UNITED STATES 

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10‑K

Commission File No. 001‑34686

HAWAIIAN TELCOM HOLDCO, INC.

(Exact name of registrant as specified in its charter)

1177 Bishop Street

Honolulu, Hawaii 96813

(Address of principal executive offices) (Zip Code)

808‑546‑4511

(Registrant’s telephone number, including area code)

Securities to be registered pursuant to Section 12(b) of the Act: None

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

Indicate by check mark if the registrant is a well‑known seasoned issuer as defined in Rule 405 of the Securities Act. Yes ☐  No ☒

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ☐  No ☒

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒  No ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, 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 ☒  No ☐

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S‑K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10‑K or any amendment to this Form 10‑K. ☐

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.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b‑2 of the Exchange Act). Yes ☐  No ☒

The aggregate market value of the registrant’s common stock held by non‑affiliates as of June 30, 2016 was $123,893,946.

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

As of March 1,  2017,  11,513,279 shares of the registrant’s common stock, $0.01 par value, were outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of registrant’s Proxy Statement (Part III of Form 10‑K)

 

 

HAWAIIAN TELCOM HOLDCO, INC.

TABLE OF CONTENTS

 

 

 

 

GLOSSARY OF TERMS

 

Defined below are certain terms used in this report:

 

 

 

Forward‑Looking Statements

 

This Annual Report on Form 10‑K contains certain statements that constitute forward‑looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. In particular, any statement, projection or estimate that includes or references the words “believes”, “anticipates”, “intends”, “expects”, or any similar expression falls within the safe harbor of forward‑looking statements contained in the Reform Act. These forward‑looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from our historical experience and our present expectations or projections. Forward‑ looking statements by us are based on estimates, projections, beliefs, and assumptions of management and are not guarantees of future performance. Such forward‑looking statements may be contained in this Form 10‑K under “Item 1A—Risk Factors” and “Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations” and elsewhere. In light of these risks, uncertainties and assumptions, you should not place undue reliance on any forward‑looking statements. Additional risks that we may currently deem immaterial or that are not currently known to us could also cause the forward‑looking events discussed in this Form 10‑K not to occur as described. Except as otherwise required by applicable securities laws, we undertake no obligation to publicly update or revise any forward‑looking statements, whether as a result of new information, future events, changed circumstances or any other reason after the date of this Form 10‑K.

 

Risks, uncertainties and other important factors that could cause actual results to differ materially from those described in forward‑looking statements and from historical results include, but are not limited to, the following:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

PART I

 

Item 1.  Business

 

Business Overview

 

Hawaiian Telcom Holdco, Inc. (the Company) is the largest full service provider of communications services and products in Hawaii. We operate two primary business segments:

 

Telecommunications.    This segment provides local telephone service including voice and data transport, enhanced custom calling features, network access, directory assistance and private lines. In addition, the Telecommunications segment provides high speed Internet, long distance services, next generation television service, next generation Internet protocol (IP) based network services, customer premises equipment, data solutions, managed services, billing and collection, wireless services, and pay telephone services. Our services are offered on all of Hawaii’s major islands, except for our next generation television service, which currently is available only on the island of Oahu. As of December 31, 2016, our telecommunications operations served approximately 296,000 voice access lines, 19,000 business Voice over Internet Protocol (VoIP) lines, 111,000 high-speed Internet lines, and 42,000 video subscribers.

Data Center Services.    This segment consists of data center services including colocation and virtual private cloud.

 

See “—Segments and Sources of Revenue” below and “Segment Information” in the notes to the financial statements for information regarding revenues and total assets for each business segment.

 

History and Organizational Structure

 

General

 

The Company was incorporated in Delaware in 2004. Originally incorporated in Hawaii in 1883 as Mutual Telephone Company, our Hawaiian Telcom, Inc. subsidiary has a strong heritage of over 133 years as Hawaii’s communications carrier. From 1967 to May 1, 2005, we operated as a division of Verizon Communications Inc. (Verizon) or its predecessors. On May 2, 2005, the Verizon businesses conducted in Hawaii were reorganized and consolidated (2005 Reorganization) into Hawaiian Telcom Communications, Inc., a Delaware corporation and wholly owned subsidiary of the Company. As a result of the 2005 Reorganization, we became a stand-alone provider of communications services, operating as Hawaiian Telcom, Inc. and Hawaiian Telcom Services Company, Inc., both wholly owned subsidiaries of Hawaiian Telcom Communications, Inc.

 

On December 1, 2008, the Company, Hawaiian Telcom Communications, Inc., Hawaiian Telcom, Inc., Hawaiian Telcom Services Company, Inc. and certain other affiliates (collectively, the Debtors) filed voluntary petitions for relief under chapter 11 of the U.S. Bankruptcy Code in order to facilitate a balance sheet restructuring. The Debtors’ chapter 11 Plan of Reorganization became effective, and the Company and other Debtors emerged from chapter 11, on October 28, 2010.

 

Hawaiian Telcom, Inc., a Hawaii corporation, is the incumbent local exchange carrier (“ILEC”) in Hawaii and operates our regulated local exchange carrier business. Hawaiian Telcom Services Company, Inc., a Delaware corporation, operates other businesses including Internet, television, advanced communications and network services, managed services, data center services including colocation and virtual private cloud, cloud‑based services, long distance and wireless businesses. SystemMetrics Corporation, a wholly‑owned subsidiary of Hawaiian Telcom Services Company, Inc. and a Hawaii corporation, provides data center services including colocation and virtual private cloud. Wavecom Solutions Corporation, a wholly‑owned subsidiary of Hawaiian Telcom, Inc. and a Hawaii corporation, provides voice, data and converged services.

 

 

Industry Overview

 

The telecommunications industry is comprised of companies involved in the transmission of voice, data and video communications over various media and through various technologies. There are two predominant types of local telephone service providers, or carriers, in the telecommunications industry: incumbent local exchange carriers (ILECs) and competitive local exchange carriers (CLECs). An ILEC refers to the regional Bell operating companies (RBOCs), which were the local telephone companies created from the breakup of AT&T in 1984, as well as small and midsize independent telephone companies, such as Hawaiian Telcom, Inc., Cincinnati Bell Inc. and Consolidated Communications, Inc., which sell local telephone service. These ILECs were the traditional monopoly providers of local telephone service prior to the passage of the Telecommunications Act of 1996. In contrast, a CLEC is a competitor to local telephone companies that has been granted permission by a state regulatory commission to offer local telephone service in an area already served by an ILEC.

 

Over the last decade, the U.S. telecommunications industry has undergone significant structural changes as many of the largest service providers have achieved growth through acquisitions and mergers, while others have restructured or entered bankruptcy to obtain protection from creditors. In addition, the Telecommunications industry continues to see changes in consumer behavior as products and services continue to evolve.  Despite these changes, the demand for telecommunications services as a whole, particularly data services, has remained strong, and telecommunications companies increasingly bundle services and provide integrated offerings for customers.  Hawaii’s telecommunications industry remains active, and demand for telecommunications services overall remains strong, due in part to the State’s geographic isolation. Hawaii is connected to the mainland United States and Asia via cable and several satellite networks.

 

Our Business Strategy

 

Our primary objective is to become the number one service provider of innovative “Always OnSM” communications, information and entertainment solutions to the people and businesses of Hawaii. The key elements of our business strategy are to grow our business with a focus on delivering superior service to our customers, which includes the following:

 

 

 

 

 

In furtherance of the Company’s growth strategy, we continue to make important investments that further our business objectives:

 

 

 

Our Competitive Strengths

 

We believe the following are among our core competitive strengths and enable us to differentiate ourselves in the marketplace and help us successfully execute our business strategy:

 

 

 

 

 

Our Products and Services

 

Telecommunications

 

We generally classify our operations and related products and services into three core customer channels: Business, Consumer, and Wholesale.  Presented below is an overview of the products and services we offer in each customer channel.

 

Business Channel

Data Services

 

We provide a broad portfolio of data services, which we believe are a key growth area driven by demand for increasing bandwidth and more advanced data solutions from business customers.  We offer a range of broadband services including High-Speed Internet access, an asymmetrical broadband service geared toward small and medium-sized business customers, with speeds up to 1 Gigabits per second (Gbps) depending on the customer’s location, and Dedicated Internet Access (DIA), a symmetrical Internet access delivered over Ethernet with speeds up to 10 Gbps. 

 

The role of business communication providers is evolving. Consistent with this, we have expanded into application centric, advanced communications and network services. Our services include Routed Network Service, a high performance IP virtual private networking service for business customers; Enhanced Internet Protocol Data Service, a multipoint switched Ethernet service; and Hosted PBX, a business VoIP service that provides businesses with a complete, converged communication solution in a hosted package.

 

In addition to advanced communications and network services, we continue to provide special access tariff services such as frame relay, a shared wide area network service, and dedicated private lines.  See “—Regulation” for further discussion of special access.

 

Voice Services

 

Voice services include basic local phone and long distance services for business customers.  We provide basic local services generally for a fixed monthly recurring charge and can be enhanced with a variety of value  added services such as call waiting, caller ID, voice messaging, three way calling, call forwarding and speed dialing. Value added services may be purchased individually or as part of a package offering for a monthly recurring charge.  The rates that can be charged to customers for basic local and certain other services are regulated by the HPUC. We charge business customers higher rates to recover a portion of the costs of providing local service to residential customers, as is customary in the industry. See “—Regulation” for further discussion of regulatory matters.

 

Equipment and Managed Services

 

We have resale relationships and certifications with a number of branded technology vendors, which allows us to competitively sell and install a wide variety of telecommunications equipment such as key, PBX, and other hardware solutions.  In addition, we provide managed services as an end to end solution that manages, monitors, and supports a business’s network, CPE, and corporate data security. As business networks become more complex, the amount of time and capital businesses must spend to support their networks increases accordingly. Our managed services enable customers to focus on their core business by leaving the day to day management of their networks to us. Our managed services product portfolio consists of managed network and security services, IT professional services, and security consulting.

 

Consumer Channel

Video Services

 

We introduced our next-generation television service on the island of Oahu in July 2011. Our Hawaiian Telcom TV service is 100% digital with hundreds of local, national, international and music channels including high-definition, premium, Pay Per View channels and Video on Demand service. During 2016, we continued to invest in our network to provide integrated digital video, high-speed Internet and voice services to new and existing customers by adding 12,000 new households enabled for our TV service (“HHE”) bringing the total number of HHE to 202,000 as of the end of 2016.  The addition of new HHE in our single family home footprint is expected to subside beginning in 2017.  Our IPTV service is expected to be a critical growth component for our consumer products portfolio and an anticipated anchor of our service bundling strategy. With television, we are now able to bundle digital video, high-speed Internet and voice services in certain areas of the island of Oahu.

 

Internet Services

 

We provide high-speed Internet access to our residential customers with speeds up to 1 Gbps in the FTTP footprint.  For customers who order speeds of 50 Mbps or higher, we also offer Wi-Fi Plus, a premium program that provides customized solutions to maximize customers’ in-home Wi-Fi experience.

 

Voice Services

 

Consumer voice services include basic local telephone and long distance services.  We provide additional value-added features such as call waiting, caller ID, voice messaging, three way calling, call forwarding and speed dialing. We also offer a variety of long distance plans, including rate plans based on minutes of use, flexible or unlimited long distance calling services.  The rates that can be charged to customers for basic local and certain other services are regulated by the HPUC.  

 

Wholesale Channel

We provide special access or network transport services to our wholesale customers, network operators and other telecommunications carriers.  Special access services include IP-based private networks, Ethernet, as well as Synchronous Optical Network (SONET), and Time Division Multiplexing (TDM) transport services.  See “—Regulation” for further discussion of special access.  In addition, we also provide wireless backhaul, or fiber-to-the-tower connections to support the growing demand for wireless broadband. 

 

Other

Other services include interstate and intrastate switched access for the origination, transport and termination of long distance calls (see “—Regulation” for further discussion of access charges), Connect America Fund support (see “—Regulation” for further discussion of universal service), operator services, billing and collection services and space

and power rents for colocation services.  We also provide other services including public pay telephone services at approximately 3,100 locations throughout the State of Hawaii.

 

In addition, we offer wireless services pursuant to a mobile virtual network operator (MVNO) services agreement with Sprint Spectrum, L.P. (Sprint). That agreement allows us to resell Sprint wireless services, including access to Sprint’s nationwide personal communication service (PCS) wireless network to residential and business customers in Hawaii under the Hawaiian Telcom® brand name. The services agreement with Sprint was renewed in May 2015 for a 3-year term which expires in May 2018.

 

Data Center Services

 

We provide colocation and virtual private cloud data center services to our business customers. Colocation enables our customers to install and remotely operate their IT equipment. Virtual private cloud services include the use of shared virtualized computing resources and a variety of customer control features and services, including back up data storage and cloud-based network security. We also offer a complete cloud service portfolio that includes Desktop-as-a-Service product, Microsoft® Office 365 suite of cloud-based Software-as-a-Service products, along with Infrastructure-as-a-Service and Security-as-a-Service.  In addition, we provide related professional services, including planning, design, implementation and support services, to enable our customers to better manage and transition between their IT solutions.  We consider data center services as part of our business channel.

 

Markets and Customers

 

Telecommunications

 

We have been a telecommunications provider in Hawaii for more than 133 years. Our market consists of 86 central offices serving an area of approximately 6,263 square miles on the islands of Oahu, Maui, Hawaii, Kauai, Molokai and Lanai. We are the incumbent provider of local exchange services within this area and own the State’s most extensive local telecommunications network, with approximately 299,000 local access lines served as of December 31, 2016, of which 45% served residential customers, 54% served business customers, and the remaining 1% served other customers.

 

Our market is characterized by high population density, with approximately 70% of the state’s population concentrated on Oahu over an area of approximately 598 square miles, or approximately 1,700 persons per square mile. In addition, approximately 34% of the households in Hawaii reside in multi dwelling units (MDUs)—approximately 44% on Oahu—compared with approximately 26% in the U.S. overall. This concentration of customers and commerce provides opportunities to leverage our network infrastructure to deliver products and services efficiently and in a cost effective manner and to market and sell our services more effectively. Given Hawaii’s geographic isolation and the diversity of its population, Hawaii residents and businesses may have telecommunications needs that are different from those on the mainland United States. Furthermore, in 2015, the median household income in Hawaii was estimated to exceed the national median household income by approximately $16,000. For the foregoing reasons, our strategy is to leverage the distinctive qualities of the Hawaii market to develop customized, local marketing strategies.

 

Our business marketplace is dominated by several key industries. The federal government accounts for approximately 12% of gross state product. With the U.S. Pacific Command, one of the largest U.S. unified service commands, based in Hawaii, the federal government, collectively through its many departments and agencies, is one of our largest customers. Similarly, Hawaii state and local government, collectively through their many departments and agencies, constitutes a significant part of our business.  The hospitality industry and financial institutions also account for a significant portion of our business. The operations of these leading sectors are communications intensive, and we believe that they are dependent on our modern, reliable services. Hawaii’s small business market (in the aggregate) is also a key driver of Hawaii’s economy—approximately 95% of the companies in Hawaii employ fewer than 50 employees, and these businesses make up a market of approximately 37,000 businesses. We believe that these business customers represent an underserved segment that we are targeting aggressively with new product and service offerings.

 

Data Center Services

 

We believe there is a significant growth opportunity to provide data center services, including colocation and virtual private cloud, to businesses across the State of Hawaii. There are two important trends driving the growth in the adoption of data center services—the increasing use of cloud based technologies by business customers to run their most important business functions, and the increasing demand for outsourced solutions. At present, the percentage of businesses in Hawaii that use colocation and virtual private cloud services is small compared to utilization in similarly sized mainland U.S. markets.

 

Competition

 

The telecommunications industry is highly competitive. We experience competition from many communications service providers, including the local cable operator Oceanic Time Warner (Oceanic), wireless carriers, long distance providers, competitive local exchange carriers, Internet service providers, Internet information providers, over‑the‑top hybrid voice providers, and other companies that offer network services and managed enterprise solutions. Many of these companies have a strong market presence, brand recognition, and existing customer relationships, all of which contribute to competition that may affect our future revenue growth. We expect competition to intensify as a result of the entrance of new competitors and the rapid development of new technologies, products and services.

 

Oceanic, a subsidiary of Time Warner Cable Inc., the second largest cable operator in the United States, is the Company’s most significant competitor. Approximately 70% of the occupied households on Oahu that subscribe to television service subscribe to Oceanic’s cable television service. Oceanic also has the majority share of the high speed Internet market in Hawaii, which it uses as a platform to offer voice services utilizing VoIP technology, and markets its cable, high speed Internet, and voice services through competitive bundled offerings. In addition, Oceanic (now marketing business products under “Spectrum Business”) has targeted communications service offerings to small and medium sized businesses.  Oceanic competes aggressively with the Company on products, pricing and marketing.  In 2016, Charter Communications acquired Time Warner Cable Inc. but Oceanic continued to operate business-as-usual. In April 2017, Charter is expected to introduce its products and pricing in Hawaii.

 

Wireless communications services continue to constitute a significant source of competition with traditional wireline phone service, especially as wireless carriers expand and improve their network coverage and continue to lower their prices. As a result, many customers have chosen to completely forego use of traditional wireline phone service and instead rely solely on wireless services. We anticipate the wireless substitution trend will continue, and could pose additional threat to our high speed Internet product, particularly if wireless service rates continue to decline and the wireless service providers are able to deliver faster data speeds. Over the top hybrid providers, such as Skype and Magic Jack, also offer the capability to provide local voice and long distance calls using an Internet equipped personal computer.

 

The advanced communications and network services business, as well as the managed services, data center services including colocation and virtual private cloud, and cloud based services businesses, are highly competitive due to the absence of significant barriers to entry. The emergence of non-traditional, application centric players in the market is redefining the role of service providers in these fields.

 

We are uniquely positioned in the State to bundle data center services with network, managed services, data communications equipment and support services for an end to end, statewide solution. Due to the high cost of commercial real estate in the State of Hawaii, there is a limited inventory of colocation data center space available for Hawaii businesses. There are numerous other providers of cloud based software, including system integrators in Hawaii and web based service providers, that offer software subscriptions and virtual machines on cloud based servers housed in data centers on the mainland U.S. and internationally. However, such out of state solutions raise concerns regarding response latency, the higher cost of private network connectivity from Hawaii and data security.

 

We employ a number of strategies to combat the competitive pressures we face. Our strategies are focused on preserving and generating new revenues through customer retention, upgrading and upselling services to existing customers, new customer growth, winbacks of former customers, new product and feature deployment, and by managing

our profitability and cash flow through targeted reductions in operating expenses and efficient deployment of capital. We believe the key to success in these strategies is the continued enhancement and expansion in the speed and reach of our broadband network, which we believe will enable us to offer new products and services that will generate growth in our business and allow us to compete more effectively in the marketplace. Another key to success is a focus on enhancing the customer experience, as we believe exceptional customer service will differentiate us from our competition. Customers expect industry leading service from their service providers. As technologies and services evolve, the requirement of the carrier to excel in this area is crucial for customer retention.

 

Network Architecture and Technology

 

Our strategy is to enhance and expand the most technologically advanced broadband communications network in the state of Hawaii and to position ourselves as a key hub for critical trans-Pacific traffic. Pursuing such a strategy has enabled us, among other things, to continue being the market leader in Hawaii for advanced communications and network services and managed and cloud-based services. In 2016, we invested approximately $79 million in our network including significant expenditures to expand the reach, capacity, and resiliency of our IP-based packet and broadband network. Significant strides were made in 2016 to add hundreds of miles to our fiber network and continuing our transformation toward an optical, IP-based broadband network. Additionally, we believe that our commitment to the SEA-US trans-pacific submarine cable system will enable us to expand data connectivity beyond Hawaii to both the Asia/Pacific and Continental U.S. locations.

 

MPLS and Transport Network

 

We believe that our statewide MPLS network is unmatched in Hawaii in reach, capacity, security, resiliency, and reliability. Consisting of two provider core routers, eight provider edge routers, and 39 service edge routers meshed throughout the island chain, we offer a wide range of Layer 2 and Layer 3 MPLS services with many advanced features, including advanced traffic engineering support of intelligent QoS (Quality of Service) Service OAM (operations, administration, and management) capabilities, multiple access technologies, standards based routing protocols, Internet access across a single physical connection, and up to 100Gb Ethernet access. Driven by continued high bandwidth demands from our high-speed Internet service, next-generation television service, wireless backhaul, and other retail and wholesale business requirements, in 2016 we continued to expand our next generation network with the introduction of a provider core architecture that simplifies our overall network while increasing scale and maintaining the level of resiliency expected by our customers. These interconnected platforms combine wave division multiplexing (WDM) transport, reconfigurable optical add-drop multiplexers (ROADM), and centralized carrier Ethernet switching in a single converged device helping us to meet the growing bandwidth needs at a more affordable price. Our current backbone infrastructure consists of two border routers with diverse trans-Pacific links to mainland carriers, along with expanded peering and content caching arrangements with global providers to reduce latency and buffering to our customers. In 2017, we plan to continue to expand bandwidth capacity in the border and core sections of our MPLS network to accommodate increased demand and utilize our trans-pacific submarine cable system for direct connections to the world’s leading internet carriers.

 

Our telecommunication infrastructure includes more than 16,000 sheath miles of fiber optic cable and copper wire distribution lines. Submarine and deep-sea fiber optic cables connect the islands of Kauai, Oahu, Maui, Molokai, Lanai and Hawaii, while digital microwave radios provide backup inter island connections. In addition to our owned or leased interisland cables between Oahu, Kauai, Maui, Hawaii, Molokai, and Lanai, we are connected by trans-Pacific fiber optic cables to the U.S. Mainland, which provide ring diversity to protect our communications between the islands and high-speed broadband links in and out of the State.

 

Voice Network

 

We continue to add services and features via our VoIP application servers to provide Hawaii businesses the communication tools they need to compete locally and globally. In 2016, we extended our VoIP platform with Unified Collaboration (UC) features such as Instant Messaging and Presence.

 

As of December 31, 2016, we operated 99 local base and remote switches and five tandem switches on the islands of Hawaii, Kauai, Lanai, Maui, Molokai and Oahu. All of our legacy access lines are served by digital switches provided predominantly by Nokia (formerly Alcatel-Lucent) and Genband.

 

Network Optimization Initiatives

 

To lower on going operational costs and to adjust our capacity to account for legacy revenue attrition, we optimized portions of our network. We exited two legacy Wavecom leased sites, shut down our oldest WDM network consisting of five nodes, and exited two Hawaiian Telcom radio facilities.  We expect to increase the pace of optimizing our legacy network infrastructure in 2017.

 

Access Infrastructure

 

In 2016, we continued our aggressive investment to transform our access network to a high-speed, fiber-based broadband network and now have approximately 202,000 households enabled on our next generation broadband network.  An additional 3,900 business addresses are also on our GPON network. GPON is a FTTP solution providing a complete fiber connection to businesses allowing for transmission speeds of over 1 Gbps.  Continued deployment of FTTP solutions will serve new (greenfield) MDU, single family subdivision developments, and targeted business corridors. By laying fiber and utilizing various passive optical network components from these developments to our central offices, we can further leverage the capabilities of our MPLS backbone, provide higher bandwidth services to our customers, including our television service, and reduce maintenance costs. We also continued to expand our fiber network deeper into neighborhoods, shortening over 1,400 customer loops in 2016 to 3,000 feet or less using FTTN technology, expanded our fiber networks to approximately 491 cell sites across the state of Hawaii to provide backhaul services to our wireless carrier customers, and fine-tuned our FTTP access infrastructure to accommodate 1 Gbps download speed internet bandwidth in selected areas on all major islands. These network enhancements allowed the increased penetration and expansion of higher broadband services including our television service.  In 2016, we concluded our NGN build to residential addresses on Oahu.  Our 2017 plans includes further expansion of our next-generation broadband network in business areas.

 

In 2016, we concluded Phase I of the federal Connect America Fund (CAF) program to provide high speed data services to a total of approximately 1,800 underserved and unserved locations on the island of Hawaii.  Our 2017 plans include a continuation of expansion of providing broadband to additional CAF-eligible areas as part of our Phase II federal grant.

 

Next-Generation Television Service

 

The implementation of IP-based television service is driving one of the largest network transformations in the telecommunications industry. We introduced our next-generation television service on the island of Oahu in July 2011, deploying the service to both copper-fed and fiber-fed customers and converting entire MDU complexes to our new service. Utilizing Ericsson Mediaroom™ middleware, we provide a wide range of content and multimedia services over our IP based network and provide our customers with new viewing experiences and applications, such as Whole Home DVR (Digital Video Recorder), instant channel change, brilliant picture and sound quality, and over 80 TV Everywhere apps that allow customers to view content on mobile devices. We continue to see strong demand for our television service.

 

Network Surveillance and Operations

 

Our statewide network infrastructure is monitored and managed by our Network Operations Center (NOC) located in Honolulu. The eNOC provides surveillance 24x7, 365 days-a-year, for our statewide network consisting of 86 central offices, TV head-end facility, associated interoffice facilities, microwave radio towers, and E911 facilities. Our network infrastructure for voice, data, and video is monitored proactively with state-of-the-art performance and fault management systems. Customer networks are also monitored proactively by our Managed Services team. We have a customer service center which also operates on a 24x7, 365 days-a-year basis to handle customer inquiries and repairs, and provide call completion services. All customer installations and repairs requiring a field technician are offered

during extended hours and coordinated by our Dispatch Center. All construction activity, for both outside and inside plant, is coordinated by our engineering operations team located at our main office on Oahu.

 

In addition to our network infrastructure, we operate a wide range of equipment from large boom trucks to small passenger vehicles, mobile generators, and other miscellaneous trailers, tools and test equipment. We own or lease most of our administrative and maintenance facilities, central offices, remote switching platforms, and transport and distribution network facilities. With limited exception, our assets are located exclusively in the state of Hawaii.

 

Information Technology and Support Systems

 

Our IT-related initiatives continue to be aimed at delivering advanced technologies to our customers as well as delivering a superior customer service experience. Our systems have evolved and we continue to focus our strategy towards customer-centric architectures. This approach focuses on delivering end-to-end system solutions based on customer improvement initiatives integrated into product development. The service delivery mechanisms are comprised of a mixture of commercial off-the-shelf-systems, internally designed and developed systems that are purpose built for functions unique to our product offerings, and select niche applications that offer optimal capabilities and flexibility at the network layer.

 

As part of our ongoing commitment to customer service, we implemented improvements in 2016 to our customer contact center systems with the implementation of a 360° customer view and a significant upgrade to the latest IVR/ACD technology. In addition, in 2016 we provided our sales force with new system capabilities in support of our next generation network for quicker quoting.

 

We continue to focus efforts on flow-through automation from order entry through billing, and in 2016 we continued to implement improvements which reduced manual processing of complex orders, increased productivity, and enhanced overall data quality. We made further improvements in 2016 through consolidation of order entry process and systems. We improved our field dispatch and fiber provisioning systems to increase installation efficiency of our next generation network. In 2017, we plan to continue to make improvements through version upgrades of our existing Business Order entry systems, IVR/ACD, and our provisioning and inventory management applications.

 

As is the case with other telecommunications companies, we are an on-going target for cyber criminals. In response, we have aggressively pursued initiatives to reduce our cyber security related risks.  In 2016, we adopted the National Institute of Standards and Technology (NIST) Cybersecurity Framework to guide our current and future cybersecurity standards, policies, guidelines and practices.  Using this framework, we implemented a unified security management infrastructure to consolidate our cybersecurity threat detection and intelligence in addition to deploying additional security control points to improve our security posture.  We continue to provide our employees, contractors and vendors awareness including evolution of our corporate cybersecurity communications and policies.   Hawaiian Telcom also provides cybersecurity awareness to our customers and the Hawaii community in general.  In 2017, we continued our investment in security access, control points and systems as our Information Technology evolved in the areas of mobility and cloud services.   In addition, we continue to leverage government resources at the federal, state and local levels to enhance the cybersecurity of Hawaiian Telcom’s network and services.  These and other investments reflect our on-going commitment to securing our information assets and protecting sensitive data in our information systems.

 

Employees

 

As of December 31, 2016, we employed approximately 1,300 full‑time employees in Hawaii. Of the total employees, approximately 55% were represented by the International Brotherhood of Electrical Workers (IBEW) Local 1357 pursuant to a five‑year collective bargaining agreement that expires at the end of 2017.  Negotiations on a new collective bargaining agreement are expected to begin on or before May 1, 2017.  We believe that management currently has a constructive relationship with the represented and non‑ represented employee group.

 

Insurance

 

We have insurance to cover risks incurred in the ordinary course of business, including errors and omissions, cyber liability, general liability, property coverage (which includes business interruption), director and officers and employment practices liability, auto, crime, fiduciary and worker’s compensation insurance in amounts typical of similar operators in our industry and with reputable insurance providers. Central office equipment, buildings, furniture and fixtures and certain operating and other equipment are insured under a blanket property insurance program. This program provides substantial coverage against “all risks” of loss including fire, windstorm, flood, earthquake, and other perils not specifically excluded by the terms of the policies. As is typical in the telecommunications industry, we are self‑insured for damage or loss to certain of our transmission facilities, including our buried, undersea and above‑ground transmission lines. We believe that our insurance coverage is adequate; however, the incurrence of substantial uninsured liabilities due to damage or loss to such facilities could have a material adverse effect on our financial results.

 

Regulation

 

Federal and State Regulation of Telecommunications Services

 

Our telephone operations generally are subject to the jurisdiction of the FCC with respect to interstate services and the HPUC with respect to intrastate services. The following summary does not purport to describe all current and proposed applicable federal and state regulation.

 

Competition

 

We face increasing competition in all areas of our business. Regulatory changes brought on by the 1996 amendments to the Communications Act, regulatory and judicial actions, and the development of new technologies, products and services have created opportunities for alternative telecommunication service providers, many of which are subject to fewer regulatory constraints than our ILEC. We are unable to predict definitively the impact that the ongoing changes in the telecommunications industry will ultimately have on our business, results of operations or financial condition. The financial impact will depend on several factors, including the timing, extent and success of competition in our markets, the timing and outcome of various regulatory proceedings and any appeals, the timing, extent and success of our pursuit of new opportunities resulting from the amendments to the Communications Act and technological advances, and any changes in the state or federal laws or regulations governing communications.

 

Universal Service

 

As a provider of interstate telecommunications, we are required to contribute to federal universal service programs. The FCC adjusts the contribution amount quarterly and may increase or decrease this amount depending on demand for support and the total base of contributors. We previously drew Interstate Access Support of approximately $1.9 million annually from this funding, which was phased out in 2015 after we accepted Connect America Fund (CAF) Phase II support, as further described below.

 

In November 2011, the FCC released its “Connect America Fund” Order which adopted a number of proposals relating to reforming existing universal service support mechanisms. Among other things, the Order transformed the FCC’s universal service and intercarrier compensation systems into a new Connect America Fund (CAF), which funds broadband deployment in census blocks that the FCC has determined are unserved by an unsubsidized wireline competitor. For price cap carriers such as our subsidiary Hawaiian Telcom, Inc., CAF Phase II support is distributed pursuant to a forward looking cost model. In August 2015, we notified the FCC that we would accept CAF Phase II support which amounts to $4.4 million in annual funding for six years for the calendar years 2015-2020. Under the terms of CAF Phase II, we will offer broadband service at 10 Mbps downstream and 1 Mbps upstream or better to approximately 11,000 eligible locations in high-cost areas in the State of Hawaii and will provide voice and broadband services at reasonable rates.  In addition, the FCC previously awarded Hawaiian Telcom, Inc. approximately $400,000 in CAF Phase I Round 1 support and approximately $1 million in CAF Phase I Round 2 support.  Broadband deployment obligations for Rounds 1 and 2 have been completed. The FCC is expected to issue additional clarifications relating to CAF Phase II including the methodology for measuring broadband speeds but we do not know if this will impact our

ability to meet the program obligations and result in a loss of some of the support if program obligations are not fully met in a timely manner.

 

Government Regulation of Retail Rates

 

The FCC and the HPUC are the two agencies that regulate our telecommunications services. In general, the FCC regulates interstate service, and the HPUC regulates intrastate service. The HPUC has, slowly over time, reduced its rate regulation of some of our services. The HPUC classifies all regulated telecommunications services as fully competitive, partially competitive, or non‑competitive.

 

In 2009 and 2010, the Hawaii State Legislature required the HPUC to treat all intrastate retail telecommunications services, including intrastate toll (i.e., inter island), central exchange (Centrex), most residential and business local exchange services, integrated service digital network (ISDN) private lines and special assemblies, and directory assistance, as “fully competitive” under the HPUC’s rules with certain qualifications. HPUC approval and cost support filings are no longer required to establish or reduce rates or to bundle service offerings; however, all service offerings must be priced above the service’s long run incremental cost, and the HPUC can require cost support demonstrating compliance with its costing rules at any time. The HPUC retains the ability to suspend and investigate any offering.  In 2012, the Hawaii State Legislature further leveled the regulatory playing field by providing us with pricing flexibility to increase tariffed intrastate rates for any retail telecommunications service without approval from the HPUC with the exception of basic exchange service. (i.e., single line residential and single line business services), which continue to require HPUC approval. Competitive forces, however, may cause us to be unable to raise our local rates in the future.

 

The classification of retail local exchange intrastate services as fully competitive and the ability to bundle the services with other fully or partially competitive services or other services that are not within the HPUC’s jurisdiction enable us to charge a discounted rate for bundled service offerings and have helped us to be more competitive.

 

State and Federal Regulation of Long Distance Services

 

We are subject to certain conditions imposed by the HPUC and the FCC on the manner in which we conduct our long distance operations. For example, we are prohibited from joint ownership of local and long‑distance telephone transmission or switching facilities. The HPUC is responsible for ensuring that our ILEC does not discriminate against other long distance providers.

 

Federal Requirements

 

As an ILEC, we are subject to federal laws governing a number of access and interconnection requirements, other competitive obligations. Among other things, an ILEC must negotiate in good faith with other carriers requesting interconnection and access to unbundled network elements (UNEs) and must offer its competitors access to UNEs, such as local loops and inter office transport, at regulated rates. The FCC also has limited our obligation to unbundle fiber facilities to multiple dwelling units, such as apartment buildings, and to homes and offices deployed in FTTC and FTTP arrangements. In addition, federal law regulates competitors’ requests to colocate facilities within our central offices and to have access to our subscriber list information in order to produce competing directories. The FCC also has imposed specific rules regarding the manner and time within which a customer’s telephone number must be ported to a competing carrier’s service, and has strict guidelines prohibiting the ILEC’s use of this information for any other purposes.

 

Interstate and Intrastate Access Charges

 

The rates that we can charge for interstate access are regulated by the FCC. The FCC has made various reforms to the existing rate structure for access charges, which, combined with greater competition, have caused the aggregate amount of access charges paid by long distance carriers to decrease over time.

 

Our interstate and intrastate access charge levels have been and will continue to be fundamentally affected by the FCC’s reform of intercarrier compensation, described below.

 

Federal Framework for Intercarrier Compensation

 

In its “Connect America Fund” Order (see “—Universal Service” above) that reformed universal service, the FCC also fundamentally restructured the regulatory regime for intercarrier compensation, which consists of state and interstate access charges and local reciprocal compensation. Among other things, this comprehensive reform unifies state and interstate intercarrier charges in certain circumstances, provides a mechanism to replace intercarrier revenues lost through rate unification, and resolves prospectively a number of outstanding disputes among carriers regarding interconnection and compensation obligations. In particular, the FCC’s order required that price-cap carriers reduce interstate and intrastate terminating switched access rates to $.0007 over a six year phase-down period.  The FCC also required that most intercarrier compensation be eliminated, and that a system of “bill & keep” replace it whereby the carrier would have to seek recovery of its costs entirely from its own end users. In the interim, the FCC capped most existing intercarrier compensation rates and established a phase down of those rates over a six-year period for price cap companies such as Hawaiian Telcom, Inc. To partially offset the resulting decrease in revenues, the Commission authorized Hawaiian Telcom, Inc. to assess its end user customers a limited recovery charge that would increase over the time period during which intercarrier compensation rates decline, then would be phased out over a three-year period beginning in 2017. Finally, the FCC decided that interstate access charges should apply to VoIP or other Internet protocol based service providers on a prospective basis, subject to the same interim phase down requirements described above. The FCC found that carriers should have the opportunity to make up for any loss of revenues either through the established recovery mechanisms or through the sale of additional services, such as broadband and television services.

 

Hawaiian Telcom, Inc. has implemented the first five phases of the intercarrier compensation reform, offsetting a portion of the resulting revenue loss through the FCC-authorized monthly recurring access recovery charge for certain classes of customers.

 

In a separate proceeding, the FCC found that Internet bound traffic is not subject to reciprocal compensation under Section 251(b)(5) of the Communications Act. Instead, the FCC established a federal rate cap for this traffic, which is and will remain $0.0007 per minute until the FCC decides otherwise.

 

Special Access

 

The FCC has adopted rules for special access services that provide for pricing flexibility and ultimately the removal of services from price regulation when prescribed competitive thresholds are met. We currently have pricing flexibility for certain special access services offered throughout our territory. In the first quarter of 2015, Hawaiian Telcom, as a provider of dedicated special access services, complied with the FCC’s order for a mandatory special access data collection by filing detailed information concerning carrier services provided to enterprise and wholesale customers, including special access services. The FCC has used the data collected to evaluate competition in the market for special access services and to help the FCC decide whether to modify the special access pricing rules for price cap carriers, including whether the pricing flexibility rules should be modified or eliminated. The FCC has compiled the data and our economic consultant, hired by a consortium in which we participate with six other price cap carriers, has submitted their findings that competition in the special access market is robust and that pricing flexibility should be continued. We also filed comments in support of these findings with respect to the Hawaii market. In late 2016, the FCC Chairman circulated an Order that would have reduced BDS prices for certain legacy services over three years but this order was not voted on and it is uncertain when this proceeding will be concluded or what impact it will have on providers of dedicated special access services, especially in light of the pending change in the FCC Chairperson.

 

In October 2015, the FCC initiated an investigation into the terms and conditions of the special access service pricing plans of four large price cap carriers (AT&T, CenturyLink, Frontier, and Verizon).  Issues designated for investigation included whether the following practices were just and reasonable practices under the Communications Act (Act): (1) percentage commitments based on a purchaser’s historical or existing levels of purchases; (2) shortfall fees; (3) upper percentage thresholds; (4) overage penalties; (5) certain long-term commitments; and (6) early-termination fees.  The investigation also considered whether certain commercial agreements should be subject to the filing requirements of the Act and whether the special access pricing plans inhibit the transition from TDM-based special access to IP-based

services.    In May 2016 the FCC ordered the affected carriers to remove such provisions from their tariffs by July 1, 2016.  We do not know if and when we may be required to remove similar provisions from our tariffs.

 

Federal Regulatory Classification of Broadband and Internet Services

 

The FCC has been considering whether, and under what circumstances, services that employ Internet protocol are “telecommunications services” subject to regulations that apply to other telecommunications services, but it has not definitively ruled on the issue and instead has made a series of decisions addressing specific services and regulations.

 

In March 2006, a request of Verizon that sought forbearance from Title II regulation for certain advanced broadband special access services was deemed granted by operation of law. This forbearance grant was applicable to us since Hawaiian Telcom, Inc. was part of Verizon when the original Verizon petition for forbearance was filed. This action permitted us to deregulate covered advanced broadband special access services, giving us greater flexibility in our pricing and terms and conditions for eligible services. In October 2011, tw telecom of hawaii l.p. and others filed a petition requesting the FCC to reverse in part the forbearance deemed granted to Verizon. We filed comments in opposition to the petition. In November 2012, the Ad Hoc Telecommunications Users Committee and others filed a petition requesting the FCC to reverse in part the forbearance for Verizon and other grants of forbearance by the FCC related to advanced broadband special access services. There is no definite timeframe for an FCC decision on these petitions, which may be addressed as part of the special access proceeding.

 

In December 2010, the FCC adopted “net neutrality” rules, termed “open Internet” rules that would bar Internet service providers from blocking or slowing Web content sent to homes and businesses. The rules continue to treat broadband Internet access services under the FCC’s Title I authority, but adopted as rules the existing guidelines applicable to Internet service providers. The FCC also adopted three additional rules concerning blocking, non discrimination, and transparency. The anti-discrimination and no blocking rules were vacated by a federal court of appeals, but the public disclosure requirement remains in place.

 

In February 2015, the FCC reclassified broadband service, both fixed and mobile, from its longstanding status as a Title I information service to a Title II common carrier telecommunications service. While reasonable network management is permitted, the open Internet order bans blocking legal content/applications, throttling lawful traffic and paid prioritization or “fast lanes”, expands transparency rules and creates a general conduct rule to bar broadband Internet service providers from unreasonably interfering with or disadvantaging the ability of consumers and edge providers to reach and communicate with each other. Further, the FCC granted new authority to address Internet interconnection issues arising in the exchange of traffic between mass market broadband providers and other networks and services such as edge providers. While the order grants forbearance from many Title II provisions such as rate regulation or tariffs, last mile unbundling, burdensome filing requirements/accounting standards, USF contributions, and any new taxes or fees, uncertainty looms concerning continued forbearance in future years. All the new rules will be effective the first quarter of 2017, but Congress is considering adopting open Internet legislation to prevent Title II regulation of broadband services, and there are indications that the FCC may also reassess its reclassification of broadband service to a Title II common carrier telecommunications service given the pending changes at the FCC. We do not know what the final outcome of these actions will be, or how our broadband services may be affected.

 

Video Services Regulation

 

Through our Hawaiian Telcom Services Company, Inc. subsidiary, we began to provide television service on the island of Oahu in July 2011. We are regulated as a cable TV operator under federal and state law. As the non‑dominant video service provider in the state of Hawaii, we face the risk that we will be unable to obtain access to programming that we need in order to compete with Oceanic Time Warner (Oceanic), the dominant cable TV provider in the state. Some of this programming is owned by the parent company of Oceanic, which may or may not be required to provide access to us under the FCC’s program access rules.

 

In October 2012, the FCC issued an order lifting the program access rule ban on exclusive contracts between any cable operator and any cable‑affiliated programming vendor. It also issued a separate notice seeking comment on whether (1) to establish a rebuttable presumption that an exclusive contract for a cable‑affiliated Regional Sports

Network (RSN) is an unfair act; (2) it should establish a standstill provision during an RSN‑related complaint; and (3) the presumptions for RSNs should be extended to a cable‑affiliated national sports network. The FCC found a preemptive prohibition on exclusive contracts is no longer necessary and that a case‑by‑case process will remain in place to assess the impact of individual exclusive contracts. The FCC order provides a 45‑day answer period for all complaints and a six‑month deadline for it to act on a complaint alleging a denial of programming. The order also incorporates safeguards regarding RSNs, by establishing a rebuttable presumption that an exclusive contract involving a cable‑affiliated RSN has the “purpose or effect” of “significantly hindering or preventing” the complainant from providing television services, placing the burden of proof on the distributor.

 

In December 2012, the FCC granted a complaint filed by the Mauna Kea Broadcasting Company with the FCC seeking to place its over-the-air broadcasting station KLEI TV on both Oceanic’s and our television systems. The order required us to place KLEI TV on channel 6, which is already occupied by another programming station. Both Oceanic and Hawaiian Telcom Services Company, Inc. have filed a petition for reconsideration of this decision, which effectively stays the mandate of the order until all appeals are resolved. We cannot predict when or how the FCC will resolve this petition.

 

In June 2015, Charter Communications Inc. filed applications with the FCC, HPUC and Hawaii State Department of Commerce and Consumer Affairs (“DCCA”) Cable TV Division for approval of the merger of Charter Communications, Inc. ("Charter") and Time Warner Cable Inc. (TWC), which owns Oceanic, the dominant cable TV provider in Hawaii.  In this same transaction, Charter is also merging with Advance/Newhouse Partnership (“Advance”), which provides video services through Bright House Networks, LLC in six states, excluding Hawaii.  We filed comments with the FCC and DCCA that given Oceanic’s large market share in both the video and broadband markets, conditions specific to the Hawaii market should be placed on the acquisition so that the merger will not further stifle competition and harm the video programming and wired broadband markets in Hawaii.  Final approval of the transaction with limited non-Hawaii specific conditions was granted in May 2016.

 

In October 2016, the FCC adopted a Broadband Privacy order that requires broadband Internet service providers (ISPs) to obtain “opt-in” permission before using or sharing information about the sites their customers visit on the Internet and their online communications but allows the ISPs to use non-sensitive information on an opt-out basis—that is, unless the consumer takes affirmative action to object.  The order also imposes data security and breach notification requirements, as well as transparency requirements regarding notice of information collection, how it is used, who it is shared with, and customer options for granting or denying permission. Privacy information must be “persistently” available on the ISP’s website or mobile app.

 

The order abandons the three-tier usage-based privacy framework for broadband ISPs in favor of an approach that bases privacy obligations on the sensitivity of the information being used or shared and in some areas is inconsistent with the FTC’s technology-neutral privacy regime. The FCC’s order is subject to numerous petitions for reconsideration. We do not know what the final outcome will be, or how our broadband services may be affected.

 

Other Federal and State Regulatory Proceedings

 

The FCC has been exploring whether to modify its rules requiring utilities to provide telecommunications carriers and cable television companies with access to their poles, ducts, and rights of way. In April 2011, the FCC adopted new pole attachment rules that, among other things, require access to poles and conduit within a shorter period of time, and further limit make ready costs. In addition, these new rules change the rates for pole attachments by mandating that broadband attachers pay pole attachment rates that are closer to existing cable TV rates, than higher rates applicable to telecommunications carriers. These rules also for the first time allow telephone companies to demand reasonable rates from utility pole owners. These rules tend to increase the burdens and costs of pole and conduit owners such as us. The rules were upheld on appeal in February 2013. In December 2015, the FCC further revised the formula for calculating pole attachment rates for telecommunications carriers.  The change will ensure that pole attachment rates for telecommunications attachers, including providers of broadband Internet access service (BIAS), approximate the rates for cable attachers.  In November 2013, the FCC adopted rules to improve the reliability and resiliency of 911 communications networks nationwide by requiring that 911 service providers take reasonable measures to provide reliable 911 service, as evidenced by an annual certification. Providers can comply with this requirement by either

implementing certain industry backed “best practices”, or by implementing alternative measures that are reasonably sufficient to ensure reliable 911 service. As a 911 service provider, Hawaiian Telcom Inc. filed its annual certification that it was 100% compliant by October 2016 with the new 911 communications networks reliability and resiliency standards.

 

In August 2015, the FCC adopted rules concerning the transition from the copper-based Time Division Multiplexing (TDM) network to a fiber-based Internet Protocol (IP) network. To address backup power requirements for residential consumers of IP based voice and data services that replace the traditional telephony used to dial 911, effective February 2016, prior to switching facilities-based, fixed, residential voice services from copper, which is line-powered, to fiber, Hawaiian Telcom must educate affected residential subscribers on the impact of this switch, and offer these subscribers the option to purchase a backup power solution that provides at least eight hours of standby power during a commercial power outage. Within three years, in accordance with FCC requirements, Hawaiian Telcom is required to offer at least one option that provides a minimum of 24 hours standby power.  The purpose of the requirement is to ensure consumers can make calls to 911 in the event of a power outage.

 

In a separate proceeding, the FCC also adopted rules governing the retirement of copper loops and the discontinuance of legacy services used as a wholesale input. Among other things, ILECs will be required to: (1) provide interconnecting entities at least six months’ advance notice of proposed copper retirement; and (2) consider the impact of their actions on the end-users of carrier-customers when discontinuing, reducing, or impairing a service used as a wholesale input. In order to receive authority to discontinue, reduce, or impair either special access services at DS1 speed and above or commercial wholesale platform service, ILECs will also be required to provide competing carriers with wholesale access to their IP services on reasonably comparable rates, terms, and conditions. The FCC’s order is subject to a court appeal and it is uncertain when this will be resolved. 

 

In October 2015, Black Diamond Capital Management, LLC, (“Black Diamond”) which through two of its managed investment funds, collectively owns approximately 24.1% of the total outstanding common stock of Hawaiian Telcom Holdco, Inc. (Holdco), filed an application with the HPUC requesting approval to increase its ownership up to 33% of the outstanding common stock of Holdco. Under state law, no more than twenty-five percent of the issued and outstanding voting stock of a corporation organized under the laws of the State and who owns, controls, operates, or manages a public utility shall be held, by any single foreign corporation or any single nonresident alien, or held by any person, unless prior written approval is obtained from the HPUC. Hawaiian Telcom supported Black Diamond’s request based on the Standstill and Support Agreement between Black Diamond and Hawaiian Telcom.  In May 2016, the HPUC granted Black Diamond approval, with conditions, to increase its ownership up to 31.5% of the outstanding common stock of the Company.

 

In December 2015, the FCC, responding to a forbearance petition filed by USTelecom in late 2014, released an order removing certain regulatory requirements for legacy voice services that are no longer relevant in today's marketplace. The FCC granted forbearance from FCC rules regarding the unbundling of 64 kbps voice-grade channels. The FCC's rules previously required unbundling of such channels in order to provide narrowband services over fiber where an ILEC retires a copper loop it has overbuilt with FTTP or FTTC. The FCC granted forbearance, subject to a narrow, targeted "grandfathering" condition, under which incumbents must maintain access to unbundled 64 kbps channels that are in use as of the adopted date of the order. The FCC also granted forbearance from rules requiring ILECs to provide access to newly-deployed entrance conduit in “greenfield” (new developments) situations to competitive LECs at regulated rates. The FCC, however, denied forbearance for “brownfield” situations (existing developments) because that concluded that ILECs have a "pre-existing advantage" in brownfield deployments that merited different treatment. The removal of these requirements helps to level the playing field in the increasingly competitive telecommunications market by relieving us of some of the outdated obligations to provide competitive access. 

 

Environmental, Health and Safety Regulations

 

We are subject to various environmental, health and safety laws and regulations that govern our operations and may adversely affect our costs. Some of our properties use, or may have used in the past, on‑site facilities or underground storage tanks for the storage of hazardous materials that could create the potential for the release of

hazardous substances or contamination of the environment. We cannot predict with any certainty our future capital expenditure requirements for environmental regulatory compliance, although we have not currently identified any of our facilities as requiring material expenditures for environmental remediation or to achieve compliance with environmental regulations.

 

Available Information

 

We make available, through the Investor Relations link on our website at www.hawaiiantel.com, under “SEC Filings,” our annual reports on Form 10‑K, quarterly reports on Form 10‑Q, current reports on Form 8‑K, and amendments to those reports, free of charge as soon as reasonably practicable after we electronically file or furnish them to the U.S. Securities and Exchange Commission. The charters for the committees of our Board of Directors (Audit, Compensation, Executive, and Nominating and Governance Committees), as well as our Code of Business Conduct and any amendments and waivers thereto, also can be found on the Investor Relations site, under “Corporate Governance.” The contents of our website are not incorporated into this Annual Report on Form 10‑K.

 

 

Item 1A.  Risk Factors

 

You should carefully consider the risks described below as well as the other information contained in this Form 10‑K. Any of the following risks could materially adversely affect our business, financial condition or results of operations.

 

Risks Relating to our Business

 

Our business faces a variety of financial, operating and market risks, including the following:

 

The telecommunications industry is increasingly competitive, and we may have difficulty competing effectively.

 

All sectors of the telecommunications industry are competitive. Competition in the markets in which we operate could, among other things:

 

 

 

 

Any of these events could have a material adverse effect on our business and financial results.

 

Wireline Services.  As the ILEC, we face competition from resellers, local providers who lease UNEs from us, from facilities‑based providers of local telephone services, and from providers of VoIP services.

 

We have historically faced access line losses as a result of competition and substitution of traditional wireline services with wireless services. Access line losses have been faced by the industry as a whole, and we cannot assure you that access line losses will not continue in the future. In particular, the increasing penetration of high‑speed Internet and VoIP could lead to further primary and secondary access line losses.

 

Interconnection duties are governed, in part, by telecommunications rules and regulations related to the UNEs that must be provided. These rules and regulations remain subject to ongoing modifications. Our business is subject to extensive governmental regulation, and applicable legislation and regulations and changes to them could adversely affect our business. However, we received some regulatory relief in 2009 when the Hawaii State Legislature passed Act 180, which classified retail local exchange intrastate services as fully competitive. While HPUC approval and cost support filings are no longer required to establish or modify rates or to bundle service offerings, HPUC approval is required to raise the rate that existed for the retail service in the tariff at the time of implementation of Act 180. In addition, while

cellular wireless services initially complemented traditional local exchange and long distance services, existing and emerging wireless and IP technologies are increasingly competitive with local exchange and, particularly, long distance services in some or all of our service areas.

 

Internet Services.  We expect that the Internet access services business will continue to be highly competitive due to the absence of significant barriers to entry. We currently compete with a number of established online services companies, inter‑exchange carriers and cable companies. Competition is particularly intense for broadband services.

 

Managed Services.  We face numerous competitors that vary based on the type of managed services being offered. Other network service providers provide some form of managed network service monitoring capability. Numerous voice and data equipment vendors provide management of the installed equipment either at an individual location or across multiple networked locations. Competitive managed IP and network security services are offered by various firms that specialize in this area. 

 

Data Center and Cloud‑Based Services.  There currently is a limited inventory of colocation data center space available in Hawaii. However, there are numerous other providers of cloud‑based software, including system integrators in Hawaii and web‑based service providers, that offer software subscriptions and virtual machines on cloud‑based servers housed in data centers on the U.S. mainland and internationally.

 

Advanced Communications and Network Services.  These advanced services businesses are highly competitive. Many non‑traditional players have emerged in the business communications market, attracted by the absence of significant barriers to entry. Many of these non‑traditional players are capable of focusing on highly specialized areas of the market.

 

Next‑Generation Television Service.  We launched our television service on the island of Oahu in July 2011. The market for television services in Hawaii is dominated by Oceanic. On the island of Oahu, approximately 70% of occupied households that subscribe to television service subscribe to Oceanic’s cable service. There is no assurance we will be able to compete successfully against Oceanic. In particular, the costs to acquire programming is a significant and increasing cost, and there is no assurance our content acquisition costs will be in line with Oceanic’s such that we can remain competitive. Direct broadcast satellite companies currently are not significant competitors, but this could change in the future.

 

Wireless Services.  We provide wireless telecommunications services by use of a mobile virtual network operator (MVNO) model in which we resell another carrier’s facilities‑based wireless services under the Hawaiian Telcom® brand name. The market in Hawaii for wireless telecommunications services is subject to intense competition. In addition, our wireless business may be less profitable than the wireless businesses of other telecommunications companies due to our use of a MVNO model.

 

We have made and expect to continue to make material capital expenditures in connection with improvements to our network and other facilities. Unforeseen increases in the amount of capital expenditures required to execute our current business plan could have a material adverse effect on our business and financial results.

 

We have made and expect to continue to make a significant amount of capital expenditures to, among other things, enhance the capabilities of our network, such as that required to provide digital video service, enhance the functionality of our existing IT systems, and support the deployment of new products and services. We intend to fund these capital expenditures and expenses with operating cash flows and funds available to us under our credit facilities. Increases in the amount of capital expenditures and expenses required to upgrade our network and other facilities above those contemplated by our current business plan, could cause our cash flows and available financing to be insufficient to fund such capital expenditures and operating expenses and have a material adverse effect on our business and financial results.

 

Failures in our critical back‑office systems and IT infrastructure could have a material adverse effect on our business and financial results.

 

We operate our own back‑office and IT infrastructure, including business processes, software applications (such as billing systems, corporate finance systems, human resources and payroll systems and customer relationship management systems), and hardware that are vital to our operations. Failures in our back‑office systems and IT infrastructure could have a material adverse effect on our business and financial results.

 

Our success will depend on our ability to attract and retain qualified management and other personnel.

 

Our success depends upon the talents and efforts of our senior management team. The loss of any member of our senior management team, due to retirement or otherwise, and the inability to attract and retain highly qualified technical and management personnel in the future, could have a material adverse effect on our business, financial condition, results of operations, liquidity and/or the market price of our outstanding securities.

 

Approximately half of our workforce is represented by a labor union and therefore subject to a collective bargaining agreement, which expires at the end of 2017. The inability to enter into a new collective bargaining agreement on favorable terms could have a material adverse effect on our business, financial condition, results of operations, liquidity and/or the market price of our outstanding securities.

 

As of December 31, 2016, approximately half of our employees were covered by a collective bargaining agreement with the International Brotherhood of Electrical Workers Local 1357 (“IBEW”) that expires at the end of 2017. The inability to negotiate and enter into a new collective bargaining agreement on favorable terms could result in an increase in our operating expenses or covered employees could strike or engage in other collective behaviors. If unionized workers were to engage in a strike, we could experience a significant disruption of our operations or higher ongoing labor costs, either of which could have a material adverse effect on our business, financial condition, results of operations, liquidity and/or the market price of our outstanding securities. Future renegotiation of these and other labor agreements or the provisions of such labor agreements could adversely impact our service reliability and significantly increase our costs for healthcare, pension plans, wages and other benefits, which could have a material adverse impact on our business, financial condition, results of operations, liquidity and/or the market price of our outstanding securities.

 

An IT and/or network security breach may lead to unauthorized use or disabling of our network, theft of customer data, unauthorized use or publication of our intellectual property and/or confidential business information and could have a material adverse effect on our business and financial results.

 

We are subject to cyber and other data security risks.  This risk may be heightened as we expand our managed services, data center services, and cloud based services. We seek to effectively prevent, detect and respond to all cyber-attacks, but, in some cases, we might be unaware of an incident or its magnitude. Significant security failures could result in the theft, loss, damage, unauthorized use or publication of our intellectual property and/or confidential business information; the theft, loss, damage, unauthorized use or publication of our customers’ personally identifiable information, intellectual property and/or confidential business information; or the unauthorized use or disabling of our network elements. While we have technology and information security processes and cybersecurity risk managment in place to mitigate these risks and respond to any incidents, there is no assurance these measures will be adequate to prevent an incident, including incidents involving sophisticated criminal organizations and nation-state actors.  A disabling of our network elements or a loss of confidential or proprietary data or other data security breaches could materially and adversely affect our customers, employees and vendors, damage our reputation among customers and the public, disrupt operations, and subject us to possible financial losses, any of which could have a material adverse effect on our financial condition and results of operations and our ability to expand our services.

 

A network disruption could cause delays or interruptions of service, which could cause us to lose customers.

 

To be successful, we will need to continue to provide our customers with reliable and uninterrupted service over our expanded network. Disruptions in our service could occur as a result of events that are beyond our control. Some of the risks to our network and infrastructure include, without limitation:

 

 

 

 

 

From time to time, in the ordinary course of business, we have experienced and in the future may experience short disruptions in our service due to factors such as cable damage, inclement weather and service failures of our third‑party service providers. We could experience more significant disruptions in the future. In addition, certain portions of our network may lack adequate redundancy to allow for expedient recovery of service to affected customers. Disruptions may cause interruptions in service or reduced capacity for customers, either of which could cause us to lose customers and incur expenses, which could have a material adverse effect on our business, financial condition, results of operations, liquidity and/or the market price of our outstanding securities.

 

We rely on several material outsourcing agreements to operate our business. The loss of certain of these agreements, or the failure of any third party to perform under certain of these agreements, could have a material adverse effect on our business and financial results.

 

Several critical services necessary to operate our business are provided by third‑party service providers. For example, we have entered into agreements with Accenture and other third parties for the provision of, among other things, critical printing, billing, and IT services.

 

Upon expiration or termination of these agreements, we may not be able to replace the services provided to us in a timely manner or on terms and conditions, including service levels and cost, favorable to us, or at all. The failure of these third‑party service providers to satisfy their obligations under their agreements with us, without a suitable replacement, could have a material adverse effect on our business and financial results. Additionally, if these third‑party service providers were to seek U.S. bankruptcy law protection, our agreements with such service providers, and such service providers’ ability to provide the services under those agreements, could be adversely impacted, and although we may have a claim for damages against the bankruptcy estate, the claim may or may not be paid in the bankruptcy proceeding.

 

Our business is subject to extensive governmental regulation. Applicable legislation and regulations and changes to them could adversely affect our business and financial results.

 

We operate in a heavily regulated industry, and most of our revenues come from the provision of services regulated by the FCC and the HPUC. Laws and regulations applicable to us and our competitors may be, and have been, challenged in the courts and could be changed by federal or state legislative initiative, judicial review or regulatory agencies at any time. We cannot predict the impact of future developments or changes to the regulatory environment or the impact such developments or changes would have on us.

 

The “Connect America Fund” Order adopted by the FCC in November 2011 comprehensively reformed both the universal service program and intercarrier compensation and has had a significant impact on us. See “—Universal Service” above for a discussion of the impact of the Order on the universal service program, and “—Federal Framework for Intercarrier Compensation” above for a discussion of the impact of the Order on intercarrier compensation. Changes

in other FCC policies under review also could have a significant impact on us by increasing our obligations and/or reducing our revenue.

 

In February 2015, the FCC reclassified broadband service, both fixed and mobile, from its longstanding status as a Title I information service to a Title II common carrier telecommunications service. Although it is too early to determine with any certainty how the order will affect our broadband services, the order could result in additional costs and reduced margins in our broadband business. See “Federal Regulatory Classification of Broadband and Internet Services”.

 

State government regulation also is a source of business uncertainty. We cannot predict whether state proceedings will be initiated or the possible outcome of such proceedings at this time.

 

The HPUC could limit the ability of Hawaiian Telcom, Inc., one of the Company’s indirect operating subsidiaries, to distribute funds or assets to its parent company.

 

All of our operations are conducted through our subsidiaries.  Any revenue we may receive is derived from distributions from such subsidiaries. Hawaiian Telcom, Inc., one of our indirect operating subsidiaries, is subject to HPUC regulatory authority which could potentially limit the ability of Hawaiian Telcom, Inc. to distribute funds or assets to its parent company. The inability of any of our regulated subsidiaries to make a distribution would, thus, limit the ability and amount of funds available for us to make a distribution to our stockholders.

 

A reduction by the HPUC or the FCC of the rates we charge our customers would reduce our revenues and could reduce our earnings.

 

The rates we charge our local telephone customers are based, in part, on a rate‑of‑return authorized by the HPUC on capital invested in our network. These authorized rates, as well as allowable investment and expenses, are subject to review and change by the HPUC at any time. If the HPUC orders us to reduce our rates, our revenues would be reduced and our earnings also could be reduced absent corresponding reductions in costs or offsetting revenue increases in other segments. We cannot assure you that our rates will remain at their current levels. The HPUC order received in connection with the 2007 sale of our directories publishing business imposed a condition requiring the imputation of revenues. Specifically, a directory publishing revenue credit in the annual amount of $42.6 million per year must be added as regulated revenues into the calculation of Hawaiian Telcom, Inc.’s earnings from 2008 to 2022 in all future rate cases, alternative form of regulation proceedings, or other proceedings before the HPUC investigating Hawaiian Telcom, Inc.’s earnings or financial performance. This condition may adversely affect our ability to obtain rate increases in the future.

 

Also, our local exchange service competitors may gain a competitive advantage based on rules which favor competitors. For example, competitors have the ability to purchase our services at discounted rates set by the HPUC and to resell them at rates that are not subject to the level of regulatory scrutiny generally faced by us. Additionally, as a result of the state regulators permitting our competitors to intervene in rate‑setting proceedings, there is a potential that such competitors could obtain business sensitive information about us during such proceedings.

 

The FCC approves tariffs for interstate access and subscriber line charges, both of which are components of our network access revenue. The FCC currently is considering whether to restrain special access pricing by carriers like us subject to price caps on interstate rates. The “Connect America Fund” Order that the FCC adopted in November 2011 reduces switched interstate access charges for carriers like us over a period of six years but allows us to recover some of the foregone revenue from our end users. It is possible we may be required to recover more revenue through subscriber line charges or forego this revenue altogether. This could reduce our revenue or impair our competitive position.

 

 

If we do not adapt to technological changes in the telecommunications industry, we could lose customers and market share.

 

The telecommunications industry is subject to rapid and significant changes in technology, frequent new product and service introductions and evolving industry standards which could reduce the competitiveness of our services. Adapting to technological developments could require unbudgeted upgrades or the procurement of additional products that could be expensive and time consuming to implement. If we fail to adapt successfully to technological changes or fail to obtain access to important new technologies, we could lose customers and be limited in our ability to attract new customers and sell new services to our existing customers.

 

Our business may be adversely affected if we cannot continue to license or enforce the intellectual property rights on which our business depends.

 

We rely on patent, copyright, trademark and trade secret laws and licenses and other agreements with our employees, customers, suppliers and other parties to establish and maintain our intellectual property rights in technology and the products and services used in our operations. Also, because of the rapid pace of technological change, we develop our own technologies, products and services and rely on technologies developed or licensed by third parties. However, any of our intellectual property rights could be challenged or invalidated, or such intellectual property rights may not be sufficient to permit us to take advantage of current industry trends or otherwise to provide competitive advantages, which could result in costly redesign efforts, discontinuance of certain product or service offerings or other competitive harm. We may not be able to obtain or continue to obtain licenses from these third parties on reasonable terms, if at all. In addition, claims of intellectual property infringement could require us to enter into royalty or licensing agreements on unfavorable terms, incur substantial monetary liability or be enjoined preliminarily or permanently from further use of the intellectual property in question, which could require us to change our business practices or offerings and limit our ability to compete effectively. Even unsuccessful claims can be time‑consuming and costly to defend and may divert management’s attention and resources away from our businesses. In recent years, the number of intellectual property infringement claims has been increasing in the communications industry and this could negatively impact us as a company.

 

The failure to renegotiate programming contracts with television content providers on acceptable terms or at all could have a material adverse effect on our business and results of operations.

We expect television content costs to continue to be one of our largest operating costs associated with providing television service. In recent years, the cable industry has experienced rapid increases in the cost of programming, especially the costs for sports programming and for local broadcast station retransmission content.

 

Programming costs are generally assessed on a per-subscriber basis, and therefore, are related directly to the number of subscribers to which the programming is provided. Our relatively small base of subscribers limits our ability to negotiate lower per-subscriber programming costs.  As our programming contracts with content providers expire, there can be no assurance that they will be renewed on acceptable terms or that they will be renewed at all, in which case we may be unable to provide such programming as part of our video services packages.  The loss of this content could have a material adverse effect on our business and results of operations.

 

The geographic concentration of our operations in Hawaii make our business susceptible to local economic and regulatory conditions and consumer trends, and an economic downturn, recession or unfavorable legislative or regulatory action affecting Hawaii could have a disproportionate and material adverse effect on our business, financial condition, results of operations, liquidity and/or the market price of our outstanding securities.

 

Substantially all of our customers and operations are located in Hawaii. Because of Hawaii’s geographic isolation, the successful operation and growth of our businesses is dependent on favorable economic and regulatory conditions in the state. The Hawaii economy, in turn, is dependent upon many factors, including:

 

 

 

 

 

 

 

The customer base for telecommunications services in Hawaii is small and geographically concentrated. The population of Hawaii is approximately 1.4 million, approximately 70% of whom live on the island of Oahu. Any adverse economic conditions affecting Oahu, or Hawaii generally, could materially impair our ability to operate our business. Labor shortages or increased labor costs in Hawaii could also have a material adverse effect on our business.

 

Limitations on our ability to use NOL carryforwards, and other factors requiring us to pay cash to satisfy our tax liabilities in future periods, may affect our ability to fund our operations, make capital expenditures and repay our indebtedness.

 

We currently have a material amount of net operating loss (“NOL”) carryforwards and so‑called “built‑in losses,” all of which we intend to use in the future to reduce our federal and state taxable income. In the event that an “ownership change” were to occur with respect to our stock, it is possible that our ability to use our NOLs and built‑in losses would become subject to an annual limitation. An ownership change could occur with respect to our stock merely as a result of one or more “5‑percent shareholders” buying or selling our shares, even if no one person were to acquire a controlling percentage of our stock. Although we will monitor transfers of our stock, there can be no assurance that we will not suffer an ownership change with substantial adverse tax consequences.

 

Our indebtedness could adversely affect our financial condition.

 

We have a significant amount of indebtedness. We maintain a Term Loan in the amount of $290 million and a revolving credit facility which may be drawn in an amount up to $30 million (Revolving Credit Facility), each with a first priority lien on all assets.

 

The debt service requirements of our indebtedness could:

 

 

 

 

 

 

 

 

In addition, the terms of our Term Loan and Revolving Credit Facility contain financial and other restrictive covenants that limit our ability to engage in activities that may be in our long‑term best interests and restrict the payment of dividends. Our failure to comply with those covenants could result in an event of default which, if not cured or waived, could result in the acceleration of all of our debts.

 

The Term Loan matures in 2019. We generally do not expect to generate the necessary cash flow to repay our Term Loan in its entirety by the maturity date and such repayment in full is dependent upon the ability to refinance the Term Loan on reasonable terms. The ability to refinance the indebtedness on reasonable terms before the maturity date cannot be assured.

 

On February 24, 2017, we entered into a Credit Agreement with CoBank, ACB, and certain other lenders that are a party thereto that is expected to close on or about May 3, 2017 (the “New Facility”).  The Company plans to use a part of the proceeds of the New Facility to retire our existing Term Loan, but there is no assurance that we will successfully close the New Facility.

 

To service our indebtedness and fund capital expenditures, we will require a significant amount of cash. Our ability to generate cash depends on many factors beyond our control.

 

Our ability to make payments on and to refinance our current indebtedness and to fund planned capital expenditures will depend on our ability to generate cash in the future. This, to a certain extent, is subject to general economic, financial, competitive, legislative, regulatory and other factors that are beyond our control.

 

We cannot assure you that our business will generate sufficient cash flow from operations or that future borrowings will be available to us in an amount sufficient to enable us to pay our indebtedness or to fund our other liquidity needs. We will likely need to refinance all or a portion of our indebtedness on or before maturity. We cannot assure you that we will be able to refinance any of our indebtedness on commercially reasonable terms or at all.

 

Restrictive covenants in the agreements governing our indebtedness restrict our ability to operate our business and pursue our business strategies, and a breach of such covenants may result in the acceleration of our long‑ term debt maturities.

 

The restrictive covenants in the Term Loan, Revolving Credit Facility and under the New Facility limit our ability, among other things, to:

 

 

 

 

 

 

 

 

In addition, the restrictive covenants may prohibit us from prepaying our other indebtedness and require us to maintain compliance with specified financial ratios. Our ability to comply with these ratios may be affected by events beyond our control.

 

Severe weather conditions and natural disasters which occur in Hawaii could have a material adverse effect on our operations and financial results.

 

From time to time, Hawaii experiences severe weather conditions such as high winds and heavy rainfall, and natural disasters such as earthquakes, volcanic eruptions and tsunami, which can overwhelm our employees, disrupt our services and severely damage our property. Such disruptions in service and damage to property could materially decrease our revenues and materially increase our expenses. In 2014, Hawaii experienced two hurricanes and a volcanic eruption which adversely affected our financial results. In 2015, seven hurricanes and six tropical storms passed near Hawaii, resulting in record rainfall which damaged infrastructure and adversely affected our financial results. In 2016, one tropical storm and two hurricanes either made landfall or passed near Hawaii causing heavy rainfall and high surf. While these events did not have a material adverse effect on our operating results or financial condition, we cannot assure you that these types of events will not become more common or severe in the future or not result in material harm to the Company’s business, financial condition, results of operations, liquidity and/or the market price of our securities.  Moreover, it is impossible to predict the extent to which climate change could cause extreme weather conditions to become more frequent or more extreme.

 

Concentration of ownership among stockholders may prevent new investors from influencing significant corporate decisions.

 

Based on Schedules 13D and 13G, and Forms 4 filed by the respective holders, as of December 31, 2016, two of our stockholders collectively (with their affiliates) own approximately 45% of our outstanding common stock.  Each of these two stockholder groups filed a Schedule 13D in 2015 indicating that it may, among other things, engage in communications with our representatives or other stockholders of the Company, purchase additional shares of Company common stock or propose directors for our Board of Directors.  In 2016, we entered into a Nomination, Standstill and Support Agreement with our largest stockholder, Black Diamond Capital Management, L.L.C. (“BD”), and a Nomination, Standstill and Support Agreement(collectively, the Standstill Agreements) with our second largest beneficial stockholder, Twin Haven Capital Partners, L.L.C., Twin Haven Special Opportunities Fund III, L.P., Twin Haven Special Opportunities Partners III, L.L.C., Twin Haven Special Opportunities Fund IV, L.P. and Twin Haven Special Opportunities Partners IV, L.L.C. (collectively, Twin Haven).  Pursuant to each of the Standstill Agreements, among other things, we agreed to nominate one designee of each of BD and Twin Haven to our Board of Directors at each of the next three annual meetings of stockholders. In return, each of BD and Twin Haven has agreed during the three-year term, among other things, to refrain from taking certain actions with respect to us and our securities (including soliciting proxies, proposing any sale transaction or tender offer, seeking representation on our Board of Directors in excess of one designee, or acquiring additional shares of Company common stock beyond an agreed-upon level) and, subject to limited exceptions, to vote all of its shares in accordance with the recommendation of our Board of Directors on any matter submitted for stockholder approval. Although the Standstill Agreements limit BD’s and Twin Haven’s influence over us, each of our major stockholders still has significant influence on the outcome of matters requiring stockholder approval, even if these stockholders are not acting in a coordinated manner, including the election of directors and significant corporate transactions, such as mergers, consolidations or the sale of substantially all of our assets. This concentration of ownership may make some transactions more difficult or impossible without the support of these stockholders, or more likely with the support of these stockholders, and may have the effect of delaying or preventing a change of control, including a merger, consolidation or other business combination involving us, or discouraging a potential acquirer from making a tender offer or otherwise attempting to obtain control, even if that change of control may otherwise benefit our other stockholders.

 

Future sales or the possibility of future sales of a substantial amount of our common stock may depress the price of our common stock.

 

Future sales, or the availability for sale in the public market, of substantial amounts of our common stock could adversely affect the prevailing market price of our common stock and could impair our ability to raise capital through future sales of equity securities. The market price of our common stock could decline as a result of sales of a large number of shares of our common stock in the market or the perception that these sales could occur.  Additionally, the high concentration of ownership of our stock could increase the risk that such a large block sale could occur. These sales,

or the possibility that these sales may occur, may also make it more difficult for us to obtain additional capital by selling equity securities in the future at a time and at a price that we deem appropriate.

 

Item 1B.  Unresolved Staff Comments.

 

None

 

Item 2.  Properties.

 

We own our corporate headquarters, which is located in 1177 Bishop Street, Honolulu, Hawaii 96813 and consists of over 465,000 square feet of office space. We also have other properties consisting primarily of approximately 124 owned (including part‑owned) and approximately 57 leased or licensed real estate properties, including our administrative facilities and facilities for call centers, customer service sites for the television business, switching equipment, fiber optic networks, microwave radio and cable and wire facilities, cable head‑end equipment, coaxial distribution networks, routers and servers used in our telecommunications business, as well as a state‑of‑the‑art data center facility with up to 6,500 square feet of data center capacity and room for expansion. See Item 1, “Business—Network Architecture and Technology.” For purposes of Hawaii state law, we are classified as a public utility and, accordingly, do not pay any property taxes on properties used in providing telecommunication services. Substantially all of our assets (including those of our subsidiaries) are pledged for the Term Loan.

 

Item 3.  Legal Proceedings

 

We are involved in various claims, legal actions and regulatory proceedings arising from time to time in the ordinary course of business. In the opinion of management, the ultimate disposition of the legal matters in which the Company is currently involved will not have a material adverse effect on our combined financial position, results of operations or cash flows.

 

Item 4.  Mine Safety Disclosures

 

Not applicable.

PART II

 

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

 

Market Information 

 

Our Common Stock trades on The NASDAQ Stock Market under the symbol “HCOM”. The holders of our Common Stock are entitled to one vote per share on any matter to be voted upon by stockholders. The following table sets forth the high and low sales prices of our Common Stock for the period from January 1, 2015 through December 31, 2016:

 

 

Holders

 

As of March 1, 2017, there were 36 holders of record of our Common Stock and approximately 3,450 beneficial owners.

 

Dividends

 

We have not declared or paid any dividends on our Common Stock. Our Term Loan and Revolving Credit Facility limit our ability to declare or pay dividends.

 

Securities Authorized for Issuance Under Equity Compensation Plans.

 

Securities authorized for issuance under equity compensation plans as of December 31, 2016 included:

 

 

 

 

Sale of Unregistered Securities

 

None.

 

Purchases of Equity Securities by the Issuer and Affiliated Purchasers

 

None.

Stockholder Return Performance Graph 

 

The graph below compares the cumulative total stockholder return on our Common Stock with the cumulative total return on the Standards & Poor’s (S&P) 500 Stock Index, and the NASDAQ Telecommunications Index for the five years ending December 31, 2016, assuming an initial investment of $100 with reinvestment of dividends.

 

COMPARISON OF CUMULATIVE TOTAL RETURN

 

Among Hawaiian Telecom Holdco, Inc., S&P 500 and NASDAQ Telecommunications

 

 

 

 

The foregoing performance graph and related information shall not be deemed “soliciting material” or to be “filed” with the SEC, nor shall such information be incorporated by reference into any future filings under the Securities Act of 1933 or the Securities Exchange Act of 1934, each as amended, except to the extent we specifically incorporate it by reference into such filing.

 

Item 6.  Selected Financial Data

 

The following selected financial data should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and related notes thereto included elsewhere in this annual report.

 

Selected Financial Data (dollars in thousands, except per share amounts)

 

 

 

 

 

 

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

 

Background

 

In the following discussion and analysis of financial condition and results of operations, unless the context otherwise requires, “we,” “us” or the “Company” refers, collectively, to Hawaiian Telcom Holdco, Inc. and its subsidiaries.

 

The statements in the discussion and analysis regarding industry outlook, our expectations regarding the future performance of our business and the other non‑historical statements in the discussion and analysis are forward‑looking statements. These forward‑looking statements are subject to numerous risks and uncertainties, including, but not limited to, the risks and uncertainties described in Item 1A, “Risk Factors.” Our actual results may differ materially from those contained in any forward‑looking statements. You should read the following discussion together with Item 6, “Selected Financial Data” and our consolidated financial statements and related notes thereto included elsewhere in this annual report. We undertake no obligation to update publicly any forward looking statements for any reason even if new information becomes available or other events occur in the future.

 

Segments and Sources of Revenue

 

We operate in two reportable segments (telecommunication and data center services) based on how resources are allocated and performance is assessed by our chief operating decision maker. Our chief operating decision maker is our Chief Executive Officer.

 

Telecommunications

 

The telecommunication segment derives revenue from the following sources in three main customer channels:

 

Business Channel

 

Business data services include high bandwidth data products such as Ethernet and Dedicated Internet Access along with traditional High-Speed Internet (“HSI”) for business customers and VoIP.  Business VoIP, also referred to as BVoIP, is a unified hosted communications solution for business that includes digital voice services bundled with internet service.

 

Voice services include local telephone service for business customers.  These revenues include monthly charges for basic service and enhanced calling features such as voice mail, caller ID and 3-way calling.  Voice also includes long distance services and subscriber line charges prescribed by the Federal Communication Commission and imposed on voice customers. 

 

Equipment and managed services includes installation and maintenance of business customer premise equipment as well as managed service for customer telephone and IT networks.

 

Consumer Channel

 

Video services are marketed as Hawaiian Telcom TV which includes digital television as well as advanced entertainment services.  High-Speed Internet services are provided to residential customers as well.  Voice services include basic local phone and long distance services, as well as enhanced features.

 

Wholesale Channel

 

Wholesale revenue represents wholesale carrier data services provided to both wireline and wireless carriers.

Other

 

We receive revenue from various other sources such as wireless services which includes the sale of wireless handsets and other wireless accessories, and switched carrier access which compensates us for origination, transport and termination of calls for long distance and other interexchange carriers.  Also included in other revenue is government subsidies generally to provide service in rural or isolated areas.

 

Data Center Services

 

The data center services segment provides physical colocation, virtual colocation and various related telephony services.  We consider data center services as part of our business channel.

 

Results of Operations for the Years Ended December 31, 2016, 2015 and 2014

 

Operating Revenues

 

The following tables summarize our volume information (lines or subscribers) as of December 31, 2016, 2015 and 2014, and our operating revenues for the years ended December 31, 2016, 2015 and 2014.

 

Volume information includes certain information by lines.  The line counts represent the number of billed units as of the end of the period as reflected in the records of our primary billing system.  The separation of units by the business and consumer channel is based on the customer account designation in the billing system which is generally consistent with how revenue information is separated by channel.  Business data lines represent digital subscriber lines used to provide internet services.  Video service subscribers are determined with a count of individual customers as reflected in our primary billing system as of period end.  For bulk contracts for multi dwelling units, we count individual residences subject to the bulk contract.  Video homes enabled is estimated based on a count of single family homes and homes in multi dwelling units that are able to obtain our television service as of the period end.

 

 

Volume Information

 

 

 

 

 

Operating Revenues (dollars in thousands)

 

 

Business Channel

 

The Company continues to transform its business channel by replacing traditional voice services with next generation strategic services.  The Company considers strategic service revenues in the business channel to include business data services and data center services.  Business strategic revenues for the year ended December 31, 2016 represent 40% of the total business channel revenues compared to 35% in the prior year.

 

Business data services,  including internet and BVoIP, for the year ended December 31, 2016 increased compared to the prior year primarily due to non-recurring fees associated with one large institutional customer.  For the year ended December 31, 2016 and 2015, business data services revenue from this customer amounted to $6.2 million and $1.1 million, respectively, including non-recurring fee revenue.  We anticipate less revenue from this customer in 2017 as the recognition of revenue on certain upfront billed amounts ended with the fixed contract term on June 30, 2016.  In addition, during the year ended December 31, 2016, we recognized the remaining balance of deferred up-front charges of $0.8 million when another institutional customer terminated the related services.  In general, the demand for data services continues to rise as reflected in the growth in BVoIP lines. 

 

Continued competition in the telecommunications industry has increasingly resulted in customers using technologies other than traditional phone lines for voice and data. Business customers are moving local voice services to VoIP technology.  Generally, VoIP technology is less expensive than traditional wireline phone service, requiring us to respond with more competitive bundled unified service such as our BVoIP product.

 

The decrease in voice service revenues for the business channel for the year ended December 31, 2016 compared to the year ended December 31, 2015 was caused primarily by the decline of voice access lines. Business voice access lines decreased 4.3% as of December 31, 2016 compared to 2015.  The decline in traditional voice access lines was partially offset by an increase in BVoIP lines of 14%.

 

Data center services revenues for the year ended December 31, 2016 increased when compared to the prior year period as a result of year-over-year increased Ethernet, security and hardware sales.  Data center services is deemed a separate business segment.  However, we consider this an integral part of our business channel.

 

Equipment and managed services sales increased for the year ended December 31, 2016 when compared to the prior year because of large contract installations for certain commercial and institutional customers.  Revenue from equipment sales varies from period to period based on the volume of large installation projects. 

 

Consumer Channel

 

The Company continues to transform its consumer channel by replacing traditional voice services with next generation strategic services.  The Company considers strategic service revenues in the consumer channel to include video and internet services.  Consumer strategic revenues increased $3.2 million for the year ended December 31, 2016 and now represent 49% of the total consumer channel revenues compared to 46% in the prior year.

 

Video services revenue increased for the year ended December 31, 2016 compared to the prior year due to an increase in video subscribers of 5,681 as well as in increase in the rates charged subscribers. 

 

Internet revenues for the year ended December 31, 2016 decreased compared to the prior year as a result of the combined effect of competitive pricing and decline in internet subscribers.

 

The decrease in voice services revenue for the year ended December 31, 2016 compared to the year ended December 31, 2015 was caused primarily by a decline in voice access lines.  Consumer voice access lines decreased 10.9% during the year which contributed an estimated $8.7 million to the decline in consumer voice services revenue.  Residential customers are increasingly using wireless services in place of traditional wireline phone services as well as using VoIP technology offered by cable competitors.

 

In an effort to slow the rate of internet and voice line loss, we are continuing retention and acquisition programs, and are increasingly focusing efforts on bundling of services. We have instituted various “saves” campaigns designed to focus on specific circumstances where we believe customer churn is controllable. These campaigns include targeted offers to “at risk” customers as well as other promotional tools designed to enhance customer retention. We also emphasize win back and employee referral programs. Additionally, we are intensifying our efforts relative to developing tools and training to enhance our customer service capability to improve customer retention and growth.

 

Wholesale and Other Channel

 

Wholesale carrier revenue decreased for the year ended December 31, 2016 compared to the prior year as certain carriers have replaced older legacy circuits with more cost effective higher bandwidth solutions. 

 

Other revenue decreased for the year ended December 31, 2016 compared to the year ended December 31, 2015 because of a decline in ancillary services.  There has been a reduction in marketing effort on certain ancillary products, such as wireless, as we focus on other telecommunication and data center services.

 

 

Operating Revenues (dollars in thousands)

 

 

Business Channel

 

Business data services revenue for the year ended December 31, 2015 increased when compared to the prior year as demand for data services continued to grow as reflected in the growth in data lines and BVoIP lines.

 

The decrease in voice services revenues for the year ended December 31, 2015 compared to the prior year period was caused primarily by the decline of voice access lines from 2014 to 2015 because of the same factors discussed previously for the decline from 2015 to 2016.  Business voice access lines decreased 4.3% during the period for an estimated $4.3 million impact. 

 

Data center services revenues for the year ended December 31, 2015 increased when compared to the prior year period as a result of year-over-year increased virtual colocation services.

 

Equipment and managed services sales for the year ended December 31, 2015 compared to the year ended December 31, 2014 increased because of large contract installations for certain institutional customers.

 

Consumer Channel

 

Video service revenue increased for the year ended December 31, 2015 compared to the prior year due to an increase in video subscribers of 7,752 as well as in increase in the rates charged subscribers. 

 

Internet services revenue for the year ended December 31, 2015 increased when compared to the prior year as a result of a rate increase and as more customers were subject to premium pricing on higher bandwidth offerings.  Consumer internet lines did not change significantly between December 31, 2015 and December 31, 2014.

 

The decrease in voice services revenues for the consumer channel for the year ended December 31, 2015 compared to the prior year period was caused primarily by the decline of voice access lines from 2014 to 2015 because of the same factors discussed previously for the decline from 2015 to 2016.  Residential voice access lines decreased 10.3% during the period for an estimated $9.0 million impact.

 

Wholesale and Other Channel

 

Wholesale carrier revenue for the year ended December 31, 2015 compared to the prior year period decreased as certain carriers have replaced older legacy circuits with more cost effective alternatives. 

 

Other revenue was impacted by government subsidies from the Universal Service Fund which increased for the year ended December 31, 2015 compared to the prior year by $2.5 million. In conjunction with reforming the Universal

Service Fund, the Federal Communications Commission (“FCC”) established the Connect America Fund (“CAF”) which provides incremental support to broadband service providers. CAF Phase II is the long-term component of the program. In August 2015, we notified the FCC that we are accepting CAF Phase II support which amounts to $4.4 million in annual funding. This support was retroactive through the beginning of 2015, net of certain other receipts from the Universal Service Fund, and will continue for six years. Under the terms of the CAF Phase II, we will offer broadband service at 10 Mbps downstream and 1 Mbps upstream or better to approximately 11,000 eligible locations in high-cost areas in the State of Hawaii and will provide voice and broadband services at reasonable rates. For the year ended December 31, 2015, we recognized $3.3 million in CAF Phase II subsidies as revenue in the consolidated statement of income.

 

Other revenues declined for the year ended December 31, 2015 compared to the year ended December 31, 2014, despite the increase in government subsidies, as there has been a reduction in marketing effort on certain ancillary products, such as wireless, as we focus on other telecommunication and data center services.

 

Operating Costs and Expenses

 

The following table summarizes our costs and expenses for 2016 compared to the costs and expenses for 2015 (dollars in thousands):

 

 

The Company’s total headcount as of December 31, 2016 was 1,290 compared to 1,315 as of December 31, 2015.  Employee related costs are included in both cost of revenues and selling, general and administrative expenses. 

 

Cost of revenues consists of costs we incur to provide our products and services including those for operating and maintaining our networks, installing and maintaining customer premise equipment, and cost of services sold directly associated with various products. Costs of revenue for the year ended December 31, 2016 increased when compared to the prior year because of higher content costs for Hawaiian Telcom TV of $6.8 million as we add subscribers.  These increases were offset by lower electricity charges of $1.9 million on lower rates and usage from various power saving initiatives.  In addition, wages were lower by $1.9 million related to less time needed for rain related repairs and efficiencies in the use of our workforce.

 

Selling, general and administrative expenses include costs related to sales and marketing, information systems and other administrative functions.  The decrease for the year ended December 31, 2016 compared to the prior year period was due to lower pension costs of $4.7 million.  There was a significantly higher volume of retirements involving