Towerstream Corporation
TOWERSTREAM CORP (Form: 10-Q, Received: 11/04/2009 16:04:47)
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 September 30, 2009

OR

¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from  __________  to __________.

Commission file number 001-33449

TOWERSTREAM CORPORATION
(Exact name of registrant as specified in its charter)
 
Delaware
(State or other jurisdiction of incorporation or organization)
20-8259086
(I.R.S. Employer Identification No.)
   
55 Hammarlund Way
Middletown, Rhode Island
(Address of principal executive offices)
02842
(Zip Code)

Registrant’s telephone number: (401) 848-5848

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 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 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. (Check one):

Large accelerated filer ¨
 
Accelerated filer   ¨
Non-accelerated filer   ¨   (Do not check if a smaller reporting company)
 
Smaller reporting company   x

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 November 2, 2009, there were 34,616,075 shares of the issuer’s common stock outstanding.



TOWERSTREAM CORPORATION

Table of Contents

     
Pages
Part I
FINANCIAL INFORMATION
   
       
Item 1.
Financial Statements.
 
1
       
 
Condensed Consolidated Balance Sheets as of September 30, 2009 (unaudited) and December 31, 2008
 
1
       
 
Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2009 and 2008 (unaudited)
 
2
       
 
Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2009 and 2008 (unaudited)
 
3-4
       
 
Condensed Consolidated Statement of Stockholders’ Equity for the nine months ended September 30, 2009 (unaudited)
 
5
       
 
Notes to Unaudited Condensed Consolidated Financial Statements
 
6-14
       
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations.
 
15-22
       
Item 3.
Quantitative and Qualitative Disclosures about Market Risk.
 
23
       
Item 4.
Controls and Procedures.
 
23
       
Part II
OTHER INFORMATION
   
       
Item 6.
Exhibits.
 
24
 
i

 
PART I
FINANCIAL INFORMATION

Item 1.  Financial Statements.

TOWERSTREAM CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS

   
(Unaudited)
September 30,
2009
   
December 31,
2008
 
Assets
           
Current Assets
           
Cash and cash equivalents
  $ 18,207,314     $ 24,740,268  
Accounts receivable, net of allowance for doubtful accounts of $92,047 and $66,649, respectively
    398,073       279,399  
Prepaid expenses and other
    241,305       319,325  
Total Current Assets
    18,846,692       25,338,992  
                 
Property and equipment, net
    13,555,867       12,890,779  
                 
FCC licenses
    975,000       875,000  
Other assets
    187,063       183,063  
Total Assets
  $ 33,564,622     $ 39,287,834  
                 
Liabilities and Stockholders’ Equity
               
                 
Current Liabilities
               
Current maturities of capital lease obligations
  $ 2,451     $ 25,346  
Accounts payable
    883,814       1,394,476  
Accrued expenses
    1,055,191       861,390  
Deferred revenues
    1,046,980       985,403  
Short-term debt, net of discount of $114,576 and $142,605, respectively
    2,705,424       2,607,395  
Derivative liabilities
    17,712       -  
Deferred rent
    70,989       52,554  
Total Current Liabilities
    5,782,561       5,926,564  
                 
Long-Term Liabilities
               
Derivative liabilities
    330,149       -  
Deferred rent
    296,221       354,071  
Total Long-Term Liabilities
    626,370       354,071  
Total Liabilities
    6,408,931       6,280,635  
                 
Commitments (Note 11)
               
                 
Stockholders' Equity
               
Preferred stock, par value $0.001; 5,000,000 shares authorized; none issued
            -  
Common stock, par value $0.001;   70,000,000 shares authorized; 34,616,075 and 34,587,854 shares issued and outstanding, respectively
    34,616       34,588  
Additional paid-in-capital
    54,900,407       54,851,755  
Accumulated deficit
    (27,779,332 )     (21,879,144 )
Total Stockholders' Equity
    27,155,691       33,007,199  
Total Liabilities and Stockholders' Equity
  $ 33,564,622     $ 39,287,834  
 
The accompanying notes are an integral part of these condensed consolidated financial statements.
 
1

 
TOWERSTREAM CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)

   
Three Months Ended
September 30,
   
Nine Months Ended
September 30,
 
   
2009
   
2008
   
2009
   
2008
 
                         
Revenues
  $ 3,782,456     $ 2,869,949     $ 10,873,103     $ 7,445,924  
                                 
Operating Expenses
                               
Cost of revenues (exclusive of depreciation)
    931,368       982,515       2,672,220       2,909,230  
Depreciation
    1,035,660       857,368       2,965,604       2,286,674  
Customer support services
    544,019       492,013       1,578,032       1,430,225  
Sales and marketing
    1,379,291       2,017,642       4,340,630       5,811,337  
General and administrative
    1,665,113       1,754,729       5,183,268       5,729,368  
Total Operating Expenses
    5,555,451       6,104,267       16,739,754       18,166,834  
Operating Loss
    (1,772,995 )     (3,234,318 )     (5,866,651 )     (10,720,910 )
Other Income (Expense)
                               
Interest income
    3,844       123,563       26,057       560,434  
Interest expense
    (184,774 )     (105,589 )     (553,700 )     (394,565 )
Loss on derivative financial instruments
    (184,717 )     -       (259,954 )     -  
Other, net
    940       311       867       315  
Total Other Income (Expense)
    (364,707 )     18,285       (786,730 )     166,184  
Net Loss
  $ (2,137,702 )   $ (3,216,033 )   $ (6,653,381 )   $ (10,554,726 )
                                 
Net loss per common share – basic and diluted
  $ (0.06 )   $ (0.09 )   $ (0.19 )   $ (0.31 )
Weighted average common shares outstanding – basic and diluted
    34,610,376       34,556,580       34,597,743       34,536,321  
 
The accompanying notes are an integral part of these condensed consolidated financial statements.

2


TOWERSTREAM CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)

   
Nine Months Ended September 30,
 
    
2009
   
2008
 
Cash Flows From Operating Activities
  $ (6,653,381 )   $ (10,554,726 )
Net loss
               
Adjustments to reconcile net loss to net cash used in operating activities:
               
Provision for doubtful accounts
    50,499       65,000  
Depreciation
    2,965,604       2,286,674  
Stock-based compensation
    575,607       697,529  
Non-cash interest on notes payable
    -       73,393  
Accretion of debt discount
    342,203       106,640  
Amortization of financing costs
    43,688       43,688  
Loss on sale and disposition of property and equipment
    51,625       21,394  
Deferred rent
    (39,415 )     146,610  
Loss on derivative financial instruments
    259,954       -  
Changes in operating assets and liabilities:
               
Accounts receivable
    (169,175 )     (139,104 )
Prepaid expenses and other current assets
    34,333       373,522  
Accounts payable
    (510,662 )     (114,773 )
Accrued expenses
    193,801       346,984  
Deferred revenues
    61,577       358,504  
Total Adjustments
    3,859,639       4,266,061  
Net Cash Used In Operating Activities
    (2,793,742 )     (6,288,665 )
                 
Cash Flows From Investing Activities
               
Acquisitions of property and equipment
    (3,683,667 )     (5,928,678 )
Proceeds from sale of property and equipment
    1,350       1,700  
Acquisition of FCC license
    -       (400,000 )
Change in security deposits
    (4,000 )     (20,215 )
Net Cash Used In Investing Activities
    (3,686,317 )     (6,347,193 )
                 
Cash Flows From Financing Activities
               
Repayment of capital leases
    (22,895 )     (36,083 )
Repayment of short-term debt
    (30,000 )     -  
Payment to warrant holders for fractional shares upon cashless exercise
    -       (9 )
Net Cash Used In Financing Activities
    (52,895 )     (36,092 )
                 
Net Decrease In Cash and Cash Equivalents
    (6,532,954 )     (12,671,950 )
                 
Cash and Cash Equivalents - Beginning
    24,740,268       40,756,865  
Cash and Cash Equivalents - Ending
  $ 18,207,314     $ 28,084,915  

The accompanying notes are an integral part of these condensed consolidated financial statements.
 
3

 
TOWERSTREAM CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED
(UNAUDITED)

   
Nine Months Ended September 30,
 
   
2009
   
2008
 
Supplemental Disclosures of Cash Flow Information
           
Cash paid during the periods for:
           
Interest
  $ 166,286     $ 171,284  
Non-cash investing and financing activities:
               
Conversion of long-term debt into shares of common stock
  $ -     $ 750,000  
Acquisition of FCC license
  $ 100,000     $ -  

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

4

 
TOWERSTREAM CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY
(UNAUDITED)
For the Nine Months Ended September 30, 2009

   
Common Stock
   
Additional
Paid-In-
   
Accumulated
       
    
Shares
   
Amount
   
Capital
   
Deficit
   
Total
 
Balance at January 1, 2009
    34,587,854     $ 34,588     $ 54,851,755     $ (21,879,144 )   $ 33,007,199  
Cumulative effect of change in accounting principle – January 1, 2009 reclassification of equity-linked financial instruments to derivative liabilities
                    (526,927 )     753,193       226,266  
Cashless options exercised
    8,910       9       (9 )             -  
Issuance of common stock for bonuses
    19,311       19       20,971               20,990  
Stock-based compensation
                    554,617               554,617  
Net loss
                            (6,653,381 )     (6,653,381 )
Balance at September 30, 2009
    34,616,075     $ 34,616     $ 54,900,407     $ (27,779,332 )   $ 27,155,691  

The accompanying notes are an integral part of these condensed consolidated financial statements.
 
5


TOWERSTREAM CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
Note 1.    Organization and Nature of Business
 
Towerstream Corporation (herein after referred to as ‘‘Towerstream’’ or the ‘‘Company’’) was formed on December 17, 1999, and was incorporated in Delaware.  The Company provides broadband services to commercial customers and delivers access over a fixed wireless network transmitting over both regulated and unregulated radio spectrum.   The Company’s service supports bandwidth on demand, wireless redundancy, virtual private networks (“VPNs”), disaster recovery, bundled data and video services. The Company provides service to business customers in New York City, Boston, Chicago, Los Angeles, San Francisco, Seattle, Miami, Dallas-Fort Worth, Providence and Newport, Rhode Island.
 
Note 2.    Summary of Significant Accounting Policies
 
Basis of Presentation.     The condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial statements and with Form 10-Q and Article 10 of Regulation S-X of the Securities and Exchange Commission (“SEC”). Accordingly, they do not contain all information and footnotes required by accounting principles generally accepted in the United States of America for annual financial statements.  The condensed consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. In the opinion of management, the accompanying unaudited condensed consolidated financial statements contain all the adjustments (consisting only of normal recurring accruals) necessary for fair presentation of the Company’s financial position, as of September 30, 2009, and the results of operations and cash flows for the periods presented. The results of operations for the three and nine months ended September 30, 2009, are not necessarily indicative of the operating results for the full fiscal year or any future period.
 
These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2008. The Company’s accounting policies are described in the Notes to Consolidated Financial Statements in its Annual Report on Form 10-K for the year ended December 31, 2008, and updated, as necessary, in this Quarterly Report on Form 10-Q.

Use of Estimates.     The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Cash and Cash Equivalents.     The Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents.

Concentration of Credit Risk .    Financial instruments that potentially subject the Company to significant concentrations of credit risk consist of cash and cash equivalents.
 
        At times, our cash and cash equivalents may be uninsured or in deposit accounts that exceed the Federal Deposit Insurance Corporation (“FDIC”) insurance limits.  The financial institution at which the Company has its deposit accounts is participating in the FDIC’s Transaction Account Guarantee Program.  Under that program, through December 31, 2009, all non-interest bearing transaction accounts at participating institutions are fully guaranteed by the FDIC for the entire amount in the account.  Coverage under the Transaction Account Guarantee Program is in addition to, and separate from, the overage available under the FDIC’s general deposit insurance rules.
 
The Company had approximately $17,712,000 invested in four Aaa rated institutional money market funds.  These funds are protected under the Securities Investor Protection Corporation (“SPIC”), a nonprofit membership corporation which provides limited coverage up to $500,000.

6

 
TOWERSTREAM CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

Accounts Receivable .   Accounts receivable are stated at cost less an allowance for doubtful accounts. The allowance for doubtful accounts reflects the Company’s estimate of accounts receivable that will not be collected.  The allowance is based on the history of past write-offs, the aging of balances, collections experience and current credit conditions.  Amounts determined to be uncollectible are written-off against the allowance for doubtful accounts.  Additions to the allowance for doubtful accounts, e.g. bad debt expense, totaled $52,874 and $66,023 for the nine months ended September 30, 2009 and 2008, respectively.  Deductions to the allowance for doubtful accounts, e.g. customer write-offs, totaled $27,476 and $41,709 for the nine months ended September 30, 2009 and 2008, respectively.

        Derivative Financial Instruments .    The Company does not use derivative instruments to hedge exposures to cash flow, market or foreign currency risks.  The Company evaluates all of its financial instruments to determine if such instruments are derivatives or contain features that qualify as embedded derivatives.  For derivative financial instruments that are accounted for as liabilities, the derivative instrument is initially recorded at its fair value and is then re-valued at each reporting date, with changes in the fair value reported in the condensed consolidated statements of operations.  For stock-based derivative financial instruments, the Company uses the Black-Scholes option pricing model to value the derivative instruments at inception and on subsequent valuation dates.  The classification of derivative instruments, including whether such instruments should be recorded as liabilities or as equity, is evaluated at the end of each reporting period.  Derivative instrument liabilities are classified in the balance sheet as current or non-current based on whether or not net-cash settlement of the derivative instrument could be required within 12 months of the balance sheet date.

Reclassifications.     Certain accounts in the prior year condensed consolidated financial statements have been reclassified for comparative purposes to conform to the presentation in the current year condensed consolidated financial statements.  These reclassifications have no effect on the previously reported net loss.
 
Recent Accounting Pronouncements.     In September 2006, the Financial Accounting Standards Board (“FASB”) issued an accounting standard which defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. The Company adopted this standard on January 1, 2008 for its financial assets and financial liabilities.  On January 1, 2009, the Company adopted the fair value measurement requirements for nonfinancial assets and nonfinancial liabilities that are not recognized or disclosed at fair value on a recurring basis.  The adoption of this standard did not have a material impact on the Company’s financial position or results of operations.  Refer to Note 9 for additional discussion on fair value measurements.
 
In December 2007, the FASB issued an accounting standard related to accounting for business combinations and related disclosures. This standard addresses the recognition and accounting for identifiable assets acquired, liabilities assumed and noncontrolling interests in business combinations. The standard also expands disclosure requirements for business combinations. The standard became effective on January 1, 2009.
 
In December 2007, the FASB issued an accounting standard related to accounting and reporting for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. Noncontrolling interests are reported as a separate component of consolidated stockholders’ equity, and net income allocable to noncontrolling interests and net income attributable to stockholders are reported separately in the consolidated statement of operations. This standard became effective on January 1, 2009 and did not have a material impact on the Company’s financial position or results of operations.
 
In March 2008, the FASB issued an accounting standard related to disclosures about derivative instruments and hedging activities. This standard amends and enhances disclosure requirements to provide a better understanding of how and why a company uses derivative instruments, how derivative instruments and related hedged items are accounted for, and their effect on a company’s financial position, financial performance and cash flows. The Company adopted this standard on January 1, 2009 and has included additional disclosures in its condensed consolidated financial statements.

7

 
TOWERSTREAM CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

In April 2008, the FASB issued an accounting standard which provides guidance for determining the useful life of an intangible asset and the period of expected cash flows used to measure the fair value of the asset. The adoption of this standard on January 1, 2009 did not impact the Company’s financial position or results of operations.

In May 2008, the FASB issued an accounting standard that requires the liability and equity components of convertible debt instruments to be accounted for separately if the debt can be settled in cash upon conversion.  The Company’s debt may not be settled in cash upon conversion.  This standard became effective January 1, 2009.  Accordingly, there was no impact on the Company’s financial position or results of operations upon adoption.

In April 2009, the FASB issued an accounting standard which affirmed that there is no change in the measurement of fair value when the volume and level of activity for an asset or a liability has significantly decreased.  This standard also identifies circumstances that indicate when a transaction is not orderly.   The adoption of this standard in the second quarter of 2009 had no material impact on the Company’s financial position and results of operations.

In April 2009, the FASB issued an accounting standard which requires disclosures about the fair value of financial instruments whenever a public company issues financial information for interim reporting periods. This standard became effective in the second quarter of 2009 and did not have a material impact on the Company’s financial position and results of operations.

In June 2009, the FASB issued an accounting standard which requires entities to disclose the date through which subsequent events have been evaluated as well as whether that date is the date the financial statements were issued or the date the financial statements were made available to be issued.  The Company adopted this standard in the second quarter of 2009.  The Company has evaluated subsequent events through the November 4, 2009 filing of its financial statements with the SEC.

In June 2009, the FASB issued the FASB Accounting Standards Codification (“Codification”). Effective this quarter, the Codification became the single source for all authoritative generally accepted accounting principles (“GAAP”) recognized by the FASB and is required to be applied to financial statements issued for interim and annual periods ending after September 15, 2009. The Codification does not change GAAP and did not impact the
Company’s financial position or results of operations.

In August 2009, the FASB issued an accounting standard to provide clarification on measuring liabilities at fair value when a quoted price in an active market is not available.  This standard will become effective for the Company on October 1, 2009 and is not expected to have a significant impact on the Company’s financial position or results of operations.

Note 3.    Property and Equipment
 
The Company’s property and equipment is comprised of:

   
September 30, 2009
   
December 31, 2008
 
Network and base station equipment
  $ 12,740,136     $ 11,075,631  
Customer premise equipment
    8,826,393       7,079,096  
Furniture, fixtures and equipment
    1,525,980       1,525,980  
Computer equipment
    606,787       559,645  
System software
    818,784       789,810  
Leasehold improvements
    775,420       775,420  
      25,293,500       21,805,582  
Less: accumulated depreciation
    11,737,633       8,914,803  
    $ 13,555,867     $ 12,890,779  

8

 
TOWERSTREAM CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED

Depreciation expense for the three months ended September 30, 2009 and 2008 was $1,035,660 and $857,368, respectively.  Depreciation expense for the nine months ended September 30, 2009 and 2008 was $2,965,604 and $2,286,674, respectively.  During the nine months ended September 30, 2009, the Company sold or wrote-off property and equipment with $195,749 of original cost and $142,774 of accumulated depreciation.  During the nine months ended September 30, 2008, the Company sold or wrote-off property and equipment with $65,177 of original cost and $42,082 of accumulated depreciation.

Property held under capital leases included within the Company’s property and equipment consists of the following:

   
September 30, 2009
   
December 31, 2008
 
Network and base station equipment
  $ 168,441     $ 168,441  
Less: accumulated depreciation
    124,411       106,099  
    $ 44,030     $ 62,342  

Note 4.  Accrued Expenses

Accrued expenses consist of the following:

   
September 30,
   
December 31,
 
   
2009
   
2008
 
Payroll and related
  $ 415,956     $ 510,608  
Penalties
    95,726       149,976  
Interest
    55,467       55,000  
Rent
    12,951       50,149  
Marketing
    73,522       -  
Property and equipment
    129,187       -  
Professional services
    147,241       17,953  
Other
    125,141       77,704  
Total
  $ 1,055,191     $ 861,390  

Note 5.    Debt

In January 2007, the Company issued $3,500,000 of 8% senior convertible debentures (the “Debentures”).  These Debentures mature on December 31, 2009 and are convertible into common stock at an initial conversion price of $2.75 per share.  Holders of the Debentures also received warrants to purchase an aggregate of 636,364 shares of common stock at an exercise price of $4.00 per share and warrants to purchase an aggregate of 636,364 shares of common stock at an exercise price of $6.00 per share.   The warrants are exercisable until January 2012 and were valued using the Black Scholes option pricing model.  The proceeds were initially allocated between the warrants ($526,927) and the Debentures ($2,973,073) based on their relative fair values.   The discounted carrying value of the Debentures is being accreted to the maturity value over the term of the Debentures.  The amount of accretion recorded in each period is recognized as non-cash interest expense.

In January 2008, a Debenture holder converted $750,000 of Debentures into common stock at a conversion price of $2.75 per share resulting in the issuance of 272,727 shares of common stock.  The carrying value of the Debenture on the date of conversion was $676,607.  Accordingly, the Company recognized the remaining debt discount of $73,393 as non-cash interest expense in connection with the conversion.

 
9

 
 
TOWERSTREAM CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED

As further described in Note 6, a new accounting standard became effective on January 1, 2009 related to the accounting for derivative financial instruments indexed to a company’s own stock. In connection with its implementation, the Company was required to classify the conversion feature of the Debentures and the warrants issued with the Debentures as derivative liabilities. The cumulative effect of adopting this standard resulted in a decrease in the carrying value of the Debentures as of January 1, 2009 from $2,607,395 to $2,293,222. Interest expense totaled $169,576 during the three months ended September 30, 2009 and included $55,000 associated with the 8% coupon and $114,576 associated with the accretion of the discount. Interest expense totaled $507,203 during the nine months ended September 30, 2009 and included $165,000 associated with the 8% coupon and $342,203 associated with the accretion of the discount. Interest expense totaled $89,501 during the three months ended September 30, 2008 and included $55,000 associated with the 8% coupon and $34,501 associated with accretion of the discount. Interest expense totaled $345,581 during the nine months ended September 30, 2008 and included $165,548 associated with the 8% coupon, $73,393 associated with accretion of the converted debentures, and $106,640 associated with accretion of the remaining debentures.

During the second quarter of 2009, the Company agreed to make a contingent payment of $100,000 under one of its FCC licenses.  A total of $100,000 is payable in monthly installments through December 31, 2009, of which $70,000 remained outstanding as of September 30, 2009 and is included in short-term debt in the Company’s condensed consolidated balance sheet.

Note 6.    Derivative Liabilities

In June 2008, the FASB issued an accounting standard related to the accounting for derivative financial instruments indexed to a company’s own stock.  Under this standard, instruments which do not have fixed settlement provisions are deemed to be derivative instruments. The conversion feature of the Company’s Debentures, and the warrants issued with the Debentures, do not have fixed settlement provisions because their conversion and exercise prices, respectively, may be lowered if the Company issues securities at lower prices in the future.  The Company was required to include the reset provisions in order to protect the Debenture holders from the potential dilution associated with future financings.  In accordance with this standard, the conversion feature of the Debentures was separated from the host contract, the Debenture, and recognized as an embedded derivative instrument.  Both the conversion feature of the Debenture and the warrants have been re-characterized as derivative liabilities. The fair value of these liabilities are re-measured at the end of every reporting period with the change in value reported in the statement of operations.

The derivative liabilities were valued using the Black-Scholes option pricing model and the following assumptions:

   
September 30,
2009
   
June 30, 
2009
   
March 31,
2009
   
January 1,
2009
   
January 18, 
2007
 
                               
Debenture conversion feature:
                             
Risk-free interest rate
    0.1 %     0.8 %     0.5 %     0.4 %     4.7 %
Expected volatility
    87 %     79 %     81 %     74 %     60 %
Expected life (in years)
    0.3       0.5       0.8       1       3  
Expected dividend yield
    -       -       -       -       -  
                                         
Warrants:
                                       
Risk-free interest rate
    1.0 %     1.4 %     1.2 %     1.0 %     4.7 %
Expected volatility
    87 %     79 %     81 %     74 %     60 %
Expected life (in years)
    2.3       2.5       2.8       3       3  
Expected dividend yield
    -       -       -       -       -  
                                         
Fair value:
                                       
Debenture conversion feature
  $ 17,713     $ 11,513     $ 13,581     $ 11,838     $ 856,025  
Warrants
  $ 330,149     $ 151,631     $ 115,475     $ 76,079     $ 620,316  
 
 
10

 

TOWERSTREAM CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

The risk-free interest rate was based on rates established by the Federal Reserve.  Effective in the first quarter of 2008, the Company based expected volatility on the historical volatility for its common stock.  Previously, the Company’s estimated volatility was based on the volatility of publicly-traded peers.  The expected life of the Debentures’ conversion option was based on the maturity of the Debentures and the expected life of the warrants was determined by the expiration date of the warrants.  The expected dividend yield was based upon the fact that the Company has not historically paid dividends, and does not expect to pay dividends in the future.

This new standard was implemented in the first quarter of 2009 and is reported as the cumulative effect of a change in accounting principle.  The cumulative effect on the accounting for the conversion feature and the warrants as of January 1, 2009 was as follows:

Derivative
Instrument
 
Additional
Paid-In-Capital
   
Accumulated
Deficit
   
Derivative
Liability
   
Debenture
 
                         
Conversion feature
  $ -     $ (277,531 )   $ (11,838 )   $ 289,369  
Warrants
  $ 526,927     $ (475,662 )   $ (76,069 )   $ 24,804  
Total
  $ 526,927     $ (753,193 )   $ (87,907 )   $ 314,173  

The warrants were originally recorded at their relative fair value as an increase in additional paid-in-capital.  Changes in the accumulated deficit include $635,241 of interest expense associated with the accretion of additional discount recognized on the Debenture and $1,388,434 in gains resulting from decreases in the fair value of the derivative liabilities through December 31, 2008.  The derivative liability amounts reflect the fair value of each derivative instrument as of the January 1, 2009 date of implementation.  The Debenture amounts represent the additional discount recorded upon adoption of this new standard.  This discount will be recognized in 2009 as additional interest expense.

Note 7.    Share-Based Compensation

The Company uses the Black-Scholes option pricing model to value options granted to employees, directors and consultants. Compensation expense, including the effect of forfeitures, is recognized over the period of service, generally the vesting period. Stock-based compensation for the amortization of stock options granted under the Company’s stock option plans totaled $189,285 and $187,732 during the three months ended September 30, 2009 and 2008, respectively. Stock-based compensation for the amortization of stock options granted under the Company’s stock option plans totaled $575,607 and $677,429 during the nine months ended September 30, 2009 and 2008, respectively. Stock-based compensation for the amortization of stock-based consulting fees totaled $20,100 for the nine months ended September 30, 2008. Stock-based compensation is included in general and administrative expenses in the accompanying condensed consolidated statements of operations.
 
The unamortized amount of stock options expense was $774,629 as of September 30, 2009 which will be   recognized over a weighted average period of 2.17 years.
 
The fair values of stock option grants were calculated on the dates of grant using the Black-Scholes option pricing model and the following weighted average assumptions:

   
Three Months Ended 
September 30,
   
Nine Months Ended 
September 30,
 
   
2009
   
2008
   
2009
   
2008
 
                         
Risk-free interest rate
    0.2%-2.9 %     3.4 %     0.2%- 2.9 %     2.5%-3.4 %
Expected volatility
    79 %     78 %     79%-87 %     76%-98 %
Expected life (in years)
    0.1 - 6.0       6.5       0.1 – 6.8       5-6.5  
Expected dividend yield
                       
Weighted average per share grant date fair value
  $ 0.57     $ 0.94     $ 0.51     $ 1.11  

 
11

 

TOWERSTREAM CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

The risk-free interest rate was based on rates established by the Federal Reserve.  The Company’s expected volatility was based upon the historical volatility for its common stock.  The expected life of the Company’s options was determined using the simplified method.  The expected dividend yield was based upon the fact that the Company has not historically paid dividends, and does not expect to pay dividends in the future.
 
Transactions under the stock option plans during the nine months ended September 30, 2009 are as follows:
 
   
Number of
   
Weighted Average
 
   
Options
   
Exercise Price
 
Options outstanding as of January 1, 2009
    3,335,793     $ 1.82  
Granted
    615,526     $ 0.77  
Exercised
    (38,542 )   $ 1.43  
Cancelled
    (140,000 )   $ 1.28  
Options outstanding as of September 30, 2009
    3,772,777     $  1.68  
Options exercisable as of September 30, 2009
    2,663,566     $  1.78  

The weighted average remaining contractual life of the outstanding options as of September 30, 2009 was 6.95 years.

Note 8.    Stock Warrants

Warrants outstanding and exercisable totaled 4,332,310 with a weighted average exercise price of $4.61 (ranging between $4.00 and $6.00) as of September 30, 2009 and January 1, 2009.  The weighted average remaining contractual life of the outstanding warrants as of September 30, 2009 was 2.31 years.
 
Note 9.    Fair Value Measurement

Valuation Hierarchy

The FASB’s accounting standard for fair value measurements establishes a valuation hierarchy for disclosure of the inputs to valuation used to measure fair value.  This hierarchy prioritizes the inputs into three broad levels as follows.  Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities.  Level 2 inputs are quoted prices for similar assets and liabilities in active markets or inputs that are observable for the asset or liability, either directly or indirectly through market corroboration, for substantially the full term of the financial instrument.  Level 3 inputs are unobservable inputs based on the Company’s own assumptions used to measure assets and liabilities at fair value.  A financial asset or liability’s classification within the hierarchy is determined based on the lowest level input that is significant to the fair value measurement.

The following table provides the assets and liabilities carried at fair value measured on a recurring basis as of September 30, 2009:

         
Fair Value Measurements at September 30, 2009
 
   
Total Carrying
Value at
September 30,
2009
   
Quoted prices
in active
markets
(Level 1)
   
Significant
other
observable
inputs (Level 2)
   
Significant
unobservable
inputs (Level 3)
 
                         
Cash and cash equivalents
  $ 18,207,314     $ 18,207,314     $ -     $ -  
Derivative liabilities
  $ 347,861     $ -     $ -     $ 347, 861  
 
 
12

 

TOWERSTREAM CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

Cash and cash equivalents are measured at fair value using quoted market prices and are classified within Level 1 of the valuation hierarchy.  The carrying amounts of accounts receivable, accounts payable, accrued liabilities and debt approximate their fair value due to their short maturities.  The derivative liabilities are measured at fair value using quoted market prices and estimated volatility factors, and are classified within Level 3 of the valuation hierarchy. There were no changes in the valuation techniques during the nine months ended September 30, 2009.

The following table sets forth a summary of the changes in the fair value of our Level 3 financial liabilities that are measured at fair value on a recurring basis:

   
Three Months
Ended September 30,
   
Nine Months
Ended September 30,
 
   
2009
   
2008
   
2009
   
2008
 
                         
Beginning balance
  $ (75,237 )   $ -     $ -     $ -  
Net unrealized loss on derivative financial instruments
    (184,717 )     -       (259,954 )     -  
Ending balance
  $ (259,954 )   $ -     $ (259,954 )   $ -  

Note 10.   Net Loss Per Common Share
 
Basic and diluted net loss per share has been calculated by dividing net loss by the weighted average number of common shares outstanding during the period.  All potentially dilutive common shares have been excluded since their inclusion would be antidilutive.

The following common stock equivalents were excluded from the computation of diluted net loss per common share because they were antidilutive.  The exercise of these common stock equivalents outstanding at September 30, 2009 could potentially dilute earnings per shares in the future.  The exercise of the outstanding stock options and warrants could generate proceeds up to approximately $26,000,000.

Stock options
    3,772,777  
Warrants
    4,332,310  
Convertible debt
    1,000,001  
  Total
    9,105,088  

Note 11.    Commitments and Contingencies
 
Lease Obligations.    The Company has entered into operating leases related to roof rights, cellular towers, office space and equipment leases under various non-cancelable agreements expiring through March 2019.
 
As of September 30, 2009, total future lease commitments were as follows:

Remainder of 2009
  $ 692,064  
2010
    2,728,369  
2011
    2,372,767  
2012
    2,171,076  
2013
    1,392,223  
Thereafter
    1,734,431  
    $ 11,090,930  

 
13

 

TOWERSTREAM CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
 
Rent expense for the three months ended September 30, 2009 and 2008 totaled approximately $661,000 and $499,000, respectively.  Rent expense for the nine months ended September 30, 2009 and 2008 totaled approximately $1,870,000 and $1,441,000, respectively.

Other Commitments and Contingencies .  One of the purchase agreements related to FCC licenses includes a contingent payment of $275,000, depending on the status of the license with the FCC, and whether the Company has obtained approval to broadcast terrestrially in the 3650 to 3700 MHz band.  The contingent payment would consist of the issuance of common stock with a value of $275,000 (due in May 2011).

 
14

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

The following discussion and analysis summarizes the significant factors affecting our condensed consolidated results of operations, financial condition and liquidity position for the three and nine months ended September 30, 2009. This discussion and analysis should be read in conjunction with our audited financial statements and notes thereto included in our Annual Report on Form 10-K for our year-ended December 31, 2008 and the condensed consolidated unaudited financial statements and related notes included elsewhere in this filing. The following discussion and analysis contains forward-looking statements that reflect our plans, estimates and beliefs. Our actual results could differ materially from those discussed in the forward-looking statements.

Forward-Looking Statements
 
Forward-looking statements in this Quarterly Report on Form 10-Q, including without limitation, statements related to our plans, strategies, objectives, expectations, intentions and adequacy of resources, are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Investors are cautioned that such forward-looking statements involve risks and uncertainties including without limitation the following: (i) our plans, strategies, objectives, expectations and intentions are subject to change at any time at our discretion; (ii) our plans and results of operations will be affected by our ability to manage growth; and (iii) other risks and uncertainties indicated from time to time in our filings with the Securities and Exchange Commission (“SEC”).
 
In some cases, you can identify forward-looking statements by terminology such as ‘‘may,’’ ‘‘will,’’ ‘‘should,’’ ‘‘could,’’ ‘‘expects,’’ ‘‘plans,’’ ‘‘intends,’’ ‘‘anticipates,’’ ‘‘believes,’’ ‘‘estimates,’’ ‘‘predicts,’’ ‘‘potential,’’ or ‘‘continue’’ or the negative of such terms or other comparable terminology. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance, or achievements. Moreover, neither we nor any other person assumes responsibility for the accuracy and completeness of such statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. We are under no duty to update any of the forward-looking statements after the date of this Report.

Overview
 
        We provide broadband services to commercial customers and deliver access over a fixed wireless network transmitting over both regulated and unregulated radio spectrum.   Our service supports bandwidth on demand, wireless redundancy, virtual private networks (“VPNs”), disaster recovery, bundled data and video services. We provide service to business customers in New York City, Boston, Chicago, Los Angeles, San Francisco, Seattle, Miami, Dallas-Fort Worth, Providence and Newport, Rhode Island.
 
Characteristics of our Revenues and Expenses

        We offer our services under agreements having terms of one, two or three years. Pursuant to these agreements, we bill customers on a monthly basis, in advance, for each month of service. Payments received in advance of services performed are recorded as deferred revenues.

         Costs of revenues consists of expenses that are directly related to providing services to our customers, including Core Network (tower and roof rent expense and utilities, bandwidth costs, Points of Presence (“PoP”) maintenance and other) and Customer Network (customer maintenance, non-installation fees and other customer specific expenses).  We collectively refer to Core Network and Customer Network as our “Network,” and Core Network costs and Customer Network costs as “Network Costs.”  When we first enter a new market, or expand in an existing market, we are required to incur up-front costs in order to be able to provide fixed wireless broadband services to commercial customers.  We refer to these activities as establishing a “Network Presence.”  These costs include building PoPs which are Company Locations where we install a substantial amount of equipment in order to connect numerous customers to the internet.  The costs to build PoPs are capitalized and expensed over a five year period.  In addition to building PoPs, we also enter tower and roof rental agreements, secure bandwidth and incur other Network Costs.  Once we have established a Network Presence in a new market or expanded our Network Presence in an existing market, we are capable of servicing a significant number of customers through that Network Presence.  The variable cost to add new customers is relatively modest, especially compared to the upfront cost of establishing or expanding our Network Presence.  As a result, our gross margins in a market normally increase over time as we add new customers in that market.  However, we may experience variability in gross margins during periods in which we are expanding our Network Presence in a market.

 
15

 

Sales and marketing expenses primarily consist of the salaries, benefits, travel and other costs of our sales and marketing teams, as well as marketing initiatives and business development expenses.

Customer support services include salaries and related payroll costs associated with our customer support services, customer care, and installation and operations staff.

General and administrative expenses include costs attributable to corporate overhead and the overall support of our operations.  Salaries and other related payroll costs for executive management, finance, administration and information systems personnel are included in this category.   Other costs include rent, utilities and other facility costs, accounting, legal, and other professional services, and other general operating expenses.

Market Information

        We operate in one segment which is the business of fixed wireless broadband services.   Although we provide services in multiple markets, these operations have been aggregated into one reportable segment based on the similar economic characteristics among all markets, including the nature of the services provided and the type of customers purchasing such services.  While we operate in only one business segment, we recognize that providing information on the revenues and costs of operating in each market can provide useful information to investors regarding our operating performance.

As of September 30, 2009, we operated in nine markets across the United States including New York, Boston, Los Angeles, Chicago, San Francisco, Miami, Seattle, Dallas-Fort Worth and Providence.  The markets were launched at different times, and as a result, may have different operating metrics based on their stage of maturation.  We incur significant up-front costs in order to establish a Network Presence in a new market.  These costs include building PoPs and Network Costs.  Other material costs include hiring and training sales and marketing personnel who will be dedicated to securing customers in that market.  Once we have established a Network Presence in a new market, we are capable of servicing a significant number of customers.  The rate of customer additions varies from market to market, and we are unable to predict how many customers will be added in a market during any specific period.  We believe that providing operating information regarding each of our markets provides useful information to shareholders in understanding the leveraging potential of our business model, the operating performance of our mature markets, and the long-term potential for our newer markets.  Set forth below is a summary of our operating performance on a per-market basis, and a description of how each category is determined.

Revenues : Revenues are allocated based on which market each customer is located in.

Costs of Revenues : Includes payroll, core network costs and customer network costs that can be specifically allocated to a specific market. Costs that can not be allocated to a specific market are classified as Centralized Costs.

Operating Costs : Costs which can be specifically allocated to a market include direct sales and marketing personnel, certain direct marketing expenses, certain customer support payroll expenses and third party commissions.

Centralized Costs : Represents costs incurred to support activities across all of our markets that are not allocable to a specific market.  This principally consists of payroll costs for customer care representatives, customer support engineers, sales support and installations personnel.  These individuals service customers across all markets rather than being dedicated to any specific market.

Corporate expenses : Includes costs attributable to corporate overhead and the overall support of our operations. Salaries and related payroll costs for executive management, finance, administration and information systems personnel are included in this category.  Other costs include office rent, utilities and other facilities costs, professional services and other general operating expenses.

 
16

 

Market EBITDA :   Represents a market’s earnings before interest, taxes, depreciation, amortization, stock-based compensation, and other income (expense).  We believe this metric provides useful information regarding the cash flow being generated in a market.

Three months ended September 30, 2009

Market
 
Revenues
   
Cost of
Revenues
   
Gross
Margin
   
Operating
Costs
   
Market
EBITDA
 
New York
  $ 1,305,680     $ 256,672     $ 1,049,008     $ 326,952     $ 722,056  
Boston
    995,674       157,284       838,390       183,915       654,475  
Los Angeles
    497,322       87,116       410,206       268,915       141,291  
San Francisco
    252,834       50,549       202,285       108,822       93,463  
Chicago
    254,160       91,508       162,652       113,750       48,902  
Providence/Newport
    127,261       38,395       88,866       44,062       44,804  
Seattle
    111,439       53,443       57,996       42,958       15,038  
Miami
    151,036       65,756       85,280       92,446       (7,166 )
Dallas-Fort Worth
    87,050       62,734       24,316       98,443       (74,127 )
Total
  $ 3,782,456     $ 863,457     $ 2,918,999     $ 1,280,263     $ 1,638,736  

Reconciliation of Non-GAAP Financial Measure to GAAP Financial Measure
     
Market EBITDA
  $ 1,638,736  
Centralized costs
    (710,958 )
Corporate expenses
    (1,475,828 )
Depreciation
    (1,035,660 )
Stock-based compensation
    (189,285 )
Other income (expense)
    (364,707 )
Net loss
  $ (2,137,702 )

Nine months ended September 30, 2009
 
Market
 
Revenues
   
Cost of
Revenues
   
Gross
Margin
   
Operating
Costs
   
Market 
EBITDA
 
New York
  $ 3,864,696     $ 682,339     $ 3,182,357     $ 952,672     $ 2,229,685  
Boston
    2,965,070       493,116       2,471,954       581,857       1,890,097  
Los Angeles
    1,345,636       236,324       1,109,312       778,753       330,559  
San Francisco
    711,549       150,190       561,359       336,749       224,610  
Providence/Newport
    394,341       112,367       281,974       158,112       123,862  
Chicago
    676,560       259,996       416,564       357,021       59,543  
Miami
    410,695       191,569       219,126       309,588       (90,462 )
Seattle
    315,070       179,210       135,860       229,433       (93,573 )
Dallas-Fort Worth
    189,486       177,350       12,136       341,779       (329,643 )
Total
  $ 10,873,103     $ 2,482,461     $ 8,390,642     $ 4,045,964     $ 4,344,678  

Reconciliation of Non-GAAP Financial Measure to GAAP Financial Measure
     
Market EBITDA
  $ 4,344,678  
Centralized costs
    (2,062,457 )
Corporate expenses
    (4,607,661 )
Depreciation
    (2,965,604 )
Stock-based compensation
    (575,607 )
Other income (expense)
    (786,730 )
Net loss
  $ (6,653,381 )

 
17

 

Three Months Ended September 30, 2009 Compared to the Three Months Ended September 30, 2008

Revenues.    Revenues totaled $3,782,456 during the three months ended September 30, 2009 as compared to $2,869,949 during the three months ended September 30, 2008, representing an increase of $912,507, or 32%.  This increase was driven by 49% growth in our customer base from September 30, 2008 to September 30, 2009.  The effect of the increase in our customer base was mitigated by a decrease in average revenue per user (“ARPU”) during the 2009 period as compared to the 2008 period.

ARPU as of September 30, 2009 totaled $731 compared to $831 as of September 30, 2008, representing a decrease of $100, or 12%.  The decrease relates to new customers purchasing lower ARPU products during the economic recession.  Customer churn, calculated as a percent of revenue lost on a monthly basis from customers terminating service or reducing their service level, totaled 1.71% for the three months ended September 30, 2009 compared to 1.22% for the three months ended September 30, 2008, representing a 40% increase on a percentage basis.  The higher churn in the 2009 period reflects the effect of the ongoing economic recession on our commercial customer base.
 
Cost of Revenues.    Cost of revenues totaled $931,368 for the three months ended September 30, 2009 as compared to $982,515 for the three months ended September 30, 2008, a decrease of $51,147, or 5%.  Gross margins increased to 75% during the 2009 period as compared to 66% during the 2008 period representing a 14% increase on a percentage basis.  During the first three quarters of 2009, we have focused on increasing market penetration in existing markets rather than expanding into new markets.  We have been able to add new customers at low marginal costs which has positively effected gross margins.  In addition, we have been able to lower certain Network Costs including bandwidth, shipping, supplies and equipment support.
 
Depreciation.    Depreciation totaled $1,035,660 for the three months ended September 30, 2009 as compared to $857,368 for the three months ended September 30, 2008, representing an increase of $178,292, or 21%. This increase was primarily related to the continued investment in our Network required to support the growth in our customer base and expansion in existing markets.  Gross fixed assets totaled $25,293,500 at September 30, 2009 as compared to $20,172,714 at September 30, 2008, representing an increase of $5,120,786, or 25%.
 
Customer Support Services.    Customer support services expenses totaled $544,019 for the three months ended September 30, 2009 as compared to $492,013 for the three months ended September 30, 2008, representing an increase of $52,006,   or 11%. This increase was primarily related to additional personnel hired to support our growing customer base.  Average headcount increased by 20%, from 35 in the 2008 period to 42 in the 2009 period.
 
Sales and Marketing.    Sales and marketing expenses totaled $1,379,291 for the three months ended September 30, 2009 as compared to $2,017,642 for the three months ended September 30, 2008, representing a decrease of $638,351, or 32%. Approximately $585,000, or 92%, of the decrease related to lower payroll costs as sales and marketing personnel totaled 68 at September 30, 2009 compared with 132 for the same period in 2008, a decrease in headcount of 48%.  In addition, commissions and bonuses decreased by approximately $48,000.
 
General and Administrative.    General and administrative expenses totaled $1,665,113 for the three months ended September 30, 2009 as compared to $1,754,729 for the three months ended September 30, 2008, representing a decrease of $89,616, or 5%.  This decrease was principally attributable to lower payroll costs of approximately $58,000.
 
Interest Income.      Interest income totaled $3,844 for the three months ended September 30, 2009 compared with $123,563 for the three months ended September 30, 2008, representing a decrease of $119,719, or 97%.  The decrease relates to lower cash balances and lower interest yields in the 2009 period compared with the 2008 period.  Average cash balances decreased from approximately $29.2 million in the third quarter 2008 to approximately $18.7 million in the third quarter 2009.  Monthly interest yields averaged 1.7% in the 2008 period compared with 0.1% in the 2009 period.

 
18

 

Interest Expense.    Interest expense totaled $184,774 for the three months ended September 30, 2009 compared with $105,589 for the three months ended September 30, 2008, representing an increase of $79,185, or 75%.  Additional non-cash interest expense of $78,540 was recognized in the third quarter of 2009 in connection with the adoption of a new accounting pronouncement as further described in Note 6 to the financial statements.

Net Loss.    Net loss totaled $2,137,702 for the three months ended September 30, 2009 as compared to a net loss of $3,216,033 for the three months ended September 30, 2008, a decrease of $1,078,331, or 34%.  This decrease related to an increase in revenues of $912,507, or 32%, and a decrease in operating expenses of $548,816, or 9%, offset by the negative effect of a decrease in other income (expense) of $382,992.

Nine Months Ended September 30, 2009 Compared to the Nine Months Ended September 30, 2008

Revenues.    Revenues totaled $10,873,103 during the nine months ended September 30, 2009 as compared to $7,445,924 during the nine months ended September 30, 2008, representing an increase of $3,427,179, or 46%.  This increase was driven by 49% growth in our customer base from September 30, 2008 to September 30, 2009.

       Cost of Revenues.    Cost of revenues totaled $2,672,220 for the nine months ended September 30, 2009 as compared to $2,909,230 for the nine months ended September 30, 2008, a decrease of $237,010, or 8%.  Gross margins increased to 75% during the 2009 period as compared to 61% during the 2008 period representing a 23% increase on a percentage basis.  During the nine months ended September 30, 2009, we lowered Core Network and Customer Network costs by approximately $195,000 and $65,000, respectively, even though our customer base increased by 49% from September 30, 2008 to September 30, 2009.  Over the past twelve months, we have decreased our use of third party vendors by hiring field technicians and other employees who can perform the same functions at a lower effective cost.

       Depreciation.    Depreciation totaled $2,965,604 for the nine months ended September 30, 2009 as compared to $2,286,674 for the nine months ended September 30, 2008, representing an increase of $678,930, or 30%. This increase was primarily related to the continued investment in our Network required to support the growth in our customer base and expansion in existing markets.  Gross fixed assets totaled $25,293,500 at September 30, 2009 as compared to $20,172,714 at September 30, 2008, representing an increase of $5,120,786, or 25%.

Customer Support Services.    Customer support services expenses totaled $1,578,032 for the nine months ended September 30, 2009 as compared to $1,430,225 for the nine months ended September 30, 2008, representing an increase of $147,807,   or 10%. This increase was primarily related to additional personnel hired to support our growing customer base.  Average headcount increased by 15%, from 34 in the 2008 period to 39 in the 2009 period.

Sales and Marketing.    Sales and marketing expenses totaled $4,340,630 for the nine months ended September 30, 2009 as compared to $5,811,337 for the nine months ended September 30, 2008, representing a decrease of $1,470,707, or 25%.  Approximately $960,000 of the decrease related to lower payroll costs as sales and marketing personnel averaged 87 during the 2009 period compared to 128 for the same period in 2008.  In addition, commissions and bonuses decreased by approximately $409,000 and advertising expenses decreased by approximately $96,000.

General and Administrative.    General and administrative expenses totaled $5,183,268 for the nine months ended September 30, 2009 as compared to $5,729,368 for the nine months ended September 30, 2008, representing a decrease of $546,100, or 10%.  This decrease was principally attributable to decreases in (i) professional fees of approximately $281,000, (ii) stock based compensation of approximately $102,000 and (iii) taxes of approximately $62,000.
 
Interest Income.     Interest income totaled $26,057 for the nine months ended September 30, 2009 compared with $560,434 for the nine months ended September 30, 2008, representing a decrease of $534,377, or 95% .   In March 2008, we transferred our cash balances into four separate U.S. Treasury based money market funds.  These funds have lower yields but are higher quality instruments than the funds in which we previously invested.  Average cash balances decreased from approximately $32.1 million in the 2008 period to approximately $20.6 million in the 2009 period. In addition, annual interest yield have decreased from 2.4% to 0.2% year over year.

 
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Interest Expense.    Interest expense totaled $553,700 for the nine months ended September 30, 2009 compared with $394,565 for the nine months ended September 30, 2008, representing an increase of $159,135, or 40%.  Additional non-cash interest expense of approximately $236,000 was recognized in the first nine months of 2009 in connection with the adoption of a new accounting pronouncement which was offset by approximately $73,000 of non-cash interest expense that was recognized when a portion of our debt was converted into equity in January 2008.

Net Loss.    Net loss totaled $6,653,381 for the nine months ended September 30, 2009 as compared to a net loss of $10,554,726 for the nine months ended September 30, 2008, a decrease of $3,901,345, or 37%.  This decrease related to an increase in revenues of $3,427,179, or 46%, and a decrease in operating expenses of $1,427,080, or 8%, offset by the negative effect of a decrease in other income (expense) of $952,914.

Liquidity and Capital Resources

We have historically met our liquidity and capital requirements primarily through the public sale and private placement of equity securities and debt financing.  Cash and cash equivalents totaled $18,207,314 and $24,740,268 at September 30, 2009 and December 31, 2008, respectively. The decrease in cash and cash equivalents related to our operating and investing activities during the nine months ended September 30, 2009, each of which is described below.

Net Cash Used in Operating Activities.    Net cash used in operating activities totaled $2,793,742 for the nine months ended September 30, 2009 as compared to $6,288,665 for the nine months ended September 30, 2008, representing a decrease of $3,494,923, or 56%.  This decrease was directly related to the lower net loss reported in the 2009 period of $6,653,381, which represented a reduction of $3,901,345, or 37%, as compared to the 2008 period.
 
Net Cash Used in Investing Activities.    Net cash used in investing activities totaled $3,686,317 for the nine months ended September 30, 2009 as compared to $6,347,193 for the nine months ended September 30, 2008, representing a decrease of $2,660,876, or 42%.  The decrease in the 2009 period related to lower spending on property and equipment which decreased by 38% from $5,928,678 to $3,683,667.  During the 2008 period, we expanded our corporate office and spent approximately $891,000 on office equipment, system software and leasehold improvements as compared to approximately $76,000 in the 2009 period.  Spending on network and base station equipment decreased by approximately $1,074,000 during the 2009 period as compared to the 2008 period.  Our decision to focus on our existing markets, rather than to expand into new markets during the ongoing economic recession, has resulted in lower network and base station equipment spending as the existing markets already have much of the network and base station equipment required to operate.  Finally, we purchased a FCC license for $400,000 during the third quarter of 2008.
 
Working Capital.    As of September 30, 2009, we had working capital of $13,064,131.  Based on our current operating activities and plans, we believe our existing working capital will enable us to meet our anticipated cash requirements for at least the next twelve months.
 
Critical Accounting Policies

Our financial statements are prepared in conformity with accounting principles generally accepted in the United States of America which require us to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of our financial statements, and the reported amounts of revenues and expenses during the reporting periods. Critical accounting policies are those that require the application of management’s most difficult, subjective, or complex judgments, often because of the need to make estimates about the effect of matters that are inherently uncertain and that may change in subsequent periods.

In preparing the financial statements, we utilized available information, including our past history, industry standards and the current economic environment, among other factors, in forming our estimates and judgments, giving due consideration to materiality. Actual results may differ from these estimates. In addition, other companies may utilize different estimates which may impact the comparability of our results of operations to other companies in our industry. We believe the following significant accounting policies may involve a higher degree of judgment and estimation.

 
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Revenue Recognition.    We normally enter into contractual agreements with our customers for periods ranging between one to three years.  We recognize the total revenue provided under a contract ratably over the contract period, including any periods under which we have agreed to provide services at no cost.  Deferred revenues are recognized as a liability when billings are received in advance of the date when revenues are earned. We apply the revenue recognition principles set forth under SEC Staff Accounting Bulletin No. 104 which provides for revenue to be recognized when (i) persuasive evidence of an arrangement exists, (ii) delivery or installation has been completed, (iii) the customer accepts and verifies receipt, and (iv) collectability is reasonably assured.

   Long-Lived Assets.    Long-lived assets consist primarily of property and equipment, and FCC licenses.  Long-lived assets are reviewed annually for impairment or whenever events or circumstances indicate their carrying value may not be recoverable.  Conditions that would result in an impairment charge include a significant decline in the market value of an asset, a significant change in the extent or manner in which an asset is used, or a significant adverse change that would indicate that the carrying amount of an asset or group of assets is not recoverable. When such events or circumstances arise, an estimate of the future undiscounted cash flows produced by the asset, or the appropriate grouping of assets, is compared to the asset’s carrying value to determine if impairment exists pursuant to the FASB’s guidance on the impairment or disposal of long-lived assets.  If the asset is determined to be impaired, the impairment loss is measured based on the excess of its carrying value over its fair value.  Assets to be disposed of are reported at the lower of their carrying value or net realizable value.
 
Asset Retirement Obligations.    The FASB’s guidance on asset retirement and environmental obligations addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs.  This guidance requires the recognition of an asset retirement obligation and an associated asset retirement cost when there is a legal obligation in connection with the retirement of tangible long-lived assets.  Our network equipment is installed on both buildings in which the Company has a lease   agreement (“Company Locations”) and at customer locations.  In both instances, the installation and removal of our equipment is not complicated and does not require structural changes to the building where the equipment is installed.  Costs associated with the removal of our equipment at company or customer locations are not material, and accordingly, we have determined that we do not presently have asset retirement obligations under the FASB’s accounting guidance.

Off-Balance Sheet Arrangements.    We have no off-balance sheet arrangements, financings, or other relationships with unconsolidated entities known as ‘‘Special Purposes Entities.’’
 
Recent Accounting Pronouncements
 
In September 2006, the Financial Accounting Standards Board (“FASB”) issued an accounting standard which defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. We adopted this standard on January 1, 2008 for our financial assets and financial liabilities.  On January 1, 2009, we adopted the fair value measurement requirements for nonfinancial assets and nonfinancial liabilities that are not recognized or disclosed at fair value on a recurring basis.  The adoption of this standard did not have a material impact on our financial position or results of operations.
 
In December 2007, the FASB issued an accounting standard related to accounting for business combinations and related disclosures. This standard addresses the recognition and accounting for identifiable assets acquired, liabilities assumed and noncontrolling interests in business combinations. The standard also expands disclosure requirements for business combinations. The standard became effective on January 1, 2009.
 
In December 2007, the FASB issued an accounting standard related to accounting and reporting for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. Noncontrolling interests are reported as a separate component of consolidated stockholders’ equity, and net income allocable to noncontrolling interests and net income attributable to stockholders are reported separately in the consolidated statement of operations. This standard became effective on January 1, 2009 and did not have a material impact on our financial position or results of operations.

 
21

 
 
In March 2008, the FASB issued an accounting standard related to disclosures about derivative instruments and hedging activities. This standard amends and enhances disclosure requirements to provide a better understanding of how and why a company uses derivative instruments, how derivative instruments and related hedged items are accounted for, and their effect on a company’s financial position, financial performance and cash flows. We adopted this standard on January 1, 2009 and have included additional disclosures in our condensed consolidated financial statements.

In April 2008, the FASB issued an accounting standard which provides guidance for determining the useful life of an intangible asset and the period of expected cash flows used to measure the fair value of the asset. The adoption of this standard on January 1, 2009 did not impact our financial position or results of operations.

In May 2008, the FASB issued an accounting standard that requires the liability and equity components of convertible debt instruments to be accounted for separately if the debt can be settled in cash upon conversion. Our debt may not be settled in cash upon conversion.  This standard became effective January 1, 2009.  Accordingly, there was no impact on our financial position or results of operations upon adoption.

In April 2009, the FASB issued an accounting standard which affirmed that there is no change in the measurement of fair value when the volume and level of activity for an asset or a liability has significantly decreased.  This standard also identifies circumstances that indicate when a transaction is not orderly.  The adoption of this standard in the second quarter of 2009 had no material impact on our financial position and results of operations.

In April 2009, the FASB issued an accounting standard which requires disclosures about the fair value of financial instruments whenever a public company issues financial information for interim reporting periods. This standard became effective in the second quarter of 2009 and did not have a material impact on our financial position and results of operations.

In June 2009, the FASB issued an accounting standard which requires entities to disclose the date through which subsequent events have been evaluated as well as whether that date is the date the financial statements were issued or the date the financial statements were made available to be issued. We adopted this standard in the second quarter of 2009.  We have evaluated subsequent events through the November 4, 2009 filing of our financial statements with the SEC.

In June 2009, the FASB issued the FASB Accounting Standards Codification (“Codification”). Effective this quarter, the Codification became the single source for all authoritative generally accepted accounting principles (“GAAP”) recognized by the FASB and is required to be applied to financial statements issued for interim and annual periods ending after September 15, 2009. The Codification does not change GAAP and did not impact our financial position or results of operations.

In August 2009, the FASB issued an accounting standard to provide clarification on measuring liabilities at fair value when a quoted price in an active market is not available.  This standard will become effective for us on October 1, 2009 and is not expected to have a significant impact on our financial position or results of operations.

 
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Item 3. Quantitative and Qualitative Disclosures about Market Risk.

   Not applicable

Item 4.  Controls and Procedures.

       We carried out an evaluation, under the supervision and with the participation of our management, including our chief executive officer and chief financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the ‘‘Exchange Act’’). Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to the issuer’s management, including its   principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure. Based upon our evaluation, our chief executive officer and chief financial officer concluded that our disclosure controls and procedures are effective, as of the nine months ended September 30, 2009, in ensuring that material information that we are required to disclose in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission rules and forms.

Changes in Internal Control over Financial Reporting

       There were no changes in our system of internal controls over financial reporting during the three months ended September 30, 2009 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 
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PART II
OTHER INFORMATION

Item 6. Exhibits.

Exhibit No.
 
Description
31.1
 
Section 302 Certification of Principal Executive Officer
31.2
 
Section 302 Certification of Principal Financial Officer
32.1
 
Section 906 Certification of Principal Executive Officer
32.2
 
Section 906 Certification of Principal Financial Officer
 
 
24

 
 
SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 
TOWERSTREAM CORPORATION
     
Date:  November 4, 2009
By:
/s/ Jeffrey M. Thompson
     
   
Jeffrey M. Thompson
   
President and Chief Executive Officer
   
(Principal Executive Officer)
     
Date:  November 4, 2009
By:
/s/ Joseph P. Hernon
     
   
Joseph P. Hernon
   
Chief Financial Officer
   
(Principal Financial Officer and Principal Accounting Officer)

 
25

 

EXHIBIT INDEX

Exhibit No.
 
Description
31.1
 
Section 302 Certification of Principal Executive Officer
31.2
 
Section 302 Certification of Principal Financial Officer
32.1
 
Section 906 Certification of Principal Executive Officer
32.2
 
Section 906 Certification of Principal Financial Officer

 
 

 
 
EXHIBIT 31.1
 
CERTIFICATION OF THE PRINCIPAL EXECUTIVE OFFICER PURSUANT
TO
SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
 
I, Jeffrey M. Thompson, certify that:
 
(1)
I have reviewed this quarterly report on Form 10-Q of Towerstream Corporation for the quarter ended September 30, 2009;
 
(2)
Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
 
(3)
Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects, the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
 
(4)
The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
 
a)
Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b) 
Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
 
c)
Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
 
d)
Disclosed in the report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of the annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
 
(5)
The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):
 
a)
All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
 
b)
Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.
 
Date: November 4, 2009

/s/ Jeffrey M. Thompson
Jeffrey M. Thompson
President and Chief Executive Officer
(Principal Executive Officer)

 
 

 
 
EXHIBIT 31.2
 
CERTIFICATION OF THE PRINCIPAL FINANCIAL OFFICER PURSUANT
TO
SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
 
I, Joseph P. Hernon, certify that:
 
(1)
I have reviewed this quarterly report on Form 10-Q of Towerstream Corporation for the quarter ended September 30, 2009;
 
(2)
Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
 
(3)
Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects, the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
 
(4)
The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
 
a)
Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
 
b) 
Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c)
Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
 
d)
Disclosed in the report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of the annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
 
(5)
The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):
 
a)
All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
 
b)
Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.
 
Date: November 4, 2009

/s/ Joseph P. Hernon
Joseph P. Hernon
Chief Financial Officer
(Principal Financial Officer)
 
 
 

 
 
EXHIBIT 32.1
 
CERTIFICATION OF THE PRINCIPAL EXECUTIVE OFFICER
PURSUANT TO 18 U.S.C. SECTION 1350
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
 
In connection with the Quarterly Report of Towerstream Corporation, (the ‘‘Company’’) on Form 10-Q for the period ended September 30, 2009 as filed with the Securities and Exchange Commission on the date hereof (the ‘‘Report’’), I, Jeffrey M. Thompson, President and Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to my knowledge:
 
(1)
The Report fully complies with the requirements of Section 13(a) of 15(d) of the Securities Exchange Act of 1934; and
 
(2)
The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.
 
Date: November 4, 2009

/s/ Jeffrey M. Thompson
Jeffrey M. Thompson
President and Chief Executive Officer
(Principal Executive Officer)
 
 
 

 
 
EXHIBIT 32.2
 
CERTIFICATION OF THE PRINCIPAL FINANCIAL OFFICER
PURSUANT TO 18 U.S.C. SECTION 1350
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
 
In connection with the Quarterly Report of Towerstream Corporation, (the ‘‘Company’’) on Form 10-Q for the period ended September 30, 2009 as filed with the Securities and Exchange Commission on the date hereof (the ‘‘Report’’), I, Joseph P. Hernon, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to my knowledge:
 
(1)
The Report fully complies with the requirements of Section 13(a) of 15(d) of the Securities Exchange Act of 1934; and
 
(2)
The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.
 
Date: November 4, 2009

/s/ Joseph P. Hernon
Joseph P. Hernon
Chief Financial Officer
(Principal Financial Officer)