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HCOM > SEC Filings for HCOM > Form 10-K on 13-Mar-2014All Recent SEC Filings

Show all filings for HAWAIIAN TELCOM HOLDCO, INC.

Form 10-K for HAWAIIAN TELCOM HOLDCO, INC.


13-Mar-2014

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

Background

In the following discussion and analysis of financial condition and results of operations, unless the context otherwise requires, "we," "us" or the "Company" refers, collectively, to Hawaiian Telcom Holdco, Inc. and its subsidiaries.

The statements in the discussion and analysis regarding industry outlook, our expectations regarding the future performance of our business and the other non-historical statements in the discussion and analysis are forward-looking statements. These forward-looking statements are subject to numerous risks and uncertainties, including, but not limited to, the risks and uncertainties described in Item 1A, "Risk Factors." Our actual results may differ materially from those contained in any forward-looking statements. You should read the following discussion together with Item 6, "Selected Financial Data" and our consolidated financial statements and related notes thereto included elsewhere in this annual report.

Segments and Sources of Revenue

We operate in two reportable segments (telecommunication and data center colocation) based on how resources are allocated and performance is assessed by our chief operating decision maker. Our chief operating decision maker is our Chief Executive Officer.

In the fourth quarter of 2013, we reevaluated our reportable segments. This was prompted by the acquisition of SystemMetrics and our current strategic focus. Previously, we presented a wireline and other segment (which was primarily wireless services). With the diminishing significance of the wireless segment, we no longer provide separate wireless information to our chief operating decision maker. Both these segments are now combined into the telecommunications segment. Prior to the acquisition of SystemMetrics on September 30, 2013, we did not have data center colocation operations. Hence, we were in a single segment prior to September 30, 2013 under the revised reportable segment structure.

Telecommunications

The telecommunication segment derives revenue from the following sources:

Local Telephone Services-We receive revenue from providing local exchange telephone services. These revenues include monthly charges for basic service, local private line services and enhanced calling features such as voice mail, caller ID and 3-way calling.

Network Access Services-We receive revenue for access to our network for wholesale carrier data, business customer data including Dedicated Internet Access, switched carrier access and subscriber line charges imposed on end users. Switched carrier access revenue compensates us for origination, transport and termination of calls for long distance and other interexchange carriers.

Long Distance Services-We receive revenue from providing long distance services to our customers.


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High-Speed Internet ("HSI") Services-We provide HSI to our residential and business customers.

Video Services-Our video services marketed as Hawaiian Telcom TV is an advanced entertainment service offered to customers in select areas.

Equipment and Managed Services-We provide installation and maintenance of customer premise equipment as well as managed service for customer telephone and IT networks.

We receive revenue from wireless services, including the sale of wireless handsets and other wireless accessories.

Data Center Colocation

The data center colocation segment provides physical colocation, virtual colocation and various related telephony services.

Results of Operations for the Years Ended December 31, 2013, 2012 and 2011

Operating Revenues

    The following tables summarize our volume information (lines or subscribers)
as of December 31, 2013, 2012 and 2011, and our operating revenues for the years
ended December 31, 2013, 2012 and 2011.


                               Volume Information

                                                       2013 vs. 2012              2012 vs. 2011
                        December 31,                      Change                      Change
                2013        2012        2011       Number     Percentage      Number      Percentage
Voice
access
lines
Residential     186,415     203,330     223,009     (16,915 )        (8.3 )%   (19,679 )         (8.8 )%
Business(1)     193,027     185,142     189,035       7,885           4.3 %     (3,893 )         (2.1 )%
Public            4,155       4,405       4,623        (250 )        (5.7 )%      (218 )         (4.7 )%


                383,597     392,877     416,667      (9,280 )        (2.4 )%   (23,790 )         (5.7 )%




High-Speed
Internet
lines
Residential      91,437      88,016      84,634       3,421           3.9 %      3,382            4.0 %
Business         19,320      18,575      17,442         745           4.0 %      1,133            6.5 %
Wholesale           963       1,020       1,156         (57 )        (5.6 )%      (136 )        (11.8 )%


                111,720     107,611     103,232       4,109           3.8 %      4,379            4.2 %




Long
distance
lines
Residential     117,282     126,551     136,921      (9,269 )        (7.3 )%   (10,370 )         (7.6 )%
Business(1)      79,496      74,781      76,160       4,715           6.3 %     (1,379 )         (1.8 )%


                196,778     201,332     213,081      (4,554 )        (2.3 )%   (11,749 )         (5.5 )%




Video
Subscribers      18,393       9,829       1,620       8,564          87.1 %      8,209          506.7 %




Homes
Enabled         120,000      65,000      27,400      55,000          84.6 %     37,600          137.2 %


(1)
Business voice access lines and business long distance lines included approximately 9,400 and 5,500 lines, respectively, as of December 31, 2013 related to the acquisition of Wavecom. These


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lines were not included in the volume information as of December 31, 2012 as they were not deemed meaningful to analyzing 2012 results.

2013 compared to 2012

Operating Revenues (dollars in thousands)

                                       For the Year Ended
                                          December 31,                Change
                                        2013        2012       Amount     Percentage
    Telecommunications
    Local voice services              $ 137,166   $ 141,352   $ (4,186 )         (3.0 )%
    Network access services
    Business data                        25,392      18,946      6,446           34.0 %
    Wholesale carrier data               59,529      63,192     (3,663 )         (5.8 )%
    Subscriber line access charge        37,739      38,885     (1,146 )         (2.9 )%
    Switched carrier access               7,698       8,883     (1,185 )        (13.3 )%


                                        130,358     129,906        452            0.3 %


    Long distance services               24,733      27,959     (3,226 )        (11.5 )%
    High-Speed Internet                  39,800      36,323      3,477            9.6 %
    Video                                13,012       4,883      8,129          166.5 %
    Equipment and managed services       26,994      31,418     (4,424 )        (14.1 )%
    Wireless                              2,713       3,336       (623 )        (18.7 )%
    Other                                14,186      10,321      3,865           37.4 %


                                        388,962     385,498      3,464            0.9 %
    Data center colocation                2,188           -      2,188             NA


                                      $ 391,150   $ 385,498   $  5,652            1.5 %




    Channel
    Business                          $ 170,544   $ 163,923   $  6,621            4.0 %
    Consumer                            141,234     137,765      3,469            2.5 %
    Wholesale                            66,206      71,673     (5,467 )         (7.6 )%
    Other                                13,166      12,137      1,029            8.5 %


                                      $ 391,150   $ 385,498   $  5,652            1.5 %

The decrease in local voice services revenues was caused primarily by the decline of $7.9 million of voice access lines. This was offset by $3.7 million of revenue from Wavecom customers acquired in December 2012. Continued competition in the telecommunications industry has increasingly resulted in customers using technologies other than traditional phone lines for voice and data. Residential customers are increasingly using wireless services in place of traditional wireline phone service as well as moving local voice service to VoIP technology offered by competitors. Generally, VoIP technology offered by cable providers is less expensive than traditional wireline phone service, requiring us to respond with more competitive pricing. Additionally, Competitive Local Exchange Carriers (CLECs) and our cable competitor continue to focus on business customers and selling services to our customer base.

In an effort to slow the rate of line loss, we are continuing retention and acquisition programs, and are increasingly focusing efforts on bundling of services. We have instituted various "saves" campaigns designed to focus on specific circumstances where we believe customer churn is controllable. These campaigns include targeted offers to "at risk" customers as well as other promotional tools designed to enhance customer retention. We also emphasize win-back and employee referral programs.


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Additionally, we are intensifying our efforts relative to developing tools and training to enhance our customer service capability to improve customer retention and growth.

Business data revenue for the year ended December 31, 2013 increased when compared to the prior year primarily because of $5.1 million of revenue from Wavecom customers acquired in December 2012 as well as growth from customer win-backs and increasing bandwidth needs from our customers. Wholesale carrier revenue decreased because of revenues received from Wavecom in 2012 which we no longer recognize as Wavecom is a wholly-owned subsidiary. In addition, the impact of the decline in voice access lines is reflected in subscriber line access charges and switched carrier access charges.

The decrease in long distance revenue was primarily because of the decline in long distance lines and customers moving to wireless and VoIP based technologies for long distance calling.

HSI revenues increased when compared to the prior year primarily because an approximate 3.8% growth in our HSI subscribers as well as improved revenue per subscriber with increased bandwidth offerings.

On July 1, 2011, we commercially launched our video service on the island of Oahu. We are rolling out Hawaiian Telcom TV gradually to selected areas to ensure delivery of superior service and an ongoing excellent customer experience. Our volume is ramping up as more homes become enabled for video service. We expect to expand both the availability and the capabilities of our Hawaiian Telcom TV service over the next several years through additional capital investment and innovation.

Equipment and managed services sales have decreased because of a decline in the sales and installations of customer premise equipment for certain large government customers during 2013 compared to 2012. Revenue from equipment sales varies from period to period based on the volume of large installation projects. The volume of such projects in future periods is uncertain.

Wireless revenues declined as there has been a reduction in marketing effort as we focus on other products.

The increase in other services revenue for the year ended December 31, 2013 compared to the prior year is because of revenue from Wavecom of $1.7 million. In addition, business VoIP equipment usage fees amounted to $2.0 million in 2013 and were negligible in 2012.

Data center colocation revenues were recognized in the fourth quarter of 2013 with the acquisition of SystemMetrics on September 30, 2013.


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2012 compared to 2011

Operating Revenues (dollars in thousands)

                                       For the Year Ended
                                          December 31,                Change
                                        2012        2011       Amount     Percentage
    Telecommunications
    Local voice services              $ 141,352   $ 146,921   $ (5,569 )         (3.8 )%
    Network access services
    Business data                        18,946      18,133        813            4.5 %
    Wholesale carrier data               63,192      64,589     (1,397 )         (2.2 )%
    Subscriber line access charge        38,885      39,857       (972 )         (2.4 )%
    Switched carrier access               8,883       9,833       (950 )         (9.7 )%


                                        129,906     132,412     (2,506 )         (1.9 )%


    Long distance services               27,959      31,945     (3,986 )        (12.5 )%
    High-Speed Internet                  36,323      35,426        897            2.5 %
    Video                                 4,883         269      4,614             NA
    Equipment and managed services       31,418      33,274     (1,856 )         (5.6 )%
    Wireless                              3,336       4,271       (935 )        (21.9 )%
    Other                                10,321      10,638       (317 )         (3.0 )%


                                      $ 385,498   $ 395,156   $ (9,658 )         (2.4 )%




    Channel
    Business                          $ 163,923   $ 168,262   $ (4,339 )         (2.6 )%
    Consumer                            137,765     137,563        202            0.1 %
    Wholesale                            71,673      74,422     (2,749 )         (3.7 )%
    Other                                12,137      14,909     (2,772 )        (18.6 )%


                                      $ 385,498   $ 395,156   $ (9,658 )         (2.4 )%

The decrease in local voice services revenues was caused primarily by the decline in voice access lines of 5.7% ($8.4 million of the decline in revenue). The decline in voice access lines from 2011 to 2012 was caused by the same factors discussed previously for the decline from 2012 to 2013.

Network access services revenue decreased as compared to the prior year because certain wireless carriers disconnected lower bandwidth circuits replaced with new more efficient higher bandwidth circuits resulting in a reduction in wholesale carrier data revenue for the year. In addition, the impact of the decline in voice access lines is reflected in subscriber line access charges and switched carrier access charges. These reductions were partially offset by growth in business data revenue.

The decrease in long distance revenue was primarily because of the decline in long distance lines.

The increase in video is attributed to the same factors discussed for the increase from 2012 to 2013 related the ramp up of Hawaiian Telcom TV services.

HSI revenues increased when compared to the prior year primarily because an approximate 4.2% growth in our HSI subscribers ($1.5 million of the increase in revenue).

Equipment and managed services sales decreased as compared to the prior year because of less sales and installations of customer premise equipment for certain large government customers in 2012.

Wireless revenues decreased as we attempted to focus our marketing efforts on other segments of our business.


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Operating Costs and Expenses

2013 compared to 2012

    The following table summarizes our costs and expenses for 2013 compared to
the costs and expenses for 2012 (dollars in thousands):

                                            For the Year Ended
                                               December 31,                Change
                                             2013        2012       Amount     Percentage
Cost of revenues (exclusive of
depreciation and amortization)             $ 163,749   $ 160,226   $  3,523            2.2 %
Selling, general and administrative
expenses                                     114,875     108,508      6,367            5.9 %
Gain on sale of property                      (6,546 )         -     (6,546 )           NA
Depreciation and amortization                 77,301      70,908      6,393            9.0 %


                                           $ 349,379   $ 339,642   $  9,737            2.9 %

Operations, including costs and expenses, for the data center colocation segment were not significant as it was newly acquired on September 30, 2013. Hence, a separate discussion for the telecommunications and data center colocation segment is not provided for the current period.

The Company's total headcount as of December 31, 2013 was 1,388 compared to 1,392 as of December 31, 2012. Employee related costs are included in both cost of revenues and selling, general and administrative expenses. As the change in headcount was less than one percent, it did not significantly impact results for 2013 as compared to 2012.

Cost of revenues consists of costs we incur to provide our products and services including those for operating and maintaining our networks, installing and maintaining customer premise equipment, and cost of goods sold directly associated with various products. The costs of revenue for the year ended December 31, 2013 increased because of an increase of $5.8 million in TV content and other costs. This was partially offset by reduced customer premise equipment costs of $3.7 million on lower revenue.

Selling, general and administrative expenses include costs related to sales and marketing, information systems and other administrative functions. The increase was because of increased gross receipt taxes of $1.9 million as there were beneficial settlements related to such taxes in 2012 as we were able to settle certain gross receipts taxes with taxing authorities for amounts less than originally anticipated. In addition, rent expense increased $1.2 million related to Wavecom and SystemMetrics operations. There was also a $2.7 million increase in bad debt expense as the prior year included a one-time benefit from the settlement of our preexisting relationship with Wavecom. See Note 3 to the consolidated financial statements for further discussion of this matter.

In 2013, we sold a parcel of land and warehouse not actively used in our operations for a purchase price, as amended, of $13.9 million. A gain on the sale of $6.5 million was recognized in the second quarter of 2013. The Hawaii Public Utilities Commission ("HPUC") approval of the sale requires we spend $0.3 million on training employees on broadband telecommunication deployment and operation. In addition, the HPUC approval provides for the balance of the sales price to be used for improvement to our broadband network.

Depreciation and amortization increased because of new property additions placed into service.


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2012 compared to 2011

The following table summarizes our costs and expense for the year ended December 31, 2012 compared to the year ended December 31, 2011 (dollars in thousands).

                                            For the Year Ended
                                               December 31,                Change
                                             2012        2011       Amount     Percentage
Cost of revenues (exclusive of
depreciation and amortization)             $ 160,226   $ 159,822   $     404           0.3 %
Selling, general and administrative
expenses                                     108,508     120,390     (11,882 )        -9.9 %
Depreciation and amortization                 70,908      63,806       7,102          11.1 %


                                           $ 339,642   $ 344,018   $  (4,376 )        -1.3 %

The Company's total headcount as of December 31, 2012 was 1,392 compared to 1,309 as of December 31, 2011.

The costs of revenues for the year ended December 31, 2012 increased when compared to the prior year even though revenues declined for the same period. Cost of video content increased with the ramp up of Hawaiian Telcom TV. This increased cost was not fully offset by other declines in revenue related cost components.

Selling, general and administrative expenses decreased primarily because of reduced labor costs of $8.9 million on lower average headcount and reduced pension costs. Average headcount for 2012 was lower than 2011 even though headcount as of December 31, 2012 increased when compared to December 31, 2011. This was primarily because of Wavecom employees obtained through the December 31, 2012 acquisition. There was also a decline in bad debt expense of $2.2 million primarily because of the settlement of balances due from Wavecom as described in Note 3 to the consolidated financial statements.

Depreciation and amortization increased because of new property additions placed into service.

Other Income and (Expense)

2013 compared to 2012

    The following table summarizes other income (expense) for the years ended
December 31, 2013 and 2012 (dollars in thousands).

                                           For the Year Ended
                                              December 31,                Change
                                            2013        2012      Amount     Percentage
  Interest expense, net                   $ (18,875 ) $ (22,183 ) $ 3,308          -14.9 %
  Loss on early extinguishment of debt       (3,660 )    (5,112 )   1,452          -28.4 %
  Interest income and other                      34          59       (25 )        -42.4 %


                                          $ (22,501 ) $ (27,236 ) $ 4,735          -17.4 %

Interest expense decreased primarily because of the lower interest rates on the refinanced debt.

In connection with the refinancing of debt in the second quarter of 2013 and in the first quarter of 2012, we incurred charges of $3.7 million and $5.1 million, respectively, which consisted of the loss on the repayment of the old debt and certain refinancing costs.


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2012 compared to 2011

The following table summarizes other income (expense) for the years ended December 31, 2012 and 2011 (dollars in thousands).

                                           For the Year Ended
                                              December 31,                Change
                                            2012        2011       Amount     Percentage
  Interest expense, net                   $ (22,183 ) $ (25,339 ) $  3,156          -12.5 %
  Loss on early extinguishment of debt       (5,112 )         -     (5,112 )           NA
  Interest income and other                      59          65         (6 )         -9.2 %


                                          $ (27,236 ) $ (25,274 ) $ (1,962 )          7.8 %

Interest expense decreased primarily because of the lower interest rates on the refinanced debt.

In connection with the refinancing of debt in the first quarter of 2012, we incurred a $5.1 million charge to income which consisted of the premium on the repayment of the old debt and certain refinancing costs.

Reorganization Items

Reorganization items represent amounts incurred as a direct result of the Company's Chapter 11 filing and are presented separately in our consolidated statements of income. Such expense items consisted of $1.1 million in professional fees for the year ended December 31, 2011.

The Company emerged from Chapter 11 in October 2010 but continued to incur reorganization related expenses until December 2011 as the Chapter 11 cases were not closed until January 2012.

Income Tax

As of December 31, 2011, we had maintained a full valuation allowance over our net deferred income tax assets. This situation resulted from our having a short history as a new entity (post Chapter 11). From emergence in 2010 through 2012, we had generated earnings in all periods. As a result of our continued positive annual earnings, as well as positive forecasted earnings in the future, management concluded that it was more likely than not that we would realize our deferred income tax assets, and therefore, we released our valuation allowance as of December 31, 2012. If there is a decline in the level of actual future or forecasted earnings, the conclusion regarding the need for a valuation allowance may change in future periods resulting in the establishment of a valuation allowance for some or all of our deferred income tax assets.

Liquidity and Capital Resources

As of December 31, 2013, we had cash of $49.6 million. From an ongoing operating perspective, our cash requirements going into 2014 consist of supporting the development and introduction of new products, capital expenditure projects, pension funding obligations and other changes in working capital. A combination of cash-on-hand and cash generated from operating activities will be used to fund our cash requirements.


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We have continued to take actions to conserve cash and improve liquidity. Efforts have also been taken to generate further operating efficiencies and focus on expense management. We have focused on improving operating results, including efforts to simplify product offerings, improve our customer service experience and increase our revenue enhancement activities. There can be no assurance that these additional actions will result in improved overall cash flow. We continue to have sizable retirement obligations for our existing employee base. Any sustained declines in the value of pension trust assets or relatively high levels of pension lump sum benefit payments will increase the magnitude of future plan contributions.

Agreements with the HPUC and the debt agreements of Hawaiian Telcom Communications, Inc. limit the ability of our subsidiaries to pay dividends to the parent company and restrict the net assets of all of our subsidiaries. This can limit our ability to pay dividends to our shareholders. As the parent company has no operations, debt or other obligations, this restriction has no other immediate impact on our operations.

Cash Flows

Our primary source of funds continues to be cash generated from operations. We use the net cash generated from operations to fund network expansion and modernization to facilitate enhanced services. We expect that our capital . . .

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