UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark one)

 

For the quarterly period ended March 31, 2016

OR

 

For the transition period from                  to                

 

Commission File Number: 001-34686

 

Hawaiian Telcom Holdco, Inc.

(Exact name of registrant as specified in its charter)

 

 

1177 Bishop Street

Honolulu, Hawaii  96813

(Address of principal executive offices)

 

808-546-4511

(Registrant's telephone number, including area code)

 

Not Applicable

(Former name, former address and former fiscal year, if changed since last report)

 

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 [X]  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 [X] No [  ]

 

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 definition of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.  (Check one):

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes [  ]  No [X]

 

Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes [X] No [  ]

 

As of May 5, 2016, 11,511,591 shares of the registrant’s common stock were outstanding.

 

 

 

 

Table of Contents

 

 

 

 

 

PART I — FINANCIAL INFORMATION

 

Item 1. Condensed Consolidated Financial Statements (Unaudited)

 

Hawaiian Telcom Holdco, Inc.

Condensed Consolidated Statements of Income

(Unaudited, dollars in thousands, except per share amounts)

 

 

See accompanying notes to condensed consolidated financial statements.

Hawaiian Telcom Holdco, Inc.

Condensed Consolidated Statements of Comprehensive Income (Loss)

(Unaudited, dollars in thousands)

 

 

See accompanying notes to condensed consolidated financial statements.

Hawaiian Telcom Holdco, Inc.

Condensed Consolidated Balance Sheets

(Unaudited, dollars in thousands, except per share amounts)

 

 

See accompanying notes to condensed consolidated financial statements.

Hawaiian Telcom Holdco, Inc.

Condensed Consolidated Statements of Cash Flows

(Unaudited, dollars in thousands)

 

 

See accompanying notes to condensed consolidated financial statements.

Hawaiian Telcom Holdco, Inc.

Condensed Consolidated Statement of Changes in Stockholders’ Equity

(Unaudited, dollars in thousands)

 

 

See accompanying notes to condensed consolidated financial statements.

Hawaiian Telcom Holdco, Inc.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

1. Description of Business

 

Business Description

 

Hawaiian Telcom Holdco, Inc. and subsidiaries (the “Company”) is the incumbent local exchange carrier for the State of Hawaii with an integrated telecommunications network. The Company offers a variety of telecommunication services to residential and business customers in Hawaii including local telephone, network access and data transport, television, Internet, long distance and wireless phone service. The Company also provides communications equipment sales and maintenance, data center colocation and network managed services.

 

Organization

 

The Company has one direct wholly-owned subsidiary, Hawaiian Telcom Communications, Inc. which has two direct wholly-owned subsidiaries – Hawaiian Telcom, Inc. and Hawaiian Telcom Services Company, Inc.  Hawaiian Telcom, Inc. operates the regulated local exchange carrier and Hawaiian Telcom Services Company, Inc. operates all other businesses.

 

2. Basis of Presentation

 

The accompanying unaudited condensed consolidated financial statements of the Company have been prepared by the Company in accordance with accounting principles generally accepted in the United States of America and pursuant to rules and regulations of the U.S. Securities and Exchange Commission. Certain information and disclosures normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been omitted and condensed. In the opinion of the Company’s management, all adjustments (consisting of only normal and recurring accruals) have been made to present fairly the results of operations, comprehensive income, financial position and cash flows for the periods presented. The results of operations for the periods presented are not necessarily indicative of the results to be expected for the full year. Although the Company believes that the disclosures are adequate to make the information presented not misleading, these financial statements should be read in conjunction with the Company’s audited consolidated financial statements as of and for the year ended December 31, 2015.

 

Cash and Cash Equivalents

 

Cash and cash equivalents include cash and money market accounts with maturities at acquisition of three months or less.  The majority of cash balances at March 31, 2016 are held in one bank in demand deposit accounts. 

 

Supplemental Non-Cash Investing and Financing Activities

 

Accounts payable included $17.0 million and $15.2 million at March 31, 2016 and 2015, respectively, for additions to property, plant and equipment.

 

Taxes Collected from Customers

 

The Company presents taxes collected from customers and remitted to governmental authorities on a gross basis, including such amounts in the Company’s reported operating revenues. Such amounts represent primarily Hawaii state general excise taxes and Hawaii Public Utility Commission fees. Such taxes and fees amounted to $2.2 million and $2.0 million for the three months ended March 31, 2016 and 2015, respectively.

 

Earnings per Share

 

Basic earnings per share is based on the weighted effect of all common shares issued and outstanding, and is calculated by dividing earnings by the weighted average shares outstanding during the period. Diluted earnings per share is calculated by dividing earnings, adjusted for the effect, if any, from assumed conversion of all potentially dilutive common shares outstanding, by the weighted average number of common shares used in the basic earnings per share calculation plus the number of common shares that would be issued assuming conversion of all potentially dilutive common shares outstanding. The denominator used to compute basic and diluted earnings per share was as follows:

 

 

The computation of weighted average dilutive shares outstanding excluded grants of restricted stock units convertible into 135,906 shares of common stock for the three months ended March 31, 2016. The unrecognized compensation on a per unit basis for these restricted stock units was greater than the average market price of the Company’s common stock for the period presented.  For the three months ended March 31, 2015, there were no restricted stock units that were anti-dilutive to earnings per share.

 

Recently Issued Accounting Pronouncements

 

In May 2014, the Financial Accounting Standards Board (the “FASB”) issued a new accounting standard which provides guidance for revenue recognition which was amended in July 2015 and in March 2016. The most recent amendment provides revised guidance on when to record revenue gross as the principal or net as the agent in accordance with the new revenue standard’s control principal.  The new standard, along with the amendments which must be adopted at the same time as the new standard, is effective for the Company in the first quarter of 2018 with either full retrospective or modified retrospective adoption permitted. Early adoption is allowed from the first quarter of 2017. The Company is currently evaluating the impact of the adoption of this accounting standard on the Company’s financial position, results of operations and cash flows, and financial statement disclosures.  As this process is still ongoing, the effect of adoption is not yet known.

 

In February 2016, the FASB issued a new standard for accounting for leases.  The new standard requires lessees to recognize a right-of-use asset and a lease liability on the balance sheet for all leases with the exception of short-term leases. For lessees, leases will continue to be classified as either operating or finance leases in the income statement. Lessor accounting is similar to the current model but updated to align with certain changes to the lessee model. The updated standard is effective for the Company beginning in the first quarter of 2019. Early adoption is permitted.  The Company is currently evaluating the effect that the new standard will have on the Company’s consolidated financial statements and financial statement disclosures.

 

In March 2016, the FASB issued a new standard that simplifies the accounting for employee share-based payment transactions.  The new standard impacts the accounting for related income taxes, forfeitures and statutory tax withholding requirements as well as the classification of certain related payments in the statement of cash flows.  The new accounting guidance is effective for the Company in the first quarter of 2017 with early adoption permitted.  The Company is evaluating the effect of the new guidance on the Company’s consolidated financial statements and financial statement disclosures.

 

 

3. Receivables

 

Receivables consisted of the following (dollars in thousands):

 

 

 

4. Long-Lived Assets

 

Property, plant and equipment consisted of the following (dollars in thousands):

 

 

Depreciation expense amounted to $21.4 million and $20.7 million for the three months ended March 31, 2016 and 2015, respectively. 

 

The gross carrying amount and accumulated amortization of identifiable intangible assets are as follows (dollars in thousands):

 

 

Amortization expense amounted to $0.5 million and $0.6 million for the three months ended March 31, 2016 and 2015, respectively.  Estimated amortization expense for the next five years and thereafter is as follows (dollars in thousands):

 

 

 

5. Accrued Expenses and Other Current Liabilities

 

Accrued expenses consisted of the following (dollars in thousands):

 

 

Other current liabilities consisted of the following (dollars in thousands):

 

 

 

6. Long-Term Debt

 

Long-term debt consisted of the following (dollars in thousands):

 

 

The term loan outstanding at March 31, 2016 provides for interest at the Alternate Base Rate, a rate which is indexed to the prime rate with certain adjustments as defined, plus a margin of 3.00% or a Eurocurrency rate on deposits of one, two, three or six months but no less than 1.00% per annum plus a margin of 4.00%. The Company has selected the Eurocurrency rate as of March 31, 2016 resulting in an interest rate currently at 5.00%.

 

The term loan provides for interest payments no less than quarterly.  In addition, quarterly principal payments of $0.8 million are required.  The balance of the loan is due at maturity on June 6, 2019.  The Company must prepay, generally within three months after year end, 50% or 25% of excess cash flow, as defined.  The percent of excess cash flow required is dependent on the Company’s leverage ratio.  There was no excess cash flow payment due for the year ended December 31, 2015.  The Company must also make prepayments on loans in the case of certain events such as large asset sales.

 

In May 2016, the Company amended the term loan allowing for a revised leverage ratio financial covenant.  The amendment modifies the maximum allowed leverage ratio, as defined, for the four consecutive fiscal quarters ended from June 30, 2016 to September 30, 2017 to 3.00:1:00, from December 31, 2017 to September 30, 2018 to 2.75:1:00 and from December 31, 2018 and each subsequent quarter to 2.50:1.00.  In conjunction therewith, the Company agreed to an increase in the interest rate margin of 0.25% and modification to the prepayment requirement of up to 75% of excess cash flow.  The interest rate margin is subject to a further increase of 0.25% for a decline in the debt rating, as defined.

 

The Company also has a revolving credit facility which matures on December 6, 2018.  The facility has an available balance of $30.0 million with no amounts drawn as of or for the periods ended March 31, 2016 and 2015.  A

commitment fee is payable quarterly to the lender under the facility.  Interest on amounts outstanding is based on, at the Company’s option, the bank prime rate plus a margin of 3.0% to 6.0% or the Eurocurrency rate for one, two, three or six month periods plus a margin of 4.0% to 5.5%.  The margin is dependent on the Company’s leverage, as defined in the agreement, at the time of the borrowing.

 

Maturities

 

The annual requirements for principal payments on long-term debt as of March 31, 2016 are as follows (dollars in thousands):

 

 

Capitalized Interest

 

Interest capitalized by the Company amounted to $0.3 million and $0.3 million for the three months ended March 31, 2016 and 2015, respectively.

 

 

7. Employee Benefit Plans

 

The Company sponsors a defined benefit pension plan, with benefits frozen as of March 1, 2012, and postretirement health and life insurance benefits for union employees.  The Company also sponsors a cash balance pension plan for nonunion employees, with benefits frozen as of April 1, 2007, and certain management employees receive postretirement health and life insurance under grandfathered provisions of a terminated plan.

 

The following provides the components of benefit costs (income) for the three months ended March 31, 2016 and 2015 (dollars in thousands):

 

Pension

 

Other Postretirement Benefits

 

 

During the three months ended March 31, 2015, the Company’s pension plan for union employees paid lump-sum benefits to plan participants in full settlement of obligations due amounting to $6.0 million.  During the three months ended March 31, 2015, the Company’s pension plan for management employees paid lump sum benefits in full settlement amounting to $0.6 million.  This resulted in the recognition of a loss on settlement for both pension plans amounting to $0.9 million for the three months ended March 31, 2015.  Because of the settlements, the Company measured its union and management pension plan obligations and plan assets as of March 31, 2015.  The Company used a discount rate of 3.54% as of March 31, 2015 to measure the union pension plan obligations.  The Company used a discount rate of 3.57% to measure the management plan obligations as of March 31, 2015.  The new measurements resulted in a retirement plan loss which was charged to other comprehensive loss of $2.2 million for the three months ended March 31, 2015.  For the three months ended March 31, 2016, lump sum benefits paid did not exceed the threshold requiring settlement accounting.

 

The Company previously disclosed in its consolidated financial statements for the year ended December 31, 2015 that it expected to contribute $9.3 million to its pension plan in 2016.  As of March 31, 2016, the Company has contributed $1.9 million.  The Company presently expects to contribute the full amount during the remainder of 2016.

 

8. Income Taxes

 

The income tax provision differs from the amounts determined by applying the statutory federal income tax rate of 34% to the income before income tax provision for the following reasons (dollars in thousands):

 

 

The Company evaluates its tax positions for liability recognition.  As of March 31, 2016, the Company had no unrecognized tax benefits.  No interest or penalties related to tax assessments were recognized in the Company’s condensed consolidated statements of income for the three months ended March 31, 2016 and 2015.  All tax years from 2012 remain open for both federal and Hawaii state tax purposes.

 

9. Stock Compensation

 

The Company has an equity incentive plan.  The Compensation Committee of the Company’s Board of Directors may grant awards under the plan in the form of incentive stock options, non-qualified stock options, stock appreciation rights, restricted stock, restricted stock units and other stock-based awards.  The maximum number of shares issuable under the equity incentive plan is 1,400,000 shares with 632,000 shares remaining to be issued at March 31, 2016.  All grants under the equity incentive plan will be issued to acquire shares at the fair value on date of grant.

 

As of March 31, 2016, all awards were restricted stock units.  Activity with respect to outstanding restricted stock units for the three months ended March 31, 2016 and 2015 was as follows:

 

 

The Company recognized compensation expense of $0.6 million and $0.4 million for the three months ended March 31, 2016 and 2015, respectively.  The fair value as of the vesting date for the restricted stock units that vested during the three months ended March 31, 2016 and 2015 was $0.9 million and $2.5 million, respectively.  Upon vesting, unit holders have the option to net share-settle to cover the required withholding tax and the remaining amount is converted into an equivalent number of shares of common stock.   The total shares withheld were 15,234 and 35,714 for the three months ended March 31, 2016 and 2015, respectively, and were based on the value of the restricted stock units as determined by the Company’s closing stock price on the date of vesting.  Total payments for the employees’ tax obligations to the tax authorities amounted to $0.4 million and $0.9 million for the three months ended March 31, 2016 and 2015, respectively.  Other than reimbursements for tax withholdings, there was no cash received under all share-based arrangements.

 

The Company also has a performance based compensation plan.  The incentive compensation is settled in March of each year for the prior year services and is based on Company performance relative to certain metrics.  The Company recognizes the expense during the performance period based on the expected compensation amount.  The compensation for the performance period ended December 31, 2015 was settled in cash in March 2016.  Beginning for the 2016 performance period, a specified portion of the compensation amount for certain employees will be settled in Company shares based on the share price at the date of settlement.  Upon settlement, employees may have the option to net share-settle to cover the required withholding tax and the remaining amount is converted into an equivalent number of shares of common stock.  The estimated performance based compensation to be settled in stock amounted to $0.2 million for the three months ended March 31, 2016. 

 

10. Stockholders’ Equity

 

Warrants

 

In 2010, the Company issued warrants to purchase 1,481,055 shares of common stock for $14.00 per share.  The warrants to purchase shares were exercisable anytime from January 26, 2011 to the maturity on October 28, 2015.  The warrants could be exercised on a cashless basis whereby a portion of the exercised warrants were tendered in lieu of payment for the exercise price.  During the three months ended March 31, 2015, warrants were exercised on a cashless basis resulting in the issuance of 12,300 shares of common stock.  

 

Accumulated Other Comprehensive Income (Loss)

 

The changes in components of accumulated other comprehensive income (loss) are as follows (dollars in thousands):

 

 

 

Reclassifications out of accumulated other comprehensive income (loss) for the three months ended March 31, 2016 and 2015 were as follows (dollars in thousands):

 

 

The amortization of loss and settlement loss was recognized primarily in selling, general and administrative expense for the periods ended March 31, 2016 and 2015.

 

11. Commitments and Contingencies

 

Trans-Pacific Submarine Cable

 

In August 2014, the Company joined several other telecommunication companies to build and operate a trans-Pacific submarine cable system.  The total system cost is expected to be $235 million and is primarily composed of a supply contract with the lead contractor.  The Company will contribute $25 million over the multi-year construction period in exchange for a fractional ownership in the system. The Company will recognize its fractional share of the cost.  In addition, the Company will construct a cable landing station in Hawaii and provide cable landing services. The system is expected to be completed in the first half of 2017. As of March 31, 2016, the Company had incurred costs of $6.3 million primarily to the cable contractor for construction with all such costs capitalized to telephone plant under construction.

 

The Company will have excess capacity on its share of the trans-Pacific cable that it will make available to other carriers for a fee.  The Company is in the process of contracting with other carriers for long-term indefeasible right of use, or IRU, agreements for fiber circuit capacity.  The Company may receive up-front payments for services to be delivered over a period of up to 25 years.  The Company has entered into agreements for the sale of capacity for $27.0 million plus fees to activate assigned capacity, and for operations and maintenance.  As of March 31, 2016, the Company had received up-front payments of $5.7 million. As provided for in one of the agreements, funds of $3.5 million were held in escrow. The funds in escrow will be released to the Company when the trans-Pacific cable is ready for service.  The

restricted cash is reflected in other assets in the condensed consolidated balance sheet.  A liability to provide services in the future for all up-front payments is included in other liabilities.  The Company will recognize revenue for the circuit, beginning upon activation of the services, on a straight-line basis over the contract term which is generally up to 25 years.

 

Connect America Fund Phase II

 

In conjunction with reforming the Universal Service Fund, the Federal Communications Commission (“FCC”) established the Connect America Fund (“CAF”) which provides incremental support to broadband service providers.  CAF Phase II is the long-term component of the program.  In August 2015, the Company notified the FCC that it was accepting CAF Phase II support which amounts to $4.4 million in annual funding. Support is retroactive through the beginning of 2015, net of certain other receipts from the Universal Service Fund, and will continue for six years.  Under the terms of the CAF Phase II, the Company will offer broadband service at 10 Mbps downstream and 1 Mbps upstream or better to approximately 11,000 eligible locations in high-cost areas in the State of Hawaii and will provide voice and broadband services at reasonable rates. 

 

For the three months ended March 31, 2016, the Company recognized $1.1 million in CAF Phase II funding as revenue. 

 

Collective Bargaining Agreement

 

The Company has a collective bargaining agreement with the International Brotherhood of Electrical Workers Local 1357 (“IBEW”) that expires on December 31, 2017.  The agreement covers approximately half of the Company’s work force.

 

Third Party Claims

 

In the normal course of conducting its business, the Company is involved in various disputes with third parties, including vendors and customers.  The outcome of such disputes is generally uncertain and subject to commercial negotiations.  The Company periodically assesses its liabilities in connection with these matters and records reserves for those matters where it is probable that a loss has been incurred and the loss can be reasonably estimated.  Based on management’s most recent assessment, the Company believes that the risk of loss in excess of liabilities recorded is not material for all outstanding claims and disputes and the ultimate outcome of such matters will not have a material adverse effect on the Company’s results of operations, cash flows or financial position.

 

Litigation

 

The Company is involved in litigation arising in the normal course of business.  The outcome of litigation is not expected to have a material adverse impact on the Company’s condensed consolidated financial statements.

 

12. Fair Value of Financial Instruments

 

The following method and assumptions were used to estimate the fair value of each class of financial instruments for which it is practical to estimate the fair value.

 

Cash and cash equivalents, accounts receivable and accounts payable – The carrying amount approximates fair value.  The valuation is based on settlements of similar financial instruments all of which are short-term in nature and generally settled at or near cost.  Cash and cash equivalents is measured at Level 1.

 

Debt – The fair value of debt is based on the value at which the debt is trading among holders.

 

The estimated fair value of financial instruments is as follows (dollars in thousands):

 

Fair Value Measurements

 

Fair value for accounting purposes is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (exit price).

 

Accounting standards establish a fair value hierarchy that prioritizes the inputs used to measure fair value.  The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurement) and the lowest priority to unobservable inputs (Level 3 measurement).

 

Liabilities carried at amortized cost with fair value disclosure on a recurring basis represent long-term debt.  A summary is as follows (dollars in thousands):