EarthLink Holdings Corp.
EarthLink Holdings Corp. (Form: 10-Q, Received: 08/09/2016 09:49:05)
Table of Contents

 
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 June 30, 2016
OR  
o
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: 001-15605
 
EARTHLINK HOLDINGS CORP.
(Exact name of registrant as specified in its charter)
Delaware
 
46-4228084
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
 
1170 Peachtree Street NE, Suite 900, Atlanta, Georgia  30309
(Address of principal executive offices)  (Zip Code)
(404) 815-0770
(Registrant’s telephone number, including area code)
 _______________________________________________________
 
(Former name, former address and former fiscal year, if changed since last report date)
_______________________________________________________
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x   No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x  No o
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 x
 
Accelerated filer o
 
 
 
Non-accelerated filer o
 
Smaller reporting company o
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o  No x
As of July 29, 2016 , 105,494,702 shares of common stock, $0.01 par value per share, were outstanding.
 


Table of Contents

EARTHLINK HOLDINGS CORP.
Quarterly Report on Form 10-Q
For the Quarterly Period Ended June 30, 2016
TABLE OF CONTENTS
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


Table of Contents

PART I

  Item 1.  Financial Statements.

EARTHLINK HOLDINGS CORP.
CONDENSED CONSOLIDATED BALANCE SHEETS
 
December 31,
2015
 
June 30,
2016
 
(in thousands, except per share data)
 
 
 
(unaudited)
ASSETS
Current assets:
 

 
 

Cash and cash equivalents
$
91,296

 
$
76,833

Accounts receivable, net of allowance of $3,537 and $2,957 as of December 31, 2015 and June 30, 2016, respectively
74,724

 
72,750

Prepaid expenses
14,187

 
16,609

Other current assets
9,724

 
10,014

Total current assets
189,931

 
176,206

Property and equipment, net
372,504

 
338,009

Goodwill
137,751

 
134,464

Other intangible assets, net
25,325

 
3,969

Other long-term assets
9,141

 
9,867

Total assets
$
734,652

 
$
662,515

 
 
 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
 

 
 

Accounts payable
$
18,442

 
$
12,158

Accrued payroll and related expenses
50,532

 
19,897

Other accrued liabilities
64,305

 
63,804

Deferred revenue
40,229

 
37,033

Current portion of long-term debt and capital lease obligations
6,787

 
33,585

Total current liabilities
180,295

 
166,477

Long-term debt and capital lease obligations
505,613

 
437,492

Long-term deferred income taxes, net
3,876

 
4,446

Other long-term liabilities
22,022

 
26,107

Total liabilities
711,806

 
634,522

 
 
 
 
Stockholders’ equity:
 

 
 

Preferred stock, $0.01 par value, 100,000 shares authorized, 0 shares issued and outstanding as of December 31, 2015 and June 30, 2016

 

Common stock, $0.01 par value, 300,000 shares authorized, 200,207 and 201,805 shares issued as of December 31, 2015 and June 30, 2016, respectively, and 103,880 and 105,478 shares outstanding as of December 31, 2015 and June 30, 2016, respectively
2,002

 
2,018

Additional paid-in capital
2,026,638

 
2,019,786

Accumulated deficit
(1,260,937
)
 
(1,248,954
)
Treasury stock, at cost, 96,327 shares as of December 31, 2015 and June 30, 2016
(744,857
)
 
(744,857
)
Total stockholders’ equity
22,846

 
27,993

Total liabilities and stockholders’ equity
$
734,652

 
$
662,515


The accompanying notes are an integral part of these financial statements.

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Table of Contents

EARTHLINK HOLDINGS CORP.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2015
 
2016
 
2015
 
2016
 
(in thousands, except per share data)
(unaudited)
Revenues
$
283,664

 
$
240,357

 
$
566,111

 
$
494,619

Operating costs and expenses:
 

 
 

 
 
 
 

Cost of revenues (exclusive of depreciation and amortization shown separately below)
127,048

 
110,934

 
256,510

 
226,140

Selling, general and administrative (exclusive of depreciation and amortization shown separately below)
94,349

 
76,925

 
189,607

 
158,337

Depreciation and amortization
47,723

 
33,571

 
94,987

 
73,770

Restructuring, acquisition and integration-related costs
3,978

 
3,279

 
9,350

 
6,292

Total operating costs and expenses
273,098

 
224,709

 
550,454

 
464,539

Income from operations
10,566

 
15,648

 
15,657

 
30,080

Gain on sale of business

 

 

 
5,727

Interest expense and other, net
(14,112
)
 
(10,824
)
 
(28,049
)
 
(21,933
)
Loss on extinguishment of debt
(5,966
)
 
(226
)
 
(7,252
)
 
(458
)
Income (loss) before income taxes
(9,512
)
 
4,598

 
(19,644
)
 
13,416

Income tax provision
(410
)
 
(483
)
 
(761
)
 
(1,434
)
Net income (loss) and comprehensive income (loss)
$
(9,922
)
 
$
4,115

 
$
(20,405
)
 
$
11,982

 
 
 
 
 
 
 
 
Net income (loss) per share
 

 
 

 
 

 
 

Basic
$
(0.10
)
 
$
0.04

 
$
(0.20
)
 
$
0.11

Diluted
(0.10
)
 
0.04

 
(0.20
)
 
0.11

 
 
 
 
 
 
 
 
Weighted average common shares outstanding
 
 
 
 
 
 
 
Basic
103,323

 
105,322

 
102,969

 
104,879

Diluted
103,323

 
108,328

 
102,969

 
108,015

 
 
 
 
 
 
 
 
Dividends declared per share
$
0.05

 
$
0.05

 
$
0.10

 
$
0.10

 
 
 
 
 
 
 
 
 
The accompanying notes are an integral part of these financial statements.

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Table of Contents

EARTHLINK HOLDINGS CORP.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
 
 
Six Months Ended June 30,
 
2015
 
2016
Cash flows from operating activities:
(in thousands)
(unaudited)
Net income (loss)
$
(20,405
)
 
$
11,982

Adjustments to reconcile net income (loss) to net cash provided by operating activities:
 
 
 
Depreciation and amortization
94,987

 
73,770

Gain on sale of business

 
(5,727
)
Non-cash income taxes
381

 
522

Stock-based compensation
7,229

 
8,161

Amortization of debt discount and debt issuance costs
2,023

 
1,720

Loss on extinguishment of debt
7,252

 
458

Other operating activities
656

 
(682
)
Decrease (increase) in accounts receivable, net
7,092

 
(2,130
)
Increase in prepaid expenses and other assets
(2,465
)
 
(4,901
)
Decrease in accounts payable and accrued and other liabilities
(44,843
)
 
(37,783
)
Increase in deferred revenue
220

 
5,548

Net cash provided by operating activities
52,127

 
50,938

Cash flows from investing activities:
 
 
 
Purchases of property and equipment
(38,402
)
 
(35,208
)
Proceeds from sale of business

 
26,000

Net cash used in investing activities
(38,402
)
 
(9,208
)
Cash flows from financing activities:
 
 
 
Proceeds (payments) from issuance of debt, net of issuance costs
54,761

 
(2,230
)
Repayment of debt and capital lease obligations
(100,624
)
 
(42,812
)
Payment of dividends
(15,882
)
 
(11,402
)
Proceeds from exercises of stock options
1,249

 
251

Net cash used in financing activities
(60,496
)
 
(56,193
)
Net decrease in cash and cash equivalents
(46,771
)
 
(14,463
)
Cash and cash equivalents, beginning of period
134,133

 
91,296

Cash and cash equivalents, end of period
$
87,362

 
$
76,833

 
The accompanying notes are an integral part of these financial statements.

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Table of Contents
EARTHLINK HOLDINGS CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
UNAUDITED



1.  Organization
 
EarthLink Holdings Corp. (“EarthLink” or the “Company”), together with its consolidated subsidiaries, is a leading managed network, security and cloud services provider to business and residential customers in the United States. The Company provides a broad range of data, voice and managed network services to retail and wholesale business customers. The Company also provides nationwide Internet access and related value-added services to residential customers. The Company operates an extensive network including more than 29,000 route fiber miles and 90 metro fiber rings. Through its owned and leased facilities, the Company provides data and voice IP service coverage across more than 90 percent of the United States. The Company operates four reportable segments aligned around distinct customer categories: Enterprise/Mid-Market, Small Business, Carrier/Transport and Consumer. For further information concerning the Company’s reportable segments, see Note 13, “Segment Information.”
 
2.  Summary of Significant Accounting Policies
 
Basis of Presentation
 
The condensed consolidated financial statements of EarthLink for the three and six months ended June 30, 2015 and 2016 and the related footnote information are unaudited and have been prepared on a basis consistent with the audited consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015 as filed with the Securities and Exchange Commission (the “SEC”) (the “Annual Report”).
 
These financial statements should be read in conjunction with the audited consolidated financial statements and the related notes thereto contained in the Annual Report. In the opinion of management, the accompanying unaudited financial statements contain all adjustments (consisting of normal recurring adjustments) which management considers necessary to present fairly the Company’s financial position, results of operations and cash flows for the interim periods presented. The results of operations for the three and six months ended June 30, 2016 are not necessarily indicative of the results anticipated for the entire year ending December 31, 2016 .
 
Basis of Consolidation
 
The accompanying condensed consolidated financial statements of EarthLink include the accounts of its wholly-owned subsidiaries. All significant intercompany transactions have been eliminated.

Use of Estimates
 
The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements. Actual results may differ from those estimates.

Recently Issued Accounting Pronouncements

Revenue Recognition . In May 2014, the Financial Accounting Standards Board (the "FASB") issued authoritative guidance on revenue from contracts with customers. The new guidance outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. The core principle of the revenue model is that an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The new standard requires significantly expanded disclosures about revenue contract assets and liabilities. The new standard also includes new accounting principles related to the deferral and amortization of contract acquisition and fulfillment costs. In August 2015, the FASB issued guidance that deferred the effective date by one year. The standard is now required to be adopted by public business entities in annual periods beginning on or after December 15, 2017, and interim periods within those annual periods, and may be applied on a full retrospective or modified retrospective approach. Early adoption at the original effective date is permitted.

The Company has elected to adopt the standard in the first quarter of the fiscal year ending December 31, 2018. The Company is in the process of determining the method of adoption and assessing the impact the new standard will have on its consolidated financial statements.

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EARTHLINK HOLDINGS CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
UNAUDITED - (Continued)


Going Concern . In August 2014, the FASB issued authoritative guidance related to the disclosure of uncertainties about an entity's ability to continue as a going concern. The new guidance requires management to evaluate whether there are conditions and events that raise substantial doubt about the entity’s ability to continue as a going concern within one year after the financial statements and to provide related footnote disclosures if so. The new standard is effective for fiscal years, and interim periods within those fiscal years, ending after December 15, 2016. Early adoption is permitted. The adoption of this standard is not expected to have a material impact on the Company's financial statements.

Leases . In February 2016, the FASB issued authoritative guidance on accounting for leases. The new guidance requires the recognition of lease assets and lease liabilities by lessees for those leases classified as operating leases. As of the lease commencement date, a lessee is required to recognize a liability for its lease obligation (initially measured at the present value of the future lease payments not yet paid over the lease term) and an asset for its right to use the underlying asset equal to the lease liability, adjusted for lease payments made at or before lease commencement, lease incentives, and any initial direct costs. The new standard is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. Early adoption is permitted. The Company is evaluating the impact of the implementation of this standard on its financial statements.

Share-Based Payments . In March 2016, the FASB issued authoritative guidance, which simplifies several aspects of the accounting for employee share-based payment transactions, including the accounting for income taxes, forfeitures and statutory tax withholding requirements, as well as classification in the statement of cash flows. The new standard is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2016. Early adoption is permitted. The Company is evaluating the impact of the implementation of this standard on its financial statements.

3.  Earnings per Share
 
Basic earnings per share represents net income (loss) divided by the weighted average number of common shares outstanding during the reported period. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock, including stock options and restricted stock units (collectively "Common Stock Equivalents"), were exercised or converted into common stock. The dilutive effect of outstanding stock options and restricted stock units is reflected in diluted earnings per share by application of the treasury stock method. In applying the treasury stock method for stock-based compensation arrangements, the assumed proceeds are computed as the sum of the amount the employee must pay upon exercise, the amount of compensation cost attributed to future services and not yet recognized and the amount of excess tax benefits, if any, that would be credited to additional paid-in capital assuming exercise of the awards.

The following table presents the computation for basic and diluted net income (loss) per share for the three and six months ended June 30, 2015 and 2016 :
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2015
 
2016
 
2015
 
2016
 
(in thousands, except per share data)
Numerator
 

 
 

 
 
 
 
Net income (loss)
$
(9,922
)
 
$
4,115

 
$
(20,405
)
 
$
11,982

Denominator
 

 
 

 
 
 
 
Basic weighted average common shares outstanding
103,323

 
105,322

 
102,969

 
104,879

Dilutive effect of Common Stock Equivalents

 
3,006

 

 
3,136

Diluted weighted average common shares outstanding
103,323

 
108,328

 
102,969

 
108,015

 
 
 
 
 
 
 
 
Basic net income (loss) per share
$
(0.10
)
 
$
0.04

 
$
(0.20
)
 
$
0.11

Diluted net income (loss) per share
$
(0.10
)
 
$
0.04

 
$
(0.20
)
 
$
0.11


The Company has not included the effect of Common Stock Equivalents in the calculation of diluted earnings per share for the three and six months ended June 30, 2015 because such inclusion would have an anti-dilutive effect due to the Company's net loss. As of June 30, 2015 , the Company had 10.0 million stock options and restricted stock units outstanding which were excluded from the determination of dilutive earnings per share. During the three and six months ended June 30, 2016 , approximately 0.6 million stock options and restricted stock units were excluded from the calculation of diluted earnings per share because their effect would have been anti-dilutive. Anti-dilutive securities could be dilutive in future periods.

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EARTHLINK HOLDINGS CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
UNAUDITED - (Continued)


4.   Sale of Business

On February 1, 2016, the Company sold certain assets related to its IT services product offerings. The primary purpose of the sale was to simplify operations and provide more flexibility to invest in new capabilities and services to drive growth in the Company's core business. The purchase price in the transaction was $29.0 million , subject to post-closing contingencies that could increase or decrease the purchase price by up to $5.0 million . The Company received $26.0 million of cash upon completion of the sale. The other $3.0 million of consideration was deposited into an escrow account to fund potential indemnification obligations. The Company recognized a pretax gain of $5.7 million and recorded a $2.0 million deferred gain for contingent consideration. The gain is included in gain on sale of business in the Condensed Consolidated Statement of Comprehensive Income (Loss). The carrying amount of the IT services assets was $17.5 million , which included $11.4 million of property and equipment, $2.3 million of goodwill, $3.5 million of other intangible assets and $0.3 million of other assets and liabilities. Total revenue of the Company's IT services business was approximately $23.5 million and $3.4 million , respectively, during the six months ended June 30, 2015 and 2016 . The sale of the IT services business did not represent a strategic shift in the Company's business nor did it have a major effect on the Company's consolidated results of operations, financial position or cash flows, and accordingly, did not qualify for reporting as a discontinued operation. The IT services business was previously included in the Company's Enterprise/Mid-Market and Small Business segments.

5.  Goodwill and Other Intangible Assets
 
Goodwill

The following table presents changes in the carrying amount of goodwill by operating segment during the six months ended June 30, 2016 :
 
Enterprise/
 
Small
 
Carrier/
 
 
 
 
 
Mid-Market
 
Business
 
Transport
 
Consumer
 
Total
 
(in thousands)
Balance as of December 31, 2015
 
 
 
 
 
 
 
 
 
Goodwill
$
237,982

 
$
57,137

 
$
98,290

 
$
88,920

 
$
482,329

Accumulated impairment loss
(208,443
)
 
(50,045
)
 
(86,090
)
 

 
(344,578
)
 
29,539

 
7,092

 
12,200

 
88,920

 
137,751

 
 
 
 
 
 
 
 
 
 
Goodwill disposed
(1,516
)
 
(746
)
 

 
(1,025
)
 
(3,287
)
 
 
 
 
 
 
 
 
 
 
Balance as of June 30, 2016
 
 
 
 
 
 
 
 
 
Goodwill
236,466

 
56,391

 
98,290

 
87,895

 
479,042

Accumulated impairment loss
(208,443
)
 
(50,045
)
 
(86,090
)
 

 
(344,578
)
 
$
28,023

 
$
6,346

 
$
12,200

 
$
87,895

 
$
134,464


Goodwill disposed includes the portion of goodwill allocated to the disposed IT services business and the portion of goodwill allocated to certain assets held for sale.


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EARTHLINK HOLDINGS CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
UNAUDITED - (Continued)


Other Intangible Assets
 
The following table presents the components of the Company’s acquired identifiable intangible assets included in the accompanying Condensed Consolidated Balance Sheets as of December 31, 2015 and June 30, 2016 :
 
As of December 31, 2015
 
As of June 30, 2016
 
Gross
Carrying
Value
 
Accumulated
Amortization
 
Net
Carrying
Value
 
Gross
Carrying
Value
 
Accumulated
Amortization
 
Net
Carrying
Value
 
(in thousands)
Customer relationships
$
346,825

 
$
(323,365
)
 
$
23,460

 
$
337,397

 
$
(334,143
)
 
$
3,254

Developed technology and software
26,261

 
(24,396
)
 
1,865

 
25,311

 
(24,596
)
 
715

Trade name
1,521

 
(1,521
)
 

 
1,521

 
(1,521
)
 

Other intangible assets, net
$
374,607

 
$
(349,282
)
 
$
25,325

 
$
364,229

 
$
(360,260
)
 
$
3,969

  
Definite-lived intangible assets are amortized over their estimated useful lives. The Company amortizes its customer relationships using the straight-line method to match the estimated cash flow generated by such assets, and amortizes its developed technology and software using the straight-line method because a pattern to which the expected benefits will be consumed or otherwise used up could not be reliably determined. As of June 30, 2016 , the weighted average amortization periods were 5.3 years for customer relationships and 3.8 years for developed technology and software. The Company sold intangible assets that had a gross carrying value of $10.4 million and a net carrying value of $3.5 million in connection with the sale of its IT services business.
 
Amortization of intangible assets, which is included in depreciation and amortization in the Condensed Consolidated Statements of Comprehensive Income (Loss) , for the three and six months ended June 30, 2015 and 2016 was as follows:
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2015
 
2016
 
2015
 
2016
 
(in thousands)
Amortization expense
$
16,596

 
$
5,898

 
$
33,276

 
$
17,845

 
Based on the current amount of definite-lived intangible assets, the Company expects to record amortization expense of approximately $4.0 million during the remaining six months in the year ending December 31, 2016 . Actual amortization expense to be reported in future periods could differ materially from these estimates as a result of acquisitions, changes in useful lives and other relevant factors.
 
6.  Other Accrued Liabilities
 
The Company's other accrued liabilities consisted of the following as of December 31, 2015 and June 30, 2016 :
 
December 31, 2015
 
June 30, 2016
 
(in thousands)
Accrued taxes and surcharges
$
14,663

 
$
14,308

Accrued communications costs
23,201

 
23,153

Customer-related liabilities
7,854

 
7,052

Accrued interest
3,822

 
3,716

Other
14,765

 
15,575

Total other accrued liabilities
$
64,305

 
$
63,804



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EARTHLINK HOLDINGS CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
UNAUDITED - (Continued)

7.  Long-Term Debt and Capital Lease Obligations
 
The Company’s long-term debt and capital lease obligations consisted of the following as of December 31, 2015 and June 30, 2016 :
 
December 31, 2015
 
June 30, 2016
 
(in thousands)
Senior secured notes due June 2020
$
300,000

 
$
300,000

Unamortized debt issue costs on senior secured notes due June 2020
(4,723
)
 
(4,188
)
Senior notes due May 2019
173,925

 
166,945

Unamortized discount and debt issue costs on senior notes due May 2019
(5,393
)
 
(4,464
)
Senior secured revolving credit facility
35,000

 

Capital lease obligations
13,591

 
12,784

Carrying value of debt and capital lease obligations
512,400

 
471,077

Less current portion of debt and capital lease obligations
(6,787
)
 
(33,585
)
Long-term debt and capital lease obligations
$
505,613

 
$
437,492

 
2016 Transactions

During the six months ended June 30, 2016 , the Company repurchased $7.0 million outstanding principal of its 8.875% Senior Notes due 2019 (the “Senior Notes”) in the open market for $7.0 million , plus accrued and unpaid interest. The Company recognized a $0.2 million loss on extinguishment of debt, consisting of the write-off of unamortized discount on debt, the write-off of debt issuance costs and payment of premium on the repurchase. The loss is included in loss on extinguishment of debt in the Condensed Consolidated Statement of Comprehensive Income (Loss). The payment of premium is included in repayment of debt and capital lease obligations in the Condensed Consolidated Statement of Cash Flows.

During the six months ended June 30, 2016 , the Company repaid $35.0 million of its senior secured revolving credit facility. As of June 30, 2016 , the Company had no amounts outstanding under its senior secured revolving credit facility. On June 30, 2016, the Company refinanced its senior secured revolving credit facility. See "2016 Credit Facility" below for more information.

On June 30, 2016, the Company exercised its right under the related indenture to call a portion of its outstanding Senior Notes. On August 4, 2016, the Company redeemed $90.0 million aggregate principal amount of its Senior Notes at a redemption price equal to 102.219% of the principal amount thereof, plus accrued and unpaid interest. The Company used approximately $34.0 million of existing cash, a $50.0 million term loan and $10.0 million under its senior secured revolving credit facility to fund the redemption, call premium and accrued interest. As of June 30, 2016, $31.7 million net carrying amount of the Senior Notes was classified within current portion of debt and capital lease obligations in the Condensed Consolidated Balance Sheet and $130.8 million net carrying amount was classified within long-term debt and capital lease obligations.

Debt Covenants

The indenture governing the Company's 7.375% Senior Secured Notes due 2020 (the “Senior Secured Notes”) includes covenants which, subject to certain exceptions, limit the ability of the Company and its Restricted Subsidiaries (as defined in the indenture) to, among other things, incur additional indebtedness, make certain types of restricted payments, create liens, transfer and sell assets, enter into certain transactions with affiliates, issue or sell stock of subsidiaries, engage in sale-leaseback transactions and create restrictions on dividends or other payments by restricted subsidiaries. Upon a change of control (as defined in the indenture), the Company may be required to make an offer to repurchase the Senior Secured Notes at 101% of their principal amount, plus accrued and unpaid interest. The indenture governing the Senior Secured Notes also contains customary events of default. As of June 30, 2016 , the Company was in compliance with these covenants.

The indenture governing the Senior Notes includes covenants which, subject to certain exceptions, limit the ability of the Company and its Restricted Subsidiaries (as defined in the indenture) to, among other things, incur additional indebtedness, make certain types of restricted payments, incur liens on assets of the Company or the Restricted Subsidiaries, engage in asset sales and enter into transactions with affiliates. Upon a change of control (as defined in the indenture), the Company may be required to make an

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EARTHLINK HOLDINGS CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
UNAUDITED - (Continued)

offer to repurchase the Notes at 101% of their principal amount, plus accrued and unpaid interest. The indenture governing the Senior Notes also contains customary events of default. As of June 30, 2016 , the Company was in compliance with these covenants.

The indentures governing the Senior Secured Notes and Senior Notes contain covenants regarding the Company's ability to make Restricted Payments (as defined in the indentures), including certain dividends, stock purchases, debt repayments and investments.  As of June 30, 2016 , the indentures governing the Company's Senior Secured Notes and Senior Notes permitted approximately $185.1 million and $313.6 million , respectively, in Restricted Payments. The Company's ability to make Restricted Payments varies over time, and is determined, in part, by the extent that the Company's cumulative EBITDA exceeds 300% of its cumulative interest expense.

2016 Credit Facility
 
General.  In June 2016, the Company entered into a second amended and restated credit agreement (the “Credit Agreement”) providing for a new senior secured revolving credit facility with aggregate revolving commitments of up to $125.0 million and an up to $50.0 million delayed draw senior secured term loan (together, the "Credit Facility"). The senior secured revolving credit facility replaces the Company’s previous $135.0 million senior secured credit facility. The Company paid $2.2 million of transaction fees and expenses related to the new Credit Facility, which are being amortized to interest expense over the life of the Credit Facility using the straight-line method. The payment of transaction fees is included in proceeds (payments) from issuance of debt, net of issuance costs, in the Condensed Consolidated Statement of Cash Flows. The Company wrote-off $0.2 million of unamortized debt issuance costs related to the previous $135.0 million senior secured revolving credit facility. The loss is included in loss on extinguishment of debt in the Condensed Consolidated Statements of Comprehensive Income (Loss).

Commitment fees and borrowing costs under this facility vary and are based on the Company’s most recent Consolidated Leverage Ratio (as defined in the Credit Agreement). As of June 30, 2016 , the Company’s commitment fee was 0.5% and the Company’s borrowing cost is LIBOR plus 3.25% for LIBOR Rate Loans and the Base Rate plus 2.25% for Base Rate Loans. As of June 30, 2016 , no amounts were outstanding under the Credit Agreement. As of June 30, 2016 , $1.7 million of letters of credit were outstanding under the Credit Agreement’s Letter of Credit Sublimit.

The amended and restated credit facility matures on June 30, 2021 and all amounts outstanding thereunder shall be due and payable in full, except that if the Company's Senior Secured Notes have not been repaid in full by February 29, 2020, the maturity date will be February 29, 2020. The term loan is subject to quarterly amortization of principal, commencing with the first fiscal quarter ending after the term loan is funded, as set forth as follows with the remaining outstanding principal amount (and any accrued and unpaid interest) due on February 29, 2020: Year 1, 5.0%; Year 2, 5.0%; Year 3, 7.5%, Year 4, 7.5%; and Year 5, 10.0%.

The Credit Facility may in the future be increased by up to $50.0 million (so long as the aggregate amount of the Credit Facility does not exceed $175.0 million ) with additional commitments from the current lenders or other financial institutions reasonably acceptable to the administrative agent and the satisfaction of conditions contained in the Credit Agreement.

The Company is the borrower under the Credit Facility. All obligations of the borrower under the Credit Agreement are guaranteed by each of the Company’s existing direct and indirect domestic subsidiaries and will be guaranteed by certain of the Company’s future direct and indirect domestic subsidiaries (other than immaterial subsidiaries). The obligations of the Company and the subsidiary guarantors under the Credit Facility, as well as obligations under any treasury management, interest protection or other hedging arrangements entered into with a lender (or affiliate thereof), are secured by (subject to certain liens permitted by the Credit Agreement) liens, which rank equally with the Company’s other senior secured indebtedness, on and security interests in, (i) substantially all of the Company’s and the subsidiary guarantors’ present and future personal property assets (subject to certain exclusions set forth in the Credit Agreement), (ii) certain of the Company’s and the subsidiary guarantors’ present and future real estate owned in fee simple that is required by the Credit Agreement to be mortgaged, (iii) all present and future shares of the capital stock of the Company’s and the subsidiary guarantors’ present and future subsidiaries (excluding any stock in excess of 66% of the voting stock of non-U.S. subsidiaries), and (iv) all proceeds and products of the foregoing property and assets.

Prepayment . The Company may prepay the Credit Facility in whole or in part at any time without premium or penalty, subject to reimbursement of the lenders’ breakage and redeployment costs in the case of prepayment of LIBOR borrowings. The Company may irrevocably reduce or terminate the unutilized portion of the revolving credit facility at any time without penalty.
 
Covenants . The Credit Agreement contains representations and warranties, covenants and events of default with respect to the Company and its subsidiaries that are customarily applicable to senior secured credit facilities. The negative covenants contained

9

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EARTHLINK HOLDINGS CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
UNAUDITED - (Continued)

in the Credit Agreement include restrictions on the ability of the Company and its subsidiaries to, among other things, incur additional indebtedness, make capital expenditures, incur liens on assets, engage in certain mergers, acquisitions or divestitures, pay dividends or make other distributions, voluntarily prepay certain other indebtedness (including certain prepayments of the Company’s senior secured notes and senior notes), enter into transactions with affiliates, make investments, and change the nature of their businesses, and amend the terms of certain other indebtedness (including the Company’s existing notes), in each case subject to certain exceptions set forth in the Credit Agreement.
 
Additionally, the Credit Agreement requires the Company to maintain a consolidated net leverage ratio of not greater than 3.5 to 1.0 (with restrictions on cash netting) and a consolidated interest coverage ratio of not less than 2.5 to 1.0. The Company was in compliance with all covenants as of June 30, 2016 .
 
Financial Information Under Rule 3-10 of Regulation S-X

The Company’s Senior Secured Notes and Senior Notes are fully and unconditionally guaranteed, jointly and severally, on a senior unsecured basis by each of the Company’s existing and future domestic subsidiaries, other than certain subsidiaries that are minor (the “Guarantor Subsidiaries”). All of the Guarantor Subsidiaries are 100% owned by the Company and have, jointly and severally, fully and unconditionally guaranteed, to each holder of the Notes, the full and prompt performance of the Company’s obligations under the Notes and the indenture governing the Notes, including the payment of principal (or premium, if any) and interest on the Notes, on an equal and ratable basis. Further, the Company has no independent assets or operations, and there are no significant restrictions on the ability of its consolidated subsidiaries to transfer funds to the Company in the form of cash dividends, loans or advances. The Company’s assets consist solely of investments it has made in its consolidated subsidiaries, and its operations consist solely of changes in its investment in subsidiaries and interest associated with the Senior Secured Notes and Senior Notes. Based on these facts, and in accordance with SEC Regulation S-X Rule 3-10, “Financial statements of guarantors and issuers of guaranteed securities registered or being registered,” the Company is not required to provide condensed consolidating financial information for the Guarantor Subsidiaries.
 
8.  Stockholders’ Equity
 
Share Repurchases
 
Since the inception of the Company’s share repurchase program, the Board of Directors has authorized a total of $750.0 million for the repurchase of EarthLink’s common stock. As of June 30, 2016 , the Company had $65.7 million available under the current authorizations. The Company may repurchase its common stock from time to time in compliance with the SEC’s regulations and other legal requirements, including through the use of derivative transactions, and subject to market conditions and other factors. The share repurchase program does not require the Company to acquire any specific number of shares and may be terminated by the Board of Directors at any time. In addition, the agreements governing the Company’s Senior Secured Notes and Senior Notes and the Company's Credit Agreement contain restrictions on the ability of the Company to repurchase common stock.

Dividends

During the six months ended June 30, 2015 and 2016 , cash dividends declared were $0.10 and $0.10 per common share, respectively. The Company also pays cash dividend amounts on each outstanding restricted stock unit to be paid at the time the restricted stock unit vests. Cash dividend amounts are forfeited if the restricted stock units do not vest. Total dividend payments were $15.9 million and $11.4 million during the six months ended June 30, 2015 and 2016 , respectively. The decision to declare future dividends is made at the discretion of the Board of Directors and will depend on, among other things, the Company’s results of operations, financial condition, cash requirements, investment opportunities and other factors the Board of Directors may deem relevant. In addition, the agreements governing the Company’s Senior Secured Notes and Senior Notes and the Company's Credit Agreement contain restrictions on the amount of dividends the Company can pay.

9.  Stock-Based Compensation
 
Stock-based compensation expense was $3.8 million and $4.1 million during the three months ended June 30, 2015 and 2016 , respectively, and $7.2 million and $8.2 million during the six months ended June 30, 2015 and 2016 , respectively. The Company has classified stock-based compensation expense within selling, general and administrative expense, the same operating expense line item as cash compensation paid to employees.
 

10

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EARTHLINK HOLDINGS CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
UNAUDITED - (Continued)

Options Outstanding
 
The following table presents stock option activity as of and for the six months ended June 30, 2016 :
 
Stock Options
 
Weighted
Average
Exercise
Price
 
Weighted
Average
Remaining
Contractual
Term (Years)
 
Aggregate
Intrinsic
Value
 
(shares and dollars in thousands)
Outstanding as of December 31, 2015
908

 
$
6.52

 
 
 
 

Granted

 

 
 
 
 

Exercised
(41
)
 
6.08

 
 
 
 

Forfeited and expired
(163
)
 
8.58

 
 
 
 

Outstanding as of June 30, 2016
704

 
6.08

 
6.3
 
$
486

Vested and expected to vest as of June 30, 2016
668

 
6.11

 
6.2
 
$
450

Exercisable as of June 30, 2016
465

 
6.43

 
5.8
 
$
243

 
The aggregate intrinsic value amounts in the table above represent the closing price of the Company’s common stock on June 30, 2016 in excess of the exercise price, multiplied by the number of stock options outstanding, exercisable or vested and expected to vest, when the closing price is greater than the exercise price. This represents the amount that would have been received by the stock option holders if they had all exercised their stock options on June 30, 2016 . The total intrinsic value of stock options exercised during the six months ended June 30, 2015 and 2016 was not material. The intrinsic value of stock options exercised represents the difference between the market value of Company’s common stock at the time of exercise and the exercise price, multiplied by the number of stock options exercised. As of June 30, 2016 , there was $0.2 million of total unrecognized compensation cost related to stock options. That cost is expected to be recognized over a weighted-average period of 1.4 years .

The following table presents the status of the Company’s stock options as of June 30, 2016 :
Stock Options Outstanding
 
Stock Options Exercisable
 
 
 
 
Weighted
 
 
 
 
 
 
 
 
Average
 
Weighted
 
 
 
Weighted
 
 
 
 
Remaining
 
Average
 
 
 
Average
Range of
 
Number
 
Contractual
 
Exercise
 
Number
 
Exercise
Exercise Prices
 
Outstanding
 
Life
 
Price
 
Exercisable
 
Price
 
 
(in thousands)
 
 
 
 
 
(in thousands)
 
 
$
4.97

 
to
 
$
4.97

 
300

 
7.5
 
$
4.97

 
150

 
$
4.97

6.08

 
to
 
6.08

 
179

 
6.6
 
6.08

 
90

 
6.08

6.90

 
to
 
9.23

 
225

 
4.3
 
7.55

 
225

 
7.55

4.97

 
to
 
9.23

 
704

 
6.3
 
6.08

 
465

 
6.43

 
Restricted Stock Units
 
The following table presents restricted stock unit activity as of and for the six months ended June 30, 2016
 
Restricted
Stock Units
 
Weighted
Average
Grant Date
Fair Value
 
(in thousands)
 
 
Outstanding as of December 31, 2015
7,751

 
$
4.58

Granted
3,234

 
5.07

Vested
(2,306
)
 
4.86

Forfeited
(622
)
 
4.53

Outstanding as of June 30, 2016
8,057

 
$
4.70

 

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EARTHLINK HOLDINGS CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
UNAUDITED - (Continued)

The fair value of restricted stock units is determined based on the closing price of EarthLink’s common stock on the grant date. The weighted-average grant date fair value of restricted stock units granted during the six months ended June 30, 2015 and 2016 was $4.49 and $5.07 , respectively.  As of June 30, 2016 , there was $24.8 million of total unrecognized compensation cost related to nonvested restricted stock units. That cost is expected to be recognized over a weighted-average period of 2.0 years . The total fair value of shares vested during the six months ended June 30, 2015 and 2016 was $8.0 million and $12.7 million , respectively, which represents the closing price of the Company’s common stock on the vesting date multiplied by the number of restricted stock units that vested.

10.  Restructuring, Acquisition and Integration-Related Costs
 
Restructuring, acquisition and integration-related costs consisted of the following during the three and six months ended June 30, 2015 and 2016 :
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2015
 
2016
 
2015
 
2016
 
(in thousands)
Integration-related costs
$
1,658

 
$
1,897

 
$
2,975

 
$
3,676

Severance, retention and other employee costs
1,048

 
667

 
3,949

 
1,558

Facility-related costs
1,272

 
715

 
2,426

 
1,058

Restructuring, acquisition and integration-related costs
$
3,978

 
$
3,279

 
$
9,350

 
$
6,292


Restructuring, acquisition and integration-related costs consist of costs related to the Company's restructuring, acquisition and integration-related activities. The Company recognizes a liability for costs associated with an exit or disposal activity when the liability is incurred. The Company recognizes severance costs when they are both probable and reasonably estimable. Restructuring, acquisition and integration-related costs include the following:

Integration-related costs, such as system conversion and integration-related consulting and employee costs. The Company is also undertaking a long-term network optimization project designed to consolidate traffic onto network facilities operated by the Company and reduce the usage of other carriers’ networks. Integration-related costs associated with this initiative include costs to migrate traffic to lower cost circuits and to terminate existing contracts prior to their expiration;
Severance, retention and other employee termination costs associated with acquisition and integration activities and as a result of evaluations of our operating structure; and
Facility-related costs, such as lease termination and asset impairments.

During the six months ended June 30, 2016 , the Company recorded $2.6 million of restructuring costs in connection with changes in its business strategy. The restructuring costs consisted of $1.6 million of severance due to reductions in workforce and $1.1 million of facilities-related costs primarily due to the closing of certain sales offices and other facilities. Restructuring costs for the six months ended June 30, 2016 are included in restructuring, acquisition and integration-related costs in the Condensed Consolidated Statement of Comprehensive Income (Loss).

The following table summarizes activity for liability balances associated with facility exit and restructuring liabilities for the six months ended June 30, 2016 :
 
Severance and Benefits
 
Facilities
 
Total
 
(in thousands)
Balance as of December 31, 2015
$
3,539

 
$
5,542

 
$
9,081

Accruals
1,558

 
1,058

 
2,616

Payments
(4,587
)
 
(1,479
)
 
(6,066
)
Balance as of June 30, 2016
$
510

 
$
5,121

 
$
5,631


As of December 31, 2015 , $5.4 million of facility exit and restructuring liabilities were classified within current liabilities and $3.7 million were classified as other long-term liabilities. As of June 30, 2016 , $2.3 million of facility exit and restructuring liabilities were classified within current liabilities and $3.3 million were classified as other long-term liabilities.
 
11.  Income Taxes
 
During the six months ended June 30, 2016 , the Company recorded an income tax provision of $1.4 million , resulting in an effective tax rate for the six months ended June 30, 2016 of approximately 10.7% . During the six months ended June 30, 2015 , the Company recorded an income tax provision of $0.8 million , resulting in an effective tax rate for the six months ended June 30, 2015 of approximately (3.9)% .

The difference between the effective tax rate and the federal statutory rate during the six months ended June 30, 2016 primarily relates to changes in the valuation allowance on net deferred tax assets. The income tax provision for the six months ended June 30, 2016 includes federal alternative minimum tax expense, tax expense for foreign and state taxes, amortization of intangibles with indefinite useful lives and a discrete expense of $0.1 million , primarily for state taxes. The difference between the effective tax rate and the federal statutory rate during the six months ended June 30, 2015 primarily relates to changes in the valuation allowance on net deferred tax assets. The income tax benefit for the six months ended June 30, 2015 includes tax expense for foreign and state taxes, amortization of intangible assets with indefinite useful lives and a discrete expense of $0.2 million primarily for state taxes.

As of June 30, 2016 , the Company had a valuation allowance of $343.5 million against its net deferred tax assets, exclusive of its deferred tax liabilities with indefinite useful lives. The Company continually reviews the adequacy of the valuation allowance and recognizes the benefits of deferred tax assets only as the reassessment indicates that it is more likely than not that the deferred tax assets will be realized. As of June 30, 2016 , the Company does not believe it is more likely than not that the remaining net deferred tax assets will be realized. Should the Company’s assessment change in a future period it may release all or a portion of the valuation allowance at such time, which would result in a deferred tax benefit in the period of adjustment.

12.  Fair Value Measurements
 
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (an exit price). A three-tier fair value hierarchy is used to prioritize the inputs used in measuring fair value.  These tiers include: Level 1, defined as observable inputs such as quoted prices in active markets; Level 2, defined as observable inputs other than quoted prices in active markets that are either directly or indirectly observable; and Level 3, defined as unobservable inputs for which little or no market data exists, therefore requiring an entity to develop its own assumptions.
 
The estimated fair value of the Company’s Senior Secured Notes and Senior Notes was determined based on Level 2 input using observable market prices in less active markets. The carrying amount of the Company’s senior secured revolving credit facility approximated its fair value as of December 31, 2015 . The following table presents the fair value of the Company’s debt, excluding capital leases, as of December 31, 2015 and June 30, 2016 :
 
As of December 31, 2015
 
As of June 30, 2016
 
Carrying
 
 
 
Carrying
 
 
 
Amount
 
Fair Value
 
Amount
 
Fair Value
 
(in thousands)
Senior Secured Notes
$
295,277

 
$
305,439

 
$
295,812

 
$
309,033

Senior Notes
168,532

 
177,404

 
162,481

 
169,917

Senior secured revolving credit facility
35,000

 
35,000

 

 

Total debt, excluding capital leases
$
498,809

 
$
517,843

 
$
458,293

 
$
478,950

 


12

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EARTHLINK HOLDINGS CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
UNAUDITED - (Continued)

13.  Segment Information
 
General

The Company reports segment information along the same lines that its Chief Operating Decision Maker reviews its operating results in assessing performance and allocating resources. The Company's Chief Operating Decision Maker is its Chief Executive Officer. The Company's reportable segments are strategic business units that are aligned around distinct customer categories to optimize operations. The Company operates the following four reportable segments:

Enterprise/Mid-Market . The Company’s Enterprise/Mid-Market segment provides a broad range of data, voice and managed network services to distributed multi-site business customers.

Small Business . The Company’s Small Business segment provides a broad range of data, voice and managed network services to small, often single-site business customers.

Carrier/Transport . The Company’s Carrier/Transport segment provides transmission capacity and other data, voice and managed network services to telecommunications carriers and large enterprises.

Consumer . The Company’s Consumer segment provides nationwide Internet access and related value-added services to residential customers.

Segment Results

The following table presents segment results for the three and six months ended June 30, 2015 and 2016 :
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2015
 
2016
 
2015
 
2016
 
(in thousands)
Enterprise/Mid-Market
 

 
 

 
 
 
 
Revenues
$
114,368

 
$
97,586

 
$
228,759

 
$
202,275

Cost of revenues (excluding depreciation and amortization)
56,216

 
50,499

 
112,488

 
102,070

Gross margin
58,152

 
47,087

 
116,271

 
100,205

Small Business
 

 
 

 
 
 
 
Revenues
79,041

 
57,270

 
$
158,095

 
$
119,403

Cost of revenues (excluding depreciation and amortization)
35,263

 
27,205

 
72,860

 
56,939

Gross margin
43,778

 
30,065

 
85,235

 
62,464

Carrier/Transport
 
 
 
 
 
 
 
Revenues
34,149

 
35,123

 
$
67,021

 
$
71,192

Cost of revenues (excluding depreciation and amortization)
15,350

 
15,289

 
30,943

 
30,753

Gross margin
18,799

 
19,834

 
36,078

 
40,439

Consumer
 
 
 
 
 
 
 
Revenues
56,106

 
50,378

 
$
112,236

 
$
101,749

Cost of revenues (excluding depreciation and amortization)
20,219

 
17,941

 
40,219

 
36,378

Gross margin
35,887

 
32,437

 
72,017

 
65,371

Total Segments
 
 
 
 
 
 
 
Revenues
283,664

 
240,357

 
566,111

 
494,619

Cost of revenues (excluding depreciation and amortization)
127,048

 
110,934

 
256,510

 
226,140

Gross margin
$
156,616

 
$
129,423

 
$
309,601

 
$
268,479



13

Table of Contents
EARTHLINK HOLDINGS CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
UNAUDITED - (Continued)

The following table presents a reconciliation of segment gross margin to consolidated income (loss) before income taxes for the three and six months ended June 30, 2015 and 2016 :
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2015
 
2016
 
2015
 
2016
 
(in thousands)
 
 
 
 
 
 
 
 
Segment gross margin
$
156,616

 
$
129,423

 
$
309,601

 
$
268,479

Operating costs and expenses:
 
 
 
 
 
 
 
Selling, general and administrative expenses
94,349

 
76,925

 
189,607

 
158,337

Depreciation and amortization
47,723

 
33,571

 
94,987

 
73,770

Restructuring, acquisition and integration-related costs
3,978

 
3,279

 
9,350

 
6,292

Total operating costs and expenses
146,050

 
113,775

 
293,944

 
238,399

Income from operations
10,566

 
15,648

 
15,657

 
30,080

Gain on sale of business

 

 

 
5,727

Interest expense and other, net
(14,112
)
 
(10,824
)
 
(28,049
)
 
(21,933
)
Loss on extinguishment of debt
(5,966
)
 
(226
)
 
(7,252
)
 
(458
)
Income (loss) before income taxes
$
(9,512
)
 
$
4,598

 
$
(19,644
)
 
$
13,416


The Company evaluates performance of its segments based on segment gross margin. Segment gross margin includes revenues from external customers and related cost of revenues. Costs excluded from segment gross margin include selling, general and administrative expenses, depreciation and amortization, restructuring, acquisition and integration-related costs, gain on sale of business, interest expense and other, net, and loss on extinguishment of debt, as they are not considered in the measurement of segment performance. Management periodically evaluates the segmentation of customers within the distinct customer categories, which may result in changes to segment information in the future.

The Company manages its working capital on a consolidated basis and does not allocate long-lived assets to segments. In addition, segment assets are not reported to, or used by, the Chief Operating Decision Maker and therefore, total segment assets and expenditures for additions of long-lived assets have not been disclosed.
 
The Company has not provided information about geographic segments because substantially all of the Company’s revenues, results of operations and identifiable assets are in the United States.

Revenues by Type

The Company generates revenues by providing a broad range of data, voice and managed network services to business and residential customers. The Company’s revenues primarily consist of the following:

Monthly recurring charges for providing data, voice and managed network services; transmission capacity; and Internet access and related value-added services;
Usage revenues;
Equipment revenues; and
Non-recurring and other revenues, such as installation fees, termination fees and administrative fees.

14

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EARTHLINK HOLDINGS CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
UNAUDITED - (Continued)

The following table presents revenue detail for the three and six months ended June 30, 2015 and 2016 :
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2015
 
2016
 
2015
 
2016
 
(in thousands)
 
 

 
 

 
 

 
 

Monthly recurring revenues
$
251,145

 
$
212,693

 
$
499,120

 
$
436,095

Usage revenues
25,120

 
21,271

 
52,798

 
43,729

Equipment revenues
3,935

 
3,947

 
7,659

 
8,054

Non-recurring and other revenues
3,464

 
2,446

 
6,534

 
6,741

Total revenues
$
283,664

 
$
240,357

 
$
566,111

 
$
494,619

 
 
14. Commitments and Contingencies
 
Legal proceedings and other disputes
 
General . The Company is party to various legal proceedings and other disputes arising in the normal course of business, including, but not limited to, regulatory audits, E911 payments, trademark and patent infringement, billing disputes, rights of access, tax, consumer protection, employment and tort. The Company accrues for such matters when it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated. Where it is probable that a liability has been incurred and there is a range of expected loss for which no amount in the range is more likely than any other amount, the Company accrues at the low end of the range. The Company reviews its accruals each reporting period.
The Company's management believes that there are no disputes, litigation or other legal proceedings, audits or disputes asserted or pending against the Company that could have, individually or in the aggregate, a material adverse effect on its financial position, results of operations or cash flows, and believes that adequate provision for any probable and estimable losses has been made in the Company's consolidated financial statements. However, the ultimate result of any current or future litigation or other legal proceedings, audits or disputes is inherently unpredictable and could result in liabilities that are higher than currently predicted.
Regulatory audits . The Company is subject to regulatory audits in the ordinary course of business with respect to various matters, including audits by local municipalities for E911 charges and audits by the Universal Service Administrative Company on universal service fund assessments and payments. These audits can cover periods for several years prior to the date the audit is undertaken and could result in the imposition of liabilities, interest and penalties if the Company's positions are not accepted by the auditing entity. The Company's financial statements contain reserves for certain of such potential liabilities.
Billing disputes . The Company is periodically involved in disputes related to its billings to other carriers for access to its network. The Company does not recognize revenue related to such matters until the period that revenues are determinable and it is reasonably assured of the collection of the amounts billed. In the event that a claim is made related to revenues previously recognized, the Company assesses the validity of the claim and adjusts the amount of revenue being recognized to the extent that the claim adjustment is considered probable and estimable. The Company recognized $1.0 million and $0.7 million of net favorable disputes related to its billings to other carriers during the three months ended June 30, 2015 and June 30, 2016 , respectively, and $3.1 million and $1.6 million of net favorable disputes related to its billings to other carriers during the six months ended June 30, 2015 and June 30, 2016 , respectively, which are included in revenues in the Condensed Consolidated Statements of Comprehensive Income (Loss).
The Company periodically disputes network access charges that it is assessed by other companies with which the Company interconnects. The Company maintains adequate reserves for anticipated exposure associated with these billing disputes. The reserves are subject to changes in estimates and management judgment as new information becomes available. In view of the length of time historically required to resolve these disputes, they may be resolved or require adjustment in future periods and relate to costs invoiced, accrued or paid in prior periods. While the Company believes its reserves for billing disputes are adequate, it is reasonably possible that the Company could record additional expense of up to $10.4 million for unrecorded disputed amounts. The Company recognized $3.1 million and $3.7 million for favorable disputes with telecommunication vendors during the three months ended June 30, 2015 and 2016 , respectively, $6.6 million and $7.5 million for favorable disputes with telecommunication

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EARTHLINK HOLDINGS CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
UNAUDITED - (Continued)

vendors during the six months ended June 30, 2015 and 2016 , respectively, which are included in cost of revenues in the Condensed Consolidated Statements of Comprehensive Income (Loss).
Regulation
The Company's services are subject to varying degrees of federal, state and local regulation. These regulations are subject to ongoing proceedings at federal and state administrative agencies or within state and federal judicial systems. Results of these proceedings could change, in varying degrees, the manner in which the Company operates. The Company cannot predict the outcome of these proceedings or their effect on the Company's industry generally or upon the Company specifically. 
15. Subsequent Event

On July 13, 2016, the Company acquired Boston Retail Partners, LLC (“BRP”), a privately-held management consulting firm focused on the retail industry, for initial consideration of approximately $11.2 million , plus possible earn-out payments. The primary purpose of the transaction was to provide additional professional services capabilities in connection with the Company's strategy to be a leading managed network, security and cloud services provider for multi-location retail and service businesses. The assets acquired and liabilities assumed of BRP will be recognized at their acquisition date fair values. The allocation of the consideration transferred to the assets acquired and liabilities assumed (and the related estimated lives of depreciable tangible and identifiable intangible assets) will require a significant amount of judgment and is subject to finalization.


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Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations.
 
Certain statements in this Quarterly Report on Form 10-Q are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, and Section 21E of the Securities Exchange Act of 1934. The words “estimate,” “plan,” “intend,” “expect,” “anticipate,” “believe” and similar expressions are intended to identify forward-looking statements. These forward-looking statements are found at various places throughout this report. EarthLink disclaims any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. Although we believe that our expectations are based on reasonable assumptions, we can give no assurance that our goals will be achieved. Important factors that could cause actual results to differ from estimates or projections contained in the forward-looking statements are described under “Cautionary Note Concerning Factors That May Affect Future Results” in this Item 2.
 
Management's Discussion and Analysis of Financial Condition and Results of Operations is intended to provide a reader of our financial statements with a narrative from the perspective of management. The following Management’s Discussion and Analysis should be read in conjunction with the accompanying unaudited Condensed Consolidated Financial Statements and related Notes thereto and with Management’s Discussion and Analysis of Financial Condition and Results of Operations and the audited Consolidated Financial Statements and the Notes thereto contained in the Annual Report on Form 10-K for the year ended December 31, 2015 .

Overview
 
EarthLink Holdings Corp. (“EarthLink” or the “Company”), together with our consolidated subsidiaries, is a leading managed network, security and cloud services provider to business and residential customers in the United States. We provide a broad range of data, voice and managed network services to retail and wholesale business customers. We also provide nationwide Internet access and related value-added services to residential customers. We operate an extensive network including more than 29,000 route miles of fiber and 90 metro fiber rings. Through our owned and leased facilities, we provide data and voice IP service coverage across more than 90 percent of the United States. We operate four reportable segments aligned around distinct customer categories: Enterprise/Mid-Market, Small Business, Carrier/Transport and Consumer.

General Developments in our Business

Key developments in our business during the six months ended June 30, 2016 are described below:

Generated revenues of $494.6 million , a 13% decrease compared to the six months ended June 30, 2015 , primarily driven by declines in traditional voice and data products for business and consumer services and the sale of our IT services business, as further discussed below. These declines were partially offset by increased sales of our growth products, targeted price increases and successful efforts to re-term customers coming out of contract.

Reduced cost of revenues 12% during the six months ended June 30, 2016 compared to the prior year period, primarily related to the decline in revenues noted above as well as successful efforts to manage cost of revenues through network grooming, auditing telecommunications vendor invoices and other cost saving initiatives.

Generated net income of $12.0 million , compared to a net loss of $20.4 million during the six months ended June 30, 2015 , primarily due to a decrease in depreciation and amortization expense, a decrease in interest expense due to lower outstanding debt, a decrease in loss on extinguishment of debt due to fewer debt repurchases and a $5.7 million pretax gain recognized on our sale of IT services business. Partially offsetting these declines was a decrease in Adjusted EBITDA as described below.

Generated Adjusted EBITDA (a non-GAAP measure, see “Non-GAAP Financial Measures” in this Item 2) of $118.3 million , a decrease from $127.2 million during the six months ended June 30, 2015 , primarily due to the decrease in revenues from traditional voice and data products, offset by improvements in our cost of revenues and operating expenses. The decrease in cost of revenues and operating expenses was driven by cost savings initiatives, including reductions in workforce implemented over the past year.

Made capital expenditures of $35.2 million during the six months ended June 30, 2016 .

Repurchased $7.0 million of outstanding principal amount of debt and repaid $35.0 million under our senior secured revolving credit facility during the six months ended June 30, 2016 .


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Made $11.4 million of dividend payments to shareholders during the six months ended June 30, 2016 .


Sale of IT Services Business

In February 2016, we sold certain assets related to our IT services product offerings in connection with our strategy to simplify our operations and provide more flexibility to invest in new capabilities and services to drive growth in our core business. The purchase price in the transaction was $29.0 million, subject to post-closing contingencies that could increase or decrease the purchase price by up to $5.0 million . We received $26.0 million of cash upon completion of the sale. The other $3.0 million of consideration was deposited into an escrow account to fund potential indemnification obligations. We recognized a pretax gain of $5.7 million and recorded a $2.0 million deferred gain for contingent consideration. The loss of revenues related to our IT services product offerings has contributed and will continue to contribute to our anticipated revenue declines in 2016.

Acquisition of Boston Retail Partners

In July 2016, we acquired Boston Retail Partners, LLC (“BRP”), a privately-held management consulting firm focused on the retail industry, for initial consideration of approximately $11.2 million, plus possible earn-out payments. The primary purpose of the transaction was to provide additional professional services capabilities in connection with our strategy to to be a leading managed network, security and cloud services provider for multi-location retail and service businesses. We believe the acquisition will provide a growth opportunity for us by enabling us to enhance our support of retailers in creating and implementing customized strategies using our professional services.

Credit Facility Refinancing and Partial Debt Redemption

On June 30, 2016, we amended and restated our existing revolving credit facility, which reduced the capacity from $135.0 million to $125.0 million, provided for an up to $50.0 million delayed draw senior secured term loan and extended the term through June 2021 (except that if our 7.375% Senior Secured Notes due 2020 have not been repaid in full by February 2020, the term will be February 2020). Also in June 2016, we exercised our right to call a portion of our outstanding 8.875% Senior Notes due 2019. As a result, we redeemed $90.0 million aggregate principal amount of our 8.875% Senior Notes due 2019 on August 4, 2016 at a redemption price equal to 102.219% of the principal amount thereof, plus accrued and unpaid interest. We used approximately $34.0 million of existing cash, $50.0 million under our term loan and $10.0 million of our revolving credit facility to fund the redemption, call premium and accrued interest.

Business Strategy

Our business strategy is to be a leading managed network, security and cloud services provider for multi-location retail and service businesses. We believe there is a significant market opportunity for managed network, security and cloud services due to the changing technological and business landscape, which is experiencing increased demand for data, evolving security threats, a shift towards more software based solutions, increased use of outsourcing and tightening budgets. We are positioning our company to focus on this opportunity. The key elements of our business strategy and transformation are as follows:

Operate each of our business units with focused, value-optimizing strategies. Our organization is aligned around four distinct business units, which are Enterprise/Mid-Market, Small Business, Carrier/Transport and Consumer. We believe this concentrates our resources and investments into areas that will drive growth and deliver improved performance, enable each business to compete more successfully in the market and provide strategic optionality. We are focused on operating each business unit with value-optimizing strategies, which are managing the decline in our Small Business and Consumer business units and investing the cash flow to grow our Enterprise/Mid-Market and Carrier/Transport business units.

Optimize our cost structure and cash flows. We are focused on optimizing our cost structure and maximizing our cash flows. This includes managing our cost of revenues and operating expenses, streamlining our internal processes and aligning our workforce to current revenue trends. It also includes the repayment and/or refinancing of debt in order to reduce our interest expense. We plan to use the cash flow generated from our improvement efforts to continue to optimize our balance sheet and invest in growth.

Invest in growth business products, marketing and sales. Our growth business products include MultiProtocol Label Switching ("MPLS"), hosted voice and other UCaaS products, hybrid WAN and managed network, security and cloud services for multi-location businesses and transport services for other communications carriers and enterprises. We are focused on investing in product and service capabilities and sales and marketing initiatives to support our growth products.

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Evaluate potential strategic transactions. We continue to evaluate potential strategic transactions in order to accelerate our transformation. We believe that targeted acquisitions, when available at the right economics, can be an effective means for growth and targeted capability building. In addition, we continue to evaluate our business, which could lead us to discontinue or divest non-strategic products, assets or customers based on management's assessment of their strategic value to our business.

Challenges and Risks
 
The primary challenges we face in executing on our business strategy are growing revenues from our growth products and services; reducing churn in our existing customer base; responding to competition; aligning costs with trends in our revenues; and ensuring adequate resources to invest in growth. To address these challenges we are taking the following actions:

Targeting larger multi-location retail and service businesses which have lower churn profiles, as well as a need for our product and services
Investing in new products and service capabilities to create value for our customers, in particular our cloud-based offerings
Focusing on customer contract re-term efforts, retention offers, targeted price increases and opportunities to upsell products and services
Improving the customer experience to increase customer satisfaction and further enhance customer retention
Continuing to refine and narrow our product portfolio
Implementing cost efficiencies, such as network grooming, workforce alignment and facility closings, and seeking to make costs more variable
Repaying and/or refinancing outstanding indebtedness in order to reduce interest expense
Considering further divestitures of non-strategic products, assets or customers in order to continue to simplify our operations and generate cash to reduce debt or to use for other strategic needs
Evaluating potential strategic transactions to add products and services

Trends in our Business
 
Our financial results are impacted by several significant trends, which are described below.
 
Industry factors . The communications industry is characterized by intense competition, changing technology and changes in customer needs, an evolving regulatory environment and industry consolidation resulting in larger competitors and fewer suppliers. We expect these trends to continue. More recently, trends in the industry have included increased demand for data, evolving security threats, the adoption of cloud computing and the increased use of outsourcing. We are trying to capitalize on these changes by focusing on our managed network, security and cloud services and transport services.
Traditional business voice and data products . Our traditional business voice and data revenues have been declining due to competition, migration to more advanced integrated voice and data services and mandated rate reductions. We expect this trend to continue. We have also experienced an increase in churn for these products. However, we are focused on decelerating these declines through customer retention efforts, contract renewals, upselling products and services and offering new services.
Consumer access declines . Our consumer access subscriber base and revenues have been declining and are expected to continue to decline due to the continued maturation of the market for Internet access, competition from cable, DSL and wireless providers and limited sales and marketing activities. In addition, we have implemented, and expect to continue to implement, targeted price increases, which could negatively impact our churn rates. However, we are focused on customer retention and, as a result, we expect the rate of churn to continue to generally decline as our customer base becomes longer tenured. In July 2016, we sold approximately 12,000 customer relationships to one of our network providers, which will also cause our consumer access subscriber base and revenues to decrease.
Operating costs and expenses . We have experienced declines in cost of revenues and operating expense due to various cost saving initiatives, lower sales of traditional voice and data products and customer churn. We are focused on continuing to optimize our cost structure to offset pressures on revenue. However, we may not be able to continue to achieve the level of cost savings we have been experiencing and there will be decreasing opportunities for cost savings in the future.
Dispute settlements. Due to the nature of our industry, we are regularly involved in disputes related to our billings to other carriers for access to our network and network access charges that we are assessed by other companies. The disputes often take significant time to resolve, and they may be resolved or require adjustment in future periods although they

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relate to costs and revenues in prior periods. We have experienced an increase in dispute settlements impacting revenues and cost of revenues over the past few years. However, this trend may not continue at the rate it has historically.
Consolidated Results of Operations
 
The following table sets forth statement of operations data for the three and six months ended June 30, 2015 and 2016 :
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2015
 
2016
 
2015
 
2016
 
(in thousands)
Revenues
$
283,664

 
$
240,357

 
$
566,111

 
$
494,619

Operating costs and expenses:
 

 
 

 
 
 
 

Cost of revenues (exclusive of depreciation and amortization shown separately below)
127,048

 
110,934

 
256,510

 
226,140

Selling, general and administrative (exclusive of of depreciation and amortization shown separately below)
94,349

 
76,925

 
189,607

 
158,337

Depreciation and amortization
47,723

 
33,571

 
94,987

 
73,770

Restructuring, acquisition and integration-related costs
3,978

 
3,279

 
9,350

 
6,292

Total operating costs and expenses
273,098

 
224,709

 
550,454

 
464,539

Income from operations
10,566

 
15,648

 
15,657

 
30,080

Gain on sale of business

 

 

 
5,727

Interest expense and other, net
(14,112
)
 
(10,824
)
 
(28,049
)
 
(21,933
)
Loss on extinguishment of debt
(5,966
)
 
(226
)
 
(7,252
)
 
(458
)
Income (loss) before income taxes
(9,512
)
 
4,598

 
(19,644
)
 
13,416

Income tax provision
(410
)
 
(483
)
 
(761
)
 
(1,434
)
Net income (loss)
$
(9,922
)
 
$
4,115

 
$
(20,405
)
 
$
11,982


Revenues

We generate revenues by providing a broad range of data, voice and managed network services to business and residential customers.
Our revenues primarily consist of the following:

Monthly recurring charges for providing data, voice and managed network services; transmission capacity; and Internet access and related value-added services;
Usage revenues;
Equipment revenues; and
Non-recurring and other revenues, such as installation fees, termination fees and administrative fees.

The following table presents revenue detail for the three and six months ended June 30, 2015 and 2016 :
 
Three Months Ended
 
 
 
 
 
Six Months Ended
 
 
 
 
 
June 30,
 
Change
 
June 30,
 
Change
 
2015
 
2016
 
Dollar
 
Percent
 
2015
 
2016
 
Dollar
 
Percent
 
(dollars in thousands)
Monthly recurring revenues
$
251,145

 
$
212,693

 
$
(38,452
)
 
(15
)%
 
$
499,120

 
$
436,095

 
$
(63,025
)
 
(13
)%
Usage revenues
25,120

 
21,271

 
(3,849
)
 
(15
)%
 
52,798

 
43,729

 
(9,069
)
 
(17
)%
Equipment revenues
3,935

 
3,947

 
12

 
 %
 
7,659

 
8,054

 
395

 
5
 %
Non-recurring and other revenues
3,464

 
2,446

 
(1,018
)
 
(29
)%
 
6,534

 
6,741

 
207

 
3
 %
Total revenues
$
283,664

 
$
240,357

 
$
(43,307
)
 
(15
)%
 
$
566,111

 
$
494,619

 
$
(71,492
)
 
(13
)%



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The following table presents the primary reasons for the change in revenues for the three and six months ended June 30, 2016 compared to the prior year periods:
 
Three Months Ended
 
Six Months Ended
 
2016 vs 2015
 
2016 vs 2015
 
(in millions)
Due to decrease in Small Business revenues (a)
$
(17.9
)
 
$
(32.1
)
Due to decrease in IT services revenues (b)
(11.7
)
 
(20.1
)
Due to decrease in Consumer revenues (c)
(5.7
)
 
(10.5
)
Due to decrease in Enterprise/Mid-Market revenues (d)
(8.9
)
 
(13.0
)
Due to increase in Carrier/Transport (e)
0.9

 
4.2

   Total change in revenues
$
(43.3
)
 
$
(71.5
)
______________

(a)
Decrease primarily due to decline in traditional voice and data products, including traditional voice, lower-end, single site broadband services and web hosting. Revenues for these voice and data products have been decreasing due to an increase in customer churn, competition and a deemphasis on certain traditional products. Partially offsetting the decline in revenues for our traditional voice and data products were efforts to protect our revenue base, such as targeted price increases implemented during the six months ended June 30, 2016 and re-terms of customers coming out of contract.
(b)
Decrease in IT services revenues primarily due to the sale of certain assets related to our IT services product offerings on February 1, 2016. Also contributing to the decrease prior to the sale in February 2016 was the discontinuance of certain products that were low margin revenue streams or that were not consistent with our more focused business strategy.
(c)
Decrease primarily due to the continued maturation of the market for Internet access, competitive pressures in the industry and limited sales and marketing activities.
(d)
Decrease primarily due to decline in traditional voice and data products due to an increase in customer churn, competition and a deemphasis on certain traditional products. Over the past year we deemphasized and discontinued certain products that were low margin revenue streams or that were not consistent with our more focused business strategy. Partially offsetting the decline in revenues for our traditional voice and data products were price increases implemented during the three months ended June 30, 2016 and an increase in sales of growth products, including MPLS, hosted voice, managed network services and transport revenues due to an increased emphasis on selling these products and services.
(e)
Increase primarily due to an increase in transport revenues as we capitalize on unique fiber routes. Also contributing to the increase was a change in settlements and disputes related to billings to other carriers, as we recognized net unfavorable settlements during the six months ended June 30, 2015 and favorable settlements during the six months ended June 30, 2016 .

Cost of revenues
 
Cost of revenues primarily consists of the cost of connecting customers to our networks via leased facilities; the costs of leasing components of our network facilities; costs paid to third-party providers for interconnect access and transport services; fees paid to suppliers of our value-added services; fees paid to content providers for information provided on our online properties; and the cost of equipment sold to customers.

The following table presents cost of revenues for the three and six months ended June 30, 2015 and 2016 :
 
Three Months Ended
 
 
 
 
 
Six Months Ended
 
 
 
 
 
June 30,
 
Change
 
June 30,
 
Change
 
2015
 
2016
 
Dollar
 
Percent
 
2015
 
2016
 
Dollar
 
Percent
 
(dollars in thousands)
Cost of revenues
$
127,048

 
$
110,934

 
$
(16,114
)
 
(13)%
 
$
256,510

 
$
226,140

 
$
(30,370
)
 
(12
)%
 

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The following table presents the primary reasons for the change in cost of revenues for the three and six months ended June 30, 2016 compared to the prior year periods:
 
Three Months Ended
 
Six Months Ended
 
2016 vs 2015
 
2016 vs 2015
 
(in millions)
Due to decrease in interconnection expenses (a)
$
(7.5
)
 
$
(15.2
)
Due to decrease in network expenses (b)
(2.2
)
 
(4.4
)
Due to decrease in usage (c)
(1.7
)
 
(4.2
)
Due to sale of IT services business (d)
(5.5
)
 
(9.7
)
Due to change in non-recurring charges and other expenses (e)
0.8

 
3.1

   Total change in cost of revenues
$
(16.1
)
 
$
(30.4
)
______________

(a)
Decrease due to decline in revenues and a concentrated effort to manage cost of revenues through auditing telecommunications vendor invoices and other cost saving initiatives and declines in traditional voice and data products. Partially offsetting these declines were increased sales of growth products.
(b)
Decrease due to a concentrated effort to manage cost of revenues through network grooming and other cost saving initiatives and declines in traditional voice and data products. Partially offsetting these declines were increased sales of growth products.
(c)
Decrease due to declines in traditional voice and data products and a decreased emphasis on selling certain lower margin products and services.
(d)
Decrease in IT services cost of revenues primarily due to the sale of certain assets related to our IT services product offerings on February 1, 2016. Also contributing to the decrease prior to the sale in February 2016 was the discontinuance of certain products that had low margins or that were not consistent with our more focused business strategy.
(e)
Increase primarily due to fewer favorable adjustments and settlements during the three and six months ended June 30, 2016 compared to the three and six months ended June 30, 2015 .

Selling, general and administrative
 
Selling, general and administrative expenses consist of expenses related to sales and marketing, customer service, network operations, information technology, regulatory, billing and collections, corporate administration, and legal and accounting. Such costs include salaries and related employee costs (including stock-based compensation), outsourced labor, professional fees, property taxes, travel, insurance, occupancy costs, advertising and other administrative expenses.

The following table presents selling, general and administrative expenses for the three and six months ended June 30, 2015 and 2016
 
Three Months Ended
 
 
 
 
 
Six Months Ended
 
 
 
 
 
June 30,
 
Change
 
June 30,
 
Change
 
2015
 
2016
 
Dollar
 
Percent
 
2015
 
2016
 
Dollar
 
Percent
 
(dollars in thousands)
Selling, general and administrative expenses
$
94,349

 
$
76,925

 
$
(17,424
)
 
(18)%
 
$
189,607

 
$
158,337

 
$
(31,270
)
 
(16)%
 

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The following table presents the primary reasons for the change in selling, general and administrative expenses for the three and six months ended June 30, 2016 compared to the prior year periods:
 
Three Months Ended
 
Six Months Ended
 
2016 vs 2015
 
2016 vs 2015
 
(in millions)
Due to decrease in people costs (a)
$
(14.0
)
 
$
(24.8
)
Due to decrease in rent and occupancy costs (b)
(1.2
)
 
(2.2
)
Due to decrease in outside sales commissions (c)
(0.8
)
 
(1.5
)
Due to decrease in bad debt expense (d)
(0.6
)
 
(1.3
)
Due to decrease in other selling, general and administrative costs (e)
(0.8
)
 
(1.5
)
   Total change in selling, general and administrative expenses
$
(17.4
)
 
$
(31.3
)
______________

(a)
Decrease in people costs as employee headcount decreased from 2,314 full-time equivalents as of June 30, 2015 to 1,875 full-time equivalents as of June 30, 2016 . The decrease was primarily due to reductions in workforce over the past year driven by changes in our business strategy and the transfer of employees in connection with the sale of IT services business on February 1, 2016.
(b)
Decrease in rent and occupancy costs primarily due to cost savings from the closing of several sales offices and other properties over the past year in connection with changes to our business strategy.
(c)
Decrease in outside sales commissions primarily due to lower sales volume.
(d)
Decrease in bad debt expense due to more effective collection efforts and the overall decrease in revenues.
(e)
Decrease in other selling, general and administrative costs such as commissions, outsourced labor, payment processing, travel and insurance due to increased focus on optimizing our cost structure.

Depreciation and amortization
 
Depreciation and amortization includes depreciation of property and equipment and amortization of definite-lived intangible assets acquired in purchases of businesses and purchases of customer bases from other companies.

The following table presents depreciation and amortization expense for the three and six months ended June 30, 2015 and 2016 :
 
Three Months Ended
 
 
 
 
 
Six Months Ended
 
 
 
 
 
June 30,
 
Change
 
June 30,
 
Change
 
2015
 
2016
 
Dollars
 
Percent
 
2015
 
2016
 
Dollars
 
Percent
 
(dollars in thousands)
Depreciation expense
$
31,127

 
$
27,673

 
$
(3,454
)
 
(11)%
 
$
61,711

 
$
55,925

 
$
(5,786
)
 
(9)%
Amortization expense
16,596

 
5,898

 
(10,698
)
 
(64)%
 
33,276

 
17,845

 
(15,431
)
 
(46)%
Depreciation and amortization expense
$
47,723

 
$
33,571

 
$
(14,152
)
 
(30)%
 
$
94,987

 
$
73,770

 
$
(21,217
)

(22)%
 
The decreases in depreciation expense during the three and six months ended June 30, 2016 compared to the prior year periods were primarily due to a decrease in capital expenditures, the sale of property and equipment related to our IT services business on February 1, 2016 and assets becoming fully amortized over the year. The decreases in amortization expense during the three and six months ended June 30, 2016 compared to the prior year periods were primarily due to definite-lived intangible assets becoming fully amortized over the year and the sale of customer relationships and developed technology related to our IT services business on February 1, 2016.
 

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Restructuring, acquisition and integration-related costs
 
Restructuring, acquisition and integration-related costs consist of costs related to our restructuring, acquisition and integration-related activities. Such costs include the following:

Integration-related costs, such as system conversion and integration-related consulting and employee costs. We are also undertaking a long-term network optimization project designed to consolidate traffic onto network facilities operated by us and reduce the usage of other carriers’ networks. Integration-related costs associated with this initiative include costs to migrate traffic to lower cost circuits and to terminate existing contracts prior to their expiration;
Severance, retention and other employee termination costs associated with acquisition and integration activities and with certain voluntary employee separations; and
Facility-related costs, such as lease termination and asset impairments.

The following table presents restructuring, acquisition and integration-related costs for the three and six months ended June 30, 2015 and 2016 :
 
Three Months Ended
 
 
 
 
 
Six Months Ended
 
 
 
 
 
June 30,
 
Change
 
June 30,
 
Change
 
2015
 
2016
 
Dollars
 
Percent
 
2015
 
2016
 
Dollars
 
Percent
 
(dollars in thousands)
Integration-related costs
$
1,658

 
$
1,897

 
$
239

 
14%
 
$
2,975

 
$
3,676

 
$
701

 
24
 %
Severance, retention and other employee costs
1,048

 
667

 
(381
)
 
(36)%
 
3,949

 
1,558

 
(2,391
)
 
(61
)%
Facility-related costs
1,272

 
715