UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark one)

[X]	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2018

[ ]	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission File Number: 001-34686

Hawaiian Telcom Holdco, Inc.

(Exact name of registrant as specified in its charter)

Delaware		16-1710376
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

1177 Bishop Street

Honolulu, Hawaii 96813

(Address of principal executive offices)

808-546-4511

(Registrant's telephone number, including area code)

Not Applicable

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

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes [X] No [ ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See definition of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):

Large Accelerated Filer [ ]

Accelerated Filer [X]

Non-Accelerated Filer [ ]

(Do not check if smaller
reporting company)

Smaller reporting company [ ]

Emerging Growth Company [ ]

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) 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 [X]

As of May 10, 2018, 11,667,205 shares of the registrant’s common stock were outstanding.

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		Page
Part I	Financial Information
Item 1	Condensed Consolidated Financial Statements (Unaudited)	3
Item 2	Management’s Discussion and Analysis of Financial Condition and Results of Operations	24
Item 3	Quantitative and Qualitative Disclosures About Market Risk	33
Item 4	Controls and Procedures	34

Part II	Other Information
Item 1	Legal Proceedings	35
Item 1A	Risk Factors	35
Item 5	Other Information	36
Item 6	Exhibits	37

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PART I — FINANCIAL INFORMATION

Item 1. Condensed Consolidated Financial Statements (Unaudited)

Hawaiian Telcom Holdco, Inc.

Condensed Consolidated Statements of Income (Loss)

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


	Three Months Ended
	March 31,
	2018		2017
Operating revenues	$	89,222	$	94,510
Operating expenses:
Cost of revenues (exclusive of depreciation and amortization)		42,088		41,191
Selling, general and administrative		27,625		29,632
Depreciation and amortization		23,333		21,269
Total operating expenses		93,046		92,092
Operating income (loss)		(3,824)		2,418
Other income (expense):
Interest expense		(4,136)		(3,993)
Retirement plan		710		(1,763)
Total other expense		(3,426)		(5,756)
Loss before income tax benefit		(7,250)		(3,338)
Income tax benefit		(1,514)		(1,386)
Net loss	$	(5,736)	$	(1,952)
Net loss per common share -
Basic	$	(0.49)	$	(0.17)
Diluted	$	(0.49)	$	(0.17)
Weighted average shares used to compute net loss per common share -
Basic		11,597,918		11,529,046
Diluted		11,597,918		11,529,046

See accompanying notes to condensed consolidated financial statements.

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Hawaiian Telcom Holdco, Inc.

Condensed Consolidated Statements of Comprehensive Income (Loss)

(Unaudited, dollars in thousands)


	Three Months Ended March 31,
	2018		2017
Net loss	$	(5,736)	$	(1,952)
Other comprehensive income (loss):
Retirement plan gain (loss)		(120)		21,142
Income tax benefit (provision) on other comprehensive income (loss)		31		(8,080)
Other comprehensive income (loss), net of tax		(89)		13,062
Comprehensive income (loss)	$	(5,825)	$	11,110

See accompanying notes to condensed consolidated financial statements.

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Hawaiian Telcom Holdco, Inc.

Condensed Consolidated Balance Sheets

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


	March 31,		December 31,
	2018		2017
Assets
Current assets
Cash and cash equivalents	$	19,191	$	40,759
Receivables, net		24,119		32,229
Material and supplies		6,805		6,810
Prepaid expenses		4,187		4,899
Other current assets		3,639		1,328
Total current assets		57,941		86,025
Property, plant and equipment, net		607,087		608,298
Intangible assets, net		30,699		31,026
Goodwill		12,104		12,104
Other assets		6,512		2,053
Total assets	$	714,343	$	739,506
Liabilities and Stockholders’ Equity
Current liabilities
Current portion of long-term debt	$	10,250	$	10,250
Accounts payable		53,290		56,874
Accrued expenses		11,832		11,736
Advance billings and customer deposits		9,349		14,807
Other current liabilities		3,934		6,774
Total current liabilities		88,655		100,441
Long-term debt		294,804		299,066
Employee benefit obligations		78,036		79,953
Deferred income taxes, net		910		910
Other liabilities		33,638		38,927
Total liabilities		496,043		519,297
Commitments and contingencies (Note 11)
Stockholders’ equity
Common stock, par value of $0.01 per share, 245,000,000 shares authorized and 11,635,116 and 11,587,963 shares issued and outstanding at March 31, 2018 and December 31, 2017, respectively		116		116
Additional paid-in capital		182,546		182,689
Accumulated other comprehensive loss		(16,053)		(15,964)
Retained earnings		51,691		53,368
Total stockholders’ equity		218,300		220,209
Total liabilities and stockholders’ equity	$	714,343	$	739,506

See accompanying notes to condensed consolidated financial statements.

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Hawaiian Telcom Holdco, Inc.

Condensed Consolidated Statements of Cash Flows

(Unaudited, dollars in thousands)


	Three Months Ended
	March 31,
	2018		2017
Cash flows from operating activities:
Net loss	$	(5,736)	$	(1,952)
Adjustments to reconcile net loss to net cash provided by operating activities:
Depreciation and amortization		23,333		21,269
Deferred financing amortization		301		529
Employee retirement benefits		(2,037)		1,410
Provision for uncollectible receivables		1,004		950
Stock based compensation		572		567
Deferred income taxes		(1,395)		(1,251)
Changes in operating assets and liabilities:
Receivables		55		1,050
Material and supplies		5		619
Prepaid expenses and other current assets		698		(217)
Accounts payable and accrued expenses		(947)		(3,162)
Advance billings and customer deposits		1,466		954
Other current liabilities		(51)		340
Other		(166)		(839)
Net cash provided by operating activities		17,102		20,267
Cash flows from investing activities:
Capital expenditures		(24,336)		(27,242)
Net cash used in investing activities		(24,336)		(27,242)
Cash flows from financing activities:
Proceeds from borrowing		—		6,000
Repayment of capital lease and installment financing		(9,056)		(1,051)
Repayment of borrowings		(4,563)		(750)
Refinancing costs		—		(2,071)
Taxes paid related to net share settlement of equity awards		(715)		(495)
Net cash provided by (used in) financing activities		(14,334)		1,633
Net change in cash, cash equivalents and restricted cash		(21,568)		(5,342)
Cash, cash equivalents and restricted cash, beginning of period		41,009		21,146
Cash, cash equivalents and restricted cash, end of period	$	19,441	$	15,804

See accompanying notes to condensed consolidated financial statements.

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Hawaiian Telcom Holdco, Inc.

Condensed Consolidated Statements of Changes in Stockholders’ Equity

(Unaudited, dollars in thousands)


						Accumulated
				Additional		Other				Total
	Common Stock			Paid-In		Comprehensive		Retained		Stockholders’
	Shares	Amount		Capital		Income (Loss)		Earnings		Equity

Balance, January 1, 2018	11,587,963	$	116	$	182,689	$	(15,964)	$	53,368	$	220,209

Cumulative effect of adoption of new accounting standard for revenue and related cost recognition, net of tax	—		—		—		—		4,059		4,059

Stock based compensation	—		—		572		—		—		572

Common stock issued for stock compensation plans, net of shares withheld and withholding paid for employee taxes	47,153		—		(715)		—		—		(715)

Net loss	—		—		—		—		(5,736)		(5,736)

Other comprehensive loss, net of tax	—		—		—		(89)		—		(89)

Balance, March 31, 2018	11,635,116	$	116	$	182,546	$	(16,053)	$	51,691	$	218,300

Balance, January 1, 2017	11,513,279	$	115	$	179,958	$	(35,218)	$	160,059	$	304,914

Cumulative effect of adoption of new accounting standard for stock compensation	—		—		—		—		550		550

Stock based compensation	—		—		567		—		—		567

Common stock issued for stock compensation plans, net of shares withheld and withholding paid for employee taxes	74,684		1		(96)		—		—		(95)

Net loss	—		—		—		—		(1,952)		(1,952)

Other comprehensive income, net of tax	—		—		—		13,062		—		13,062

Balance, March 31, 2017	11,587,963	$	116	$	180,429	$	(22,156)	$	158,657	$	317,046

See accompanying notes to condensed consolidated financial statements.

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Hawaiian Telcom Holdco, Inc.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

1. Description of Business

Business Description

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

Proposed Merger

On July 9, 2017, Hawaiian Telcom Holdco, Inc. (“Holdco”), a Delaware corporation, Cincinnati Bell Inc. (“Cincinnati Bell”), an Ohio corporation, Twin Acquisition Corp., a Delaware corporation and a wholly owned subsidiary of Cincinnati Bell (“Merger Sub”), entered into an Agreement and Plan of Merger (the “Merger Agreement”), pursuant to which Merger Sub will merge with and into Holdco and Holdco will be the surviving corporation (the “Merger”).

Pursuant to the Merger Agreement and as consideration for the Merger, Holdco shareholders will have the option to elect either $30.75 in cash, 1.6305 shares of Cincinnati Bell common stock, or a mix of $18.45 in cash and 0.6522 shares of Cincinnati Bell common stock for each Holdco share. The final distribution to Holdco shareholders is subject to proration such that the aggregate consideration to be paid to Holdco stockholders will be 60 percent cash and 40 percent Cincinnati Bell common stock. Such distribution will be made upon closing of the Merger.

The completion of this transaction is subject to closing conditions including the receipt of regulatory approvals from, among others, the Federal Communications Commission which is pending and the Hawaii Public Utilities Commission which was received on April 30, 2018, and approval by the Holdco shareholders which occurred on November 7, 2017. The Merger Agreement contains certain termination rights for Holdco and Cincinnati Bell. The Merger Agreement stipulates that in the event of a termination of the Merger Agreement under specified circumstances, primarily related to if the Company receives and favors a competing merger offer, the Company will be required to pay Cincinnati Bell a fee of $11.9 million.

In connection with the Merger Agreement with Cincinnati Bell, the Company incurred professional fees related to the transaction of $0.2 million during the three months ended March 31, 2018.

Organization

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

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Other Developments

The Company incurred a loss for the quarter ended March 31, 2018 of $5.7 million. In addition, the Company has experienced a decline in its reported earnings before interest, taxes, depreciation and amortization (“EBITDA”) as defined in its primary debt facility and used for covenant compliance. During the quarter ended March 31, 2018, the Company’s cash balance declined by $21.6 million in part because of payments of debt. As disclosed in Note 6, while the Company was in compliance with the financial covenants on its primary credit facility as of March 31, 2018, the margin of compliance for the leverage ratio was relatively narrow and necessitated, in part, the payments of debt to assure such compliance. The Company has evaluated these factors on its future liquidity with a focus on its cash balance and financial debt covenant compliance for one year from issuance of these condensed consolidated financial statements. This included consideration of the need to amend the maximum allowed debt service coverage covenant. While the Company presently anticipates that the merger with Cincinnati Bell will close in the second or third quarter of 2018, the Company has assessed its covenant compliance and liquidity on a stand-alone basis.

Management of the Company has developed plans in response to the matters identified in the preceding paragraph. Such plans include the Company’s ability to scale its expenses to align to its revenue volume in particular related to low margin businesses, the ability to adjust its capital spending to defer or avoid expenditures that will not significantly impact its ability to sell and deliver services, and its ability to sell certain excess capacity on its existing terrestrial and undersea networks. On May 7, 2018, as more fully discussed in Note 6, the Company obtained an amendment to the 2018 third and fourth quarter maximum leverage ratio covenant in its primary credit facility to provide for a greater margin of compliance on its leverage ratio on a prospective basis. The Company will also consider making additional payments of debt to facilitate compliance with the leverage ratio covenant while still maintaining sufficient liquidity for operating purposes.

Management believes that it is probable that the Company will continue to comply with its debt covenants at each quarterly test date and maintain adequate liquidity for the following year.

2. Basis of Presentation

The accompanying unaudited condensed consolidated financial statements of the Company have been prepared by the Company in accordance with accounting principles generally accepted in the United States of America and pursuant to rules and regulations of the U.S. Securities and Exchange Commission. Certain information and disclosures normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been omitted and condensed. In the opinion of the Company’s management, all adjustments have been made to present fairly the results of operations, comprehensive income, financial position and cash flows for the periods presented. The results of operations for the periods presented are not necessarily indicative of the results to be expected for the full year. Although the Company believes that the disclosures are adequate to make the information presented not misleading, these financial statements should be read in conjunction with the Company’s audited consolidated financial statements as of and for the year ended December 31, 2017.

Cash and Cash Equivalents

Cash and cash equivalents include cash and money market accounts with maturities at acquisition of three months or less. The majority of cash balances at March 31, 2018 are held in one bank in demand deposit accounts.

Supplemental Non-Cash Investing and Financing Activities

Accounts payable included $24.8 million and $21.9 million at March 31, 2018 and 2017, respectively, for additions to property, plant and equipment.

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Revenue Recognition

Revenue is measured based on consideration specified in a contract with a customer and excludes any sales incentives. The Company recognizes revenue when it satisfies a performance obligation by transferring control over a product or service to a customer. The prices for certain services are filed in tariffs with the regulatory body that exercises jurisdiction over the services.

The majority of data services, voice services, hosted and managed services, video services, internet services regardless of channel are billed one month in advance. Revenue for these services is recognized in the month services are rendered. The portion of advance-billed services associated with services that will be delivered in a subsequent period is deferred. To the extent that the advance billing has been collected as of period end or is unconditional because of contract provisions, then the advance billing is recorded as a liability in advance billings and customer deposits.

Charges for service activation are generally deferred and recognized in revenue over the contract term.

Revenues for providing usage based services, such as per-minute long-distance service included in voice services, access charges billed to long-distance companies for originating and terminating long-distance calls on the Company’s network included in other revenue and video on demand included in video services, are billed in arrears. Revenues for these services are based on actual rated usage and, where necessary, historical usage patterns, and are recognized in the month services are rendered.

Included in wholesale carrier data is revenue for long-term indefeasible right of use, or IRU, contracts for fiber circuit capacity. The Company may receive up-front payments for these services to be delivered for a period of up to 25 years. In these situations, the Company defers the revenue and amortizes it on a straight-line basis to earnings over the term of the contract. The Company recognizes a related financing component for the advance payment which is amortized to interest expense using the effective interest method also over the term of the contract.

Universal Service revenue subsidies included in other revenue, including those related to Connect America Fund Phase II, are government-sponsored support received in association with providing service in mostly rural, high-cost areas. These revenues are typically calculated by the government agency responsible for administering the support program. These revenues are recognized as granted by the government agency.

Equipment and related services for telecommunication systems and structured cabling project revenues are recognized as delivered. Maintenance services are recorded when the service is provided. With respect to arrangements with multiple performance obligations, the Company allocates the transaction price to each performance obligation on the basis of the relative standalone selling prices of each distinct good or service promised in the contract. If a standalone selling price is not observable, the Company estimates it. Revenue is recognized for each performance obligation as delivered or as the service is performed depending on the nature of the performance obligation.

The Company presents taxes and surcharges collected from customers and remitted to governmental authorities on a gross basis when such taxes and surcharges are being imposed on the Company and the Company is not merely acting as an agent for the government. Such amounts are included in the Company’s reported operating revenues and selling, general and administrative expenses and amounted to $2.1 million and $2.2 million for the three months ended March 31, 2018 and 2017, respectively.

Costs to obtain a contract, which are selling commissions, are deferred and recognized over the expected contract term. Costs to fulfill a contract are generally accounted for under other accounting standards. For example, they are capitalized if related to installation of an asset.

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Earnings per Share

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


	Three Months Ended
	March 31,
	2018	2017
Basic earnings per share - weighted average shares	11,597,918	11,529,046
Effect of dilutive securities:
Employee and director restricted stock units	—	—
Diluted earnings per share - weighted average shares	11,597,918	11,529,046

The computation of weighted average dilutive shares outstanding excluded grants of restricted stock units convertible into 388,101 shares and 278,701 shares of common stock for the three months ended March 31, 2018 and 2017, respectively. For the three months ended March 31, 2018 and 2017 the Company incurred a net loss so the restricted stock units are anti-dilutive to the computation of diluted net loss per share.

Recently Adopted Accounting Pronouncement for Revenue Recognition

Effective January 1, 2018, the Company adopted a new accounting standard issued by the Financial Accounting Standard Board (“FASB”) which provides guidance for revenue recognition. The new accounting standard supersedes existing revenue recognition requirements and most industry-specific guidance. The standard’s core principal is that a company will recognize revenue when it transfers promised goods or services to customers in an amount that reflects consideration to which the company expects to be entitled in exchange for those goods and services. The Company selected the modified retrospective method of adoption which requires a cumulative effect adjustment to retained earnings as of the adoption date. The initial application of the new standard was limited to contracts not yet completed as of the effective date. The details of significant changes in the Company’s revenue recognition and the quantitative impact are provided below.

Prior to 2018, the Company recognized revenue for telecommunication and structured cabling project revenues on a percentage of completion basis, generally based on the relative portion of costs incurred to total estimated costs of a project, except for short duration projects which were recognized upon completion of the project. Beginning in 2018, revenue is recognized on all projects as completed as the Company concluded it retains primary control of the project assets during the installation process. In addition, beginning in 2018, the Company began recognizing a financing component to the up-front payments for services to be delivered under indefeasible right of use contracts for fiber circuit capacity.

Beginning in 2018, Company began deferring costs to obtain a contract, on all existing contracts, which are selling commissions, and is recognizing such costs over the expected contract term. Prior to 2018, the Company had deferred certain costs related to activation in an amount that approximated the related revenue and recognized such costs over the expected customer life. The Company has concluded that such costs are accounted for under other accounting standards such as those related to capitalization in conjunction with installation of an asset.

The new accounting standard also provides guidance on presentation of contract assets and liabilities in the consolidated balance sheet. The standard provides specific guidance on presentation of advance billings. Beginning in 2018, a liability is recognized for advance billings where cash has been received in advance of delivery of goods or services, or when payment is due and the contract is non-cancellable. Prior to 2018, a liability was recognized when the related goods or services were invoiced in advance of delivery of goods or services.

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The cumulative effect of application of the new accounting standard as of January 1, 2018, net of tax, was to increase retained earnings by $4.1 million. The impacts on the Company’s condensed consolidated financial statements as of March 31, 2018 and for the three months then ended are as follows (dollars in thousands):


					Without
					Adoption of
	As Reported		Adjustments		New Standard
Statement of income data:
Operating revenues	$	89,222	$	(214)	$	89,008
Operating expenses		93,046		207		93,253
Operating income (loss)		(3,824)		(421)		(4,245)
Interest expense		(4,136)		367		(3,769)
Loss before income tax benefit		(7,250)		(54)		(7,304)
Income tax benefit		(1,514)		1,395		(119)
Net loss		(5,736)		(1,449)		(7,185)

Balance sheet data:
Receivables, net	$	24,119	$	6,850	$	30,969
Other current assets		3,639		(2,292)		1,347
Total current assets		57,941		4,558		62,499
Other assets		6,512		(4,046)		2,466
Total assets		714,343		512		714,855
Advance billings and customer deposits		9,349		7,039		16,388
Total current liabilities		88,655		7,039		95,694
Other liabilities		33,638		(989)		32,649
Total liabilities		496,043		6,050		502,093
Accumulated other comprehensive loss		(16,053)		(31)		(16,084)
Retained earnings		51,691		(5,507)		46,184
Total stockholders' equity		218,300		(5,538)		212,762
Total liabilities and stockholders' equity		714,343		512		714,855

Statement of cash flow data:
Cash flows from operating activities
Net loss	$	(5,736)	$	(1,449)	$	(7,185)
Deferred income taxes		(1,395)		1,395		—
Changes in operating assets and liabilities:
Receivables		55		202		257
Prepaid expenses and other current assets		698		(4)		694
Advance billings and customer deposits		1,466		(202)		1,264
Other		(166)		58		(108)
Net cash provided by operating activities		17,102		—		17,102

Recently Adopted Accounting Pronouncement for Retirement Plan Costs

Effective January 1, 2018, the Company adopted a new accounting standard that amends the income statement presentation of net periodic benefit cost for defined benefit and other postretirement plans. The new standard requires that the current service costs component be disaggregated from the other components of net benefit cost. The other components must be presented elsewhere in the income statement outside of income from operations. In addition, only the service-cost component of net benefit cost is eligible for capitalization related to self-constructed assets. The presentation requirements were adopted on a retrospective basis resulting in a reclassification of retirement plan expense of $1.8 million for the three months ended March 31, 2017 from selling, general and administrative expense to other income and expense. The change in capitalization methodology required is being applied on a prospective basis.

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Recently Issued Accounting Pronouncements

New accounting pronouncements are issued periodically that affect the Company’s current and future operations. See the Company’s audited consolidated financial statements as of and for the year ended December 31, 2017 for further information. No new standards impacting the Company were released subsequent to issuance of those consolidated financial statements. As more fully discussed in the Company’s audited consolidated financial statements, in February 2018, the FASB amended the accounting rules to allow for a reclassification from accumulated other comprehensive income to retained earnings for the stranded tax effects resulting from the Tax Cut and Jobs Act. In the first quarter of 2018, the Company concluded it will not adopt the optional provisions of the amendment.

3. Contracts with Customers

Revenue from contracts by customer channel and by major product line is summarized as follows (dollars in thousands):


	Three Months Ended
	March 31,
	2018		2017
Business
Data services	$	14,846	$	15,617
Voice services		19,652		21,258
Hosted and managed services		1,599		1,532
Equipment and related services		3,029		5,443
		39,126		43,850
Consumer
Video services		11,225		10,594
Internet services		7,105		6,681
Voice services		15,272		16,986
		33,602		34,261
Wholesale carrier data		13,932		12,828
Other		2,562		3,571
	$	89,222	$	94,510

The majority of revenue from all channels and product lines, except for equipment and related services, is recognized over time as the data, voice or video service is made available to the customer. The majority of revenue from equipment and related services is recognized at a point in time as the equipment is delivered or when installation is complete. Installation may occur in phases. We recognize revenue of an individual phase when completed if it represents a stand-alone component that can operate independent of other components.

Contract Balances

Receivables consisted of the following (dollars in thousands):


	March 31,		December 31,
	2018		2017
Customers and other	$	27,930	$	36,118
Allowance for doubtful accounts		(3,811)		(3,889)
	$	24,119	$	32,229

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Contract liabilities consisted of the following (dollars in thousands):


	March 31,		December 31,
	2018		2017
Current presented as advance billings	$	9,349	$	14,807
Noncurrent deferred revenue included in other liabilities		28,554		28,036
	$	37,903	$	42,843

Revenue recognized in the period that was included in the contract liability balances at the beginning of the period amounted to $2.8 million for the three months ended March 31, 2018.

Performance Obligations

The Company generally delivers telecommunication services ratably over the contract term. The majority of services are invoiced in advance and balances are due within 30 days of issuance of an invoice or statement to the customer. Many customers are on a month-to-month contract that can be cancelled at any time or within short notice. Even for those customers on long term contracts, the Company will generally invoice the customer based on services provided during the month either at the beginning or end of the monthly service period. For business equipment and related services, the Company will generally invoice upon delivery or project completion. Certain large projects with installation periods of up to one year may be invoiced at set milestones. Invoices are also due within 30 days of issuance.

Certain IRU contracts for extended periods of up to 25 years are invoiced at the beginning of the contract term. The revenue from such contracts is recognized over time as services are provided over the contract term. The expected revenue to be recognized is as follows (dollars in thousands):


Year ended December 31,
2018 (remaining months)	$	2,015
2019		2,686
2020		2,686
2021		2,686
2022		2,686
Thereafter		30,112
	$	42,871

Costs to Obtain Contracts

Costs to obtain contracts representing sales commissions on certain products have been deferred and recognized over the expected contract term. Total costs deferred amounted to $7.2 million at March 31, 2018. Costs amortized to expense amounted to $0.7 million for the three months ended March 31, 2018.

4. Long-Lived Assets

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


	March 31,		December 31,
	2018		2017
Property, plant and equipment cost	$	1,151,184	$	1,131,271
Less accumulated depreciation		(544,097)		(522,973)
	$	607,087	$	608,298

Depreciation expense amounted to $23.0 million and $20.8 million for the three months ended March 31, 2018 and 2017, respectively.

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


	March 31, 2018						December 31, 2017
	Gross				Net		Gross				Net
	Carrying		Accumulated		Carrying		Carrying		Accumulated		Carrying
	Value		Amortization		Value		Value		Amortization		Value
Subject to amortization:
Customer relationships	$	21,709	$	18,310	$	3,399	$	21,709	$	17,983	$	3,726
Trade name and other		320		320		—		320		320		—
		22,029		18,630		3,399		22,029		18,303		3,726
Not subject to amortization:
Brand name		27,300		—		27,300		27,300		—		27,300
		27,300		—		27,300		27,300		—		27,300
	$	49,329	$	18,630	$	30,699	$	49,329	$	18,303	$	31,026

As of March 31, 2018, the Company had goodwill of $12.1 million. As further discussed in Note 14, the Company has concluded it has only one segment and one reporting unit. As such, the Company classifies all goodwill in the one segment.

Amortization expense amounted to $0.3 million and $0.4 million for the three months ended March 31, 2018 and 2017, respectively. Estimated amortization expense for the next five years and thereafter is as follows (dollars in thousands):


Year ended December 31,
2018 (remaining months)	$	980
2019		930
2020		574
2021		270
2022		223
Thereafter		422
	$	3,399

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5. Accrued Expenses and Other Liabilities

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


	March 31,		December 31,
	2018		2017
Salaries and benefits	$	7,893	$	7,875
Interest		2,969		2,890
Other taxes		970		971
	$	11,832	$	11,736

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


	March 31,		December 31,
	2018		2017
Other postretirement benefits, current	$	3,226	$	3,226
Installment financing contracts, current		194		2,978
Other		514		570
	$	3,934	$	6,774

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


	March 31,		December 31,
	2018		2017
Deferred revenue, noncurrent	$	28,554	$	28,036
Installment financing contracts, noncurrent		3,233		8,982
Other		1,851		1,909
	$	33,638	$	38,927

Deferred revenue includes advance billings of capacity and other services related to the Company’s trans-Pacific cable.

6. Long-Term Debt

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


	Average Interest Rate		Final	March 31,		December 31,
	March 31, 2018		Maturity	2018		2017
Term loan A-1	5.52	%	May 4, 2022	$	86,070	$	87,750
Term loan A-2	5.77		May 4, 2023		224,242		227,125
Debt issue costs and issue discount					(5,258)		(5,559)
					305,054		309,316
Current					10,250		10,250
Noncurrent				$	294,804	$	299,066

In February 2017, the Company entered into a delayed draw credit agreement for new term loans and a new revolving credit facility. The new facility fully funded the repayment of the existing term loan and replacement of the existing revolving credit on May 4, 2017. Included in the new facility is a term loan A-1 for $90.0 million with quarterly principal payments of $1.1 million with the balance due at maturity in May 2022. Interest, payable at least quarterly, is at the Alternate Base Rate plus a margin of 2.75% or a Eurocurrency rate plus a margin of 3.75%. In addition, the facility provides for a second term loan A-2 for $230.0 million with quarterly principal payments of $1.4 million for the first eight quarters and $2.9 million per quarter thereafter with the balance due at maturity in May 2023. Interest, payable at least quarterly, is at the Alternate Base Rate plus a margin of 3.0% or a Eurocurrency rate plus a margin of 4.0%.

The new facility also provides for a line of credit in the amount of $30.0 million with maturity in May 2022. A commitment fee is payable quarterly to the lender under the facility. Interest on the line of credit is at the Alternate Base Rate plus a margin of 2.75% or a Eurocurrency rate plus a margin of 3.75%. There were no drawings as of or for the period ended March 31, 2018 on the new line of credit.

The interest rate margins on the facility are subject to a decrease of 0.25% with a defined improvement in the Company’s leverage ratio. The obligations under the bank facilities are guaranteed by the Company and each subsidiary with certain exceptions. In addition, the bank credit facilities are collateralized by substantially all of the Company’s assets.

The bank credit facilities contain various negative and affirmative covenants that restrict, among other things, incurrence of additional indebtedness, payment of dividends, redemptions of stock, other distributions to shareholders and sales of assets. In addition, there are financial covenants which have the following metrics as of March 31, 2018: debt service coverage with minimum allowed ratio of 2.75:1 of earnings before interest, taxes, depreciation and amortization to debt service which includes scheduled principal payments and cash interest; leverage with a maximum allowed ratio of 3.25:1 of indebtedness to earnings before interest, taxes, depreciation and amortization; and a maximum level of annual capital expenditures of $105.0 million. The Company was in compliance with these covenants as of March 31, 2018. On May 7, 2018, the Company amended the credit facility to modify the leverage ratio to maintain the maximum allowed ratio of 3.25:1 through the December 31, 2018 test date. To maintain compliance with the leverage ratio, the Company will also consider making additional debt payments as needed to reduce the indebtedness component of the ratio computation.

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The Company had a revolving credit facility which was repaid and terminated on May 4, 2017. Drawings for the three months ended March 31, 2017 amounted to $6.0 million. Such draws were used primarily to fund the construction of the Company’s jointly-owned SEA-US submarine cable system.

One of the syndicated lenders in both the new term loan and the term loan retired is a cooperative bank owned by its customers. Annually, this bank distributes patronage in the form of cash and stock in the cooperative based on the Company’s average outstanding loan balance. The Company recognizes the patronage, generally as declared, as a reduction of interest expense. The stock component is recognized at its stated cost basis with the accumulated stock investment included in other noncurrent assets. The investment balance as of March 31, 2018 was not significant.

Maturities

The annual requirements for principal payments on long-term debt as of March 31, 2018 are as follows (dollars in thousands):


Year ended December 31,
2018 (remaining months)	$	7,688
2019		13,125
2020		16,000
2021		16,000
2022		81,250
Thereafter		176,249
	$	310,312

Capitalized Interest

Interest capitalized by the Company amounted to $0.3 million and $0.5 million for the three months ended March 31, 2018 and 2017, respectively.

7. Employee Benefit Plans

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

The following provides the components of benefit costs (income) for the applicable periods (dollars in thousands):

Pension


	Three Months Ended
	March 31,
	2018		2017
Recognized in other income (expense):
Interest cost	$	1,514	$	1,781
Expected asset return		(2,590)		(2,656)
Amortization of loss		95		124
Net periodic benefit income		(981)		(751)
Settlement loss		—		1,956
Total benefit (income) expense	$	(981)	$	1,205

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Other Postretirement Benefits


	Three Months Ended
	March 31,
	2018		2017
Recognized in operating expenses:
Service cost	$	179	$	254
Recognized in other income (expense):
Interest cost		485		596
Amortization of gain		(214)		(38)
		271		558
Total benefit expense	$	450	$	812

During the three months ended March 31, 2017, the Company’s pension plans for union employees and management employees paid lump-sum benefits to certain plan participants in full settlement of obligations due amounting to $10.6 million. This resulted in the recognition of a loss on settlement for both pension plans. Because of the settlements, the Company measured its pension plan obligations and plan assets as of March 31, 2017. The Company used discount rates ranging from 3.81% to 3.82% as of March 31, 2017 to measure the pension plan obligations. The new measurements resulted in recognition in other comprehensive income (loss) of a gain of $1.6 million for the three months ended March 31, 2017. For the three months ended March 31, 2018, lump sum benefits paid for the union and management pension plans did not exceed the threshold requiring settlement accounting.

In January 2017, the Company amended the postretirement health benefits plan for management employees by implementing a cap on the amount of the premium subsidy at 2017 levels. This resulted in recognition of a negative plan amendment as of January 31, 2017. Because of the plan amendment, the Company measured its management postretirement benefits obligation as of January 31, 2017 using a discount rate of 4.07%. The new measurement resulted in a retirement plan gain which was recognized in other comprehensive income of $19.7 million for the three months ended March 31, 2017.

The Company previously disclosed in its consolidated financial statements for the year ended December 31, 2017 that it expected to contribute $5.4 million to its pension plan in 2018. For the three months ended March 31, 2018, the Company has made contributions to the plan amounting to $1.1 million. The Company presently expects to contribute the full amount during the remainder of 2018.

8. Income Taxes

The income tax benefit differs from the amounts determined by applying the statutory federal income tax rate of 21% for 2018 and 34% for 2017 to the loss before income tax benefit for the following reasons (dollars in thousands):


	Three Months Ended
	March 31,
	2018		2017
Income tax benefit at federal rate	$	(1,523)	$	(1,135)
Increase (decrease) resulting from:
State income taxes, net of federal income tax		(363)		(123)
Tax credit included in taxable income		31		93
Other permanent differences		—		52
Capital goods excise tax credit		(119)		(273)
Change in valuation allowance		460		—
Total income tax benefit	$	(1,514)	$	(1,386)

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The income tax benefit reflected in the condensed consolidated statements of income (loss) for the three months ended March 31, 2018, was recognized, as provided for by intraperiod tax allocation, to the extent of the net credit to stockholders’ equity during the period.

Deferred income tax assets and liabilities are determined based on the differences between the financial reporting and tax bases of assets and liabilities at each balance sheet date using enacted tax rates expected to be in effect in the year differences are expected to reverse. Valuation allowances are recognized to reduce deferred income tax assets to the amount that will more likely than not be realized.

The Company assesses the ability to realize its deferred tax assets and assesses the need for a valuation allowance on an ongoing basis. The Company is required to consider all available positive and negative evidence in evaluating the likelihood that it will be able to realize the benefit of its deferred tax assets in the future. Such evidence includes scheduled reversals of deferred tax liabilities, projected future taxable income, tax planning strategies and the results of recent operations.

In considering the impact of recent operations on the Company’s deferred tax asset assessment, the Company utilizes a rolling three years of actual and current year anticipated results as the primary measure of cumulative income or losses. Beginning in 2017, the Company had and as of March 31, 2018 continues to have a cumulative loss from operations for the three-year period. Because of the three-year cumulative losses, the Company is required to look only to sources of income that are deemed objective and verifiable based on historical experience. With the challenge of predicting future taxable income based on actual historical results, the Company has to limit the amount of future taxable income included in its assessment of deferred income tax asset recoverability.

Based on the more likely than not criteria for realization of deferred income tax assets, the Company established a full valuation allowance for its deferred income tax assets in the third quarter of 2017. If, in future periods, new positive evidence becomes available, the conclusion regarding the need for a full valuation allowance may change resulting in the reversal of some or all of the valuation allowance.

The Company evaluates its tax positions for liability recognition. As of March 31, 2018, the Company had no unrecognized tax benefits. No interest or penalties related to income tax assessments were recognized in the Company’s condensed consolidated statements of income (loss) for the three months ended March 31, 2018 and 2017. All tax years from 2014 remain open for both federal and Hawaii state tax purposes.

9. Stock Compensation

The Company has an equity incentive plan. The Compensation Committee of the Company’s Board of Directors may grant awards under the plan in the form of incentive stock options, non-qualified stock options, stock appreciation rights, restricted stock, restricted stock units and other stock-based awards. The maximum number of shares issuable under the equity incentive plan is 1,400,000 shares with 389,276 shares remaining to be issued at March 31, 2018. All grants under the equity incentive plan will be issued to acquire shares at the fair value on date of grant.

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As of March 31, 2018, all awards were restricted stock units. Activity with respect to outstanding restricted stock units for the three months ended March 31, 2018 and 2017 was as follows:


		Weighted-
		Average
		Grant-Date Fair
	Shares	Value per Share
2018
Nonvested at January 1, 2018	311,090	$	25
Granted	107,462		28
Vested	(72,726)		25
Forfeited	(7,725)		30
Nonvested at March 31, 2018	338,101	$	25

2017
Nonvested at January 1, 2017	226,690	$	25
Granted	131,801		23
Vested	(78,623)		25
Forfeited	(1,167)		21
Nonvested at March 31, 2017	278,701	$	25

The Company recognized compensation expense of $0.6 million and $0.6 million for the three months ended March 31, 2018 and 2017, respectively. The fair value as of the vesting date for the restricted stock units that vested during the three months ended March 31, 2018 and 2017 was $2.0 million and $1.3 million, respectively. Upon vesting, unit holders have the option to net share-settle to cover the required withholding tax and the remaining amount is converted into an equivalent number of shares of common stock. The total shares withheld were 25,569 and 20,996 for the three months ended March 31, 2018 and 2017, respectively, and were based on the value of the restricted stock units as determined by the Company’s closing stock price on the date of vesting. Total payments for the employees’ tax obligations to the tax authorities amounted to $0.7 million and $0.5 million for the three months ended March 31, 2018 and 2017, respectively. Other than reimbursements for tax withholdings, there was no cash received under the restricted stock unit arrangements.

The Company also has a performance based compensation plan. The incentive compensation is settled in March of each year for the prior year services and is based on Company performance relative to certain company specific metrics. The Company recognizes the expense during the performance period based on the expected compensation amount. Beginning for the 2016 performance period, a specified portion of the compensation amount for certain employees is settled in Company shares based on the share price at the date of settlement. There was no estimated performance based compensation for the three months ended March 31, 2018. The estimated performance based compensation to be settled in stock amounted to $0.2 million for the three months ended March 31, 2017. There was no performance based compensation to settle in 2018. The fair value of the shares granted under the plan in March 2017 amounted to $0.7 million. Upon grant, employees were required to net share-settle to cover the required withholding tax. Total payments for the employees’ tax obligations to the tax authorities by the Company amounted to $0.3 million. The net shares issued amounted to 17,174 shares which was based on the value of shares on the date of vesting.

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10. Accumulated Other Comprehensive Loss

The balance of and all of the changes in accumulated other comprehensive loss as of and for the three months ended March 31, 2018 and 2017, net of tax, are attributed to the Company’s retirement plans.

Reclassifications out of accumulated other comprehensive loss were as follows (dollars in thousands):


	Three Months Ended
	March 31,
	2018		2017
Retirement plans
Amortization of gain/loss and settlement loss	$	(120)	$	2,042
Income tax provision on comprehensive income		31		(776)
Total	$	(89)	$	1,266

The amortization of gains and losses, and settlement loss were recognized primarily in selling, general and administrative expense for the periods ended March 31, 2018 and 2017.

11. Commitments and Contingencies

Connect America Fund Phase II

In conjunction with reforming the Universal Service Fund, the Federal Communications Commission (“FCC”) established the Connect America Fund (“CAF”) which provides incremental support to broadband service providers. CAF Phase II is the long-term component of the program. In August 2015, the Company notified the FCC that it was accepting CAF Phase II support which amounts to $4.4 million in annual funding. Support is retroactive through the beginning of 2015 and will continue for six years. Under the terms of the CAF Phase II, the Company will offer broadband service at 10 Mbps downstream and 1 Mbps upstream or better to approximately 11,000 eligible locations in high-cost areas in the State of Hawaii and will provide voice and broadband services at reasonable rates. On a cumulative basis, as of December 31, 2017, the Company had an interim deployment obligation for approximately 4,400 locations. As of December 31, 2017, the Company had deployed to 5,452 locations and expects to meet all of its interim and final deployment obligations. For the three months ended March 31, 2018 and 2017, the Company recognized $1.1 million and $1.1 million, respectively, in CAF Phase II funding as revenue.

Collective Bargaining Agreement

The Company has a collective bargaining agreement with the International Brotherhood of Electrical Workers Local 1357 (“IBEW”) that expires on September 30, 2022. The agreement covers approximately half of the Company’s work force.

Third Party Claims

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

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Joint-Owned Utility Poles

Each of the electric utilities for the four counties in the State of Hawaii have separate agreements with the Company for the joint ownership and maintenance of utility poles along with other third parties, such as the State of Hawaii. The agreements set forth various circumstances requiring pole removal, installation and replacement and the sharing of costs among the joint pole owners. The agreements allow for the cost of work done by one joint pole owner to be shared by the other joint pole owners based on the apportionment of costs in the agreements. Generally, the electric utilities have maintained, replaced and installed the majority of the jointly-owned poles and have billed the other joint pole owners for their respective share of the costs. The Company has a disagreement with the common owner of the utilities in three of the counties in Hawaii regarding the amount the utilities are requesting for their share of the capitalized costs.

For one of the three utilities referenced above, a dispute resolution process is proceeding as specified by the joint pole agreement. For another of the utilities, a complaint for payment was filed by the utility with the State court in 2016. In April 2018, the Company entered into agreements for transferring responsibilities for control of the poles and related maintenance to the three utilities in settlement of the disputes. However, implementation of the agreements requires approval of the Hawaii Public Utilities Commission with its jurisdiction over both the Company and the utilities with such approval pending. Management of the Company believes the amount recognized in the Company’s condensed consolidated financial statements for amounts due the utilities are reflective of what is owed and a reasonable estimate of the final settlement to be reached with the utilities.

Litigation

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

12. Fair Value of Financial Instruments

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

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

Debt – The fair value of debt is estimated at its present value using current market rates for similar types of borrowing arrangements.

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


	Carrying		Fair
	Value		Value
March 31, 2018
Liabilities - long-term debt (carried at cost)		305,054		310,709
December 31, 2017
Liabilities - long-term debt (carried at cost)		309,316		315,339

Fair Value Measurements

The objective of the fair value measurement is to estimate the price at which an orderly transaction to sell the asset or to transfer the liability would take place between market participants at the measurement date under current market conditions.

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

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


	March 31,		December 31,
	2018		2017
Liability value measurements using:
Quoted prices in active markets for identical liabilities (Level 1)	$	—	$	—
Significant other observable inputs (Level 2)		310,709		315,339
Significant unobservable inputs (Level 3)		—		—
	$	310,709	$	315,339

13. Cash Flow Information

Supplemental cash flow information is as follows:


	Three Months Ended
	March 31,
	2018		2017
Cash paid during the year:
Income taxes paid	$	—	$	—
Interest paid, net of amounts capitalized		3,391		3,537
Non-cash investing activities - capital assets acquired under installment contracts		—		617
Non-cash financing activities - common shares issued for performance based compensation, net of withholding taxes paid		—		400

The Company includes restricted cash with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown in the statement of cash flows. The following is a reconciliation of cash, cash equivalents and restricted cash reported in the condensed consolidated balance sheets to the total of such amounts in the condensed consolidated statements of cash flows (dollars in thousands):

Hawaiian Telcom Holdco, Inc. 10-Q