UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2014
OR
¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES ACT OF 1934
FOR THE TRANSITION PERIOD FROM _________ TO _____
COMMISSION FILE NUMBER 000-25147
INTERNET AMERICA, INC.
(Exact name of registrant as specified in its charter)
| TEXAS | 86-0778979 |
| (State or other jurisdiction of | (I.R.S. Employer |
| incorporation or organization) | Identification Number) |
| 6210 Rothway Street, Suite 100 | 77040 |
| (Address of principal executive offices) | (Zip Code) |
(713) 968-2500
(Registrant's telephone number, including area code)
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.
Yesx 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).
Yesx No¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
| Large accelerated filer ¨ | Accelerated filer¨ |
| Non-accelerated filer¨ | Smaller reporting company x |
| (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 Exchange Act).
Yes¨ Nox
As of November 12, 2014, the registrant had 16,747,062 shares of Common Stock at $0.01 par value, outstanding.
INTERNET AMERICA, INC.
TABLE OF CONTENTS
FORM 10-Q
QUARTERLY PERIOD ENDED SEPTEMBER 30, 2014
PART I - FINANCIAL INFORMATION
ITEM 1. | FINANCIAL STATEMENTS |
INTERNET AMERICA, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED BALANCE SHEETS
| | | September 30, | | | June 30, | |
| | | 2014 | | | 2014 | |
| | | (unaudited) | | | | |
| ASSETS | | | | | | |
| CURRENT ASSETS: | | | | | | | | |
| Cash and cash equivalents | | $ | 3,437,001 | | | $ | 3,107,142 | |
| Accounts receivable, net of allowance for uncollectible accounts of $11,333 and $10,496 as of September 30, 2014 and June 30, 2014, respectively | | | 174,785 | | | | 215,805 | |
| Inventory | | | 413,651 | | | | 354,080 | |
| Prepaid expenses and other current assets | | | 66,187 | | | | 94,001 | |
| Deferred tax asset | | | 422,000 | | | | 422,000 | |
| Total current assets | | | 4,513,624 | | | | 4,193,028 | |
| | | | | | | | | |
| Property and equipment, net | | | 1,560,289 | | | | 1,585,546 | |
| Goodwill | | | 1,968,127 | | | | 1,968,127 | |
| Subscriber acquisition costs, net | | | 591,540 | | | | 691,193 | |
| Deferred tax asset | | | 8,126,733 | | | | 8,178,000 | |
| Other assets | | | 51,176 | | | | 41,181 | |
| TOTAL ASSETS | | $ | 16,811,489 | | | $ | 16,657,075 | |
| | | | | | | | | |
| LIABILITIES AND SHAREHOLDERS' EQUITY | | | | | | | | |
| CURRENT LIABILITIES: | | | | | | | | |
| Accounts payable | | $ | 219,928 | | | $ | 158,059 | |
| Accrued liabilities | | | 720,763 | | | | 597,529 | |
| Deferred revenue | | | 786,623 | | | | 798,320 | |
| Current portion of long-term debt and capital lease | | | 131,154 | | | | 187,029 | |
| Total current liabilities | | | 1,858,468 | | | | 1,740,937 | |
| Other liability, net | | | 169,986 | | | | 193,433 | |
| Long-term debt and capital lease, net of current portion | | | 101,773 | | | | 110,647 | |
| Total liabilities | | | 2,130,227 | | | | 2,045,017 | |
| | | | | | | | | |
| COMMITMENTS AND CONTINGENCIES | | | - | | | | - | |
| | | | | | | | | |
| SHAREHOLDERS' EQUITY: | | | | | | | | |
| Preferred stock, $0.01 par value: 5,000,000 shares authorized, 2,718,428 issued and outstanding as of September 30, 2014 and June 30, 2014. | | | 27,185 | | | | 27,185 | |
| Common stock, $0.01 par value: 40,000,000 shares authorized, 16,747,062 outstanding as of September 30, 2014 and June 30, 2014. | | | 167,471 | | | | 167,471 | |
| Additional paid-in capital | | | 63,070,857 | | | | 63,069,658 | |
| Accumulated deficit | | | (48,584,251 | ) | | | (48,652,256 | ) |
| Total shareholders' equity | | | 14,681,262 | | | | 14,612,058 | |
| TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY | | $ | 16,811,489 | | | $ | 16,657,075 | |
See accompanying notes to condensed consolidated financial statements.
INTERNET AMERICA, INC AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
| | | Three Months Ended | |
| | | September 30, | |
| | | 2014 | | | 2013 | |
| REVENUES: | | | | | | | | |
| Internet services | | $ | 2,047,822 | | | $ | 1,967,096 | |
| TOTAL REVENUES | | | 2,047,822 | | | | 1,967,096 | |
| | | | | | | | | |
| OPERATING EXPENSES: | | | | | | | | |
| Connectivity and operations | | | 1,108,075 | | | | 978,281 | |
| Sales and marketing | | | 80,555 | | | | 100,225 | |
| General and administrative | | | 514,596 | | | | 421,638 | |
| Depreciation and amortization | | | 209,007 | | | | 179,093 | |
| TOTAL OPERATING EXPENSES | | | 1,912,233 | | | | 1,679,237 | |
| | | | | | | | | |
| INCOME FROM OPERATIONS | | | 135,589 | | | | 287,859 | |
| | | | | | | | | |
| OTHER INCOME (EXPENSE) | | | | | | | | |
| Interest income | | | 1,783 | | | | 2,445 | |
| Interest expense | | | (4,050 | ) | | | (3,914 | ) |
| OTHER EXPENSE, net | | | (2,267 | ) | | | (1,469 | ) |
| | | | | | | | | |
| INCOME BEFORE INCOME TAX EXPENSE | | | 133,322 | | | | 286,390 | |
| Income tax expense | | | 65,317 | | | | 12,600 | |
| | | | | | | | | |
| NET INCOME | | $ | 68,005 | | | $ | 273,790 | |
| | | | | | | | | |
| NET INCOME PER COMMON SHARE: | | | | | | | | |
| BASIC | | $ | 0.00 | | | $ | 0.02 | |
| DILUTED | | $ | 0.00 | | | $ | 0.01 | |
| | | | | | | | | |
| WEIGHTED AVERAGE COMMON SHARES OUTSTANDING: | | | | | | | | |
| BASIC | | | 16,747,062 | | | | 16,729,562 | |
| DILUTED | | | 20,024,300 | | | | 19,840,970 | |
See accompanying notes to condensed consolidated financial statements.
INTERNET AMERICA, INC AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
| | | Three Months Ended | |
| | | September 30, | |
| | | 2014 | | | 2013 | |
| OPERATING ACTIVITIES: | | | | | | | | |
| Net income | | $ | 68,005 | | | $ | 273,790 | |
| Adjustments to reconcile net income to net cash provided by operating activities: | | | | | | | | |
| Depreciation and amortization | | | 209,007 | | | | 179,093 | |
| Loss from sale or disposal of assets | | | - | | | | 4,502 | |
| Provision for bad debt | | | 34 | | | | 8 | |
| Stock based compensation | | | 1,199 | | | | 1,508 | |
Deferred tax expense | | | 51,267 | | | | - | |
| Changes in operating assets and liabilities: | | | | | | | | |
| Accounts receivable | | | 40,986 | | | | 4,342 | |
| Inventory | | | (59,571 | ) | | | (66,300 | ) |
| Prepaid expenses and other current assets | | | 11,557 | | | | (10,753 | ) |
| Other assets | | | - | | | | 22,989 | |
| Accounts payable and accrued liabilities | | | 185,103 | | | | 131,923 | |
| Other long-term assets | | | (9,995 | ) | | | - | |
| Deferred revenue | | | (11,697 | ) | | | (22,231 | ) |
| Net cash provided by operating activities | | | 485,895 | | | | 518,871 | |
| INVESTING ACTIVITIES: | | | | | | | | |
| Purchases of property and equipment | | | (91,288 | ) | | | (107,172 | ) |
| Net cash used in investing activities | | | (91,288 | ) | | | (107,172 | ) |
| FINANCING ACTIVITIES: | | | | | | | | |
| Principal payments of long-term debt | | | (56,332 | ) | | | (56,771 | ) |
| Principal payments of capital lease | | | (8,416 | ) | | | - | |
| Net cash used in financing activities | | | (64,748 | ) | | | (56,771 | ) |
| NET INCREASE IN CASH AND CASH EQUIVALENTS | | | 329,859 | | | | 354,928 | |
| CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD | | | 3,107,142 | | | | 2,295,190 | |
| CASH AND CASH EQUIVALENTS, END OF PERIOD | | $ | 3,437,001 | | | $ | 2,650,118 | |
| SUPPLEMENTAL INFORMATION: | | | | | | | | |
| Cash paid for interest | | $ | 3,805 | | | $ | 4,058 | |
| NON-CASH INVESTING AND FINANCING ACTIVITIES: | | | | | | | | |
| Disposal of fully depreciated assets | | $ | - | | | $ | 7,652 | |
| Assets acquired through capital lease | | $ | 16,475 | | | $ | - | |
| Discount of accrued purchase consideration | | $ | (24,385 | ) | | $ | - | |
See accompanying notes to condensed consolidated financial statements.
INTERNET AMERICA, INC. AND SUBSIDIARY
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Certain information and footnote disclosures normally included in consolidated financial statements prepared in accordance with U.S. generally accepted accounting principles have been condensed or omitted pursuant to Article 8 of Regulation S-X of the Securities and Exchange Commission. The accompanying unaudited condensed consolidated financial statements reflect, in the opinion of management, all adjustments necessary to achieve a fair presentation of the consolidated financial position and results of operations of Internet America, Inc. (the “Company” or “Internet America” or "we") for the interim periods presented. All such adjustments are of a normal and recurring nature. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and the notes thereto included in the Company’s Annual Report on Form 10-K for its fiscal year ended June 30, 2014.
| 2. | Principles of Consolidation |
The condensed consolidated financial statements include the accounts of the Company and its subsidiary, TeleShare Communication Services, Inc. All material intercompany accounts and transactions have been eliminated.
| 3. | Basic and Diluted Net Income Per Share |
For the three months ended September 30, 2014 and 2013, common stock equivalent shares totaling 2,718,428 have been added to the weighted average common shares outstanding, assuming the shares of preferred stock were converted into shares of common stock as of the first day of each respective period, for the purpose of computing diluted earnings per share ("EPS"). For the three months ended September 30, 2014 and 2013, additional common stock equivalent shares totaling 558,810 and 392,980, respectively, were included in the calculation of diluted EPS. These additional shares are attributable to outstanding in-the-money stock options and warrants. Options to purchase 20,000 shares of the Company’s common stock were excluded in the computation of diluted EPS for the three months ended September 30, 2014 as the effect of these options were anti-dilutive. Options to purchase 471,526 shares of the Company’s common stock were excluded in the computation of diluted EPS for the three months ended September 30, 2013 as the effect of these options were anti-dilutive. All outstanding warrants were included in the computation of diluted EPS for the three months ended September 30, 2014 and 2013. All of these warrants expired in September 2014.
The preparation of condensed consolidated financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ significantly from these estimates.
| 5. | Acquisition of Subscribers |
During fiscal 2014, the Company completed one acquisition of subscribers and tangible assets to grow the Company's subscriber base. The Company has not made any acquisitions through the first quarter of fiscal 2015. These acquisitions were accounted for using the purchase method. The Company immediately began integrating the acquired assets of each acquisition into the Company’s existing operations and continues to operate these assets within a single business segment.The amortization period of the intangible assets acquired in each acquisition is four years, which is management's best estimate of the average economic life of a subscriber based on historical experience.
On November 1, 2013, the Company completed an acquisition of the subscribers associated with the wireless ISP operations of UpperSpace Corporation ("UpperSpace") conducted in and around northeast Oklahoma for an estimated total purchase consideration of $580,300, payable as follows: (i) a $193,433 cash payment, inclusive of $61,325 retained by the seller representing deferred revenues, made at closing, (ii) an estimated $193,433 cash payment to be made on the twelve month anniversary of the closing (which estimated payment is included in accrued liabilities) and (iii) an estimated $193,433 cash payment to be made on the thirty-six month anniversary of the closing (which payment is included in other long term liabilities, net of a discount of $24,385 recorded in the quarter ended September 30, 2014). The total estimated purchase consideration of $580,300 is allocated as follows: $530,486 to subscriber acquisition costs, $42,132 to fixed assets and $7,681 to other intangible assets. The final purchase price will be determined twelve months from the closing date at which time a note payable will be issued for the remaining purchase price owed.
| 6. | Goodwill and Subscriber Acquisition Costs |
Pursuant to Financial Accounting Standards Board (“FASB”) guidance on goodwill and other intangibles, the Company performs a qualitative evaluation of goodwill annually or more frequently when indicators of impairment exist, and if that evaluation indicates impairment has occurred, the following two-step process is applied. The first step is used to identify a potential impairment by comparing the fair value of a reporting unit with its net book value (or carrying amount) including goodwill. If the fair market value exceeds the carrying amount, goodwill of the reporting unit is not considered impaired and the second step of the impairment test is unnecessary. If the carrying amount of the reporting unit exceeds its fair value, the second step of the goodwill impairment test compares the fair value of the reporting unit’s goodwill with the carrying amount of that goodwill. If the carrying amount exceeds the implied fair value, an impairment loss is recognized in an amount equal to that excess. The Company concluded that no impairment of goodwill occurred during the three months ended September 30, 2014.
The Company amortizes customer acquisition costs over the estimated life of the acquired customers. The weighted average amortization period for subscriber acquisition costs was 48 months for both dial-up and wireless broadband Internet customers during the three months ended September 30, 2014 and 2013. As of September 30, 2014, unrecognized amortization expense for the remainder of fiscal year ended June 30, 2015 is expected to be $202,000 and unrecognized amortization expense for fiscal years ended June 30, 2016, 2017 and 2018 is expected to be $208,000, $140,000 and $42,000, respectively.
During the three months ended September 30, 2014 and 2013, the Company generated income before income tax expense of $133,322 and $286,390, respectively, and recognized Texas franchise tax expense of $14,050 and $12,600, respectively. The provision for federal income taxes recorded for the three months ended September 30, 2014 and 2013 was $51,267 and zero, respectively. The effective tax rate for the three months ended September 30, 2014 and 2013 was 49.0% and 4.4%, respectively. At September 30, 2014, the differences from the statutory rate of 34.0% include an increase of 9.0% for non-deductible expenses and 6.0% for state tax expense, net of federal benefit. At September 30, 2013, the differences from the statutory rate of 34.0% include a decrease of 22.0% for the reduction in the valuation allowance, 10.5% for non-deductible expenses, offset by an increase of 2.9% for state tax expense, net of federal benefit.
The Company has provided a valuation allowance totaling $3,503,000 and $3,452,000 of net deferred tax assets at September 30, 2014 and June 30, 2014, respectively, as it is deemed more likely than not that these assets will not be realized due to lack of positive evidence to suggest otherwise. Future adjustments to the valuation allowance associated with a change in management's determination of the Company's ability to realize these deferred tax assets will result in an adjustment to income tax expense (benefit) in future periods when those determinations are made. Management will continue to assess the realizability of the deferred tax assets at each interim and annual balance sheet date based on actual and forecasted operating results.
At September 30, 2014, the Company had net operating loss carry forwards of approximately $36 million for federal income tax purposes. These net operating loss carryforwards may be carried forward in varying amounts and expire beginning in fiscal year 2019 continuing through fiscal year 2033 and may be limited in their use due to significant changes in the Company's ownership.
The preparation of various tax returns requires the use of estimates for federal and state income tax purposes. Those estimates may be subject to review by respective taxing authorities. A revision, if any, to an estimate may result in assessment of additional taxes, penalties and interest. Tax years 2009 through 2012 remain subject to examination by various federal and state tax jurisdictions. The Company performed an assessment of its various income tax positions for all periods subject to examination and concluded that no accrual of uncertain tax positions was necessary as of September 30, 2014 and June 30, 2014. The Company will account for interest and penalties related to uncertain tax positions in the current period consolidated statement of operations, as necessary.
As of September 30, 2014 and June 30, 2014, accrued liabilities consisted of the following:
| | | September 30, | | | June 30, | |
| | | 2014 | | | 2014 | |
| Purchase consideration for acquisition of subscribers | | $ | 193,433 | | | $ | 193,433 | |
| Property, franchise and sales tax expense | | | 197,876 | | | | 180,992 | |
| Employee wages and benefits | | | 195,360 | | | | 117,229 | |
| Professional fees | | | 79,457 | | | | 56,000 | |
| Deferred rent expense | | | 48,328 | | | | 48,688 | |
| Other | | | 6,309 | | | | 1,187 | |
| Total accrued liabilities | | $ | 720,763 | | | $ | 597,529 | |
| 9. | Acquisition Credit Facility and Long-Term Debt |
On October 28, 2013, the Company entered into a loan agreement and other related agreements and documents with Frost Bank (the "Bank") creating a non-revolving acquisition credit facility (the “Acquisition Facility”) designed to provide the Company with an additional source of funding for the potential acquisition of subscribers from internet companies (each, an "Acquisition").
The amount that may be borrowed under the Acquisition Facility is $2,000,000 (the “Loan Cap”). For each specific Acquisition, the maximum amount that can be borrowed under the Acquisition Facility, subject to the Loan Cap, is (i) 55% of the cost of such Acquisition in the case of an Acquisition that is partially paid for using seller financing that has a maturity of less than three years and (ii) 65% of the cost of such Acquisition in the case of an Acquisition that is partially paid for using seller financing that has a maturity of three years or more. The Acquisition Facility is currently set to terminate on April 25, 2015. Through the date of this report, there has been no borrowing under the Acquisition Facility.
Each advance made by the Bank under the Acquisition Facility will be evidenced by the Company’s execution and delivery to the Bank of a separate promissory note (an “Acquisition Note”) that will provide for a maturity of not more than three years and equal monthly principal reduction payments, plus interest, to be made over the term of the Acquisition Note. Each Acquisition Note will bear interest at a fixed rate equal to the then current index rate for one and one-half (1.5) year to two (2) year loans established by the Federal Home Loan Bank of Dallas, plus 4%.
There are two financial covenants under the Acquisition Facility. The first covenant requires the Company to maintain a debt (excluding subordinated debt) to tangible net worth ratio of less than or equal to 2.5 to 1.0. The second covenant requires the Company to maintain a cash flow to debt service ratio of greater than or equal to 2.0 to 1.0, to be calculated on a rolling four-quarter basis. Both covenants are to be tested as of the end of each fiscal quarter. At September 30, 2014, the Company is in compliance with these covenants.
Indebtedness under the Acquisition Facility will be secured by a perfected, continuing security interest in favor of Frost Bank in all of the Company’s assets. Advances will be conditioned on, among other things, all representations and warranties contained in the loan documents being true and correct as of the date of the advance request and there being no default under the Acquisition Facility at the time of, or as a result of, the advance request. With each advance, the Company will be charged a loan processing fee equal to the greater of $250 and one-tenth of one percent (0.10%) of the amount of the advance.
As of September 30, 2014 and June 30, 2014, long term debt consisted of the following:
| | | September 30, | | | June 30, | |
| | | 2014 | | | 2014 | |
| Note payable due February 15, 2015, payable in monthly payments of $4,346 with fixed interest at 4.5% | | $ | 21,489 | | | $ | 34,190 | |
| Note payable due February 15, 2015, payable in monthly payments of $11,189 with interest imputed at 3.25% (net of unamortized discount of $452 and $1,081, respectively) | | | 55,494 | | | | 88,432 | |
| Note payable due November 1, 2014, payable in monthly installments of $1,674 with interest imputed at 8% (net of unamortized discount of $33 and $165, respectively) | | | 3,315 | | | | 8,206 | |
| Note payable due May 1, 2015, payable in monthly installments of $2,067 with interest imputed at 8% (net of unamortized discount of $485 and $884, respectively) | | | 16,048 | | | | 21,850 | |
| Capital lease obligation due May 31, 2018, payable in monthly installments of $3,390 with interest imputed at 4.5% (net of unamortized discount of $12,586 and $13,730, respectively) | | | 136,581 | | | | 144,998 | |
| Total | | | 232,927 | | | | 297,676 | |
| Less current portion | | | (131,154 | ) | | | (187,029 | ) |
| Total long-term debt, less current portion | | $ | 101,773 | | | $ | 110,647 | |
| 10. | Commitments and Contingencies |
We are involved from time to time in disputes and legal proceedings. At this time, management believes that such matters, individually and in the aggregate, are not material to our financial condition, results of operations and cash flows.
| 11. | Stock Options and Warrants |
As of September 30, 2014, options consisted of the following:
| | | September 30, 2014 | |
| | | Shares | | | Weighted Average
Exercise
Price | |
| | | | | | | |
| Outstanding at June 30, 2014 | | | 1,226,526 | | | $ | 0.40 | |
| Granted | | | 20,000 | | | | 0.66 | |
| Forfeited | | | (105,000 | ) | | | 0.40 | |
| Outstanding at September 30, 2014 | | | 1,141,526 | | | | 0.40 | |
| Options exercisable at September 30, 2014 | | | 529,026 | | | | 0.48 | |
As of September 30, 2014, 1,141,526 stock options were outstanding and 840,974 stock options were available for future issuance under the Company’s 2007 Stock Option Plan. During the three months ended September 30, 2014, the Company granted 20,000 stock options. The stock options granted during the three months ended September 30, 2014 consisted of a single grant of an option to purchase 20,000 shares of the Company's common stock at an exercise price of $0.66 per share. The Company determined the total fair value of such option grant to be $4,599, or $0.23 per stock option. The option grant vests as follows: 25% of the option (covering 5,000 shares) vests on the grant date and the remaining portion of the option (covering 15,000 shares) will vest 5,000 shares each on July 8, 2015, 2016 and 2017. Stock based compensation expense of $1,199 and $1,508 was recognized during the three months ended September 30, 2014 and 2013, respectively, based on granted options. As of September 30, 2014, the total stock based compensation expense related to non-vested awards not yet recognized was $9,740.
During the quarter ended September 30, 2014, all of the Company’s outstanding warrants (covering 394,922 shares) expired and at September 30, 2014 no warrants were issued or outstanding.
During the three months ended September 30, 2014 and 2013, a total of $7,375 and $11,703, respectively, was recorded as expense for non-employee directors serving on the Company's board of directors.
| 13. | Recent Accounting Pronouncements |
The Company has reviewed recently issued accounting standards, none of which are expected to have a material impact on the Company’s financial positions or results of operations.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Certain statements contained in this Quarterly Report on Form 10-Q constitute "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These statements, identified by words such as "anticipate," "believe," "estimate," "should," "expect" and similar expressions include our expectations and objectives regarding our future financial position, operating results and business strategy. These statements reflect the current views of management with respect to future events and are subject to risks, uncertainties and other factors that may cause our actual results, performance or achievements, or industry results, to be materially different from those described in the forward-looking statements. We do not intend to update the forward-looking information to reflect actual results or changes in the factors affecting such forward-looking information. Our Annual Report on Form 10-K for the fiscal year ended June 30, 2014 and other publicly filed reports discuss some of the important factors that could cause our actual results to differ materially from those in any forward-looking statements. Some of these factors are also discussed under the heading “Safe Harbor Statement and Risk Factors” later in this Item 2.
Overview
We are a Wireless ISP that is focused on providing high-speed broadband internet in rural underserved and non-served markets. At September 30, 2014, we served approximately 25,600 total subscribers in Texas, Oklahoma and Missouri. A subscriber represents an active, billed service. One customer account may represent multiple subscribers depending on the number of active and billed services for that customer. The Company derives substantially all of its revenues from internet access services and related fees.
During the three months ended September 30, 2014, we continued to focus on quality process implementation and simplifying internal systems and procedures. Additionally, we began investing in new sales initiatives with tests in a limited number of existing markets. Should these tests prove successful, we expect to roll them out in more of our markets. During the three months ended September 30, 2014, we incurred approximately $32,000 in added personnel dedicated to this sales initiative. In addition, during the quarter ended September 30, 2014, we incurred legal and advisory fees of $56,000 and $25,000, respectively. As announced on April 8, 2014, we continue to work closely with the financial advisory firm we engaged to evaluate strategic alternatives for the Company. As a result, adjusted EBITDA (as defined below) for the three months ended September 30, 2014 decreased 26% to approximately $345,000, as compared to adjusted EBITDA of approximately $469,000 for the three month period ended September 30, 2013. Based on present operations, we expect an upward trend in adjusted EDITDA during fiscal 2015.
During the three months ended September 30, 2014, we used $91,288 of our available cash on capital upgrades and infrastructure expansion. We also reduced our debt by $64,749. In spite of the $156,036 used on these items, our cash on hand at September 30, 2014 increased by $329,859 to $3,437,001 as compared to cash on hand at June 30, 2014 of $3,107,142. Our cash on hand at September 30, 2014 also represented a $786,883 increase, or 29.7%, as compared to cash on hand at September 30, 2013 of $2,650,118.
Effective cash management and efforts to improve the quality and efficiency of our operations over the last few years has positioned us well to manage the current and anticipated economic environment and to capitalize on growth possibilities through acquisitions and internal growth. We believe that we have sufficient capital, banking resources and cash on hand to take advantage of the opportunities that are now coming our way.
Statement of Operations
Internet services revenue is derived from dial-up Internet access, including analog and ISDN access, DSL access, dedicated connectivity, wireless access, bulk dial-up access, web hosting services, and value-added services, such as multiple e-mail boxes, personalized e-mail addresses and Fax-2-Email services.
Connectivity and operations expenses consist primarily of setup costs for new subscribers, telecommunication costs, merchant processing fees, and wages of network operations and customer support personnel. Connectivity costs include fees paid to telephone companies for subscribers' dial-up connections to our network, fees paid to backbone providers for connections from our network to the Internet, and equipment and tower lease costs for our new wireless networks.
Sales and marketing expenses consist primarily of creative and production costs, costs of media placement, management salaries and call center wages. Advertising costs are expensed as incurred.
General and administrative expenses consist primarily of administrative salaries, professional services, rent and other general office and business expenses.
Depreciation expense is computed using the straight-line or double declining method over the estimated useful lives of the assets or the capital lease term, as appropriate. Data communications equipment, computers, data servers and office equipment are depreciated over five years. Furniture, fixtures and leasehold improvements are depreciated over five years or the lease term. Buildings are depreciated over fifteen years. Amortization expense consists of the amortization of subscriber acquisition costs, which are amortized over four years.
Our business is not subject to any significant seasonal influences.
Results of Operations
Three Months Ended September 30, 2014 Compared to Three Months Ended September 30, 2013
The following table sets forth certain unaudited financial data for the three months ended September 30, 2014 and September 30, 2013. Operating results for any period are not indicative of results for any future period. Amounts are shown in thousands (except share and per share data).
| | | Three Months Ended September 30, |
| | | 2014 | | % of Revenues | | 2013 | | % of Revenues |
| REVENUES: | | | | | | | | |
| Internet services | | $ 2,048 | | 100.0% | | $ 1,967 | | 100.0% |
| TOTAL REVENUES | | 2,048 | | 100.0% | | 1,967 | | 100.0% |
| OPERATING EXPENSES: | | | | | | | | |
| Connectivity and operations | | 1,108 | | 54.1% | | 978 | | 49.7% |
| Sales and marketing | | 81 | | 4.0% | | 100 | | 5.1% |
| General and administrative | | 515 | | 25.1% | | 422 | | 21.5% |
| Depreciation and amortization | | 209 | | 10.2% | | 179 | | 9.1% |
| TOTAL OPERATING EXPENSES | | 1,913 | | 93.4% | | 1,679 | | 85.4% |
| INCOME FROM OPERATIONS | | 135 | | 6.6% | | 288 | | 14.6% |
| | | | | | | | | |
| OTHER INCOME (EXPENSE) | | | | | | | | |
| Interest income | | 2 | | 0.1% | | 2 | | 0.1% |
| Interest expense | | (4) | | (0.2)% | | (4) | | (0.2)% |
| OTHER EXPENSE, net | | (2) | | (0.1)% | | (2) | | (0.1)% |
| | | | | | | | | |
| INCOME BEFORE INCOME TAX EXPENSE | | 133 | | 6.5% | | 286 | | 14.5% |
| Income tax expense | | 65 | | (3.2)% | | 13 | | 0.7% |
| NET INCOME | | $ 68 | | 3.3% | | $ 273 | | 13.9% |
| | | | | | | | | |
| NET INCOME PER COMMON SHARE: | | | | | | | | |
| BASIC | | $ 0.00 | | | | $ 0.02 | | |
| DILUTED | | $ 0.00 | | | | $ 0.01 | | |
| WEIGHTED AVERAGE COMMON SHARES OUTSTANDING: | | | | | | | | |
| BASIC | | 16,747,062 | | | | 16,729,562 | | |
| DILUTED | | 20,024,300 | | | | 19,840,970 | | |
| OTHER DATA: | | | | | | | | |
| Adjusted EBITDA(1) | | $ 345 | | | | $ 469 | | |
| Adjusted EBITDA margin(2) | | 16.8% | | | | 23.8% | | |
| CASH FLOW DATA: | | | | | | | | |
| Cash flow provided by operations | | $ 486 | | | | $ 519 | | |
| Cash flow used in investing activities | | $ (91) | | | | $ (107) | | |
| Cash flow used in financing activities | | $ (65) | | | | $ (57) | | |
| Reconciliation of net income to adjusted EBITDA: | | | | | | | | |
| Net Income | | $ 68 | | | | $ 273 | | |
| Add: Depreciation and amortization | | 209 | | | | 179 | | |
| Stock based compensation | | 1 | | | | 2 | | |
| Interest expense | | 4 | | | | 4 | | |
| Income tax expense | | 65 | | | | 13 | | |
| Less: Interest income | | (2) | | | | (2) | | |
| Adjusted EBITDA(1) | | $ 345 | | | | $ 469 | | |
(1) Adjusted EBITDA, which as used herein means earnings before the effect of interest, taxes, depreciation, amortization and stock based compensation, is not a measurement of financial performance under generally accepted accounting principles (GAAP) and should not be considered an alternative to net income as a measure of performance. Management has consistently used adjusted EBITDA on a historical basis as a measurement of the Company’s current operating cash income.
(2) Adjusted EBITDA margin represents adjusted EBITDA as a percentage of total revenue.
Total revenue.Total revenue increased by $81,000, or 4.1%, to $2,048,000 for the three months ended September 30, 2014, from $1,967,000 for the three months ended September 30, 2013. Wireless broadband Internet revenue increased by $111,000 to $1,692,000 during the current year period compared to $1,581,000 for the prior year period. This increase was primarily due to the stability of the subscriber base and customers migrating to upgraded service levels during the quarter ended September 30, 2014, as well as the full period results from the acquisitions of wireless subscribers completed in the twelve months ended September 30, 2014. The increase in revenues derived from wireless broadband Internet subscribers was partially offset by a net decrease in other types of Internet service revenues of $30,000 to $356,000 during the current year period compared to $386,000 for the prior year period, which is primarily attributed to the expected decline of dial-up and DSL customers.
Connectivity and operations. Connectivity and operations expense increased by $130,000, or 13.3%, to $1,108,000 for the three months ended September 30, 2014, from $978,000 for the three months ended September 30, 2013. An increase of $89,000 in salaries, wages and related personnel expense to $537,000 was recorded for the current year period compared to $448,000 for the prior year period. Materials and supplies expense increased by $33,000 to $59,000 for the current year period compared to $26,000 for the prior year period. These increases are primarily a result of the Company's growth and network expansion from acquisitions of wireless subscribers completed in the twelve months ended September 30, 2014. The expense of seven trucks leased in June 2014 increased expenses by $13,000 for the three months ended September 30, 2014 as compared to the prior year period. Rents, utilities and lower lease costs increased $4,000 to $168,000 in the current year period as compared to $164,000 in the prior year period due to increases in the number of towers and tower rents. Merchant fees increased by $3,000 to $44,000 for the current year period as compared to $41,000 in the prior year period due to increased cash transaction activity.
The above mentioned increases were partially offset by a decrease of $10,000 in telecommunications expense to $239,000 for the current year period compared to $249,000 in the prior year period due to renegotiating more favorable terms with telecommunications service providers. Travel, meals and mileage expense also decreased by $2,000 compared to the prior year period due to the leasing of the seven trucks in June 2014.
Sales and marketing.Sales and marketing expense decreased by $19,000, or 19.0%, to $81,000 for the three months ended September 30, 2014 compared to $100,000 for the three months ended September 30, 2013. Advertising expense decreased by $11,000 to $2,000 for the current year period compared to $13,000 for the prior year period primarily due to employing more cost effective forms of advertising. Outside sales expense decreased by $7,000 to $9,000 for the current year period compared to $16,000 for the prior year period due to increased sales efforts through in-house personnel. Facilities expense also decreased by $5,000 to $4,000 for the current year period as compared to the prior year period due primarily to savings in utilities compared to the prior period.
The above mentioned decreases were partially offset by an increase in personnel expense of $4,000 compared to the prior year period due to new direct sales personnel hired in the three month period ending September 30, 2014.
General and administrative.General and administrative expense increased by $93,000, or 22.0%, to $515,000 for the three months ended September 30, 2014, from $422,000 for the three months ended September 30, 2013. Professional fees increased by $94,000 to $159,000 for the current year period compared to $65,000 for the prior year period due to primarily to increased consulting and legal fees from legal matters and engaging a financial advisor for the Company. Personnel costs increased by $51,000 to $221,000 for the current year period compared to $170,000 for the prior year period due to changes in compensation and increases in staff. Travel, meals and mileage increased $3,000 to $7,000 for the current year period as compared to $4,000 for the prior year period due to increases in corporate executive travel. Insurance expense increased by $2,000 to $28,000 for the current year period compared to $26,000 for the prior year period primarily due to general rate increases.
The above mentioned increases were partially offset by a decrease in rents, utilities and tower lease costs of $32,000 to $35,000 from $67,000 in the prior year period due to reductions in utility costs of $9,000, reduction of rent expense due to closing of the Stafford office of $4,000, reduction in phone lease expense of $1,000 and rent reduction for the corporate office of $18,000 in the three months ended September 30, 2014. Telecommunications expense in the current year period decreased by $14,000 as compared to the prior year period due to renegotiating more favorable terms with providers and credits received for sales tax and USF charges. G&A-other expense in the current year period decreased by $7,000 as compared to the prior year period due to reductions in office supply and package delivery costs. Stock-based compensation expense and director fees also decreased by $4,000 in the current year period as compared to the prior year period due to the resignation of one member of the Board of Directors in March 2014.
Depreciation and amortization. Depreciation and amortization increased by $30,000, or 16.8%, to $209,000 for the three months ended September 30, 2014, from $179,000 for the three months ended September 30, 2013. This increase was due to a $33,000 increase in amortization relating to acquired subscriber costs resulting from the Company’s wireless acquisitions completed during the twelve months ended September 30, 2014 offset by a decrease in depreciation expense of $3,000 to $133,000 for the three months ended September 30, 2014 as compared to $136,000 for the three months ended September 30, 2013 caused by assets becoming fully depreciated and fewer additions.
Interest income and expense.Interest income remained constant at $2,000 for the three months ended September 30, 2014 and 2013. Interest expense also remained constant at $4,000 for the three months ended September 30, 2014 and 2013.
Income tax expense.Income tax expense increased by $53,000, or 407.7%, for the three months ended September 30, 2014 to $65,000 as compared to $13,000 for the prior year period related to federal income tax accrual of $51,000 for the current year period as compared to zero for the prior year period and higher Texas franchise tax expense accrued for increased revenues in the current year period of $2,000 to $15,000 as compared to $13,000 in the prior year period.
Liquidity and Capital Resources
We have historically financed our operations to date primarily through cash flows from operations. During the three months ended September 30, 2014, the Company recognized net income and an increase in cash on hand of approximately $68,000 and $330,000, respectively. In addition, during the three months ended September 30, 2014 and 2013, the Company recognized net cash provided by operating activities of $486,000 and $519,000, respectively, enabling the Company to fund its operations from current period operating cash flow and resulting in cash on hand of $3,437,001 at September 30, 2014. The Company expects to fund its operations during fiscal 2015 with cash flow from operations. The Company’s addition of technical personnel to its technical staff during the quarter ended March 31, 2014 and the anticipated expansion of its sales and marketing initiatives during fiscal 2015 are expected to cause future cash flow from operations to decrease slightly yet remain strong.
The Company plans to pursue strategic acquisitions in the near and medium term in addition to upgrading its systems to provide higher speeds and increased reliability for its customers. In addition, we engaged a financial advisor, the GulfStar Group, Inc., who is continuing to help evaluate strategic alternatives for the Company. We expect that capital expenditures and any future acquisitions will be funded from available cash, seller financing and/or borrowings from commercial banks or third parties; however there is no assurance that such financing will be able to be obtained when needed at desirable rates which could affect our success in achieving any or all of our initiatives. Any unexpected decreases in revenue or subscriber count may adversely affect our liquidity and plans for future growth.
Changes in operating assets and liabilities provided cash of $156,000 and $60,000 for the three months ended September 30, 2014 and 2013, respectively.
Cash used in investing activities totaled $91,000 and $107,000 for the three months ended September 30, 2014 and 2013, respectively, due primarily to purchases of capital improvements for existing wireless broadband internet infrastructure and an acquisition of subscribers.
Cash used in financing activities totaled $65,000 and $57,000 for the three months ended September 30, 2014 and 2013, respectively, and consisted of principal payments on long term debt and capital leases, including notes related to acquisitions.
Cash on hand increased by $330,000 during the three months ended September 30, 2014. As of September 30, 2014, cash on hand was $3,437,001 as compared to $2,650,118 as of September 30, 2013. We believe our continuing efforts to improve the quality and efficiency of our operations, along with our focus on increasing revenues, may lead to a more rapid rate of growth and improving cash flow from operations.
Off Balance Sheet Arrangements
None.
“Safe Harbor” Statement and Risk Factors
The following "Safe Harbor" Statement is made pursuant to the Private Securities Litigation Reform Act of 1995.
Certain of the statements contained in the body of this Quarterly Report are forward-looking statements (rather than historical facts) that are subject to risks and uncertainties that could cause actual results to differ materially from those described in the forward-looking statements. With respect to such forward-looking statements, we seek the protections afforded by the Private Securities Litigation Reform Act of 1995. These risks include, without limitation, that (1) we will not be able to increase our rural customer base at the expected rate, (2) we will not improve Adjusted EBITDA, profitability or product margins, (3) Internet revenue in high-speed broadband will continue to increase at a slower pace than the decrease in revenue from other Internet services resulting in greater operating losses in future periods, (4) financing will not be available to us if and as needed, (5) we will not be competitive with existing or new competitors, (6) we will not keep up with industry pricing or technological developments impacting the Internet, (7) we will be adversely affected by dependence on network infrastructure, telecommunications providers and other vendors or by regulatory changes, (8) service interruptions or impediments could harm our business, (9) acts of God and other events outside our control, such as hurricanes and other dangerous weather conditions, fires and lightning, could damage or destroy our facilities and network infrastructure, (10) we may be accused of infringing upon the intellectual property rights of third parties, which will be costly to defend and could limit our ability to use certain technologies in the future, (11) government regulations could force us to change our business practices, (12) we may be unable to hire and retain qualified personnel, including our key officers, (13) future acquisitions of wireless broadband Internet customers and infrastructure may not be available on attractive terms and, if available, we may not successfully integrate those acquisitions into our operations, (14) provisions in our certificate of incorporation, bylaws and shareholder rights plan could limit our share price and delay a change of management and (15) our stock price has historically been thinly traded and volatile and may continue to be thinly traded and volatile. This list is intended to identify certain of the principal factors that could cause actual results to differ materially from those described in the forward-looking statements included elsewhere herein but is not a comprehensive list of all of such factors.
| ITEM 3. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK |
Not applicable
| ITEM 4. | CONTROLS AND PROCEDURES |
(a) Evaluation of disclosure controls and procedures.We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports pursuant to the Securities Exchange Act of 1934, as amended (the “Exchange Act”), is recorded, processed, summarized and reported within the time periods specified in the rules and forms, and that such information is accumulated and communicated to us, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.
As required by Rules 13a-15(b) and 15d-15(b) of the Exchange Act, an evaluation as of September 30, 2014 was conducted under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act). As stated in our Annual Report on Form 10-K for the fiscal year ended June 30, 2014, our management identified a material weakness in the forecast analysis used in estimating the valuation allowance for deferred tax assets as of June 30, 2014. The forecast used assumptions that were estimates of projected operating results. As of the date of the filing of this report, we developed and implemented new procedures to remediate this material weakness. Specifically, management evaluated and determined the objectively verified assumptions to use in our projections and tax timing differences to estimate our taxable income for the next five years and beyond to determine the related valuation allowance each year. Management will update these assumptions annually as part of the audit process. These procedures will be documented internal controls and will be reviewed annually. Based on their evaluation as of September 30, 2014 and because the previously identified material weakness in our internal control over financial reporting discussed above (which is an integral component of our disclosure controls and procedures) had not been fully remedied by such date, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were not effective as of September 30, 2014.
(b) Changes in internal control over financial reporting.Except for the remedial measures discussed above, there were no changes in our internal control over financial reporting that occurred during the fiscal quarter ended September 30, 2014 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
PART II - OTHER INFORMATION
On July 17, 2014, the Steven G. Mihaylo Trust and Summit Growth Management LLC filed a petition against the Company, William E. Ladin, Jr., Randall J. Frapart, Raymond L. Horn, Dean L. Greenberg, and Justin McClure in the 127th Judicial District Court of Harris County, Texas. The petition alleges that the individual defendants mismanaged the Company and asserts claims for breach of fiduciary duty, shareholder oppression, failure to call a shareholder meeting, and declaratory relief. The petition seeks an order compelling the Company to set an annual meeting and is seeking damages, a declaration of the parties’ rights, and attorneys' fees. The matter is in its preliminary stages. As previously disclosed in its filings with the Securities and Exchange Commission, the Company has engaged a financial advisor, GulfStar Group, Inc., to assist the Board in evaluating possible strategic alternatives. The defendants believe that the Company has implemented a robust process to evaluate potential strategic alternatives to maximize value for the shareholders and intend to mount a vigorous defense.
Not applicable.
| ITEM 2. | UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS |
None.
| ITEM 3. | DEFAULTS UPON SENIOR SECURITIES |
None.
| ITEM 4. | MINE SAFETY DISCLOSURES |
Not applicable.
None.
| Exhibit | | Description |
| | | |
| 31.1* | | Rule 13a-14(a)/15d-14(a) Certification of William E. Ladin, Jr. |
| 31.2* | | Rule 13a-14(a)/15d-14(a) Certification of Randall J. Frapart |
| 32.1* | | Section 1350 Certification of William E. Ladin, Jr. |
| 32.2* | | Section 1350 Certification of Randall J. Frapart |
| 101.INS* | | XBRL Instance Document |
| 101.SCH* | | XBRL Taxonomy Extension Schema |
| 101.CAL* | | XBRL Taxonomy Extension Calculation Linkbase |
| 101.LAB* | | XBRL Taxonomy Extension Label Linkbase |
| 101.PRE* | | XBRL Taxonomy Extension Presentation Linkbase |
*Filed herewith
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| INTERNET AMERICA, INC. | |
| (Registrant) | |
| | |
| Date: November 12, 2014 | |
| By: | /s/ William E. Ladin, Jr. | |
| William E. Ladin, Jr. | |
| Chief Executive Officer | |
| (duly authorized officer) | |
| | |
| Date: November 12, 2014 | |
| By: | /s/ Randall J. Frapart | |
| Randall J. Frapart | |
| Chief Financial Officer | |
| (principal financial officer) | |
INDEX TO EXHIBITS
| Exhibit No. | | Description |
| | | |
| 31.1* | | Rule 13a-14(a)/15d-14(a) Certification of William E. Ladin, Jr. |
| | | |
| 31.2* | | Rule 13a-14(a)/15d-14(a) Certification of Randal J. Frapart |
| | | |
| 32.1* | | Section 1350 Certification of William E. Ladin, Jr. |
| | | |
| 32.2* | | Section 1350 Certification of Randall J. Frapart |
| | | |
| 101.INS* | | XBRL Instance Document |
| | | |
| 101.SCH* | | XBRL Taxonomy Extension Schema |
| | | |
| 101.CAL* | | XBRL Taxonomy Extension Calculation Linkbase |
| | | |
| 101.LAB* | | XBRL Taxonomy Extension Label Linkbase |
| | | |
| 101.PRE* | | XBRL Taxonomy Extension Presentation Linkbase |
*Filed herewith
