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Section 1: 10-K (10-K)

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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

[   ]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:  000-35180

 

 

Lumos Networks Corp.

(Exact name of registrant as specified in its charter)

 

 

Delaware

(State or other jurisdiction of incorporation or organization)

80-0697274

(I.R.S. Employer Identification No.)

 

One Lumos Plaza, Waynesboro, Virginia 22980

(Address of principal executive offices) (Zip Code)

 

(540) 946-2000

(Registrant’s telephone number, including area code)

 

Securities registered pursuant to Section 12(b) of the Act:

Title of each class

Name of each exchange on which registered

Common stock, $0.01 par value

The NASDAQ Stock Market LLC

 

 

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   [X]  No

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.

[  ]  Yes   [X]  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.   [ X ]  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).  [X]  Yes   [ ]  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 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.  [X]

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

 

 

 

 

Large accelerated filer  [ ]

Accelerated filer [X]

Non-accelerated filer [ ]

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  [X] No

As of June 30, 2013, the aggregate market value of the Registrant’s common stock was $269,794,771.

There were 22,187,783 shares of the registrant’s common stock outstanding as of the close of business on March 3, 2014. 

DOCUMENTS INCORPORATED BY REFERENCE

 

Document

Incorporated Into

Proxy Statement for the 2014 Annual Meeting of Stockholders

Part III

 

 

 

 


 

Table of Contents

LUMOS NETWORKS CORP.
2013 ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS

 

 

 

 

 

 

 

Page

Part I 

 

 

Item 1.

Business

2

Item 1A.

Risk Factors

9

Item 1B.

Unresolved Staff Comments

18

Item 2.

Properties

18

Item 3.

Legal Proceedings

18

Item 4.

Mine Safety Disclosures

18

 

 

 

Part II 

 

 

Item 5.

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

19

Item 6.

Selected Financial Data

21

Item 7.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

23

Item 7A.

Quantitative and Qualitative Disclosures About Market Risk

41

Item 8.

Financial Statements and Supplementary Data

42

Item 9.

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

71

Item 9A.

Controls and Procedures

71

Item 9B.

Other Information

73

 

 

 

Part III 

 

 

Item 10.

Directors, Executive Officers and Corporate Governance

73

Item 11.

Executive Compensation

73

Item 12.

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

73

Item 13.

Certain Relationships and Related Transactions, and Director Independence

73

Item 14.

Principal Accountant Fees and Services

73

 

 

 

Part IV 

 

 

Item 15.

Exhibits and Financial Statement Schedules

74

 

 

 

Signatures 

 

 

 

 

 

 

 

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Part I

FORWARD-LOOKING STATEMENTS

Any statements contained in this report that are not statements of historical fact, including statements about our beliefs and expectations, are forward-looking statements and should be evaluated as such.  The words “anticipates,” “believes,” “expects,” “intends,” “plans,” “estimates,” “targets,” “projects,” “should,” “may,” “will” and similar words and expressions are intended to identify forward-looking statements. These forward-looking statements are contained throughout this report, for example in “Business,” “Risk Factors,” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”  Such forward-looking statements reflect, among other things, our current expectations, plans and strategies, and anticipated financial results, all of which are subject to known and unknown risks, uncertainties and factors that may cause our actual results to differ materially from those expressed or implied by these forward-looking statements.  Many of these risks are beyond our ability to control or predict.  All forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by the cautionary statements contained throughout this report.  Because of these risks, uncertainties and assumptions, you should not place undue reliance on these forward-looking statements.  These risks and other factors include those listed under “Risk Factors” and elsewhere in this report.  Furthermore, forward-looking statements speak only as of the date they are made.  We do not undertake any obligation to update or review any forward-looking information, whether as a result of new information, future events or otherwise.

Item 1.  Business. 

Lumos Networks Corp. Overview

Lumos Networks Corp. (“Lumos Networks,” the “Company,” “we,” “us” or “our”) is a fiber-based bandwidth infrastructure and service provider in the Mid-Atlantic region.  We provide services to carriers and enterprise customers, including healthcare providers, local government agencies, financial institutions, educational institutions, and other enterprises over our approximately 7,400 route-mile fiber network.  Our principal products and services include Multiprotocol Label Switching (“MPLS”) based Ethernet, Metro Ethernet (“Metro E”), Fiber to the Cell site (“FTTC”) wireless backhaul and data transport services, wavelength transport services and IP services.  

We  became an independent, publicly traded company on October 31, 2011, as a result of our spin-off from NTELOS Holdings Corp. (“NTELOS”).  Our common stock has been publicly traded on The NASDAQ Stock Market LLC (“NASDAQ”) under the ticker symbol “LMOS since November 1, 2011.    We conduct all of our business through our wholly-owned subsidiary Lumos Networks Operating Company and its subsidiaries.  Our principal executive offices are located at One Lumos Plaza, Waynesboro, Virginia 22980.  The telephone number at that address is (540) 946-2000. 

Business Strategy

Our primary objective is to leverage and expand our fiber assets to capture the growing demand for data transport and mobility services among our carrier and enterprise customers in our marketplace.  Our strategy is to (i) leverage our fiber network to expand to new fiber to the cell site opportunities; (ii)  monetize our approximately 7,400 route-mile fiber optic network by selling bandwidth and data transport services to new and existing carrier and enterprise customers while maintaining a ratio of approximately 70% to 80% of our strategic data revenue from on-net traffic; (iii) proactively manage our churn by upgrading existing customers from legacy technologies to carrier Ethernet services;  (iv) continue to provide high quality customer service and a compelling value proposition; (v) renew focus on managing resources from the declining legacy voice products into our faster growing and more profitable strategic data products; (vi) use our “edge-out” strategy to expand into new adjacent geographic markets to expand our addressable market; and (vii) execute our success-based investment strategy to improve capital efficiency and expand margins.

Our strategic data segment, which provided approximately  59%  of our total revenue in 2013, represents the main growth opportunity and the key focal point of our strategy and currently includes our enterprise data, data transport, FTTC and IP services product linesGiven our focus on on-net customers, our strategic data services typically carry higher gross margins than many of our other services.    A significant majority of our capital expenditures and sales force are dedicated to increasing revenue and profit from our strategic data segmentWe believe that a balanced split between enterprise and carrier revenue results in the most effective capital allocation and resulting profitability.

The remaining 41% of our total revenue in 2013 was generated from our legacy voice and access segments.  These legacy businesses, in the aggregate, require limited incremental capital to maintain the underlying assets and deliver reasonably predictable cash flows.  It is our belief that revenue from these legacy businesses, in the aggregate, will continue to decline at an annual rate of approximately 10% to 15%.  This decline is the expected result of regulatory actions taken to reduce intra-state tariffs, access line loss resulting from residential wireless substitution, technology changes, the effect of current economic conditions on businesses and product replacement of voice service offerings from cable operators in our marketsDespite the declining revenues, we expect the cash flows from these legacy businesses to continue to significantly contribute to funding the capital investment in our growing strategic data segment.

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The key imperatives for our strategic data growth initiatives are as follows:

Enhance Carrier Ethernet Network and Manage Technology Churn

As demand for Long Term Evolution (“LTE”) FTTC services, greater data transport bandwidth, and guaranteed network stability continues, there is an increasing demand to provide carrier Ethernet networks to our wireless carrier customers and large data transport customers. To meet this need, we plan to invest capital resources in 2014 to enhance our fiber network and effectively create a dedicated carrier network within our existing fiber network to provide LTE FTTC solutions and data transport services to multiple large telecommunications providers who operate in our markets.    As of December 31, 2013, we provided LTE FTTC connectivity to 608 cell sites.  We intend to significantly increase LTE FTTC connectivity to cell sites in close proximity to our fiber network over the next several years to capitalize on the growth opportunity in our footprint.  In addition, we will deliberately and proactively manage our legacy customers from legacy technologies to our carrier Ethernet services with the intent of reducing churn and improving the customer experience with our services.

Edge-Out into Key Markets Adjacent to Our Existing Network Footprint

Driven by demand from existing enterprise and carrier customers our edge-out strategy expands our fiber network into new contiguous markets  by leveraging existing and new assets.  Our current edge-out markets are Richmond, VA and Western PA.  We recently completed the build out of our 110 metro-mile fiber network in Richmond, VA and lit up the network, with anchor enterprise and carrier customers under contract.  In Western PA, we own fiber assets we can leverage to build out metro Ethernet and Ethernet rings, and we also plan to enhance parts of the Western PA network as part of our carrier Ethernet investment.  As we edge-out into new markets, we are able to bring new carrier customers, LTE cell sites and enterprise customers onto our fiber networks, thus significantly increasing our addressable market size.

Drive Incremental On-Net Data Traffic

Our on-net strategy focuses on driving traffic through our network, thereby increasing profitability.  As our network footprint grows and the bandwidth demand increases, we are able to drive incremental revenue through our existing network with minimal increase in operating expenses or incremental capital expenditures.  We evaluate this on-net approach and the associated capital expenditure against the revenue opportunity and have determined that maintaining approximately 70% to 80% of our strategic data revenue from on-net traffic is the most effective use of capital.

Use Disciplined Success-Based Capital Investment Strategy

We seek to maximize our capital expenditure efficiency by requiring that a significant percentage of our capital investment be tied to specific revenue generating products based on customer commitments, which we refer to as “success-based projects”.  Our success-based capital investment strategy involves maximizing capital expenditure efficiency by pursuing on-net and near-net customer opportunities and maintaining a balanced mix of FTTC, carrier and enterprise business.  Our capital investment strategy targets a 10% to 15% return on investment and a less than 4-year payback.  In 2013, approximately 75% of our funds committed to capital projects were for success-based projects.  Since the beginning of 2012, we have invested approximately $104 million of capital within our strategic data segment, the majority of which was allocated to success-based projects.  Our goal is to continue to achieve a similar ratio of success-based projects to total capital expenditures again in 2014.

As of December 31, 2013, our fiber network spanned approximately 7,400 route miles and we were connected to 608 cell towers, approximately 1,344 buildings and 12 data center locations.  We believe there is significant opportunity to compete for opportunities to connect to new cell towers, buildings and data centers in close proximity to our existing fiber network.  To assist us in capturing these opportunities, we have strengthened our management team with hires over the last two years and intend to drive growth by focusing on leveraging our existing strategic fiber assets and expanding our carrier Ethernet network to deliver next-generation communications services.

Business Segments 

We have three reportable business segments, as follows:

Strategic Data 

Our strategic data segment includes our enterprise data, carrier data and IP services product groups.  We market and sell these services primarily to carriers and enterprise customers, including healthcare providers, local government agencies, financial institutions, and educational institutions.  IP services are also provided to a residential base of customers by this segment.  Revenues from our strategic data segment accounted for approximately 58.5%, 52.7% and 45.1% of our total revenue for the years ended December 31, 2013, 2012 and 2011, respectively.  Strategic data products are growing at a pace that significantly exceeds our other product lines and given our focus on on-net customers, they typically also provide a higher gross margin.  The objective of our strategic data segment is to leverage the ever increasing data bandwidth demands for our enterprise and carrier customers in our addressable markets.  As of

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December 31, 2013, we had approximately 1,400 major business customers and approximately 47,000 broadband network connections in service.

Our strategic data segment operations are based upon both our edge-out and on-net strategies that seek to expand into new markets by maximizing the use of our fiber assets while optimizing capital efficiency and profitability.  In 2013, we continued to re-deploy capital and personnel resources away from our declining legacy product lines (both legacy voice and access) towards our growth businesses within our strategic data segment.  Our “on-net” strategy utilizes a facilities-based approach that requires disciplined use of capital expenditures on success-based projects to grow our fiber assets and reach an increasing number of both carrier and enterprise customers.

In addition to the higher gross margins that are characteristic of on-net expansion, we have also been able to deliver other enterprise services, such as metro Ethernet transport as a direct result of on-net connectivity growth.  We believe our dedication to the facilities-based strategy, combined with our commitment to customer service, will continue to attract the larger customers in our key vertical markets.

We generate growth within our strategic data segment through increased bandwidth demand, particularly for long-term FTTC contracts from wireless carriers deploying LTE services, improving enterprise penetration within our existing markets and selling into the edge-out markets.  In 2013, we added 238 FTTC sites, representing a year-over-year increase of approximately 64%, and 140 on-net buildings, representing an increase of approximately 12% year-over-year.  Our sales force is focused on capitalizing on these sources of growth as we are organized into carrier and enterprise teams to effectively pursue the opportunity.  Our ability to sustain or accelerate revenue growth in our strategic data segment depends on our effectively deploying capital to upgrade our fiber network and implementing our FTTC and edge-out plans in a timely and disciplined manner, attracting new customers and managing churn by upgrading existing customers from legacy technologies to carrier Ethernet services.  

Legacy Voice

Our legacy voice segment includes the following products:  local lines, primary rate interface (“PRI”), long distance, toll and directory advertising and other voice services, excluding voice over IP (“VoIP”) services which are typically provided to enterprise customers and are included in our strategic data segment.  These products are sold to enterprise and residential customers through our competitive local exchange carrier (“CLEC”) and rural local exchange carrier (“RLEC”) network.  Revenues from our legacy voice segment accounted for approximately 27.2%, 31.0% and 36.5% of our total revenue for the years ended December 31, 2013, 2012 and 2011, respectively.  As of December 31, 2013, we operated approximately 95,700 CLEC lines and 28,900 RLEC telephone access lines, a portion of which are fiber-fed and have IPTV-based video services and broadband Internet access with speeds up to 300Mpbs.  We also leverage our existing copper assets to provide video services over copper and DSL services to customers typically in our legacy business.  Revenues from video, broadband Internet and DSL services are included in our strategic data segment.

Access

Our access segment provides carrier customers access to our network within our footprint and primarily includes switched access services.  Revenues from our access segment accounted for approximately 14.3%, 16.3% and 18.4% of our total revenue for the years ended December 31, 2013, 2012 and 2011, respectively.  A  significant portion of our access segment revenues are derived from programs funded by regulatory agencies for recovery of lost revenues resulting from intercarrier compensation reform.  During 2013, we continued to experience declines in revenues from our access segment and anticipate continuing declines primarily resulting from regulatory actions taken by applicable regulatory authorities as described in the Regulation section below and also due to network grooming activities by carriers. 

For detailed financial information about our business segments, see Note 4 in Part II, Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K, and for a detailed review of our financial performance and results of operations by business segment, see Part II, Item 7.  Managements’ Discussion and Analysis of Financial Condition and Results of Operations of this Annual Report on Form 10-K.

Products and Services

Data Services:

We provide data services to data carriers and enterprise customers including healthcare providers, local government agencies, financial institutions, educational institutions, and other enterprises over our fiber network.  Our key data service offerings include the following:

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MPLS Ethernet / Metro E

 

Ethernet connectivity among multiple locations in the same city or region over our fiber optic network.

Connectivity to/from our partner networks through connections to carrier hotels and Network-to-Network Interface (“NNI”) circuits.

Metro Ethernet Forum (“MEF”) 2.0 certified products (E-line, E-Tree, E-LAN and E-Access).

Fiber to the cell sites (“FTTC”), used by wireless carriers as backhaul.

Speeds ranging from 1.5 Mbps to 10 Gbps.

 

 

 

High-capacity Private Line Service and Wavelength Transport Services

High-capacity, non-switched facilities provided to end users and carriers for voice and data applications.

Wavelength technology provides a point-to-point connection between two locations that is dedicated to a single customer and provisioned on our high-speed fiber optic backbone. Our wavelength services now offer speeds up to 100 Gbps.

T1/DS3 and Sonet OCX based services with speeds from OC3 to OC192.

 

 

 

Dedicated Internet Access (DIA)

Dedicated synchronous bandwidth for large enterprise and ISP customers in speeds from 5 Mbps to 10 Gbps over our protected fiber optic network with resilient connectivity to high speed transit and peering connection locations in Ashburn, VA and Chicago, IL.

 

 

 

Data  Center/Collocation Services

Secure, reliable and high speed access to computing resources for regional data center/collocation facilities that provide security, UPS, generator and HVAC technologies.

 

Residential and Small Business:

 

We provide DSL and Broadband XL Internet, voice, video and IP services to our residential and small business customers.  Our voice service offerings include local lines, PRI, long distance, toll and directory advertising and other voice services.  Our customers have the option of bundling our voice, broadband and video service offerings.  Our IP-enabled product offerings combine voice and data services over a dedicated broadband facility utilizing VoIP protocols allowing customers dynamically allocated bandwidth to maximize voice and data transmission. VoIP technology also enables advanced features such as simultaneous ring, remote office, business continuity and fixed mobile convergence.  Our IPTV-based video services offer over 300 channels, including 77 high definition channels, video-on-demand and DVR capability.

 

Carrier Access:

 

In addition to our data services, we also provide carrier customers with access to our network within our footprint which primarily includes switched access services.

 

Sales, Marketing and Customer Care

Sales.  We serve our carrier and enterprise customers in the competitive space with our suite of fiber-based strategic data products, which include metro Ethernet, MPLS, VPN and dedicated Internet access.  We have continued to see increased demand for these products across our customer base, particularly as demand for data transport and mobility services grow.  The mission of our sales team is to capitalize on this growing demand by offering customized solutions to our carrier and enterprise customers with a continued focus on expanding within our key vertical markets, which include healthcare, education, financial services and government.  Our technical team plays a significant role in our sales approach in order to focus on selling customized long-term secure networking and data solutions

Over the course of the last year, we have added experienced leaders to our sales teams, and we continue to look to add talent to our sales teams opportunistically.  Our overall strategy of deliberately and strategically shifting resources from the declining legacy voice and access business into our strategic data business also extends to our sales and sales engineering teams.  Our sales force is organized into carrier and enterprise teams to effectively pursue opportunities with the focus on capitalizing on the increased bandwidth demand, particularly for long-term FTTC contracts from wireless carriers deploying LTE services, improving enterprise penetration within our existing markets and selling into the edge-out markets.  We continue to further upgrade our sales technology to include the use of mobile devices and applications by key sales people and sales engineers.  We believe the use of these mobile tools by our sales teams will improve sales productivity and enhance the customer experience.

Our current edge-out markets include Richmond, VA and Western PA.  In the second half of 2013, we completed the build out of our 110 metro-mile fiber network in Richmond, VA and lit up the network with anchor enterprise and carrier customers already under contract.  In Western PA we own long-haul fiber assets and can leverage these assets to build out metro Ethernet and Ethernet rings.  We employ in-market sales teams to drive revenue growth in these markets. 


Marketing.  Our marketing team is primarily focused on driving revenue growth in our strategic data business.  During 2013, we

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further enhanced the interactive network mapping tools for our website to provide detailed insight into our network footprint.  Prospective customers can access the mapping tools online and pin point their location in proximity to our fiber by typing in an address.  Our marketing strategy is centered on the customer experience and a strong alignment with our sales, product management, network operations and service delivery teams to provide customized data solutions.    

Customer Care.  We have continued to refine our customer care teams in support of the multiple touch points for our customers.  This includes moving personnel to operations functions in support of a new service delivery team.  In 2012, we rolled out a comprehensive “Platinum Care” program to serve our top strategic data clients and in 2013 we further differentiated our customer care teams and levels of service in order to provide what we believe to be an even higher level of customer serviceIn 2014, we intend to further differentiate the customer care organization so that strategic data customers are better served and our residential and small business customers still receive the quality customer care they are accustomed to in an effort to manage the churn in this part of the business effectively.

Our Network and Platform

We have developed a fiber optic network of long-haul fiber, metro Ethernet and Ethernet rings located primarily in Virginia and West Virginia, and portions of Pennsylvania, Maryland, Ohio and Kentucky.  As of December 31, 2013, our fiber network spanned approximately 7,400 route miles.

Our integrated fiber transport network allows us to offer a suite of advanced next-generation communications services, including, but not limited to, 100Gbps wavelength services, which provides greater throughput and superior latency performance, multi-site networking, dedicated Internet and MEF 2.0 certified Ethernet solutions, high-speed Internet and VoIP services.  We use a multi-vendor approach, including Cisco, Alcatel-Lucent and Ciena, among others, to deliver high-speed wavelength services directly to end customers as infrastructure for the MPLS Ethernet and high-speed Internet backbone.  Network-to-network interconnection points allow us to engage carrier partners to provide end to end service for carrier and enterprise customers.  We continue to invest in our fiber network to support the deployment of next-generation products and services, expand our addressable market and bring new customers on-net.

Our local networks consist of central office digital switches, routers, loop carriers and virtual and physical collocations interconnected primarily with fiber facilities. A mix of fiber optic and copper facilities connect our customers with the core network. Our network operations center provides technical surveillance of our network using IBM-based network management systems.

In 2013, we began an upgrade of our internal business processes and systems including financial, provisioning, billing and customer care, which will allow us to scale our back office systems as our business continues to grow.  We expect to begin realizing the benefits of this initiative in the second half of 2014, including operating efficiencies, improved customer facing capabilities and streamlined business processes.

Competition

We compete with incumbent local exchange carriers (“ILECs”),  broadband service providers, incumbent cable operators, and fiber providers and to a lesser extent,  CLECs.  We also face competition from potential future market entrants.  In the last two years, we have seen increasing competition from the cable operators and ILECs for metro-Ethernet services to mid-size businesses.  To remain competitive, we position our company as a customer-focused and leading edge provider with a full portfolio of broadband and IP-based services and the theme that “our technology comes with people.”

As a result of the rapid growth in demand for broadband data transport, we expect that our competition will increase from market entrants offering FTTC, metro Ethernet solutions and other high-speed data services, including cable and wireless access.  Our competition includes:

 

 

ILECs, including AT&T, Verizon, Frontier, Windstream and CenturyLink;

national fiber service providers and CLECs, including Level 3, Zayo and Time Warner Telecom; and

national and regional cable operators, including Comcast, Shentel, Cox, Time Warner Cable and Suddenlink. 

 

As the RLEC for the western Virginia cities of Waynesboro, Clifton Forge and Covington and portions of the Virginia counties of Alleghany, Augusta and Botetourt, we have competition from cable companies and are subject to competition from wireless carriers.  A portion of residential customers moving into our service area do not purchase landline phone service.  Although CLECs have not entered our incumbent markets to compete with us, it is possible that one or more may enter our markets.  To minimize potential competition in the RLEC markets, we offer fiber-to-the-home, DSL, video over copper and a variety of bundled services for broadband, voice and video.

We believe our competitive strengths include our advanced fiber network; our footprint, including contiguous markets, which we believe provides opportunities for growth with a favorable competitive environment relative to first-tier markets; our robust and

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expanding products and services, including FTTC and metro Ethernet; our disciplined, success-based capital investment strategy aimed at optimizing our capital efficiency and delivering attractive returns; our diverse customer base, our strong liquidity position and future cash flow visibility from our legacy voice and access segments; and our experienced management team, with deep industry experience and a strong track record of operating and scaling bandwidth infrastructure assets.    

Employees 

As of December 31, 2013, we employed 577 full-time and two part-time employees.  Of these employees, 49 are covered by a collective bargaining agreement that expires June 30, 2014.

Access to Public Filings

We routinely post important information on our website at www.lumosnetworks.com.  Information contained on our website is not incorporated by reference into this annual report on Form 10-K.  We provide public access to our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to these reports filed with the U.S. Securities and Exchange Commission (“SEC”) under the Securities Exchange Act of 1934.  These documents may be accessed free of charge on our website at the following address: http://ir.lumosnetworks.com.    These reports are available as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC.

Regulation

The following summary does not describe all present and proposed federal and state legislation and regulations affecting the telecommunications industry.  Some legislation and regulations are currently the subject of judicial proceedings, legislative hearings and administrative proposals which could change the manner in which this industry operates.  Neither the outcome of any of these developments, nor their potential impact on us, can be predicted at this time.  Regulation can change rapidly in the telecommunications industry, and such changes may have an adverse effect on us in the future.  See “Risk Factors” elsewhere in this report.

Regulation Overview

Our communications services are subject to varying degrees of federal, state and local regulation.  Under the federal Communications Act, the Federal Communications Commission (“FCC”) has jurisdiction over interstate and international common carrier services.  Under the Telecommunications Act of 1996, the FCC has jurisdiction over certain aspects of local interconnection terms and rates between carriers.

In addition to FCC regulation, our communications services are regulated to different degrees by state public service commissions and by local authorities.  Such local authorities have jurisdiction over public rights-of-way and video and telecommunications franchises.

Our operations are subject to various federal and state laws intended to protect the privacy of customers who subscribe to our services.  The FCC has regulations that place restrictions on the permissible uses that we can make of customer-specific information, known as Customer Proprietary Network Information (“CPNI”), received from subscribers and that govern procedures for release of such information and the Federal Trade Commission’s “Red Flag” rules require that companies develop and implement written Identity Theft Prevention programs.

Many of the services we offer are unregulated or subject only to minimal regulation.  Internet services are not considered to be common carrier services, although the regulatory treatment of certain Internet services, including VoIP services, is evolving and still uncertain.  To date, the FCC has, among other things, directed providers of certain VoIP services to offer E-911 emergency calling capabilities to their subscribers, applied the requirements of the Communications Assistance for Law Enforcement Act, or CALEA, to these VoIP providers, determined that the VoIP providers are subject to federal universal service assessments and must pay access charges at interstate rates.  The FCC has preempted states from exercising entry and related economic regulation of nomadic VoIP providers but the FCC has not preempted state regulation of fixed VoIP service commonly offered by cable operators.

Federal Regulation of Interconnection and Interexchange Services

The Communications Act requires all common carriers to interconnect on a non-discriminatory basis with other carriers, imposes additional requirements on incumbent local exchange carriers (such as our RLEC’s), and imposes even more comprehensive requirements on the largest ILECs.  The large ILECs are required to provide competitors with physical collocation to allow competitors to place qualifying equipment in ILEC central offices; to unbundle some of their services into unbundled network elements (“UNE”) at “forward looking” rates, permit resale of some of their services, provide access to poles, ducts, conduits and rights-of-way, and to establish reciprocal compensation for the transport and termination of local traffic The obligations of the large ILECs to provide these network facilities and services are in flux and could be further altered or removed by new legislation, regulations or court order.

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ILEC operating entities that serve fewer than 50,000 lines are defined as “rural telephone companies” under the Communications Act and are exempt from the additional requirements applicable to the large ILECs unless and until such exemption is removed by the state regulatory body.  Each of our RLEC operations is considered separately and each has this rural telephone company exemption.   

Access Charges and Universal Service    

Intercarrier compensation includes regulated interstate and intrastate access charges that we and other ILECs and CLECs receive from long distance carriers for the origination and termination of long distance calls and reciprocal compensation that interconnected local carriers pay to each other for terminating interconnected local wireline calls.

The FCC has reformed and continues to reform the structure of the federal access charge system.  In 2011, the FCC released a significant order on access reform and USF reform.  In the order, the FCC adopted a uniform national bill-and-keep framework (in which carriers do not collect or pay access charges or reciprocal compensation) as the ultimate end state for all telecommunications traffic exchanged with any local exchange carrier.   Multiple parties appealed the FCC’s order.  Those appeals were consolidated at the 10th Circuit Court of Appeals and oral argument was held on November 19, 2013.

Effective July 1, 2013, our ILECs and CLECs took their intrastate rates for end office switching for terminating traffic, carrier common line charges on terminating traffic, and certain intrastate, transport services to interstate rates.  The FCC order permitted ILECs to implement a new charge on end users to partially offset the loss in access charge revenues, the Access Recovery Charge (“ARC”), effective July 1, 2012.  The maximum ARC for residential customers is $3 per month after six years.  Multi-line business customers have their Subscriber Line Charge and ARC combined capped at $12.20 per line.   In addition, RLECs are able to recover a portion of lost access revenues from the Connect America Fund (“CAF”).  Our RLECs began charging the ARC and began receiving funding from the CAF on July 1, 2012.

Net Neutrality.  On January 14, 2014, the Federal Court of Appeals for the District of Columbia struck down the FCC’s  “net neutrality” rules, including the following portions of those rules:

 

 

No blocking. Fixed broadband providers may not block lawful content, applications, services or non-harmful devices; mobile broadband providers may not block lawful websites, or block applications that compete with their voice or video telephony services; and

No unreasonable discrimination. Fixed broadband providers may not unreasonably discriminate in transmitting lawful network traffic.

The FCC has announced that it will not appeal the court order.

State Regulation of RLEC, CLEC and Interexchange Services

Most states require wireline telecommunications providers to obtain authority from state regulatory commissions prior to offering common carrier services.  State regulatory commissions generally regulate RLEC rates for intrastate services and RLECs must file tariffs setting forth the terms, conditions and prices for their intrastate services.  Our RLECs are subject to regulation in Virginia by the State Corporation Commission (“SCC”).  In addition, the SCC establishes service quality requirements applicable to RLECs, including ours, and resolves disputes involving intrastate communications services.

We are certificated as a CLEC in Virginia, West Virginia, Pennsylvania, Maryland, Ohio and Kentucky.  Although we file tariffs covering our CLEC services, our rates for such CLEC services generally fluctuate based on market conditions.

Local Government Authorizations

Certain governmental authorities require permits to open streets for construction and/or telecommunications franchises to install or expand facilities.  Video franchises are also required for our video services.  We obtain such permits and franchises as required.  We hold video franchises in the City of Waynesboro, Botetourt County, City of Lynchburg, City of Staunton (for the Gypsy Hill Development only), Bedford County, Alleghany County, City of Covington, Town of Clifton Forge, and Town of Iron Gate.  All of these localities are in the Commonwealth of Virginia.

Retransmission Consent.  Local television stations may require that a video provider obtain “retransmission consent” for carriage of the station’s signal, which can enable a popular local television station to obtain concessions from video providers for the right to carry the station’s signal.

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Item 1A.  Risk Factors.  

RISK FACTORS

The following risk factors and other information included in this Form 10-K should be carefully considered.  The risks and uncertainties described below are not the only ones we face.  Additional risks and uncertainties not presently known to us or that we currently deem immaterial also may adversely impact our business operations.  Our business, financial condition or results of operations could be materially adversely affected by any or all of these risks.

Risks Relating to Our Business: 

Adverse economic conditions may harm our business. 

Economic uncertainty or a lack of economic growth could negatively impact our business results.  Unfavorable economic conditions, including a return to recession or disruptions to the credit and financial markets, could cause customers to slow or delay spending.  If demand for our services decreases, our revenues would be adversely affected and churn may increase.  In addition, during challenging economic times our customers may face issues gaining timely access to sufficient credit, which may impair the ability of our customers to pay for services they have purchased.  Any of the above could have a material effect on our business, financial position, results of operations and cash flows. 

We are also susceptible to risks associated with the potential financial instability of the vendors and third parties on which we rely to provide services or to which we outsource certain functions.  The same economic conditions that may affect our customers could also adversely affect vendors and third parties and lead to significant increases in prices, reduction in quality or the bankruptcy of our vendors or third parties upon which we rely.  Any interruption in the services provided by our vendors or by third parties could adversely affect our business, financial position, results of operations and cash flows.  

We may not be able to successfully implement our strategy and thereby sustain our revenue and cash flow growth.

We must grow our strategic data business and manage the decline in our legacy voice and access segments in order to sustain our revenue and cash flow growth.  We have pursued several growth initiatives including:

·

Increasing network investments in our core markets;

·

Investing in fiber network expansion into new adjacent geographic markets;

·

Building fiber to wireless carrier cell sites; and

·

Launching new products and services that meet customers’ data and IP needs.

Our ability to manage this expansion depends on many factors, including our ability to:

·

Attract new customers and sell additional services to existing customers by effectively implementing our sales and marketing plans;

·

Manage churn, particularly as it relates to upgrading existing customers from legacy technology to advanced Ethernet services;

·

Complete customer installations in a timely manner to meet customer demands;

·

Successfully train our sales force to adapt to evolutionary demand for advanced data service;

·

Efficiently manage our capital expansion plans;

·

Manage increased competition from other data service providers in existing and new markets; and

·

Remain competitive with customer pricing and service expectations.

We face substantial competition in our markets; our competitors may have substantial business advantages over us and we may not be able to compete successfully.

We compete with ILECs, broadband service providers, incumbent cable operators, fiber companies and to a lesser extent, CLECs.  As a result of the rapid growth in demand for broadband data transport, we expect that our competition will increase from market entrants offering FTTC, metro Ethernet solutions and other high-speed data services, including cable and wireless access. Our competition includes ILECs, such as AT&T, Verizon, Frontier, Windstream and Centurylink; national fiber service providers and CLECs, including Level 3, Zayo and Time Warner Telecom, and national and regional cable operators, such as Comcast, Shentel, Cox, Time Warner Cable and Suddenlink.    In addition, due to consolidation and strategic alliances within the telecommunications industry, we cannot predict the number of competitors that will emerge.    Such increased competition from existing and new entities could lead to price reductions, loss of customers, reduced operating margins and/or loss of market share.

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Many of our competitors have financial resources, corporate backing, customer bases, marketing programs and brand names that are greater than ours.  Additionally, competitors may charge less than we do for services, causing us to reduce, or preventing us from raising, our fees. 

Network delays or interruptions of service could cause us to lose customers.  

To be successful, we must provide our customers reliable network service.  Some of the risks to our network and infrastructure include:  physical damage to outside plant facilities, power surges or outages; network equipment failures due to aging or other factors;  software defects; human error; disruptions beyond our control, including disruptions caused by terrorist activities or severe weather; and failures in operational support systems.

Furthermore, as the demand for increased bandwidth from our customers has grown and as it continues to grow, our fiber optic network could experience greater data loads that may also result in network interruptions in service and reduced capacity for our customers.  Service interruptions and lack of redundancy could cause us to incur additional expenses and/or issue network outage credits to our customers and may cause us to lose customers.

The telecommunications industry is generally characterized by rapid development and introduction of new technologies; if we are unable to adapt to these rapid changes, we could suffer price reductions, customer losses, reduced operating margins and/or loss of market share. 

The telecommunications industry continues to experience rapid and significant changes in technologies and architectures to deliver new services to customers and to deliver existing services more cost-effectively.  We expect that new technologies will continue to enable advances in our customers’ environments that create new demand drivers.  We believe that our future success will depend in part on our ability to anticipate and respond to the rapidly changing needs and demands of our customers on a timely basis and to compete with our competitors' offerings.  Our failure to obtain and integrate new technologies and applications, and develop new service offerings to meet those customer needs or to keep pace with or exceed the service capabilities of our competitors could impact the breadth of our service portfolio, resulting in less competitive and compelling offerings that could impair our ability to attract and retain customers.  We may be unable to keep pace with competitive offerings without making significant additional capital investments or adversely affecting our margins.

 

Revenue from certain of our more traditional products such as dedicated network services and certain voice services is growing slowly or is declining.  As a result, our overall revenue growth is driven primarily by our Ethernet services and we must continue to develop those and other next generation services in order to continue to grow our revenue.  New product development may be capital intensive and may pressure margins until the new products begin to generate substantial revenue.  New products that are largely software based are increasingly complex and may require more customer support and additional systems development.  In addition to investing in new technologies, we must replace equipment that supports our traditional services as that equipment ages or becomes redundant.  If we do not properly manage this process, including the migration of customers to our newer technologies, we may lose customers and market share, and our margins and returns could be adversely affected.

Losses or a decrease in usage from certain key customers may result in lower revenues or higher expenses.  

We generated approximately 10% of our operating revenue from Verizon in each of the years ended December 31, 2013 and 2012.  In addition, we have substantial business relationships with several other telecommunications carriers.  Our next four largest carrier customers, in the aggregate, accounted for approximately 21%  and 17% of our operating revenues for the years ended December 31, 2013 and 2012, respectively.  If we were to lose Verizon or one or more of these other carrier customers, our revenues would decline, which could have a material adverse effect on our business, financial condition and operating results. 

Many of our competitors are less heavily regulated than we are, which could increase our expenses or force us to lower prices, causing our revenues and operating results to decline. 

As the rural local telephone companies for the western Virginia cities of Waynesboro and Covington, and portions of the Virginia counties of Alleghany, Augusta and Botetourt, we currently compete with a number of different providers, many of which are unregulated or less heavily regulated than we are including Verizon and other large ILECs such as Frontier and CenturyLink.  These companies represent the dominant competition in much of our target service areas, and we expect this competition to intensify.  The large ILECs have established brand names, can diversify their risks across markets nationwide, possess sufficient capital to upgrade existing and deploy new equipment, own their telephone lines and can bundle digital data services with their existing analog voice services and other services, such as long-distance, wireless and video services, to achieve economies of scale in serving customers.  Additionally, the large ILECs that serve our markets are also our suppliers, which may affect their willingness to respond in a timely manner to our requests or to assist in the enhancement of the services we provide to our customers.

Our rural telephone company subsidiaries qualify as rural local telephone companies under the Telecommunications Act and are, therefore, exempt from many of the most burdensome obligations of the Telecommunications Act, such as the obligation to sell unbundled elements of our network to our competitors at “forward-looking” prices that the Telecommunications Act places on larger

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carriers.  Nevertheless, our rural telephone company subsidiaries face significant competition, particularly from competitors that do not need to rely on access to our network to reach their customers.    Wireless carriers, cable companies and other VoIP providers are able to compete with our rural telephone company subsidiaries even though the “rural exemption” under the Telecommunications Act is in place.  If our rural exemption were removed, CLECs could more easily enter our rural telephone company subsidiaries’ markets.  Moreover, the regulatory environment governing wireline local operations has been, and we believe will likely continue to be, very liberal in its approach to promoting competition and network access. 

Consistent with the experience of other rural telephone companies, our rural telephone company subsidiaries have experienced a reduction in access lines caused by, among other things, wireless competition, cable competition and business customer migration from Centrex services to IP-based and other PBX services using fewer lines.  As penetration rates of these technologies increase in our markets, our revenues from our legacy voice and access segments could decline at a faster pace than currently expected.  Our rural telephone company subsidiaries experienced a net loss of approximately 2,300 access lines in the year ended December 31, 2013, or 7.4% of our access lines served at the end of 2012.  A continued net loss of access lines would negatively impact our revenues and operating results.

We have substantial indebtedness, which could restrict our ability to pay dividends and have a negative impact on our financing options and liquidity position.    

On April 30, 2013, Lumos Networks Operating Company, our wholly-owned subsidiary, entered into a $425 million credit facility (the “Credit Facility”).  The Credit Facility consists of a  $100 million senior secured five-year term loan, a $275 million senior secured six-year term loan and a $50 million senior secured five-year revolving credit facility.  Our indebtedness under the Credit Facility was $373.6 million at December 31, 2013 and it carries interest expense of approximately $14 million annually. 

Our indebtedness could adversely affect our financial health and business and future operations by, among other things: 

·

making it more difficult for us to satisfy our obligations with respect to our indebtedness;

·

increasing our vulnerability to adverse economic and industry conditions by making it more difficult for us to react quickly to changing conditions;

·

limiting our ability to obtain any additional financing we may need to operate, develop and expand our business;

·

requiring us to dedicate a substantial portion of any cash flows from operations to service our debt, which reduces the funds available for operations and future business opportunities;

·

potentially making us more highly leveraged than our competitors, which could potentially decrease our ability to compete in our industry;

·

exposing us to risks inherent in interest rate fluctuations because some of our borrowings are at variable rates of interest, which could result in higher interest expense in the event of increases in interest rates; and

·

limiting our flexibility in planning for, or reacting to, changes in our business, and the industry in which we operate. 

The ability to make payments on our debt will depend upon our future operating performance, which is subject to general economic and competitive conditions and to financial, business and other factors, many of which we cannot control.  If the cash flows from our subsidiaries’ operating activities are insufficient to service our debt obligations, we may take actions, such as delaying or reducing capital expenditures, reducing or eliminating our quarterly cash dividend, attempting to restructure or refinance our debt, selling assets or operations or seeking additional equity capital.  Any or all of these actions may not be sufficient to allow us to service our debt obligations.  Further, we may be unable to take any of these actions on satisfactory terms, in a timely manner or at all. 

Our Credit Facility imposes certain operating and financial restrictions, which may prevent us from capitalizing on business opportunities and taking some corporate actions.  

Our Credit Facility imposes certain operating and financial restrictions on our subsidiaries.  These restrictions generally:

·

restrict our subsidiaries’ ability to incur additional indebtedness;

·

restrict our subsidiaries from entering into transactions with affiliates;

·

restrict our subsidiaries’ ability to consolidate, merge or sell all or substantially all of their assets;

·

impose financial covenants relating to the business of our subsidiaries, including leverage and interest coverage ratios;

·

require our subsidiaries to use a portion of “excess cash flow” (as defined in the debt agreement) to repay indebtedness if our leverage ratio exceeds specified levels;

·

restrict our subsidiaries’ ability to pay dividends or make advances to us, which will restrict our ability to pay dividends; and

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·

restrict our subsidiaries’ ability to agree to liens on assets or agreements (such as leases). 

We cannot assure you that those covenants will not adversely affect our ability to pay dividends or repurchase stock, finance our future operations or capital needs or pursue available business opportunities.  A breach of any of these covenants could result in a default with respect to the Credit Facility.  If a default occurs, our indebtedness under the Credit Facility could be declared immediately due and payable.

We may require additional capital to respond to customer demand and to competition, and if we fail to raise the capital or fail to have continued access to the capital required to fund our strategic growth plan, we may experience a material adverse effect on our business.  

Our strategic growth plans require a significant amount of capital investment in our fiber network.  Our aggregate capital expenditures for 2013 were approximately $68 million, approximately 75% of which were for success-based customer projects and network expansion and the remaining 25% was for infrastructure upgrades, network sustainment and internal IT projects.  We estimate that our capital expenditures for 2014 will be in the range of approximately $70 million to $75 million.

To remain competitive, we will need to upgrade the technical requirements of our existing network infrastructure and build out our network with advanced fiber technology within our territories which will require a significant investment of capital resources.  A portion of our planned capital expenditures in 2014 are earmarked to fund these projects; however, the cost or extent of the work could be more significant than anticipated.  Any such unplanned capital expenditures may adversely affect our business, financial condition and operating results.  Although we refinanced our debt in 2013 on favorable terms and expect to be able to fund our capital requirements with cash on hand and cash generated from operations, we may need to obtain additional financing in the future.  There is no assurance that we would be able to secure such financing on terms acceptable to us or at all.

Our RLEC subsidiaries are subject to several regulatory regimes and consequently face substantial regulatory burdens and uncertainties; regulatory developments will further reduce revenues that we receive from access charges and/or from the federal Universal Service Fund, the Connect America Fund or other fund allocations

Our rural telephone company subsidiaries are subject to several regulatory regimes and consequently face substantial regulatory burdens and uncertainties. The SCC imposes service quality obligations on our rural telephone company subsidiaries and requires us to adhere to prescribed service quality standards, but many of our competitors are not subject to these standards.  These standards measure the performance of various aspects of our business.  If we fail to meet these standards, the SCC may impose fines or penalties or take other actions that may impact our revenues or increase our costs.  The FCC may also impose fines and forfeitures for failure to comply with FCC rules and requirements.    

Over time, FCC and state regulations have resulted in reducing our switched access and reciprocal compensation revenue.  In 2011, the FCC released an order comprehensively reforming its Universal Service Fund (“USF”) and intercarrier compensation systems.  In the order, the FCC determined that interstate and intrastate access charges, as well as local reciprocal compensation, should be eliminated entirely over time.  These FCC pricing reductions commenced on July 1, 2012 and continue through July 1, 2020.  A portion of the access revenue previously received from carriers is being recovered through payments from the FCC’s “Connect America Fund” (“CAF”) and from increases in charges to end user subscribers in the form of rate increases and the FCC’s “Access Recovery Charge.”  For the year ended December 31, 2013, we recognized $16.6 million of revenue from cost recovery mechanisms, including $10.3 million from the CAF.  Regulatory changes could impact the amount and timing of the revenues received from these funds in the future.  There is no guarantee that we will recover all or a portion of lost revenues resulting from intercarrier compensation system reform or that we will not be subject to further rate reductions in the future.  Furthermore, by accepting government funding, we are subject to audit by the FCC or certain other government agencies that administer the funds and our methodologies or approaches taken to determine the amounts of eligible access revenues or costs could be called into question during an audit. Although we believe our methodologies and approaches are compliant and reasonable, there is no assurance that an audit would not result in a demand for a partial refund or nonpayment of future funding by the respective government agency. 

Lumos Networks and other industry participants are frequently involved in disputes over issues that, if decided adversely to us, could harm our financial and operational prospects. 

We anticipate that we will continue to be subject to risks associated with the resolution of various disputes, lawsuits, arbitrations and proceedings affecting our business.  These issues include the administration and enforcement of existing interconnection agreements and tariffs, the terms of new interconnection agreements, operating performance obligations and intercarrier compensation.  We also may be included in proceedings and arbitrations before state and regulatory commissions, private arbitration organizations, and courts over many issues that will be important to our financial and operation success.  While we believe we have adequate reserves for the probable and estimable losses related to the expected outcomes of our current disputes, the results of these disputes are inherently unpredictable.

The implementation of our business strategy is dependent upon our ability to maintain, expand and update our information technology infrastructure in response to growth and changing business needs.

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Our business relies on our data, billing and other operational and financial reporting and business systems.  To effectively implement our business strategy, we will need to continue to maintain and, in some cases, make upgrades to modernize our information technology systems and infrastructure, which can be costly.  Our inability to maintain, expand or upgrade our technology infrastructure could have adverse consequences, which could include service or billing interruptions, the diversion of critical resources and inhibiting our growth plans due to an inability to scale effectively.

In 2013, we began an upgrade of our internal business processes and systems including financial, provisioning, billing and customer care, which will allow us to scale our back office systems as our business continues to grow.  We expect to begin realizing the benefits of this initiative in the second half of 2014, including operating efficiencies, improved customer facing capabilities and streamlined business processes.  If we are unable to successfully implement the systems in a timely manner, we could face delays or disruptions in providing services to or billing our customers or we could incur additional costs, which could have an adverse impact to our financial and operating results.

We are dependent on third-party vendors for our information and billing systems.  Any significant disruption in our relationship with these vendors could increase our costs and affect our operating efficiencies.  

Sophisticated information and billing systems are vital to our ability to monitor and control costs, bill customers, process customer orders, provide customer service and achieve operating efficiencies.  We currently rely on internal systems and third-party vendors to provide all of our information and processing systems.  Some of our billing, customer service and management information systems have been developed by third parties and may not perform as anticipated or the third parties may experience interruptions or other problems delivering these systems.  In addition, our plans for developing and implementing our information and billing systems rely to some extent on the delivery of products and services by third-party vendors.  Our right to use these systems is dependent upon license agreements with third-party vendors.  Some of these agreements are cancelable by the vendor, and the cancellation or nonrenewable nature of these agreements could impair our ability to process customer information and/or bill our customers.  Since we rely on third-party vendors to provide some of these services, any switch in vendors could be costly and affect operating efficiencies.

If we fail to extend or renegotiate our collective bargaining agreements with our labor union when they expire, or if our unionized employees were to engage in a strike or other work stoppage, our business and operating results could be materially harmed.  

We are a party to collective bargaining agreements with our labor union, which represented 49 employees as of December 31, 2013.  Although we believe that relations with our employees are satisfactory, no assurance can be given that we will be able to successfully extend or renegotiate our collective bargaining agreements when they expire.  If we fail to extend or renegotiate our collective bargaining agreements, if disputes with our union arise, or if our unionized workers engage in a strike or a work stoppage, we could experience a significant disruption of operations or incur higher ongoing labor costs, either of which could have an adverse effect to the business.  Our collective bargaining agreements expire June 30, 2014 and are currently under review for extension.

We rely on a limited number of key suppliers and vendors for timely supply of equipment and services relating to our network infrastructure.  If these suppliers or vendors experience problems or favor our competitors, we could fail to obtain sufficient quantities of the products and services we require to operate our businesses successfully.  

We depend on a limited number of key suppliers and vendors for equipment and services relating to our network infrastructure.  If these suppliers experience interruptions or other problems delivering these network components on a timely basis, our subscriber growth and operating results could suffer significantly.  Our initial choice of a network infrastructure supplier can, where proprietary technology of the supplier is an integral component of the network, cause us effectively to be locked into one or a few suppliers for key network components.  As a result, we have become reliant upon a limited number of network equipment manufacturers, including Cisco, Alcatel-Lucent, Ciena and others.  If alternative suppliers and vendors become necessary, we may not be able to obtain satisfactory and timely replacement supplies on economically attractive terms, or at all.

If we cannot obtain and maintain necessary rights-of-way and access to pole attachments for our network, our operations may be interrupted and we would likely face increased costs.  

We need to obtain and maintain the necessary rights-of-way for our network from governmental and quasi-governmental entities and third parties, such as railroads, utilities, state highway authorities, local governments, transit authorities and private landowners.  We may not be successful in obtaining and maintaining these rights-of-way or obtaining them on acceptable terms.  Some agreements relating to rights-of-way may be short-term or revocable at will, and we cannot be certain that we will continue to have access to existing rights-of-way after the governing agreements are terminated or expire.  If any of our right-of-way agreements were terminated or could not be renewed, we may be forced to remove our network facilities from the affected areas, relocate or abandon our networks.  This would interrupt our operations and force us to find alternative rights-of-way and make unexpected capital expenditures.  In addition, our failure to maintain the necessary rights-of-way, franchises, easements, licenses and permits may result in an event of default under our credit agreement and may subject us to legal complaints or claims.  We may also incur costs resulting from a disruption of service or the relocation of equipment for other carriers that use our network under IRUs granted by us.

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Under federal law, we have a right to use the poles, ducts, and conduits of investor-owned utilities (electric and telephone) at regulated rates for our cables, including fiber optic facilities.  Some of the poles we use are exempt from federal regulation because they are owned by utility cooperatives and municipal entities.  If the rates, terms and conditions imposed by utilities are unreasonable, or if the utilities do not allow us access to the poles, ducts, and conduits in a timely manner, our business, financial results or financial condition could suffer.   

Our rights to the use of fiber that are part of our network may be affected by the ability to continue long term contracts and the financial stability of our Indefeasible Rights to Use fiber providers. 

A portion of our services are provided on network fiber facilities licensed or leased from other network service providers through IRUs or similar arrangements.  The facilities under these agreements have remaining terms generally ranging from 5 years to 25 years.  In these agreements, the network owner is responsible for network maintenance for which we pay such network owners.  If our network provider under IRU agreements has financial troubles, it could adversely affect our costs, especially maintenance costs and ability to deliver service.  Also, if our network providers under IRU agreements are unable to obtain and maintain necessary rights-of-way and access to pole attachments for their fiber networks or if they fail to renew or extend our IRUs, our operations may be interrupted and/or we could incur material expenses if we were required to relocate to alternative network assets.

We are dependent upon interconnection agreements with other carriers to reach some of our customer locations.

We have interconnection agreements with the ILEC networks in the markets we serve.  Based on customer growth and our assessment of growth opportunities in these markets, we purchase wholesale voice lines, data circuits and access to collocation facilities under these agreements.  From time to time, we are required to negotiate amendments to, extensions of, or replacements for these agreements.  Additionally, we may be required to negotiate new interconnection agreements in order to enter new markets in the future.  We may not be able to successfully negotiate amendments to existing agreements, negotiate new interconnection agreements, renew our existing interconnection agreements, opt in to new agreements or successfully arbitrate replacement agreements for interconnection on terms and conditions acceptable to us.  Our inability to do so would adversely affect our existing operations and opportunities to expand our business in existing and new markets.  If rates became unfavorable or we could no longer access collocation facilities, we could be forced to alter our service delivery which could reduce our customer base.  As the FCC modifies and implements rules related to unbundling of ILEC network elements and collocation of competitive facilities at ILEC central offices, we generally have to renegotiate our interconnection agreements to implement those new or modified rules. 

If interest rates increase, our net income could be negatively affected.

Our long-term debt exposes us to adverse changes in interest rates.  We cannot predict whether interest rates for long-term debt will increase, and thus we cannot assure you that our future interest expense will not have a material adverse effect on our business, financial condition, operating results and cash flows.  We did enter into interest rate swap contracts on 50% of the credit facility through 2015 in order to mitigate this exposure.

Any significant impairment of our goodwill or intangible assets would lead to a decrease in our assets and a reduction in net operating performance. 

As of December 31, 2013, we had goodwill and other intangible assets of approximately $125.4 million (approximately 21% of total assets).  If the impact or the timing of ongoing regulatory reform actions is significantly different than what we anticipate or if there are other regulatory or operating changes to our business, we may be forced to record an additional impairment charge, which would lead to a decrease in the company’s assets and reduction in net income.  We test goodwill and other indefinite-lived intangible assets for impairment annually or more frequently if events or changes in circumstances indicate an impairment may have occurred.  If the testing performed indicates that impairment has occurred, we are required to record an impairment charge for the difference between the carrying value of the goodwill or indefinite-lived intangible asset and the implied fair value of the asset in the period in which the determination is made.  The testing of goodwill and indefinite-lived intangible assets for impairment requires us to make significant estimates about our future performance and cash flows, as well as other assumptions.  These estimates can be affected by numerous factors, including changes in economic, industry or market conditions, changes in underlying business operations, future reporting unit operating performance, existing or new product market acceptance, changes in competition or changes in technologies.  Any changes in key assumptions, or actual performance compared with those assumptions, about our business and our future prospects or other assumptions could affect the fair value of one or more of the indefinite-lived intangible assets or of the reporting units, resulting in an additional impairment charge. 

Security breaches to our physical facilities, computer networks, and informational databases, and unauthorized use of, or interference with, our network could disrupt services and result in loss of customer data and customers, and increase our costs.  

The nature of our business necessitates that parts of our network remain in the public domain and as a result it is possible that unauthorized use, interference with, or malicious or unintentional disruptions of our network may occur. In addition, computer viruses, theft, attacks by hackers, or similar disruptive problems may occur.  If hackers gain improper access to our databases, they may be able to steal, publish, delete or modify confidential personal information concerning our subscribers. 

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In addition, misuse of our customer information could result in more substantial harm perpetrated by third parties.  This could damage our business and reputation, and result in a loss of customers.  Misuse of our customer information would also subject us to fines by the FCC.  We may incur costs associated with the unauthorized use of our network including administrative and capital costs associated with detecting, monitoring and reducing the incidence of malice and fraud.  Malicious and fraudulent use of our network may impact interconnection costs, capacity costs, legal and administrative costs, fraud prevention costs and payments to other carriers for fraudulent use.  

Our physical facilities may be vulnerable to physical break-ins which may also result in the misuse of our customer information, malicious and fraudulent use of our networks that may impact interconnection costs, capacity costs, legal and administrative costs, fraud prevention costs and payments to other carriers for fraudulent use.

If or when we lose a member or members of our senior management, our business may be adversely affected.  

The success of our business is largely dependent on our senior management team, as well as on our ability to attract and retain other highly qualified technical and management personnel, including talented sales and technical personnel

We believe that there is, and will continue to be, intense competition for qualified personnel in the telecommunications industry, and we cannot assure you that we will be able to attract and retain the personnel necessary for the development of our business.  The unexpected loss of key personnel or the failure to attract additional personnel as required could have a material adverse effect on our business, financial condition and operating results.   

Risks Related to Our Common Stock: 

The Quadrangle entities have significant influence over our business and could delay, deter or prevent a change of control, change in management or business combination that may not be beneficial to our stockholders and as a result, may depress the market price of our common stock.  

Pursuant to our shareholders agreement with Quadrangle, we agreed to register shares of our common stock held by the Quadrangle entities.  Upon a request from Quadrangle to comply with these registration obligations, we prepared and filed a registration statement on Form S-3 with the SEC on August 26, 2013 utilizing a shelf registration process.  Under this shelf registration process, Quadrangle may offer and sell in one or more offerings, up to an aggregate of 5,680,837 shares of our common stock.  On November 20, 2013, in a secondary offering of our common stock, Quadrangle sold 2,888,939 shares. 

As of December 31, 2013, Quadrangle beneficially owned 2,791,898 shares, or approximately 13%, of our outstanding common stock, all of which could be offered for sale in the future under the existing shelf registrationIn addition, two of the eight directors that serve on our board of directors are representatives or designees of Quadrangle.  Pursuant to the terms of our shareholders agreement, with stock ownership below 20% of the voting power of our common stock, Quadrangle currently has the right to designate two directors, who do not need to be independent as defined by the rules of the NASDAQ Stock Market.  If Quadrangle’s ownership falls below 10% they may designate only one director and no directors if their ownership falls below 5%.  The shareholders agreement also provides that one director will be our Chief Executive Officer for so long as he or she is employed by us.

By virtue of the shareholders agreement and such stock ownership and representation on the board of directors, Quadrangle has a significant influence over day-to-day corporate and management policies and all matters submitted to our stockholders, including the election of the directors, and can exercise significant control over our business, policies and affairs.  Such concentration of voting power could have the effect of delaying, deterring or preventing a change of control, change in management or a business combination that might otherwise be beneficial to our stockholders and as a result, may depress the market price of our common stock.

The interests of the Quadrangle entities may not coincide with the interests of a holder of our common stock and because the Quadrangle entities have significant influence over our business, they could cause us to enter into transactions or agreements adverse to the interests of our other stockholders.

 

The interests of the Quadrangle entities may not always coincide with the interests of our other stockholders.  Accordingly, because the Quadrangle entities have significant influence over our business, they could cause us to enter into transactions or agreements adverse to the interests of our other stockholders.

 

In addition, the Quadrangle entities are in the business of making investments in companies and may, from time to time, acquire and hold interests in businesses that compete directly or indirectly with us.  The Quadrangle entities may also pursue, for their own account, acquisition opportunities that may be complementary to our business, and as a result, those acquisition opportunities may not be available to us.  Additionally, we have specifically renounced in the shareholders agreement any interest or expectancy that the Quadrangle entities will offer to us any investment or business opportunity of which they are aware.

 

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The shares of our common stock owned by the Quadrangle entities are not freely tradable on The NASDAQ Global Market, and a sale of the shares of our common stock by Quadrangle  would increase the number of shares of our common stock eligible to be freely traded on The NASDAQ Global Market, which could depress the market price of our common stock.

 

As of December 31, 2013, Quadrangle beneficially owned 2,791,898 shares, or approximately 13%, of our outstanding common stock, all of which could be offered for sale in the future under the existing shelf registration.  The remainder of our shares of issued and outstanding common stock are freely tradable on The NASDAQ Global Market without restriction or further registration under the Securities Act of 1933, as amended (the “Securities Act”), unless such shares constitute “restricted securities” within the meaning of Rule 144 under the Securities Act or are purchased by our “affiliates” as that term is defined in Rule 144 under the Securities Act. The shares of common stock subject to the shelf registration were not freely tradable on The NASDAQ Global Market and the sale of Quadrangles remaining shares  would increase the number of shares of our common stock eligible to be freely traded on The NASDAQ Global Market, which could depress the market price of our common stock.

 

Provisions in our charter documents and the General Corporation Law of Delaware could discourage potential acquisition proposals, could delay, deter or prevent a change in control and could limit the price certain investors might be willing to pay for our common stock. 

Certain provisions of the General Corporation Law of Delaware, the state in which we are organized, and our certificate of incorporation and bylaws may inhibit a change of control not approved by our board of directors or changes in the composition of our board of directors, which could result in the entrenchment of current management.  These provisions include:

·

advance notice requirements for stockholder proposals and director nominations;

·

limitations on the ability of stockholders to amend, alter or repeal our bylaws;

·

limitations on the removal of directors;

·

the inability of the stockholders to act by written consent; and

·

the authority of the board of directors to issue, without stockholder approval, preferred stock with such terms as the board of directors may determine and additional shares of our common stock. 

A portion of our current investor base may be required to sell our common stock.    

A portion of our common stock is held by index funds tied to broad stock indices in which we are included as a component.  If at any time we are not included as a component in those indices, the corresponding index funds will likely be required to sell their shares of our common stock and the price of our common stock could be depressed by those sales. 

We may not be able to pay dividends on our common stock in the future. 

We intend to pay regular quarterly dividends on our common stock.  However, any decision to declare future dividends will be made at the discretion of the board of directors and will depend on, among other things, our results of operations, cash requirements, investment opportunities, financial condition, contractual restrictions, and other factors that our board of directors may deem relevant.  We are a holding company that does not operate any business of our own.  As a result, we are dependent on cash dividends and distributions and other transfers from our subsidiaries to make dividend payments to our stockholders.  Amounts that can be made available to us to pay cash dividends or repurchase stock are permitted by our credit agreement within the parameters of a restricted payment basket.

Our certificate of incorporation designates the Court of Chancery of the State of Delaware as the sole and exclusive forum for certain litigation that may be initiated by our stockholders, which could limit our stockholders’ ability to obtain a favorable judicial forum for disputes with the Company.

Our certificate of incorporation provides that, unless we consent in writing to the selection of an alternative forum, the Court of Chancery of the State of Delaware shall be the sole and exclusive forum for (i) any derivative action or proceeding brought on our behalf, (ii) any action asserting a claim of breach of fiduciary duty owed by any of our directors, officers or other employees or our stockholders, (iii) any action asserting a claim arising pursuant to any provision of the DGCL or our certificate of incorporation or bylaws, or (iv) any action asserting a claim governed by the internal affairs doctrine.  Our certificate of incorporation further provides that any person or entity purchasing or acquiring any interest in shares of our capital stock shall be deemed to have notice of and to have consented to the provisions described above.  This forum selection provision in our certificate of incorporation may limit our stockholders’ ability to obtain a favorable judicial forum for disputes with the Company.    

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Risks Related to Our Business Separation from NTELOS:

If the Distribution does not qualify as a tax-free transaction, tax could be imposed on NTELOS and we may be required to indemnify NTELOS for such tax. 

If the Distribution were not to be tax-free to NTELOS, NTELOS would be required to recognize gain in an amount up to the fair market value of our common stock that NTELOS distributed on the distribution date. 

Furthermore, events subsequent to the Distribution could cause NTELOS to recognize gain on the Distribution.  For example, under Code Section 355(e), even minimal acquisitions of either our equity securities or NTELOS’s equity securities that are deemed to be part of a plan or a series of related transactions that include the Distribution could cause NTELOS to recognize gain on the Distribution. 

Under the tax matters agreement entered into between NTELOS and us, we are generally required to indemnify NTELOS against any tax resulting from the Distribution to the extent that such tax resulted from any of the following events (among others): (1) an acquisition of all or a portion of our stock or assets, whether by merger or otherwise, (2) any negotiations, understandings, agreements or arrangements with respect to transactions or events that cause the Distribution to be treated as part of a plan pursuant to which one or more persons acquire, directly or indirectly, stock representing a 50% or greater interest in Lumos Networks, (3) certain other actions or failures to act by us, or (4) any breach by us of certain of our representations or undertakings.  Our indemnification obligations to NTELOS and its subsidiaries, officers and directors are not limited by any maximum amount. 

We have agreed to certain restrictions to preserve the tax-free treatment of the Distribution to NTELOS, which may reduce our strategic and operating flexibility. 

To preserve the tax-free treatment to NTELOS of the Distribution, under the tax matters agreement that we entered into with NTELOS, we are prohibited from taking or failing to take any action that prevents the Distribution and related transactions from being tax-free.  These restrictions may limit our ability to pursue strategic transactions or engage in new business or other transactions that may maximize the value of our business. 

Certain of our officers and directors may have actual or potential conflicts of interest because of their cross directorships and stock ownership with NTELOS. 

We continue to have overlap in directors with NTELOS, which may lead to conflicting interests.  James A. Hyde, the Chief Executive Officer and President of NTELOS, is serving on our board of directors and our CEO is serving on NTELOS’s board of directors.  Our board of directors also includes representatives of Quadrangle who are members of the board of directors of NTELOS.  Mr. Hyde and the members of our board of directors who overlap with NTELOS have fiduciary duties to both NTELOS’s and our stockholders.  These individuals may have actual or apparent conflicts of interest with respect to matters involving or affecting each company.  NTELOS continues to be a significant customer of the Company and therefore potential conflicts of interest could exist or arise in the future.  This arrangement may also subject us to regulation under state and federal affiliated interest’s regulatory requirements. 

Also, because of their current or former positions with NTELOS, certain of our directors and executive officers may continue to own shares of NTELOS common stock and the individual holdings may be significant for some of these individuals compared to their total assets.  Given our commercial arrangements with NTELOS, this ownership may create, or, may create the appearance of, conflicts of interest when these executive directors and officers are faced with decisions that could have different implications for NTELOS and the Company

In connection with our separation from NTELOS, NTELOS will indemnify us for certain liabilities and we will indemnify NTELOS for certain liabilities.  If we are required to indemnify NTELOS, we may need to divert cash to meet those obligations and our financial position could be negatively impacted.  In the case of NTELOS’s indemnity, there can be no assurance that the indemnity will be sufficient to insure us against the full amount of such liabilities, or as to NTELOS’s ability to satisfy its indemnification obligations in the future. 

Pursuant to the separation and distribution agreement and certain other agreements with NTELOS, NTELOS agreed to indemnify us from certain liabilities, and we agreed to indemnify NTELOS for certain liabilities, in each case for uncapped amounts.  Indemnities that we may be required to provide NTELOS are not subject to any cap, may be significant and could negatively impact our business, particularly indemnities relating to our actions that could impact the tax-free nature of the Distribution.  Third-parties could also seek to hold us responsible for any of the liabilities that NTELOS has agreed to retain.  Further, there can be no assurance that the indemnity from NTELOS will be sufficient to protect us against the full amount of such liabilities, or that NTELOS will be able to fully satisfy its indemnification obligations.  Moreover, even if we ultimately succeed in recovering from NTELOS any amounts for which we are held liable, we may be temporarily required to bear these losses ourselves.  Each of these risks could negatively affect our business, results of operations and financial condition. 

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Item 1B.  Unresolved Staff Comments.

None.

Item 2.  Properties.

We are headquartered in Waynesboro, Virginia and own offices and facilities in a number of locations within our operating markets.  Our offices and facilities are generally shared by our operating segments. We believe that our current facilities are adequate to meet our needs in our existing markets for the foreseeable future.  The table below provides the location, description and approximate square footage of our material owned properties.

Location

Property Description

Approximate Square Footage

Harrisonburg, VA

Competitive POP

2,500 

Troutville, VA

Switch and Video Headend Building

11,400 

Clifton Forge, VA

Switch Building

12,000 

Covington, VA

Service Center

13,000 

Waynesboro, VA

Service Center

20,000 

Daleville, VA

Regional Operations Center

21,000 

Covington, VA

Switch Building

32,000 

Waynesboro, VA

Corporate Headquarters

30,000 

Waynesboro, VA

Switch Building

33,920 

Daleville, VA

Service Center

9,400 

 

We also lease the following material properties:

·

Our Charleston, West Virginia regional operations center (wireline switching) under a sub-lease from NTELOS Inc. for approximately 3,200 square feet of this space; 

·

Our Charleston, West Virginia switch building under a lease agreement by and between Nelson Trust and FiberNet, LLC dated April 19, 2005; and

·

Our Charleston, West Virginia office and switch building under a lease agreement by and between Williams Land Company and Mountaineer Telecommunications, LLC dated April 12, 2005.

Item 3.  Legal Proceedings.

We are involved in routine litigation in the ordinary course of our business,  including litigation involving disputes relating to our billings to other carriers for access to our network (see Note 13 in Part II, Item 8. Financial Statements and Supplementary Data).  We do not believe that any pending or threatened litigation of which we are aware will have a material adverse effect on our financial condition, results of operations or cash flows.

Item 4.  Mine Safety Disclosures.

Not applicable.

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Part II 

Item 5.  Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities. 

Market Information

Our common stock is traded on the NASDAQ Global Market under the symbol “LMOS.    On March  3, 2014, the last reported sale price for our common stock was $14.52 per share.

Our common stock has been traded on the NASDAQ Global Market under the symbol “LMOS” since November 1, 2011.  Prior to that time, there was no established public trading market for our common stock.  The following table sets forth the high and low prices per share of our common stock and the cash dividends declared per common share for each of the quarters in 2013 and 2012, which correspond to our quarterly fiscal periods for financial reporting purposes: 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Stock Price per Share

 

 

 

 

 

High

 

Low

 

Cash Dividends Declared per Common Share

2012:

 

 

 

 

 

 

 

 

 

First Quarter

 

$

18.18 

 

$

10.13 

 

$

0.14 

Second Quarter

 

 

10.76 

 

 

7.65 

 

 

0.14 

Third Quarter

 

 

9.86 

 

 

7.50 

 

 

0.14 

Fourth Quarter

 

 

10.54 

 

 

7.61 

 

 

0.14 

 

 

 

 

 

 

 

 

 

 

2013:

 

 

 

 

 

 

 

 

 

First Quarter

 

$

13.57 

 

$

8.82 

 

$

0.14 

Second Quarter

 

 

17.72 

 

 

12.27 

 

 

0.14 

Third Quarter

 

 

22.25 

 

 

15.02 

 

 

0.14 

Fourth Quarter

 

 

25.10 

 

 

18.83 

 

 

0.14 

 

Stock Performance Graph 

The following indexed line graph indicates our total return to stockholders from November 1, 2011 (the first day our Common Stock began trading on the NASDAQ Global Market) to December 31, 2013, as compared to the total return for the NASDAQ Composite Index and the NASDAQ Telecommunications Index for the same period.  The calculations in the graph assume that $100 was invested on November 1, 2011 in our Common Stock and each index and also assume dividend reinvestment.

Cumulative Total Shareholder Return

Lumos Networks, NASDAQ Composite Index
and NASDAQ Telecommunications Index
(11/1/11 - 12/31/13) 

Picture 16

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Table of Contents

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

November 1, 2011

 

 

December 31, 2011

 

 

December 31, 2012

 

 

December 31, 2013

Lumos Networks Corp.

$

100 

 

$

98 

 

$

67 

 

$

141 

NASDAQ Composite Index

$

100 

 

$

101 

 

$

116 

 

$

160 

NASDAQ Telecommunications Index

$

100 

 

$

105 

 

$

105 

 

$

130 


Holders

There were approximately 3,300 holders of our common stock on March 3,  2014. 

Dividends/Dividend Policy

We intend to continue to pay regular quarterly dividends on our common stock. Cash dividends of $0.14 per share were declared and subsequently paid for each of the four quarters in 2013 and 2012On February 20, 2014, our board of directors declared a dividend in the amount of $0.14 per share, which is to be paid on April 10, 2014 to stockholders of record on March 13, 2014All decisions to declare dividends will be made at the discretion of our board of directors and will depend on, among other things, our results of operations, cash requirements, investment opportunities, financial condition, credit agreement and contractual restrictions and other factors that our board of directors may deem relevant.  We are a holding company that does not operate any business of our own.  As a result, we are dependent on cash dividends and distributions and other transfers from our subsidiaries to make dividend payments or to make other distributions to our stockholders.  Amounts that can be made available to us to pay cash dividends will be permitted by our credit agreement within the parameters of a restricted payment basket.

Issuer Purchases of Equity Securities

The Company does not have a share repurchase program in effect.  However, during the three months ended December 31, 2013, the Company repurchased 9,715 shares of Company stock for $0.2 million in connection with the vesting of certain restricted stock grants issued pursuant to the Company’s 2011 Equity and Cash Incentive Plan.  The Company repurchased these shares from employee plan participants for settlement of tax withholding obligations.

The number of shares repurchased and the average price paid per share for each month in the three months ended December 31, 2013 are as follows:

 

 

 

 

 

 

 

 

 

 

 

Period

 

(a)
Total Number of
Shares Repurchased

 

(b)
Average Price Paid
per Share

 

(c)
Total Number of
Shares Repurchased
as Part of Publicly Announced Plans or
Programs

 

(d)
Maximum Number
of Shares that May
Yet be Purchased
Under the Plans or
Programs

October 1, 2013 - October 31, 2013

 

9,715 

 

$

22.01 

 

N/A

 

N/A

November 1, 2013 - November 30, 2013

 

 -

 

$

 -

 

N/A

 

N/A

December 1, 2013 - December 31, 2013

 

 -

 

$

 -

 

N/A

 

N/A

 

 

9,715 

 

$

22.01 

 

N/A

 

 

 

 

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Item 6.  Selected Financial Data

SELECTED HISTORICAL FINANCIAL INFORMATION(1)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Lumos Networks Corp.
Year Ended December 31,

(In thousands, except per share amounts)

 

2013

 

2012

 

2011

 

2010

 

2009

Consolidated Statements of Operations Data:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating Revenues

 

$

207,475 

 

$

206,871 

 

$

207,414 

 

$

145,964 

 

$

130,595 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating Expenses

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Network access costs

 

 

42,417 

 

 

46,845 

 

 

47,715 

 

 

24,381 

 

 

21,715 

Selling, general and administrative (2)

 

 

76,749 

 

 

79,176 

 

 

66,571 

 

 

49,078 

 

 

39,623 

Depreciation and amortization and accretion of asset retirement

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

obligations

 

 

42,424 

 

 

39,008 

 

 

43,206 

 

 

31,376 

 

 

28,719 

Asset impairment charges

 

 

 -

 

 

 -

 

 

86,295 

 

 

 -

 

 

 -

Restructuring charges

 

 

50 

 

 

2,981 

 

 

 -

 

 

 -

 

 

 -

Gain on settlements, net

 

 

 -

 

 

(2,335)

 

 

 -

 

 

 -

 

 

 -

Total Operating Expenses, net

 

 

161,640 

 

 

165,675 

 

 

243,787 

 

 

104,835 

 

 

90,057 

Operating Income (Loss)

 

 

45,835 

 

 

41,196 

 

 

(36,373)

 

 

41,129 

 

 

40,538 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other Income (Expenses)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest expense

 

 

(14,191)

 

 

(11,921)

 

 

(11,993)

 

 

(5,752)

 

 

(1,478)

Loss on interest rate swap derivatives

 

 

(144)

 

 

(1,898)

 

 

 -

 

 

 -

 

 

 -

Other income, net

 

 

(1,587)

 

 

81 

 

 

105 

 

 

43 

 

 

105 

Total Other Expenses, net

 

 

(15,922)

 

 

(13,738)

 

 

(11,888)

 

 

(5,709)

 

 

(1,373)

Income (Loss) Before Income Taxes

 

 

29,913 

 

 

27,458 

 

 

(48,261)

 

 

35,420 

 

 

39,165 

Income Tax Expense (Benefit)

 

 

12,019 

 

 

11,010 

 

 

(4,383)

 

 

14,477 

 

 

15,768 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net Income (Loss)

 

 

17,894 

 

 

16,448 

 

 

(43,878)

 

 

20,943 

 

 

23,397 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net Income Attributable to Noncontrolling Interests

 

 

(121)

 

 

(108)

 

 

(52)

 

 

(119)

 

 

(39)

Net Income (Loss) Attributable to Lumos Networks Corp.

 

$

17,773 

 

$

16,340 

 

$

(43,930)

 

$

20,824 

 

$

23,358 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic and Diluted Earnings (Loss) per Common Share

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Attributable to Lumos Networks Corp. Stockholders

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(Pro Forma and Unaudited for 2011)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Earnings (Loss) per Share - Basic (3)

 

$

0.81 

 

$

0.78 

 

$

(2.11)

 

 

 

 

 

 

Earnings (Loss) per Share - Diluted (3)

 

$

0.80 

 

$

0.76 

 

$

(2.11)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash Dividends Declared per Share - Common Stock

 

$

0.56 

 

$

0.56 

 

$

0.14 

 

 

 

 

 

 

 

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Table of Contents

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As of December 31,

(In thousands)

 

2013

 

2012

 

2011

 

2010

 

2009

Balance Sheet Data:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

14,114 

 

$

 

$

10,547 

 

$

489 

 

$

Marketable securities

 

 

38,480 

 

 

 -

 

 

 -

 

 

 -

 

 

 -

Property and equipment, net

 

 

378,723 

 

 

336,589 

 

 

299,958 

 

 

273,906 

 

 

203,239 

Total assets

 

 

606,300 

 

 

516,519 

 

 

498,600 

 

 

540,793 

 

 

347,151 

Total debt

 

 

379,978 

 

 

312,225 

 

 

326,576 

 

 

180,721 

 

 

651 

Stockholders' equity attributable to

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Lumos Networks Corp.

 

$

86,333 

 

$

64,050 

 

$

52,383 

 

$

265,794 

 

$

272,681 

 

(1)

The consolidated financial statements of Lumos Networks for the period January 1, 2011 through October 31, 2011 and as of and for the years ended December 31, 2010 and 2009 have been adjusted to reflect certain corporate expenses, including equity-based compensation expense, of NTELOS which were not previously allocated to the NTELOS segments (see Note 2 in Part II, Item 8. Financial Statements and Supplementary Data).  These adjustments have been reflected beginning January 1, 2006.  Equity attributable to Lumos Networks has not been adjusted to reflect these corporate expenses for periods prior to January 1, 2006.

(2)

Selling, general and administrative expenses include equity-based compensation expense, as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Year Ended December 31,

(In thousands)

 

2013

 

2012

 

2011

 

2010

 

2009

Equity-based compensation expense

 

$

6,778 

 

$

3,912 

 

$

2,383 

 

$

1,529 

 

$

794 

 

(3)

Basic and diluted loss per share for the year ended December 31, 2011 is computed on a pro forma basis by dividing net loss for the year by the weighted average number of common shares outstanding during the two month post-Business Separation period beginning November 1, 2011 and ending December 31, 2011, as if such shares had been outstanding for the entire year.    Prior to the Business Separation from NTELOS on October 31, 2011, we did not have any common stock outstanding.

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

You should read the following discussion of our financial condition in conjunction with our consolidated financial statements and the related notes included herein (Item 8).  This discussion contains forward looking statements that involve risks and uncertainties.  For additional information regarding some of these risks and uncertainties that affect our business and the industry in which we operate, please see “Risk Factors” and “Forward-Looking Statements” elsewhere in this report.

Overview

Lumos Networks is a fiber-based bandwidth infrastructure and service provider in the Mid-Atlantic region.  We provide services to carrier and enterprise customers, including healthcare providers, local government agencies, financial institutions, educational institutions, and other enterprises over our approximately 7,400 route-mile fiber network.  Our principal products and services include Multiprotocol Label Switching (“MPLS”) based Ethernet, Metro Ethernet (“Metro E”), Fiber to the Cell site (“FTTC”) wireless backhaul and data transport services, wavelength transport services and IP services.  

Our primary objective is to leverage and expand our fiber assets to capture the growing demand for data and mobility services among our carrier and enterprise customers in our marketplace. Our overall strategy is to (i) leverage our fiber network to expand to new fiber to the cell site opportunities; (ii) monetize our approximately 7,400 route-mile fiber optic network by selling bandwidth infrastructure services to new and existing carrier and enterprise customers while maintaining a ratio of approximately 70% to 80% of our strategic data revenue from on-net traffic; (iii) proactively manage our churn by upgrading existing customers from legacy technologies to carrier Ethernet services; (iv) continue to provide high quality customer service and a compelling value proposition; (v) renew focus on managing resources from the declining legacy voice products into our faster growing and more profitable strategic data products; (vi) use our “edge-out” strategy to expand into new adjacent geographic markets to expand our addressable market; and (vii) execute our success-based investment strategy to improve capital efficiency and expand margins.

Our strategic data segment, which provided approximately 59% of our total revenue in 2013 represents the main growth opportunity and the key focal point of our strategy and currently includes our enterprise data, data transport, FTTC and IP services product lines.  Given our focus on on-net  customers, our strategic data services typically carry higher gross margins than many of our other services.  A significant majority of our capital expenditures and sales force are dedicated to increasing revenue and profit from our strategic data segment.  We believe that a balanced split between enterprise and carrier revenue results in the most effective capital allocation and resulting profitability.

The remaining 41% of our total revenue in 2013 was generated from our legacy voice and access segments.  These legacy businesses, in the aggregate, require limited incremental capital to maintain the underlying assets and deliver reasonably predictable cash flows.  It is our belief that revenue from these legacy businesses, in the aggregate, will continue to decline at an annual rate of approximately 10% to 15%.  This decline is the expected result of regulatory actions taken to reduce intra-state tariffs, access line loss resulting from residential wireless substitution, technology changes and product replacement of voice service offerings from cable operators in our markets.  Despite the declining revenues, we expect the cash flows from these legacy businesses to continue to significantly contribute to funding the capital investment in our growing strategic data segment.

Business Separation

On October 14, 2011,  NTELOS announced a distribution date of October 31, 2011 for the spin-off of all of the then issued and outstanding shares of common stock of Lumos Networks, which operated NTELOS’s wireline operations.  We have been publicly traded on NASDAQ under the ticker symbol “LMOS” since November 1, 2011.

Financial data included in this Form 10-K reflects Lumos Networks as a standalone public company.  Revenue for 2011 includes services sold to the NTELOS wireless segment that was previously eliminated, which amounted to $6.6 million for the period January 1, 2011 through October 31, 2011.   Expenses include items previously unallocated by NTELOS, inclusive of legal and professional fees, equity-based compensation expense and certain expenses related to acquisitions.  These additional expenses for the period January 1, 2011 through October 31, 2011 totaled $2.6 million.    

Business Segments

Our operating segments closely align with our product and service offerings, which coincides with the way that our chief operating decision makers measured performance and allocated resources during 2013Our reportable operating segments are strategic data, legacy voice and access. 

Our strategic data segment provided approximately 58.5%, 52.7% and 45.1% of our total revenue for the years ended December 31, 2013, 2012 and 2011, respectively.  Revenue for our strategic data segment increased 11.3% for the year ended December 31, 2013, as compared to 2012.  This segment, which includes our enterprise data, data transport, FTTC and IP services product groups, represents the main growth opportunity and the key focal point of our strategy.  We market and sell these services primarily to carrier and enterprise customers, including healthcare providers, local government agencies, financial institutions and educational institutions.  These businesses, in the aggregate, typically carry higher gross margins than many of our other product lines.  A majority of our

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capital expenditures and the focus of our sales force are dedicated to expanding revenue and profit from our strategic data products.  We believe that a balanced split between carrier and enterprise revenue results in the most effective capital allocation and resulting profitability.  Our ability to successfully implement our strategy and thereby sustain our revenue growth in our strategic data segment depends on our ability to effectively allocate capital and implement our “edge out” expansion plans in a timely manner, attract new customers, manage our churn by upgrading existing customers from legacy technologies to carrier Ethernet services and respond to competition from other data service providers in existing and new markets. 

The 11.3% growth in our strategic data segment revenues in 2013 was achieved primarily through increases in customer bandwidth demand, as reflected in the addition of 238 fiber to the cell sites, and an approximate 12% increase in the number of on-net buildings.  Our sales force is focused on taking advantage of increased carrier bandwidth demand, particularly for long-term fiber to the cell site contracts from wireless carriers that are deploying LTE data services, selling into the “edge out” markets, and improving penetration in existing markets.  We had fiber deployed to 370 cell towers at December 31, 2012 and we added 238 cell towers in 2013 for a total of 608 fiber to the cell sites as of December 31, 2013.  Although all of our strategic data product groups (enterprise data, carrier data and IP services) contributed to the year-over-year growth in revenues, the revenue growth from both our enterprise data and transport products, within our carrier data group, was negatively impacted by network grooming as existing customers redesign their networks and upgrade to newer products to improve efficiency.  As we make further progress with implementing our “edge out” strategy in 2014, which includes extending and upgrading our fiber optic network in the Richmond, VA and Western PA markets, we believe that the effect of churn on these product lines will begin to be more than offset by revenue from new enterprise customers, FTTC contracts and inter-carrier connectivity.

The remainder of our total revenue was generated by our legacy voice and access segments.  Our legacy voice segment provided 27.2%, 31.0% and 36.5% of revenue for the years ended December 31, 2013, 2012 and 2011, respectively.  Our access segment provided 14.3%, 16.3% and 18.4% of revenue for the years ended December 31, 2013, 2012 and 2011, respectively.  These businesses, in the aggregate, require limited incremental capital to maintain the underlying assets, and deliver reasonably predictable cash flows.  Revenue declined 12.0% for both our legacy voice and access segments in 2013 as compared to 2012 and declined 15.2% and 11.8%, respectively, in 2012 as compared to 2011.  This decline is the expected result of regulatory actions taken to reduce intra-state tariffs, access line loss resulting from residential wireless substitution, technology changes and product replacement by competitive voice service offerings from cable operators in our markets. We currently expect aggregate revenue from these businesses will continue to decline at an annual rate of approximately 10% to 15%. Despite the declining revenues, we expect the cash flows from these legacy businesses to continue to significantly contribute to funding the capital expenditures for our growing strategic data segment.

We anticipate further access revenue declines as a result of certain actions taken by applicable regulatory authorities, principally the FCC and the SCC.  In 2011, the FCC released an order comprehensively reforming its Universal Service Fund (“USF”) and intercarrier compensation systems.  In the order, the FCC determined that interstate and intrastate access charges, as well as local reciprocal compensation, should be eliminated entirely over time.  These FCC pricing reductions commenced on July 1, 2012 and continue through July 1, 2020.  However, a portion of the access revenue previously received from carriers is being recovered through payments from the FCC’s “Connect America Fund” (“CAF”) and from increases in charges to end user subscribers in the form of rate increases and the FCC’s “Access Recovery Charge”.  These new payments and revenues were also effective July 1, 2012.  These actions directly impact the access rates charged by our RLECs, which provide service to the rural Virginia cities of Waynesboro and Covington, and portions of the Virginia counties of Alleghany, Augusta and Botetourt.  Our total revenues from RLEC access services were $26.0 million, $27.3 million and $30.2 million for the years ended December 31, 2013, 2012 and 2011, respectively.  Of these amounts, $16.6 million, $9.8 million and $7.7 million, respectively, were derived from cost recovery mechanisms including the USF and the CAF.  

Our operating income margins were 22.1%, 19.9%  and 24.1% for the years ended December 31, 2013, 2012 and 2011, respectively, excluding the asset impairment charge recognized in 2011.  Our Adjusted EBITDA margins, as defined below, were 46.4%, 43.0% and 46.7% for the years ended December 31, 2013, 2012 and 2011, respectively.  The increase in our Adjusted EBITDA margin for 2013 is due to a shift towards higher margin product lines combined with decreases in network access costs and selling, general and administrative expenses.  We took certain cost reduction measures at the end of 2012, which were intended to increase our ability to fund our capital investment in our strategic data segment,  and consisted of a reduction of approximately 10% of our workforce (primarily in our legacy businesses), consolidation of certain facilities and freezing the accumulation of benefits under certain postretirement benefit plans. The overall decrease in selling, general and administration expenses in 2013 is partially attributable to reduced salaries, wages and benefits and rental expense as a direct result of these initiatives (see “Results of Operations” below for further discussion).  The decrease in our Adjusted EBITDA margin from 2011 to 2012 was primarily as a result of increased corporate expenses from the Company having been an independent, public company a full year for the first time in 2012.

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Operating Revenues

Our revenues are generated from the following segments: 

·

Strategic data, which includes the following products:  enterprise data (dedicated internet, metro Ethernet, and private line), carrier data (wholesale transport and fiber to the cell site) and IP services (integrated access, DSL, broadband XL, VoIP, and IP-based video);

·

Legacy voice, which includes the following products:  local lines, PRI, long distance, and toll and directory services; and

·

Access, which primarily includes switched access services and revenue derived from programs funded by regulatory agencies for recovery of lost revenues resulting from intercarrier compensation reform.

Operating Expenses

Our operating expenses are incurred from the following categories: 

·

Network access costs, including usage-based access charges, long distance and other direct costs incurred in accessing other telecommunications providers’ networks in order to provide telecommunication services to our end-user customers and leased facility expenses for connection to other carriers;

·

Selling, general and administrative expenses, including network operating costs (which includes salaries, wages and benefits of network operations personnel, customer care, engineering, marketing, sales and other indirect network costs, but excludes network access costs), billing, publication of regional telephone directories, directory services, bad debt expenses, taxes other than income taxes, executive services, accounting, legal, purchasing, information technology, human resources and other general and administrative expenses, including earned bonuses and equity-based compensation expense related to shares of restricted stock and stock option instruments granted to employees and non-employee directors  and amortization of actuarial losses related to retirement plans;

·

Depreciation and amortization, including depreciable long-lived property, plant and equipment and amortization of intangible assets where applicable;

·

Accretion of asset retirement obligations;

·

Asset impairment charges;

·

Gain on settlements, net; and

·

Restructuring charges.

Adjusted EBITDA

Adjusted EBITDA, as defined by us, is net income attributable to Lumos Networks Corp. before interest, income taxes, depreciation and amortization, accretion of asset retirement obligations, net income attributable to noncontrolling interests, other income or expenses, equity-based compensation charges, acquisition-related charges, amortization of actuarial gains or losses on retirement plans, employee separation charges, restructuring-related charges, gain or loss on settlements and gain or loss on interest rate swap derivatives.    Adjusted EBITDA margin is calculated as the ratio of Adjusted EBITDA, as defined above, to operating revenues.

Adjusted EBITDA is a non-GAAP financial performance measure.  It should not be considered in isolation, as an alternative to, or more meaningful than measures of financial performance determined in accordance with GAAP.  Management believes that Adjusted EBITDA is a standard measure of operating performance and liquidity that is commonly reported in the telecommunications and high- speed data transport industry and provides relevant and useful information to investors for comparing performance period to period and for comparing financial performance of similar companies.   Management utilizes Adjusted EBITDA internally to assess its ability to meet future capital expenditure and working capital requirements, to incur indebtedness if necessary, and to fund continued growth.  Management also uses Adjusted EBITDA to evaluate the performance of its business for budget planning purposes and as a  factor in the Company’s employee compensation programs.

Note 4 – Disclosures About Segments of an Enterprise and Related Information, of the Notes to Consolidated Financial Statements provides a reconciliation of Adjusted EBITDA to Operating Income on a consolidated basis.  

Other Income (Expenses)

Our other income (expenses) are generated (incurred) from interest expense on debt instruments and capital lease obligations, including amortization of debt issuance costs, gains or losses on interest rate swap derivatives and other income or expense, which

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includes interest income and fees, expenses related to our senior secured credit facility and, as appropriate under the circumstances,  secondary public offering and stock registration costs and write-off of unamortized debt issuance costs

Income Taxes

Our income tax expense and effective tax rate increases or decreases based upon changes in a number of factors, including primarily the amount of our pre-tax income or loss, state minimum tax assessments and non-deductible expenses. 

Noncontrolling Interests in Losses (Earnings) of Subsidiaries

We have partnership through our RLEC with a 46.3% noncontrolling interest that owns certain signaling equipment and provides services to a number of small RLECs and to TNS (an inter-operability solution provider)

Results of Operations

Year ended December 31, 2013 compared to year ended December 31, 2012

Operating revenues increased $0.6 million, or 0.3%, from 2012 to 2013 resulting from an increase in strategic data segment revenues of $12.3 million, largely offset by an aggregate decrease in legacy voice and access segment revenues of $11.7 million.   The growth in strategic data segment revenues was primarily driven by an increase in carrier data revenue of $8.9 million and increases in enterprise data and IP services revenues of $3.0 million and $0.5 million, respectively, from 2012 to 2013.  The $11.7 million decline in legacy voice and access segment revenues is due primarily to line loss, access rate reductions resulting from regulatory actions, access reconfigurations and network grooming by carriers. For further details regarding these revenue fluctuations, see “Operating Revenues” below.

Operating income increased $4.6 million from $41.2 million in 2012 to $45.8 million in 2013 due to a $5.0 million increase in gross margin (operating revenues less network access costs) and a $2.4 million decrease in selling, general and administrative expenses.  These favorable results were partially offset by an increase in depreciation and amortization costs of $3.4 million due to capital investment primarily in our fiber network assets.  Variances in the individual line items on the consolidated statements of operations are described in the operating expenses section below.

Adjusted EBITDA was $96.3 million in 2013 compared to Adjusted EBITDA of  $88.9 million in 2012.  The increase in Adjusted EBITDA is directly attributable to the decrease in operating expenses, as described above and in further detail below.

Net income attributable to Lumos Networks increased $1.4 million from 2012 to 2013 primarily due to a $4.6 million increase in operating income, partially offset by an increase in income taxes of $1.0 million and an increase in interest expense of $2.3 million due to our debt refinancing in 2013.

OPERATING REVENUES

The following table identifies our operating revenues by major product group for the years ended December 31, 2013 and 2012:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Year Ended December 31,

 

 

 

 

 

 

(Dollars in thousands)

 

2013

 

2012

 

$  Variance

 

%  Variance

Operating Revenues:

 

 

 

 

 

 

 

 

 

 

 

 

Strategic data:

 

 

 

 

 

 

 

 

 

 

 

 

Enterprise data

 

$

40,377 

 

$

37,416 

 

$

2,961 

 

7.9 

%

Carrier data

 

 

61,884 

 

 

52,978 

 

 

8,906 

 

16.8 

%

IP services

 

 

19,072 

 

 

18,616 

 

 

456 

 

2.4 

%

Total strategic data

 

 

121,333 

 

 

109,010 

 

 

12,323 

 

11.3 

%

Legacy voice

 

 

56,466 

 

 

64,146 

 

 

(7,680)

 

(12.0)

%

Access

 

 

29,676 

 

 

33,715 

 

 

(4,039)

 

(12.0)

%

Total operating revenues

 

$

207,475 

 

$

206,871 

 

$

604 

 

0.3 

%


Strategic Data.    Our strategic data segment consists of the enterprise data, carrier data (which includes FTTC) and IP services product groups.  Changes in revenue by product group are as follows:

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·

Enterprise DataEnterprise data revenues increased $3.0 million, or 7.9%, in 2013, primarily driven by growth in customer bandwidth demand and a 12.4% increase in on-net buildings, from 1,196 as of December 31, 2012 to 1,344 as of December 31, 2013.  Revenue from our metro Ethernet product was the largest contributor to our enterprise data growth in 2013, increasing $4.0 million, or 25.8%, from the prior year.  The growth in metro Ethernet product revenues was partially offset by declines in private line and other enterprise data products as a result of network grooming and technological product upgrades by existing customers.

·

Carrier DataThe 16.8% increase in carrier data revenue was primarily attributable to growth in FTTC revenue as a result of a 64% increase in our fiber connections to wireless cell sites, from 370 as of December 31, 2012 to 608 as of December 31, 2013 and increases in carrier transport product revenues due to growth in carrier demand and fiber network expansion.

·

IP ServicesThe 2.4% increase in IP services revenue was primarily driven by increases in high speed fiber to the premises Internet and video services and other Voice over IP (“VoIP”) services partially offset by declines in the legacy DSL products.

Legacy Voice.  Revenue from legacy voice products declined 12.0% in 2013 as compared to 2012.  These declines were primarily due to the continuing churn from the commoditization of these products, the increasing use of wireless devices and our shift in focus to VoIP services (which is included in IP services revenue).  As of December 31, 2013, we operated approximately 28,900 RLEC telephone access lines and 95,700 competitive voice lines, compared to approximately 31,200 and 110,000, respectively, as of December 31, 2012.  This represents a 7.4% year-over-year decline in RLEC telephone access lines and a 13.0% year-over-year decline in competitive voice lines primarily due to competition from cable operators in our markets and wireless substitution.

Access.  The 12.0% decline in access revenues is primarily due to a net 11.8% year-over-year decrease in access lines and rate reductions beginning in July 2012 based on rate actions from regulatory authorities, partially offset by the impact of certain cost recovery programs, as described in the overview section above.

OPERATING EXPENSES

The following table identifies our operating expenses for the years ended December 31, 2013 and 2012:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Year Ended December 31,

 

 

 

 

 

 

(Dollars in thousands)

 

2013

 

2012

 

$ Variance

 

%Variance

Consolidated Operating Expenses:

 

 

 

 

 

 

 

 

 

 

 

 

Network access costs

 

$

42,417 

 

$

46,845 

 

$

(4,428)

 

(9.5)

%

Selling, general and administrative expenses

 

 

76,749 

 

 

79,176 

 

 

(2,427)

 

(3.1)

%

Depreciation and amortization

 

 

42,320 

 

 

38,884 

 

 

3,436 

 

8.8 

%

Accretion of asset retirement obligations

 

 

104 

 

 

124 

 

 

(20)

 

(16.1)

%

Restructuring charges (1)

 

 

50 

 

 

2,981 

 

 

(2,931)

 

(98.3)

%

Gain on settlements, net (2)

 

 

 -

 

 

(2,335)

 

 

2,335 

 

(100.0)

%

Total operating expenses

 

$

161,640 

 

$

165,675 

 

$

(4,035)

 

(2.4)

%

(1)

In 2012, the Company completed a cost reduction plan involving an employee reduction-in-force, the consolidation of certain facilities and freezing of the accumulation of benefits under certain postretirement plans.  Restructuring charges of $3.0 million were recognized in 2012 and less than $0.1 million were recognized in 2013 in connection with this plan (see Note 12 in Part II, Item 8. Financial Statements).

(2)

We recognized a net pre-tax gain of approximately $2.3 million in 2012 in connection with the settlement of outstanding matters related to a prior acquisition and the settlement of an outstanding lawsuit.

 

Network Access Costs.  Network access costs decreased $4.4 million, or 9.5%, from the prior year primarily due to network grooming and the overall decrease in voice access lines.

Selling, General and Administrative Expenses.  Selling, general and administrative expenses decreased $2.4 million, or 3.1%, in 2013 as compared to 2012.  The decrease is primarily attributable to a non-recurring charge for employee separation benefits of $2.3 million in 2012, a $1.9 million net decrease in salaries, wages and benefits, a $0.5 million decrease in rent and a $0.5 million decrease in amortization of actuarial losses, partially offset by a $2.9 million increase in non-cash compensation expense.  The decreases in employee benefits and rent expense are primarily attributable to the restructuring plan that was completed in December 2012, which included an employee reduction-in-force, consolidation of certain facilities and freezing certain retirement benefits.  The increase in non-cash compensation expense is related to stock-based awards granted in 2013 under employee compensation plans and the accelerated vesting of certain performance-based awards upon attainment of the stock price target in accordance with the terms of the awards.

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Depreciation and Amortization.  Depreciation and amortization increased $3.4 million, or 8.8%, over 2012.  This net increase is attributable to a $4.8 million increase in depreciation expense partially offset by a $1.3 million decrease in amortization expense related to customer intangibles for which amortization expense is escalated in the early years of the asset lives based on these assets’ estimated pattern of benefit.  The increase in depreciation expense is a result of the year-over-year increase in our depreciable base of assets primarily from capital investment in our network including fiber to the cell site installations.


The following table identifies our operating expenses by segment for the years ended December 31, 2013 and 2012 and provides a reconciliation from total segment operating expenses to consolidated operating expenses for each period.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Year Ended December 31,

 

 

 

 

 

 

(Dollars in thousands)

 

2013

 

2012

 

$ Variance

 

%Variance

Segment Operating Expenses:

 

 

 

 

 

 

 

 

 

 

 

 

Strategic data

 

$

67,604 

 

$

58,118 

 

$

9,486 

 

16.3 

%

Legacy voice

 

 

36,214 

 

 

49,296 

 

 

(13,082)

 

(26.5)

%

Access

 

 

7,333 

 

 

10,568 

 

 

(3,235)

 

(30.6)

%

Total segment operating expenses

 

$

111,151 

 

$

117,982 

 

$

(6,831)

 

(5.8)

%

 

 

 

 

 

 

 

 

 

 

 

 

 

Reconciliation of Segment Operating Expenses to Consolidated Operating Expenses:

 

 

 

 

 

 

 

 

 

 

 

 

Total segment operating expenses

 

$

111,151 

 

$

117,982 

 

$

(6,831)

 

(5.8)

%

Depreciation and amortization and

 

 

 

 

 

 

 

 

 

 

 

 

accretion of asset retirement obligations

 

 

42,424 

 

 

39,008 

 

 

3,416 

 

8.8 

%

Equity-based compensation expense

 

 

6,778 

 

 

3,912 

 

 

2,866 

 

73.3 

%

Employee separation charges

 

 

 -

 

 

2,346 

 

 

(2,346)

 

(100.0)

%

Restructuring charges

 

 

50 

 

 

2,981 

 

 

(2,931)

 

(98.3)

%

Amortization of actuarial losses

 

 

1,237 

 

 

1,781 

 

 

(544)

 

(30.5)

%

Gain on settlements, net

 

 

 -

 

 

(2,335)

 

 

2,335 

 

100.0 

%

Total operating expenses

 

$

161,640 

 

$

165,675 

 

$

(4,035)

 

(2.4)

%

 

Strategic Data.  Total operating expenses allocated to our strategic data segment increased $9.5 million, or 16.3%, from 2012 to 2013 due to a $0.6 million increase in network access costs, a $7.4 million increase in network operating and engineering costs and a $1.5 million increase in other selling, general and administrative expenses.   The increases in network access and operating costs are directly attributable to our investment of resources in our network operations to support the 11.3% growth in this segment in 2013 and drive future growth.  The increase in selling, general and administrative costs is primarily attributable to the increase in allocated corporate expenses as the strategic data segment grows in relation to the other segments and the redirection of our sales, marketing, customer service, engineering and other resources to support and grow the strategic data segment. 

Legacy Voice.  The $13.1 million, or 26.5%, decrease in total operating costs allocated to our legacy voice segment is primarily attributable to a $4.9 million decrease in network access costs, a $7.0 million decrease in network operating and engineering costs, and a $1.2 million decrease in other selling, general and administrative expenses.  The decrease in network access costs and network operating costs is due to an approximate 11.8% year-over-year decrease in voice lines, as reflected in the decline in segment revenues, network grooming activities and internal reorganization to shift resources away from the legacy businesses to our strategic data segmentAt the end of 2012, we completed a reduction-in-force of approximately 10% of our employees, which primarily impacted our legacy businesses.

Access.  The decrease in operating costs allocated to the access segment of our business of $3.2 million, or 30.6%, is primarily attributable to increased corporate costs for the same factors described above for the legacy voice segment.


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OTHER INCOME (EXPENSES) AND INCOME TAXES

The following table summarizes our other income (expenses) and income taxes for the years ended December 31, 2013 and 2012:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Year Ended December 31,

 

 

 

 

 

 

(Dollars in thousands)

 

2013

 

2012

 

$ Variance

 

%Variance

Interest expense

 

$

(14,191)

 

$

(11,921)

 

$

(2,270)

 

19.0 

%

Loss on interest rate swap derivatives

 

 

(144)

 

 

(1,898)

 

 

1,754 

 

(92.4)

%

Other income, net

 

 

(1,587)

 

 

81 

 

 

(1,668)

 

N/M

 

Total other expenses, net

 

$

(15,922)

 

$

(13,738)

 

$

(2,184)

 

15.9 

%

Income tax expense

 

$

12,019 

 

$

11,010 

 

$

1,009 

 

9.2 

%

 

 

 

 

 

 

 

 

 

 

 

 

 

N/M - not meaningful

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest Expense.  Interest expense in 2013 and 2012 primarily consists of incurred interest costs associated with our Credit Facility as well as amortization of debt issuance costs.  The year-over-year increase in interest expense of $2.3 million is attributable to the debt refinancing that closed on April 30, 2013, which resulted in a higher outstanding principal balance (see Note 5 in Part II, Item 8. Financial Statements and Supplementary Data).

Loss on Interest Rate Swap DerivativesThe Company recognized losses on interest rate swap derivatives of $0.1 million and $1.9 million for 2013 and 2012, respectively.  These losses are reflective of mark-to-market adjustments to record the liability associated with the interest rate swap derivatives at fair value on the consolidated balance sheets, which is impacted by fluctuations in interest rates and other market factors.

Other Income (Expenses).  Other expenses of $1.6 million for 2013 includes approximately $0.9 million of expense related to unamortized debt issuance costs that were written off in connection with the April 30, 2013 debt refinancing transaction and $0.8 million of administrative, legal and accounting costs associated with the secondary offering of our common stock in November 2013 (see Note 1 in Part II, Item 8. Financial Statements and Supplementary Data).

Income Tax Expense.  Income tax expense for the years ended December 31, 2013 and 2012 was $12.0 million and $11.0 million, respectively, which represents the federal statutory tax rate applied to pre-tax income and the effects of state income taxes and certain non-deductible charges for each period.  Our recurring non-deductible expenses relate primarily to certain non-cash equity-based compensation for 2012 and 2013 and limitations on certain officer compensation for 2013 which could recur in future periods.  The increase in income tax expense was primarily due to an increase in income before taxes and nondeductible secondary offering costs incurred in 2013.  Our effective tax rate was 40.2% in 2013 as compared to 40.1% in 2012.    

At December 31, 2013, we had unused federal net operating losses (“NOLs”) of approximately $15.7 million, net of adjustments for unrecognized income tax benefits, and unused state NOLs of approximately $15.6 million.  Our NOLs, if not utilized to reduce taxable income in future periods, will expire in varying amounts from 2022 through 2034.  We believe that it is more likely than not that the results of future operations will generate sufficient taxable income to realize the deferred tax assets.

Year ended December 31, 2012 compared to year ended December 31, 2011

Operating revenues decreased $0.5 million, or 0.3%, from 2011 to 2012 resulting from an aggregate decrease in legacy voice and access segment revenues of $16.0 million, largely offset by an increase in strategic data segment revenues of $15.5 million.  The $16.0 million decline in legacy voice and access segment revenues is due primarily to the loss of access lines described in the overview above, a biennial rate reduction as a result of our tariff filing with the FCC in mid-year 2011, reductions in intrastate access as part of the FCC’s access reform plan, access reconfigurations and network grooming by carriers. The growth in strategic data segment revenues was primarily driven by an increase in carrier data revenue of $9.9 million and increases in enterprise data and IP services revenues of $4.0 million and $1.5 million, respectively from 2011 to 2012.  For further details regarding these revenue fluctuations, see “Operating Revenues” below.

Operating income increased $77.6 million from a loss of $36.4 million in 2011 to income of $41.2 million in 2012 due primarily to asset impairment charges of $86.3 million recorded in 2011.  Excluding the 2011 asset impairment charges, operating income decreased $8.7 million from 2011 to 2012 due to increased operating expenses primarily due to increases in corporate expenses as a result of operating as an independent public company for the full year in 2012 combined with restructuring charges, employee separation charges and amortization of actuarial losses on benefit plans.  Variances in the individual line items on the condensed combined statements of operations are described in the “Operating Expenses section below.

Adjusted EBITDA was $88.9 million in 2012 compared with $96.9 million in 2011.  The decrease in Adjusted EBITDA is directly attributable to the increase in operating expenses, as described above and in further detail below.

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Net income attributable to Lumos Networks increased $60.3 million due in large part to the $86.3 million of asset impairment charges ($65.7 million net of tax) discussed above.  Excluding the effects of the 2011 asset impairment charges, net income attributable to Lumos Networks decreased $5.5 million, or 25.2%, from 2011 to 2012 due to the $8.7 million decrease in operating income combined with a $1.9 million increase in interest and other expenses, offset by a reduction in income tax expense of $5.2 million.

OPERATING REVENUES

The following table identifies our external operating revenues by business segment for years ended December 31, 2012 and 2011:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Year Ended December 31,

 

 

 

 

 

 

(Dollars in thousands)

 

2012

 

2011

 

$ Variance

 

% Variance

Operating Revenues:

 

 

 

 

 

 

 

 

 

 

 

 

Strategic data:

 

 

 

 

 

 

 

 

 

 

 

 

Enterprise data

 

$

37,416 

 

$

33,391 

 

$

4,025