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INTERNET AMERICA INC - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) Certain statements contained in this Quarterly Report on Form 10-Q constitute "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These statements, identified by words such as "anticipate," "believe," "estimate," "should," "expect" and similar expressions include our expectations and objectives regarding our future financial position, operating results and business strategy. These statements reflect the current views of management with respect to future events and are subject to risks, uncertainties and other factors that may cause our actual results, performance or achievements, or industry results, to be materially different from those described in the forward-looking statements. We do not intend to update the forward-looking information to reflect actual results or changes in the factors affecting such forward-looking information. Our Annual Report on Form 10-K for the fiscal year ended June 30, 2013 and other publicly filed reports discuss some of the important factors that could cause our actual results to differ materially from those in any forward-looking statements. Some of these factors are also discussed under the heading "Safe Harbor Statement and Risk Factors" laterin this Item 2. Overview The quarter ended March 31, 2014 continued to show consistent results in operations and cash flow. During the quarter, we completed the integration of UpperSpace, a Wireless Internet Service Provider (WISP) located in northeast Oklahoma that we purchased on November 1, 2013. In line with our acquisition strategy we are talking to other WISP acquisition candidates, but, as of this time none of them have reached a definitive agreement. We continue to execute on our strategy to grow not only through acquisitions, but organically through sales and marketing initiatives and the implementation of new technologies. In furtherance of this strategy, we are investing in a direct sales program that we expect to commence in the quarter ended June 30, 2014. With regard to new technologies, we have entered into an agreement to test LTE in Joplin, Missouri utilizing our 2.5 GHz spectrum. In addition, we recently engaged a financial advisor, the GulfStar Group, Inc., who is continuing to help us evaluate strategic alternatives for the Company. Our Adjusted EBITDA (as defined below) and net income margins for the quarter ended March 31, 2014 decreased slightly as compared to the immediately preceding quarter as we have invested in some important initiatives during the March 2014 quarter. In particular, we added personnel to our technical staff that will enhance our ability to be responsive to our service levels with our customers, we have invested in the development of sophisticated tools to allow us to be more proactive and less reactive to issues with our customers and we are hiring sales staff as we pursue a direct sales program. Our cash position increased by $737,000 from $2,295,000 as of June 30, 2013 to $3,032,000 as of March 31, 2014. This represents an increase in cash of $73,000 or 11.0% over the prior comparable period net increase in cash and cash equivalents of $664,000 for the nine months ended March 31, 2013. We experienced a 4.6% and 3.8% increase in revenues to $2,059,000 and $6,054,000 for the three and nine months ended March 31, 2014, respectively, as compared to the comparable prior year periods. Our adjusted earnings before interest, taxes, depreciation and amortization and stock based compensation ("Adjusted EBITDA") for the three months ended March 31, 2014 decreased slightly from the comparable prior year period to $405,000 from $435,000 representing an Adjusted EBITDA margin of 19.7% and 22.1%, respectively. Our Adjusted EBITDA for the nine month period ended March 31, 2014 decreased slightly from the comparable prior year period to $1,386,000 from $1,395,000 representing an Adjusted EBITDA margin of 22.9% and 23.9%, respectively. 11 Our net income for the three months ended March 31, 2014 was slightly lower compared with the comparable prior year period at $190,000 and $224,000, respectively, representing a net income margin of 9.2% and 11.4%, respectively. Our net income for the nine months ended March 31, 2014 also remained relatively consistent with the comparable prior year periods at $747,000 and $729,000, respectively, representing a net income margin of 12.3% and 12.5%, respectively. Statement of Operations Internet services revenue is derived from dial-up Internet access, including analog and ISDN access, DSL access, dedicated connectivity, wireless access, bulk dial-up access, web hosting services, and value-added services, such as multiple e-mail boxes, personalized e-mail addresses and Fax-2-Email services. Connectivity and operations expenses consist primarily of setup costs for new subscribers, telecommunication costs, merchant processing fees, and wages of network operations and customer support personnel. Connectivity costs include fees paid to telephone companies for subscribers' dial-up connections to our network, fees paid to backbone providers for connections from our network to the Internet, and equipment and tower lease costs for our new wireless networks. Sales and marketing expenses consist primarily of creative and production costs, costs of media placement, management salaries and call center wages. Advertising costs are expensed as incurred. General and administrative expenses consist primarily of administrative salaries, professional services, rent and other general office and business expenses. Depreciation expense is computed using the straight-line or double declining method over the estimated useful lives of the assets or the capital lease term, as appropriate. Data communications equipment, computers, data servers and office equipment are depreciated over five years. Furniture, fixtures and leasehold improvements are depreciated over five years or the lease term. Buildings are depreciated over fifteen years. Amortization expense consists of the amortization of subscriber acquisition costs, which are amortized overfour years. Our business is not subject to any significant seasonal influences. 12 Results of Operations Three Months Ended March 31, 2014 Compared to Three Months Ended March 31, 2013 The following table sets forth certain unaudited financial data for the three months ended March 31, 2014 and March 31, 2013. Operating results for any period are not indicative of results for any future period. Amounts are shown in thousands (except share and per share data). Three Months Ended March 31, % of 2014 Revenues 2013 % of Revenues REVENUES: Internet services $ 2,059 100.0 % $ 1,968 100.0 % TOTAL REVENUES 2,059 100.0 % 1,968 100.0 % OPERATING EXPENSES:Connectivity and operations 1,075 52.2 % 1,009 51.3 % Sales and marketing 80 3.9 % 121 6.2 % General and administrative 500 24.3 % 403 20.5 % Depreciation and amortization 200 9.7 % 198 10.1 % TOTAL OPERATING EXPENSES 1,855 90.1 % 1,731 88.1 % INCOME FROM OPERATIONS 204 9.9 % 237 11.9 % OTHER INCOME (EXPENSE) Interest income 2 0.1 % 3 0.2 % Interest expense (3 ) (0.1 )% (4 ) (0.2 )%OTHER INCOME (EXPENSE), net (1 ) 0.0 % (1 ) 0.0 % INCOME BEFORE INCOME TAX EXPENSE 203 9.9 % 236 12.0 % Income tax expense 13 0.6 % 12 0.6 % NET INCOME $ 190 9.2 % $ 224 11.4 % NET INCOME PER COMMON SHARE: BASIC $ 0.01 $ 0.01 DILUTED $ 0.01 $ 0.01 WEIGHTED AVERAGE COMMON SHARES OUTSTANDING: BASIC 16,733,832 16,729,562 DILUTED 19,849,915 19,474,299 OTHER DATA: Adjusted EBITDA(1) $ 405 $ 435 Adjusted EBITDA margin(2) 19.7 % 22.1 % CASH FLOW DATA:Cash flow provided by operations $ 410 $ 345 Cash flow used in investing activities $ (17 ) $ (184 ) Cash flow used in financing activities $ (51 ) $ (67 ) Reconciliation of net income to Adjusted EBITDA: Net Income $ 190 $ 224 Add: Depreciation and amortization 200 198 Stock based compensation 1 - Interest expense 3 4 Income tax expense 13 12 Less: Interest income (2 ) (3 ) Adjusted EBITDA(1) $ 405 $ 435 13 (1) Adjusted EBITDA, which as used herein means earnings before the effect of interest, taxes, depreciation, amortization and stock based compensation, is not a measurement of financial performance under generally accepted accounting principles (GAAP) and should not be considered an alternative to net income as a measure of performance. Management has consistently used adjusted EBITDA on a historical basis as a measurement of the Company's current operating cash income. (2) Adjusted EBITDA margin represents Adjusted EBITDA as a percentage of total revenue. Total revenue. Total revenue increased by $91,000, or 4.6%, to $2,059,000 for the three months ended March 31, 2014, from $1,968,000 for the three months ended March 31, 2013. Wireless broadband Internet revenue increased by $150,000 to $1,699,000 during the current year period compared to $1,549,000 for the prior year period. This increase was primarily due to the stability of the subscriber base and customers migrating to upgraded service levels during the quarter ended March 31, 2014, as well as the full period results from the acquisitions of wireless subscribers completed in fiscal years 2013 and 2014. The increase in revenues derived from wireless broadband Internet subscribers was partially offset by a net decrease in other types of Internet service revenues of $59,000 to $360,000 during the current year period compared to $419,000 for the prior year period, which is primarily attributed to the expected decline of dial-up customers. Connectivity and operations. Connectivity and operations expense increased by $66,000, or 6.5%, to $1,075,000 for the three months ended March 31, 2014, from $1,009,000 for the three months ended March 31, 2013. Materials and supplies expense increased by $12,000 to $54,000 for the current year period compared to $42,000 for the prior year period primarily due to a one time vendor concession granted in connection with a manufacturer's recall during the prior year period. An increase of $63,000 in salaries, wages and related personnel expense to $537,000 was recorded for the current year period compared to $474,000 for the prior year period. These increases are all a result of the Company's growth and network expansion from acquisitions of wireless subscribers completed in the twelve months ended March 31, 2014. The above mentioned increases were partially offset by a decrease of $9,000 in telecommunications expense to $229,000 for the current year period compared to $238,000 in the prior year period due to renegotiating more favorable terms with telecommunications service providers. Sales and marketing. Sales and marketing expense decreased by $41,000, or 33.9%, to $80,000 for the three months ended March 31, 2014 compared to $121,000 for the three months ended March 31, 2013. Salaries, wages and related personnel costs decreased by approximately $17,000 to $60,000 for the current year period compared to $77,000 for the prior year period due to changes in personnel. Advertising expense decreased by $16,000 to $4,000 for the current year period compared to $20,000 for the prior year period primarily due to employing more cost effective forms of advertising. Outside sales expense also decreased by $10,000 to $8,000 for the current year period compared to $18,000 for the prior year period due to increased sales efforts through in house personnel. 14 The above mentioned decreases were partially offset by an increase in facilities expense of $2,000 compared to the prior year period. General and administrative. General and administrative expense increased by $97,000, or 24.1%, to $500,000 for the three months ended March 31, 2014, from $403,000 for the three months ended March 31, 2013. Professional fees increased by $59,000 to $100,000 for the current year period compared to $41,000 for the prior year period due to the addition of a new Chief Financial Officer in July 2013 who is engaged as a non-employee consultant to the Company and recruiting fees for new accounting personnel. Personnel costs increased by $9,000 to $192,000 for the current year period compared to $183,000 for the prior year period due to changes in compensation. Insurance expense increased by $7,000 to $43,000 for the current year period compared to $36,000 for the prior year period primarily due to additional workers' compensation expense incurred. Occupancy expense increased $18,000 to $70,000 for the three months ended March 31, 2014 from $52,000 for the prior year period due primarily to the addition of utility expenses for the Upperspace acquisition in November 2013. G&A-other expense increased by $11,000 due to general increases in bank charges and property taxes. The above mentioned increases were partially offset by a decrease of $7,000 in telecommunications expense due to renegotiating more favorable terms with providers. Depreciation and amortization. Depreciation and amortization increased by $2,000, or 1.0%, to $200,000 for the three months ended March 31, 2014, from $198,000 for the three months ended March 31, 2013. This increase is due to a $34,000 increase in amortization relating to acquired subscriber costs resulting from the Company's wireless acquisitions completed during the twelve months ended March 31, 2014 offset by a decrease in depreciation expense of $32,000, or 20.6%, to $123,000 for the three months ended March 31, 2014, from $155,000 for the three months ended March 31, 2013 caused by assets becoming fully depreciated and fewer additions. Interest income and expense. Interest expense decreased by $1,000, or 25.0%, to $3,000 for the three months ended March 31, 2014 from $4,000 for the three months ended March 31, 2013, primarily resulting from the reduction of the Company's debt balances outstanding. Interest income decreased by $1,000, or 33.3%, to $2,000 for the three months ended March 31, 2014 from $3,000 for the three months ended March 31, 2013 due primarily to changes in banking. Income tax expense. Income tax expense increased by $1,000, or 8.3%, for the three months ended March 31, 2014 to $13,000 as compared to $12,000 for the prior year period related to higher Texas franchise tax expense accrued for increased revenues in the current year period. Nine Months Ended March 31, 2014 Compared to Nine Months Ended March 31, 2013 The following table sets forth certain unaudited financial data for the nine months ended March 31, 2014 and March 31, 2013. Operating results for any period are not indicative of results for any future period. Amounts are shown in thousands (except share and per share data). 15 Nine Months Ended March 31, % of % of 2014 Revenues 2013 Revenues REVENUES: Internet services $ 6,054 100.0 % $ 5,833 100.0 % TOTAL REVENUES 6,054 100.0 % 5,833 100.0 % OPERATING EXPENSES: Connectivity and operations 3,060 50.5 % 2,931 50.3 % Sales and marketing 266 4.4 % 338 5.8 % General and administrative 1,362 22.5 % 1,179 20.3 % Depreciation and amortization 576 9.5 % 610 10.5 % TOTAL OPERATING EXPENSES 5,264 87.0 % 5,058 86.9 % INCOME FROM OPERATIONS 790 13.0 % 775 13.1 % OTHER INCOME (EXPENSE) Interest income 5 0.1 % 5 0.1 % Interest expense (10 ) (0.2 )% (15 ) (0.3 )% OTHER INCOME (EXPENSE), net (5 ) (0.1 )% (10 ) (0.2 )% INCOME BEFORE INCOME TAX EXPENSE 785 13.0 % 765 13.2 % Income tax expense 38 0.6 % 36 0.7 % NET INCOME $ 747 12.3 % $ 729 12.5 % NET INCOME PER COMMON SHARE: BASIC $ 0.04 $ 0.04 DILUTED $ 0.04 $ 0.04 WEIGHTED AVERAGE COMMON SHARES OUTSTANDING: BASIC 16,730,954 16,729,562 DILUTED 19,805,672 19,449,575 OTHER DATA: Adjusted EBITDA(1) $ 1,386 $ 1,395 Adjusted EBITDA margin(2) 22.9 % 23.9 % CASH FLOW DATA:Cash flow provided by operations $ 1,335 $ 1,355 Cash flow used in investing activities $ (433 ) $ (499 ) Cash flow used in financing activities $ (165 ) $ (192 ) Reconciliation of net income to Adjusted EBITDA: Net Income $ 747 $ 729 Add: Depreciation and amortization 576 610 Stock based compensation 20 10 Interest expense 10 15 Income tax expense 38 36 Less: Interest income (5 ) (5 ) Adjusted EBITDA(1) $ 1,386 $ 1,395 (1) Adjusted EBITDA, which as used herein means earnings before the effect of interest, taxes, depreciation, amortization and stock based compensation, is not a measurement of financial performance under generally accepted accounting principles (GAAP) and should not be considered an alternative to net income as a measure of performance. Management has consistently used adjusted EBITDA on a historical basis as a measurement of the Company's current operating cash income. (2) Adjusted EBITDA margin represents Adjusted EBITDA as a percentage of total revenue. Total revenue. Total revenue increased by $221,000, or 3.8%, to $6,054,000 for the nine months ended March 31, 2014, from $5,833,000 for the nine months ended March 31, 2013. Wireless broadband internet revenue increased by $396,000 to $4,953,000 for the current year period compared to $4,557,000 for the prior year period. This increase was primarily due to the stability of the subscriber base and customers migrating to upgraded service levels during the nine months ended March 31, 2014 as well as the full period results from the acquisitions of wireless subscribers completed in fiscal years 2013 and 2014. Increased revenues derived from wireless broadband Internet subscribers were partially offset by decreases in other types of Internet service revenues of $175,000 to $1,101,000 during the current year period compared to $1,276,000 for the prior year period, which is primarily attributed to the expected decline of dial-up customers moving to other providers' broadband service. 16 Connectivity and operations. Connectivity and operations expense increased by $129,000, or 4.4%, to $3,060,000 for the nine months ended March 31, 2014, from $2,931,000 for the nine months ended March 31, 2013. Salaries, wages and related personnel expense increased $92,000, or 6.9%, to $1,430,000 for the current year period compared to $1,338,000 for the prior year period due to increases in technical personnel. Rents, utilities and tower lease expenses increased $21,000 to $483,000 for the nine months ended March 31, 2014, from $462,000 for the nine months ended March 31, 2013. A total increase of $16,000 in merchant fees, travel and materials and supplies to $432,000 was recorded for the current year period as compared to $416,000 for the prior year period. These increases are all a result of the Company's growth and network expansion from acquisitions of wireless subscribers completed in the twelve months ended March 31, 2014. Data and telecommunications expense remained steady at $715,000 for the current year period and the prior year period. Sales and marketing. Sales and marketing expense decreased by $72,000, or 21.3%, to $266,000 for the nine months ended March 31, 2014 compared to $338,000 for the nine months ended March 31, 2013. Salaries, wages and related personnel costs decreased by approximately $31,000 to $182,000 for the current year period compared to $213,000 for the prior year period due to changes in personnel. Outside sales expense decreased by $29,000 to $33,000 for the current year period compared to $62,000 for the prior year period due to increased sales efforts through in house personnel. Advertising expense decreased by $17,000 to $28,000 for the current year period compared to $45,000 for the prior year period primarily due to employing more cost effective forms of advertising. The above mentioned decreases were partially offset by an increase of $5,000 in facilities expense to $23,000 for the current year period compared to $18,000 in the prior year period related to general increases in utility expenses. General and administrative. General and administrative expense increased by $183,000, or 15.5%, to $1,362,000 for the nine months ended March 31, 2014, from $1,179,000 for the nine months ended March 31, 2013. Professional fees increased by $105,000 to $237,000 for the current year period compared to $132,000 for the prior year period due primarily to the addition of a new Chief Financial Officer in July 2013 who is engaged as a non-employee consultant to the Company and recruiting fees for accounting personnel. Personnel costs increased by $36,000 to $539,000 for the current year period compared to $503,000 for the prior year period due to changes in compensation. Stock based compensation expense and directors' fees increased by $15,000 to $53,000 for the current year period compared to $38,000 for the prior year period primarily due to options issued during the current year period and the addition of a board member. Tower expenses increased by $39,000, or 25.3%, to $193,000 for the current year period compared to $154,000 for the prior year period due to annual tower lease escalations and new towers added with new acquisitions. Insurance expense also increased by $15,000, or 17.9%, to $99,000 compared to $84,000 for the prior year period due primarily to increases in workers' compensation expense. The above mentioned increases were partially offset by a decline in travel and other general and administrative costs of $27,000 to $172,000 for the current year period compared to $199,000 in the prior year period due primarily to recruiting fees having been incurred during the prior year period for technical services. Depreciation and amortization. Depreciation and amortization decreased by $34,000, or 5.6%, to $576,000 for the nine months ended March 31, 2014, from $610,000 for the nine months ended March 31, 2013. This decrease was due to a $104,000 decrease in depreciation expense related to assets becoming fully depreciated during the last nine months ended March 31, 2014, partially offset by an increase of $70,000 in amortization of acquired subscriber costs resulting from recent acquisitions completed by the Company. Interest income and expense. For the nine months ended March 31, 2014 and March 31, 2013, the Company recorded interest expense of $10,000 and $15,000, respectively. The decrease in interest expense of $5,000, or 33.3%, is related to a decrease in acquisition related debt outstanding. Interest income costs remained constant at $5,000 for the current and prior year periods. 17 Income tax expense. Income tax expense increased by $2,000, or 5.6%, for the nine months ended March 31, 2014 to $38,000 as compared to $36,000 for the prior year period primarily related to higher Texas franchise tax expense accrued for increased revenues in the current year period. Liquidity and Capital Resources We have historically financed our operations to date primarily through cash flows from operations. During the nine months ended March 31, 2014, the Company recognized net income and positive cash flow from operations of approximately $747,000 and $1,335,000, respectively, enabling the Company to fund its operations from current period operating cash flow and resulting in cash on hand of $3,032,000 at March 31, 2014. The Company expects to fund its operations during fiscal 2014 with cash flow from operations. During the March 2014 quarter the Company added technical personnel to its technical staff. The Company also expects to expand its sales and marketing initiatives during fiscal 2014, which we expect to cause future cash flow from operations to slightly decrease yet remain strong. The Company plans to pursue strategic acquisitions in the near and medium term in addition to upgrading its systems to provide higher speeds and increased reliability for its customers. In addition, we recently engaged a financial advisor, the GulfStar Group, Inc., who is continuing to help us evaluate strategic alternatives for the Company. We expect that our capital expenditures and any future acquisitions will be funded from available cash, seller financing and borrowings from commercial banks and/or third parties; however there is no assurance that such financing will be able to be obtained when needed at desirable rates which could affect our success in achieving any or all of our initiatives. Any unexpected decreases in revenue or subscriber count may adversely affect our liquidity and plans for future growth. Cash provided by operating activities is comprised of net income adjusted for certain non-cash items and changes in operating assets and liabilities. For the nine months ended March 31, 2014, cash provided by operations was $1,335,000 as compared to $1,354,000 for the nine months ended March 31, 2013. For the nine months ended March 31, 2014, net income plus non-cash items contributed cash of $1,353,000 as compared to $1,346,000 contributed during the prior year period. Changes in operating assets and liabilities used cash of $18,000 and provided cash of $9,000 for the nine months ended March 31, 2014 and 2013, respectively. Cash used in investing activities totaled $433,000 and $499,000 for the nine months ended March 31, 2014 and 2013, respectively, due primarily to purchases of capital improvements for existing wireless broadband internet infrastructure and an acquisition of subscribers. Cash used in financing activities totaled $165,000 and $192,000 for the nine months ended March 31, 2014 and 2013, respectively, and consisted of principal payments on long term debt, including notes related to acquisitions. Cash on hand increased by $737,000 during the nine months ended March 31, 2014. As of March 31, 2014, cash on hand was $3,032,000 as compared to $2,295,000 as of June 30, 2013. We believe our continuing efforts to improve the quality and efficiency of our operations, along with our focus on increasing revenues, may lead to a more rapid rate of growth and improving cash flow from operations. Off Balance Sheet Arrangements None. "Safe Harbor" Statement and Risk Factors The following "Safe Harbor" Statement is made pursuant to the Private Securities Litigation Reform Act of 1995. 18 Certain of the statements contained in the body of this Quarterly Report are forward-looking statements (rather than historical facts) that are subject to risks and uncertainties that could cause actual results to differ materially from those described in the forward-looking statements. With respect to such forward-looking statements, we seek the protections afforded by the Private Securities Litigation Reform Act of 1995. These risks include, without limitation, that (1) we will not be able to increase our rural customer base at the expected rate, (2) we will not improve Adjusted EBITDA, profitability or product margins, (3) Internet revenue in high-speed broadband will continue to increase at a slower pace than the decrease in revenue from other Internet services resulting in greater operating losses in future periods, (4) financing will not be available to us if and as needed, (5) we will not be competitive with existing or new competitors, (6) we will not keep up with industry pricing or technological developments impacting the Internet, (7) we will be adversely affected by dependence on network infrastructure, telecommunications providers and other vendors or by regulatory changes, (8) service interruptions or impediments could harm our business, (9) acts of God and other events outside our control, such as hurricanes and other dangerous weather conditions, fires and lightning, could damage or destroy our facilities and network infrastructure, (10) we may be accused of infringing upon the intellectual property rights of third parties, which will be costly to defend and could limit our ability to use certain technologies in the future, (11) government regulations could force us to change our business practices, (12) we may be unable to hire and retain qualified personnel, including our key officers, (13) future acquisitions of wireless broadband Internet customers and infrastructure may not be available on attractive terms and, if available, we may not successfully integrate those acquisitions into our operations, (14) provisions in our certificate of incorporation, bylaws and shareholder rights plan could limit our share price and delay a change of management and (15) our stock price has historically been thinly traded and volatile and may continue to be thinly traded and volatile. This list is intended to identify certain of the principal factors that could cause actual results to differ materially from those described in the forward-looking statements included elsewhere herein but is not a comprehensive list of all of such factors. |