

Deferred revenues
1,103

 
1,077

Capital lease obligations, net of current portion
276

 
1,080

Deferred income taxes payable
6,917

 
5,948

Other
455

 
792

Total liabilities
201,010

 
209,718

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

 
100

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

 

Additional paid-in capital
306,792

 
306,792

Accumulated deficit
(298,680
)
 
(290,199
)
Total stockholders’ equity
8,212

 
16,693

Total liabilities and stockholders’ equity
$
209,222

 
$
226,411

See notes to consolidated financial statements.

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BROADVIEW NETWORKS HOLDINGS, INC. AND SUBSIDIARIES

Consolidated Statements of Operations
(in thousands)
 
Year Ended December 31,
 
2013
 
2012
 
2011
Revenues
$
315,363

 
$
340,907

 
$
377,989

Operating expenses:
 
 
 
 
 
Cost of revenues (exclusive of depreciation and amortization)
147,505

 
164,232

 
178,292

Selling, general and administrative
124,001

 
130,777

 
132,997

Depreciation and amortization
32,839

 
36,382