UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
x
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
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For the quarterly period ended March 31, 2012
OR
¨
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
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For the transition period
from
to
Commission file number: 001-33778
NEUTRAL
TANDEM, INC.
(Exact name of registrant as specified in its charter)
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Delaware
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31-1786871
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(State or other Jurisdiction of
Incorporation or Organization)
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(IRS Employer
Identification No.)
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550 West Adams Street
Suite 900
Chicago, IL 60661
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(Address of principal executive offices, including zip code)
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(312) 384-8000
(Registrants telephone number, including area code)
Indicate by
checkmark 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 is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act. (Check
one):
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Large accelerated filer
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¨
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Accelerated filer
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x
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Non-accelerated filer
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¨
(Do not check if a smaller reporting company)
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Smaller reporting company
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¨
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Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Exchange Act). Yes
¨
No
x
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
¨
As of April 30, 2012, 31,777,998 shares of the registrants Common Stock, $0.001 par value, were issued and outstanding.
NEUTRAL TANDEM, INC.
INDEX
PART I. FINANCIAL INFORMATION
Item 1.
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Condensed Consolidated Financial Statements (Unaudited)
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NEUTRAL TANDEM, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share amounts)
(Unaudited)
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March 31,
2012
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December 31,
2011
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ASSETS
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Current assets:
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Cash and cash equivalents
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$
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97,749
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$
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90,279
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Receivables, net of allowance of $2,018 and $1,929, respectively
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45,182
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46,991
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Deferred income taxes-current
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2,648
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3,227
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Other current assets
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8,881
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6,655
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Total current assets
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154,460
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147,152
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Property and equipment net
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76,166
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75,045
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Intangible assets net
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28,853
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28,644
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Goodwill
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49,584
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48,137
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Restricted cash
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962
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962
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Other assets
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2,752
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2,870
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Total assets
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$
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312,777
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$
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302,810
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LIABILITIES AND SHAREHOLDERS EQUITY
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Current liabilities:
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Accounts payable
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$
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11,009
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$
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13,792
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Accrued liabilities:
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Taxes payable
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1,928
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2,567
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Circuit cost
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10,073
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8,743
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Rent
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1,610
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1,525
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Payroll and related items
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3,905
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4,366
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Other
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3,938
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2,640
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Total current liabilities
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32,463
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33,633
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Other liabilities
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2,166
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1,693
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Deferred income taxes-noncurrent
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6,307
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7,806
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Total liabilities
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40,936
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43,132
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Commitments and contingencies
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Shareholders equity:
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Preferred stock par value of $.001; 50,000,000 authorized shares; no shares issued and outstanding at March 31, 2012
and December 31, 2011
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Common stock par value of $.001; 150,000,000 authorized shares; 31,802,728 shares and 31,520,121 shares issued and
outstanding at March 31, 2012 and December 31, 2011, respectively
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32
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32
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Less treasury stock, at cost; 3,083,446 shares at March 31, 2012 and December 31, 2011
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(50,103
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)
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(50,103
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)
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Additional paid-in capital
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187,820
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185,014
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Accumulated other comprehensive loss
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(1,644
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)
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(4,346
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)
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Retained earnings
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135,736
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129,081
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Total shareholders equity
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271,841
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259,678
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Total liabilities and shareholders equity
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$
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312,777
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$
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302,810
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The accompanying notes are an integral part of these condensed consolidated financial statements.
3
NEUTRAL TANDEM, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
(In thousands, except per share amounts)
(Unaudited)
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Three Months Ended
March 31,
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2012
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2011
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Revenue
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$
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70,696
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$
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66,418
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Operating expense:
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Network and facilities expense (excluding depreciation and amortization)
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30,515
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25,819
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Operations
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11,551
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9,419
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Sales and marketing
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4,034
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3,359
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General and administrative
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6,738
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10,058
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Depreciation and amortization
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7,300
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7,106
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Gain on disposal of fixed assets
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(105
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)
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(6
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Total operating expense
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60,033
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55,755
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Income from operations
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10,663
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10,663
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Other (income) expense:
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Interest income
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(3
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)
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(13
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)
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Other (income) expense
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(13
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)
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14
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Foreign exchange gain
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(227
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)
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(1,763
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)
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Total other income
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(243
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)
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(1,762
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)
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Income before income taxes
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10,906
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12,425
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Provision for income taxes
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4,251
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4,241
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Net income
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$
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6,655
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$
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8,184
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Net income per share:
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Basic
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$
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0.21
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$
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0.24
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Diluted
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$
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0.21
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$
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0.24
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Weighted average number of shares outstanding:
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Basic
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31,664
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34,251
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Diluted
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32,058
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34,695
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Total Comprehensive income
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$
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9,357
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$
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12,947
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The accompanying notes are an integral part of these condensed consolidated financial statements
4
NEUTRAL TANDEM, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
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Three Months Ended
March 31,
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2012
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2011
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Cash Flows From Operating Activities:
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Net income
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$
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6,655
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$
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8,184
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Adjustments to reconcile net cash flows from operating activities:
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Depreciation and amortization
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7,300
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7,106
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Deferred income taxes
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(965
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)
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(663
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)
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Gain on disposal of fixed assets
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(105
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)
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(6
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)
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Non-cash share-based compensation
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3,116
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6,582
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Gain on intercompany foreign exchange transactions
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(326
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)
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Excess tax deficiency associated with share-based payments
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62
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98
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Changes in assets and liabilities:
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Receivables
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2,400
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(1,827
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)
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Other current assets
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(1,973
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)
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184
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Other noncurrent assets
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64
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(1,919
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)
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Accounts payable
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(1,305
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)
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(1,000
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)
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Accrued liabilities
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1,265
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2,258
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Noncurrent liabilities
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428
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(14
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)
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Net cash flows from operating activities
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16,616
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18,983
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Cash Flows From Investing Activities:
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Purchase of equipment
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(9,122
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)
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(5,590
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)
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Proceeds from sale of equipment
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100
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6
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Net cash flows from investing activities
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(9,022
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)
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(5,584
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)
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Cash Flows From Financing Activities:
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Proceeds from the exercise of stock options
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8
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94
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Restricted shares withheld to cover employee taxes paid
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(256
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)
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(597
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)
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Excess tax deficiency associated with share-based payments
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(62
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)
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|
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(98
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)
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|
|
|
|
|
|
|
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Net cash flows from financing activities
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(310
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)
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(601
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)
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|
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Effect of exchange rate changes on cash
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186
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|
|
|
153
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Net Increase In Cash And Cash Equivalents
|
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7,470
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|
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12,951
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Cash And Cash Equivalents Beginning
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90,279
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|
|
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106,674
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|
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|
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Cash And Cash Equivalents End
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$
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97,749
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|
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$
|
119,625
|
|
|
|
|
|
|
|
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Supplemental Disclosure Of Cash Flow Information:
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|
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|
|
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Cash paid for taxes
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$
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6,160
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|
|
$
|
349
|
|
|
|
|
|
|
|
|
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Supplemental Disclosure Of Noncash Flow Items:
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|
|
|
|
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Investing Activity Accrued purchases of equipment
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$
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4,635
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|
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$
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4,433
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|
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The accompanying notes are an integral part of these condensed consolidated financial statements.
5
NEUTRAL TANDEM, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. DESCRIPTION OF THE BUSINESS
Organization
Neutral Tandem, Inc. d/b/a Inteliquent (the Company) provides U.S. and international
voice, IP Transit, and Ethernet telecommunications services primarily on a wholesale basis. The Company offers these services using an all-IP network, which enables the Company to deliver global connectivity for a variety of media, including voice,
data and video. The Companys solutions enable carriers and other providers to deliver telecommunications traffic or other services where they do not have their own network or elect not to use their own network. These solutions are sometimes
called off-net services. The Company also provides its solutions to customers, like content providers, who also typically do not have their own network.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The condensed consolidated financial statements include the accounts
of the Company and its wholly owned subsidiaries. All intercompany balances and transactions have been eliminated in consolidation.
Interim Condensed Consolidated Financial Statements
The accompanying condensed consolidated balance sheets as of March 31, 2012 and December 31, 2011, the condensed
consolidated statements of income and comprehensive income for the three months ended March 31, 2012 and 2011, and the condensed consolidated statements of cash flows for the three months ended March 31, 2012 and 2011 are unaudited. The
condensed consolidated balance sheet data as of December 31, 2011 was derived from the audited consolidated financial statements which are included in the Companys Annual Report on Form 10-K for the fiscal year ended December 31,
2011. The accompanying statements should be read in conjunction with the audited consolidated financial statements and related notes contained in the Companys Annual Report on Form 10-K for the fiscal year ended December 31, 2011.
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting
principles generally accepted in the United States (GAAP) pursuant to the rules and regulations of the Securities and Exchange Commission applicable to interim periods. Certain information and footnote disclosures normally included in financial
statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to such rules and regulations.
In the opinion of management, the unaudited interim condensed consolidated financial statements as of March 31, 2012 and for the three months ended March 31, 2012 and 2011 have been prepared on
the same basis as the audited consolidated statements and reflect all adjustments, which are normal recurring adjustments, necessary for the fair presentation of its statement of financial position, results of operations and cash flows. The results
of operations for the three months ended March 31, 2012 are not necessarily indicative of the operating results for any subsequent quarter, for the full fiscal year or any future periods.
Cash and Cash Equivalents
The Company considers all highly liquid investments with an original maturity of
90 days or less to be cash and cash equivalents. At March 31, 2012 the Company had $11.9 million of cash in banks and $85.8 million in two money market mutual funds. At December 31, 2011, the Company had $11.5 million of cash in banks
and $78.8 million in two money market mutual funds.
The carrying amounts of our cash and equivalents, receivables and
accounts payable approximate fair value due to their short-term nature.
Property and Equipment
Property
and equipment are recorded at historical cost. These costs are depreciated over the estimated useful lives of the individual assets using the straight-line method. Any gains and losses from the disposition of property and equipment are included in
operations as incurred. The estimated useful life for network equipment and tools and test equipment is five years. The estimated useful life for computer equipment, computer software and furniture and fixtures is three years. Leasehold improvements
are amortized on a straight-line basis over an estimated useful life of five years or the life of the lease, whichever is less. As discussed in further detail below, the impairment of long-lived assets is periodically evaluated when events or
changes in circumstances indicate that a potential impairment has occurred.
Goodwill and Intangible Assets, Net
The change in the carrying amount of goodwill during the three months ended March 31, 2012, is as follows:
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|
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|
|
|
|
|
(Dollars in thousands)
|
|
December 31,
2011
|
|
|
Currency
Translation Effect
|
|
|
March 31,
2012
|
|
Goodwill
|
|
$
|
48,137
|
|
|
$
|
1,447
|
|
|
$
|
49,584
|
|
6
Intangible assets, net consist of the following:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
March 31, 2012
|
|
(Dollars in thousands)
|
|
Gross Carrying
Amount
|
|
|
Accumulated
Amortization
|
|
|
Net Intangible
Assets
|
|
Customer relationships
|
|
$
|
32,278
|
|
|
$
|
(3,425
|
)
|
|
$
|
28,853
|
|
|
|
December 31, 2011
|
|
(Dollars in thousands)
|
|
Gross Carrying
Amount
|
|
|
Accumulated
Amortization
|
|
|
Net Intangible
Assets
|
|
Customer relationships
|
|
$
|
31,337
|
|
|
$
|
(2,693
|
)
|
|
$
|
28,644
|
|
Intangible assets, which consist of customer relationships, have a definite life and are amortized on an
accelerated basis over the period expected to be benefited (useful lives) of 15 years. Intangible asset amortization expense was $0.6 million and $0.6 million in the three months ended March 31, 2012 and March 31, 2011, respectively.
Intangible asset amortization for each of the five succeeding fiscal years is estimated at $2.5 million for 2012, $2.9 million for 2013, $2.8 million for 2014, $2.4 million for 2015 and $2.0 million in 2016.
Revenue Recognition
The Company generates revenue from sales of its voice, IP Transit, and Ethernet services. The
Company maintains tariffs and executed service agreements with each of its customers in which specific fees and rates are determined. Voice revenue is recorded each month on an accrual basis based upon minutes of traffic switched by the
Companys network by each customer, which is referred to as minute of use. The rates charged per minute are determined by contracts between the Company and its customers or by filed and effective tariffs.
IP Transit revenue and Ethernet services revenue, comprised of both Ethernet Private Line (EtherCloud P2P) and EtherCloud Extension
(EtherCloud E2E) revenues, are recorded each month on an accrual basis based upon bandwidth used by each customer. The rates charged are the total of a monthly fee for bandwidth (the Committed Traffic Rate) plus additional charges for the sustained
peak bandwidth used monthly in excess of the Committed Traffic Rate.
Earnings Per Share
Basic earnings
per share is computed based on the weighted average number of common shares and participating securities outstanding. Diluted earnings per share is computed based on the weighted average number of common shares and participating securities
outstanding adjusted by the number of additional shares that would have been outstanding during the period had the potentially dilutive securities been issued. The following table presents a reconciliation of the numerators and denominators of basic
and diluted earnings per share of common stock:
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
March 31,
|
|
(In thousands, except per share amounts)
|
|
2012
|
|
|
2011
|
|
Numerator:
|
|
|
|
|
|
|
|
|
Net income applicable to common shareholders
|
|
$
|
6,655
|
|
|
$
|
8,184
|
|
Denominator:
|
|
|
|
|
|
|
|
|
Weighted average common shares outstanding
|
|
|
31,664
|
|
|
|
34,251
|
|
Effect of dilutive securities:
|
|
|
|
|
|
|
|
|
Stock options
|
|
|
394
|
|
|
|
444
|
|
|
|
|
|
|
|
|
|
|
Denominator for diluted earnings per share
|
|
|
32,058
|
|
|
|
34,695
|
|
|
|
|
|
|
|
|
|
|
Net earnings per share:
|
|
|
|
|
|
|
|
|
Basic as reported
|
|
$
|
0.21
|
|
|
$
|
0.24
|
|
|
|
|
|
|
|
|
|
|
Diluted as reported
|
|
$
|
0.21
|
|
|
$
|
0.24
|
|
|
|
|
|
|
|
|
|
|
Outstanding share-based awards of 2.8 million and 2.4 million were outstanding during the three
months ended March 31, 2012 and March 31, 2011, respectively, but were not included in the computation of diluted earnings per share because the effect would have been antidilutive.
For both the three months ended March 31, 2012 and 2011, the undistributed earnings allocable to participating securities were $0.3
million
7
Accounting for Share-Based Payments
The fair value of stock options is
determined using the Black-Scholes valuation model. This model takes into account the exercise price of the stock option, the fair value of the common stock underlying the stock option as measured on the date of grant and an estimation of the
volatility of the common stock underlying the stock option. Such value is recognized as expense over the service period, net of estimated forfeitures, using the straight line method. The estimation of stock awards that will ultimately vest requires
judgment, and to the extent actual results or updated estimates differ from the Companys current estimates, such amounts will be recorded as a cumulative adjustment in the period estimates are revised. The Company considers many factors when
estimating expected forfeitures, including types of awards, employee class, and historical experience. Actual results, and future changes in estimates, may differ from the Companys current estimates.
The amount of share-based expense recorded in the three months ended March 31, 2012 and 2011, is $3.1 million and $6.6 million,
respectively.
Compensation expense for non-vested shares is measured based upon the quoted closing market price for the stock
on the date of grant. The compensation cost is recognized on a straight-line basis over the vesting period. See Note 5, Stock Options and Non-vested Shares
Foreign Currency Translation
The functional currency of each of the Companys subsidiaries is the currency of the country in which the subsidiary operates. Assets and
liabilities of foreign operations are translated using period end exchange rates, and revenues and expenses are translated using average exchange rates during the period. Translation gains and losses are reported in accumulated other comprehensive
earnings as a component of stockholders equity.
Recent Accounting Pronouncements
Effective
January 1, 2012, the Company adopted the Financial Accounting Standards Board Accounting Standards Update No. 2011-05, Presentation of Comprehensive Income in U.S. GAAP (ASU 2011-05) and Accounting Standards Update No. 2011-12,
Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income (ASU 2011-12). These ASUs require that comprehensive income and the related components of net income and of
other comprehensive income be presented in a single continuous statement of comprehensive income or in two separate but consecutive statements. The amendments did not change the items reported in other comprehensive income or when an item of
other comprehensive income is reclassified to net income. As a result, the adoption of this guidance did not affect the Companys financial position, results of operations or cash flows. The Company has presented the components of total net
income and total comprehensive income in one continuous statement.
3. LEGAL PROCEEDINGS
Peerless Network, Inc.
Proceeding in the United States District Court for the Northern District of Illinois
As previously disclosed, on June 12, 2008, the Company commenced a patent infringement action against Peerless Network, Inc., Peerless Network of Illinois, LLC, and John Barnicle (collectively,
Peerless Network) in the United States District Court for the Northern District of Illinois to enforce the 708 Patent (
Neutral Tandem, Inc. v Peerless Network, Inc., Peerless Network of Illinois, LLC and John Barnicle, 08 CV 3402
). On
July 28, 2008, Peerless Network filed a response to the Companys complaint denying liability and asserting various affirmative defenses and counterclaims. Peerless Network generally alleged (i) that the 708 Patent was invalid
and unenforceable under a variety of theories, (ii) that assertion of the 708 Patent amounted to patent misuse and violation of certain monopolization laws, and (iii) that certain conduct surrounding the litigation gave rise to
tortious interference and business disparagement claims and Lanham Act violations. On December 4, 2008, the court granted the Companys motion to dismiss the claims alleging business disparagement and Lanham Act violations but denied the
Companys motion to dismiss the claims related to the allegations of tortious interference and alleged violation of certain monopolization laws. On January 27, 2010, the court issued an order construing each of the disputed terms in the
patent in the manner the Company had proposed. On March 30, 2010, the court issued an order denying the Companys motion dated August 25, 2009 for preliminary injunctive relief which sought to enjoin Peerless Network from providing
certain tandem transit services.
On April 27, 2010, the court issued an order denying without prejudice the motion of
Peerless Network seeking leave to file a motion to stay the patent litigation. Peerless Network sought to stay the patent litigation pending the
inter partes
reexamination by the United States Patent and Trademark Office (the USPTO) of the
validity of the 708 Patent, which is discussed under
Inter partes proceeding before the United States Patent and Trademark Office
below.
On June 1, 2010, Peerless Network filed a renewed motion asking the court to extend the trial date by nine months or stay proceedings pending the
inter partes
reexamination by the USPTO of the
validity of the 708 Patent. The court heard the motion on June 8, 2010. After hearing the motion, the court issued an order that in substance removed the previously scheduled September 2010 trial date from the courts calendar.
However, the court also ordered that proceedings on the parties respective motions for summary judgment would continue, and the court set a ruling date on the parties summary judgment motions for September 1, 2010.
8
On September 2, 2010, the court issued an opinion and order granting Peerless
Networks motion for summary judgment. The court found that the 708 Patent is invalid in light of a prior patent, U.S. Patent No. 6,137,800. In light of the summary judgment ruling, the court denied the Companys request to
reinstate the trial date as moot.
The courts September 2, 2010 order also denied the Companys motion for
summary judgment. The Company sought summary judgment on its claim that Peerless Network infringed the 708 Patent, as well as summary judgment on Peerless Networks claim that the 708 Patent is unenforceable. At a hearing on
September 22, 2010, the court allowed the Company to file a new motion for summary judgment on Peerless Networks claim that the 708 Patent is unenforceable. The court also dismissed Counts IV-VII of Peerless Networks
counterclaims, which were claims against the Company based on allegations of monopolization, monopoly leveraging, violations of the Illinois Antitrust Act, and tortious interference with prospective business relations.
On December 9, 2010, the court issued an opinion and order granting the Companys motion for summary judgment on Peerless
Networks claim that the 708 Patent was unenforceable based on alleged inequitable conduct and patent misuse. The court entered a final judgment with respect to all claims in the litigation on December 17,
2010.
On December 20, 2010, the Company filed notice that it planned to appeal the courts order granting Peerless
Networks motion for summary judgment and finding that the 708 Patent is invalid. On January 13, 2011, Peerless Network cross-appealed the courts order granting the Companys motion for summary judgment and finding that
the 708 Patent is not unenforceable, as well as the courts earlier ruling construing disputed terms of the patent in the Companys favor.
On June 6, 2011, Peerless Network agreed to withdraw its cross-appeal. Briefing in the Companys appeal was completed on July 19, 2011. Oral argument in the Companys appeal occurred
on December 8, 2011. On December 13, 2011, the federal appellate court affirmed the finding that our patent is invalid, and on January 30, 2012, the appellate court denied our petition for rehearing of the December 13, 2011
ruling. The Company has the option to ask the United States Supreme Court to review that ruling. A petition for such review was due by April 30, 2012. The Company has elected not to ask the United States Supreme Court to review that ruling.
On September 1, 2011, the district court issued an order that awarded approximately $102,000 in litigation-related costs
to Peerless Network, and approximately $48,000 in litigation-related costs to the Company. The Company filed notice that it planned to appeal that part of the courts order awarding costs to Peerless Network on September 30, 2011. Peerless
Network has not cross-appealed the courts award of costs to the Company.
Peerless Network has notified us that it
intends to pursue a claim for attorneys fees in the trial court. The trial court has stayed proceedings with respect to this potential claim pending resolution of our appeal. The Company believes that a loss with respect to any such claim, if
such a claim is made, is remote.
Inter partes proceeding before the United States Patent and Trademark Office
As previously disclosed, in a separate proceeding, on January 28, 2010, Peerless Network filed a request with the
USPTO requesting that the USPTO reexamine the 708 Patent. On March 26, 2010, the USPTO granted Peerless Networks
inter partes
reexamination request and issued an initial office action which rejected the 708
Patents 23 claims. The claims of the 708 Patent as originally issued by the USPTO remain valid and enforceable during the USPTO reexamination proceeding. Under the USPTOs rules, the Company was not allowed to respond to Peerless
Networks request prior to the USPTOs initial determination.
On May 20, 2010, the USPTO granted the
Companys request to extend the time by which it must file its response to the March 26, 2010 office action from May 26, 2010 to July 26, 2010.
On April 12, 2010, the Company moved separately to suspend the
inter partes
reexamination proceeding in its entirety, pending resolution of the litigation between the Company and Peerless
Network. On June 30, 2010, the USPTO denied the Companys petition seeking to suspend the separate reexamination proceeding. Although the USPTO did not suspend the reexamination proceeding, the USPTO stated in its decision, among other
things, that it is appropriate to continue both [the reexamination and litigation] proceedings to obtain the results and benefits of each, as they accrue.
On July 26, 2010, the Company responded to the USPTOs March 26, 2010 office action. On November 24, 2010, the USPTO issued an action closing prosecution, in which the USPTO maintained
its rejection of the 708 Patents 23 original claims, as well as 35 additional claims added to the 708 Patent in the Companys July 26, 2010 response.
On January 7, 2011, the Company filed a response to the USPTOs November 24, 2010 action closing prosecution. Thereafter,
Peerless Network filed comments in opposition to the Companys response on February 4, 2011.
9
On March 11, 2011, the USPTO issued a right of appeal notice, in which the USPTO
maintained its rejection of the 708 Patents 23 original claims, as well as the 35 additional claims added to the 708 Patent in the Companys July 26, 2010 response.
On April 11, 2011, the Company filed a notice of appeal of the USPTOs decision to the Board of Patent Appeals and
Interferences (the BPAI). Peerless Network filed a notice of appeal of the USPTOs decision to the BPAI on April 19, 2011. Briefing in those appeals was completed in December 2011.
If the decision of the federal district court finding our patent invalid becomes final and nonappealable, proceedings at the USPTO will
end with respect to existing claims, though we may ask the USPTO to continue proceedings with respect to new claims. If the decision of the federal district court finding our patent invalid does not become final and nonappealable, the BPAI will
review the parties positions on appeal. In that event, after reviewing the parties positions on appeal, the BPAI may affirm the USPTOs rejection of some or all of the claims, allow some or all of the claims of the 708 Patent
to issue in their current form, or return the matter for further examination with respect to some or all of the claims. Thereafter, there may be further proceedings at the USPTO regarding the validity of some or all of the claims of the 708
Patent. The decision of the BPAI is ultimately appealable by either party to the United States Court of Appeals for the Federal Circuit.
The USPTO action will determine whether the patent is valid or invalid. The USPTO will not directly assess liability against the Company or Peerless Network. For a discussion of the Companys patent
infringement claim against Peerless Network, see
Proceeding in the United States District Court for the Northern District of Illinois
above.
Carrier Dispute
The Company has a dispute with a carrier to which it
terminates voice traffic. The carrier claims the Company has been improperly terminating long distance traffic to it in breach of the parties agreement. The final outcome and impact of this dispute cannot be predicted. The Company establishes
accruals only for those matters where it determines that a loss is probable and the amount of loss can be reasonably estimated. The Company is not currently able to estimate reasonably the loss that it may incur, if any, in connection with this
dispute. However, such loss, if any, could be material to the Companys result of operations in the period recognized.
4. INCOME TAXES
Income taxes were computed using an effective tax rate, which is subject to ongoing review and evaluation by the
Company. The Companys estimated effective income tax rate was 39.0% for the three months ended March 31, 2012, compared to 34.1% for the same period last year.
The Company evaluates its deferred income taxes quarterly to determine if a valuation allowance is required or should be adjusted. The Company assesses whether a valuation allowance should be established
against our deferred tax assets based upon consideration of all available evidence, both positive and negative, using a more likely than not standard. This assessment considers, among other matters, forecasts of future profitability, the duration of
statutory carryforward periods, the Companys experience with tax attributes expiring unused and tax planning alternatives. In making such judgments, significant weight is given to evidence that can be objectively verified. The Companys
state income tax credit carry forward, the Illinois EDGE credit, can be carried forward five years. For the three months ended March 31, 2012 the Company recorded a partial valuation allowance of $0.2 million against the credit as the Company
believed it more likely than not that future taxable income would be insufficient to realize the full benefit of the credit.
The increase in the Companys effective income tax rate for the three months ended March 31, 2012, as compared to the three
months ended March 31, 2011, was primarily due to changes in the Companys estimated valuation allowance recorded against its Illinois EDGE Credit tax carryforward.
We operate in multiple income tax jurisdictions both inside and outside the United States. Accordingly, we expect that the net amount of tax liability for unrecognized tax benefits will change in the next
twelve months due to changes in audit status, expiration of statutes of limitations and other events which could impact our determination of unrecognized tax benefits. Currently, the Company has estimated $1.1 million as its unrecognized tax
benefit. At December 31, 2011, the Company had estimated $1.0 million as its unrecognized tax benefit.
10
5. STOCK OPTIONS AND NON-VESTED SHARES
The Company established the 2003 Stock Option and Stock Incentive Plan (2003 Plan), which provided for the issuance of
up to 4.7 million options and non-vested shares to eligible employees, officers, and independent contractors of the Company. In 2007 the Company adopted the Neutral Tandem, Inc. 2007 Equity Incentive Plan (2007 Plan) and ceased awarding equity
grants under the 2003 Plan. As of March 31, 2012, the Company had granted a total of 3.5 million options and 1.3 million non-vested shares that remained outstanding under the 2007 Plan. Awards for 0.7 million shares, representing
approximately 2.3% of the Companys outstanding common stock as of March 31, 2012, remained available for additional grants under the 2007 Plan.
The Company records stock-based compensation expense in connection with any grant of options and non-vested shares to its employees. The Company calculates the expense associated with its stock options
and non-vested shares by determining the fair value of the options and non-vested shares.
Options
All options granted under the 2003 Plan and the 2007 Plan have an exercise price equal to the market value of the underlying common stock
on the date of the grant. During the three months ended March 31, 2012, the Company did not grant any options. During the three months ended March 31, 2011, the Company granted less than 0.1 million options at a weighted-average
exercise price of $16.73.
The fair value of each option granted during the three months ended March 31, 2011 was
estimated on the date of grant using the Black-Scholes option-pricing model and was measured using the following assumptions:
|
|
|
|
|
March 31,
2011
|
Expected life
|
|
7.0 years
|
Risk-free interest rate range
|
|
2.54 2.87%
|
Expected dividends
|
|
|
Volatility
|
|
51.6%
|
The weighted-average fair value of options granted, as determined by using the Black-Scholes valuation
model, for the three months ended March 31, 2011 was $9.25 and the total grant date fair value of options that vested during the period was approximately $0.9 million. The total intrinsic value (market value of stock less option exercise price)
of stock options exercised was $0.1 million and $0.5 million during the three months ended March 31, 2012 and March 31, 2011, respectively.
The following summarizes activity under the Companys stock option plan for the three months ended March 31, 2012:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shares
(000)
|
|
|
Weighted-
Average
Exercise
Price
|
|
|
Aggregate
Intrinsic
Value
($000)
|
|
|
Weighted-
Average
Remaining
Term (yrs)
|
|
Options outstanding January 1, 2012
|
|
|
3,520
|
|
|
$
|
16.09
|
|
|
|
|
|
|
|
|
|
Granted
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
(2
|
)
|
|
|
4.59
|
|
|
|
|
|
|
|
|
|
Cancelled
|
|
|
(13
|
)
|
|
|
21.32
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options outstanding March 31, 2012
|
|
|
3,505
|
|
|
$
|
16.06
|
|
|
$
|
7,414
|
|
|
|
6.48
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Vested or expected to vest March 31, 2012
|
|
|
3,312
|
|
|
$
|
16.05
|
|
|
$
|
7,409
|
|
|
|
6.48
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable-March 31, 2012
|
|
|
2,499
|
|
|
$
|
15.13
|
|
|
$
|
7,251
|
|
|
|
5.86
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The unrecognized compensation cost associated with options outstanding at March 31, 2012 and
December 31, 2011 was $7.0 million and $8.5 million, respectively. The weighted average remaining term that the compensation will be recorded is 2.1 years and 2.2 years as of March 31, 2012 and December 31, 2011, respectively.
Non-vested Shares
During the three months ended March 31, 2012 and March 31, 2011, the Company granted 0.3 million and less than 0.1 million non-vested shares to members of the Companys executive
management team as well as various employees within the Company. The non-vested shares were issued as part of the 2007 plan. The shares typically vest over a four year period. The fair value of the non-vested shares is determined using the
Companys closing stock price on the grant date. Compensation cost, measured using the grant date fair value, is recognized over the requisite service period on a straight-line basis.
11
A summary of the Companys non-vested share activity and related information for the
three months ended March 31, 2012 is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shares
(000)
|
|
|
Weighted-
Average
Grant Date
Fair Value
|
|
|
Aggregate
Intrinsic
Value
($000)
|
|
Non-vested shares outstanding January 1, 2012
|
|
|
1,096
|
|
|
$
|
14.47
|
|
|
|
|
|
Granted
|
|
|
300
|
|
|
|
12.15
|
|
|
|
|
|
Vested
|
|
|
(51
|
)
|
|
|
15.86
|
|
|
|
|
|
Cancelled
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-vested shares outstanding March 31, 2012
|
|
|
1,345
|
|
|
$
|
13.90
|
|
|
|
16,396
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-vested shares vested or expected to vest March 31, 2012
|
|
|
1,271
|
|
|
$
|
13.90
|
|
|
|
15,493
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The aggregate intrinsic value represents the total pre-tax intrinsic value based on the Companys
closing stock price of $12.19 on March 31, 2012. The amount changes based upon the fair market value of the Companys common stock.
The unrecognized compensation cost associated with non-vested shares at March 31, 2012 and December 31, 2011 was $16.0 million and $14.3 million, respectively. The weighted average remaining
term that the compensation will be recorded is 2.8 years and 2.4 years as of March 31, 2012 and December 31, 2011, respectively.
During the quarter ended March 31, 2011, Rian J. Wren, the Companys Chief Executive Officer since 2006, announced his decision to retire from the Company on March 31, 2011. He continues to
serve on the Board of Directors following his retirement. As a result of this decision, the Board approved the acceleration of the vesting on approximately 0.2 million options and 0.1 million non-vested shares, in addition to the
forfeiture of 0.1 million non-vested shares. All options and non-vested shares are fully vested as of March 31, 2011. Non-cash compensation expense of $6.6 million recorded in the first quarter 2011 included $2.0 million related to the
acceleration of options and $1.6 million related to the acceleration of non-vested shares.
6. SEGMENT AND GEOGRAPHIC INFORMATION
Segment Reporting establishes standards for reporting information about operating segments. Operating segments are
defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker, or decision making group, in deciding how to allocate resources and in assessing
performance.
The Companys chief operating decision maker is the Chief Executive Officer. The Chief Executive Officer
reviews financial information presented on a consolidated basis. The Company operates in one industry segment, which is to provide voice, IP Transit and Ethernet interconnection services via the Companys international telecommunications
network to fulfill customer agreements. Therefore, the Company has concluded that it has one operating segment.
7. COMPREHENSIVE INCOME
Comprehensive income for the three months ended March 31, 2012 and 2011 consists of net income and other
comprehensive income. Other comprehensive income includes certain changes in equity that are excluded from net income. Specifically, foreign currency translation adjustments are included in accumulated other comprehensive loss in the consolidated
balance sheets.
The following table reconciles net income to comprehensive income for the periods ended March 31, 2012
and March 31, 2011 (in thousands):
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
March 31,
2012
|
|
|
March 31,
2011
|
|
Net income
|
|
$
|
6,655
|
|
|
$
|
8,184
|
|
Other comprehensive income
|
|
|
2,702
|
|
|
|
4,763
|
|
|
|
|
|
|
|
|
|
|
Total comprehensive income
|
|
$
|
9,357
|
|
|
$
|
12,947
|
|
|
|
|
|
|
|
|
|
|
12
I
tem 2.
|
Managements Discussion and Analysis of Financial Condition and Results of Operations
|
This quarterly report on Form 10-Q contains forward-looking statements that involve substantial risks and uncertainties.
All statements, other than statements of historical fact, included in this quarterly report on Form 10-Q are forward-looking statements. The words anticipates, believes, expects, estimates,
projects, plans, intends, may, will, would, and similar expressions are intended to identify forward-looking statements, although not all forward-looking statements contain
these identifying words. Actual results or events could differ materially from the plans, intentions and expectations disclosed in the forward-looking statements we make. Factors that might cause such differences include, but are not limited to: the
impact of current and future regulation, including intercarrier compensation reform enacted at the Federal Communications Commission; the effects of competition, including direct connects; the risks associated with our ability to successfully
develop and market international voice services and Ethernet services, many of which are beyond our control and all of which could delay or negatively affect our ability to offer or market international voice and Ethernet services; the ability to
develop and provide other new services; the risk that our business and the Tinet business will not be integrated successfully; technological developments; the ability to obtain and protect intellectual property rights; the impact of current or
future litigation; the potential impact of any future acquisitions, mergers or divestitures; natural or man-made disasters; the ability to attract, develop and retain executives and other qualified employees; changes in general economic or market
conditions, including currency fluctuations; and other important factors included in our reports filed with the Securities and Exchange Commission, particularly in the Risk Factors section of our Annual Report on Form 10-K for the period
ended December 31, 2011 and included elsewhere in this report. Furthermore, such forward-looking statements speak only as of the date of this report. We undertake no obligation to update any forward-looking statements to reflect events or
circumstances after the date of such statements.
Overview
We provide U.S. and international voice, IP Transit, and Ethernet telecommunications services primarily on a wholesale basis. We offer
these services using an all-IP network, which enables us to deliver global connectivity for a variety of media, including voice, data and video. Our solutions enable carriers and other providers to deliver telecommunications traffic or other
services where they do not have their own network or elect not to use their own network. These solutions are sometimes called off-net services. We also provide our solutions to customers, such as content providers, who also typically do
not have their own network. We were incorporated in Delaware on April 19, 2001 and commenced operations in 2004.
Voice Services
We provide voice interconnection services primarily to competitive carriers, including wireless, wireline, cable and broadband telephony companies. Competitive carriers use our tandem switches to
interconnect and exchange local and long distance traffic between their networks without the need to establish direct switch-to-switch connections. Competitive carriers are carriers that are not Incumbent Local Exchange Carriers, or ILECs, such as
AT&T, Verizon and Qwest.
Prior to the introduction of our local voice service, competitive carriers generally had two
alternatives for exchanging traffic between their networks. The two alternatives were interconnecting to the ILEC tandems or directly connecting individual switches, commonly referred to as direct connects. Given the cost and complexity
of establishing direct connects, competitive carriers often elected to utilize the ILEC tandem as the method of exchanging traffic. The ILECs typically required competitive carriers to interconnect to multiple ILEC tandems with each tandem serving a
restricted geographic area. In addition, as the competitive telecommunications market grew, the process of establishing interconnections at multiple ILEC tandems became increasingly difficult to manage and maintain, causing delays and inhibiting
competitive carrier growth, and the purchase of ILEC tandem services became an increasingly significant component of a competitive carriers costs.
The tandem switching services offered by ILECs consist of local transit services, which are provided in connection with local calls, and switched access services, which are provided in connection with
long distance calls. Under certain interpretations of the Telecommunications Act of 1996 and implementing regulations, ILECs are required to provide local transit services to competitive carriers. ILECs generally set per minute rates and other
charges for tandem transit services according to rate schedules approved by state public utility commissions, although the methodology used to review these rate schedules varies from state to state. ILECs are also required to offer switched access
services to competing telecommunications carriers under the Telecommunications Act of 1996 and implementing regulations. ILECs generally set per minute rates and other charges for switched access services according to mandated rate schedules set by
the Federal Communications Commission for interstate calls and by state public utility commissions for intrastate calls. Our solution enables competitive carriers to exchange traffic between their networks without using an ILEC tandem for both local
and long distance calls.
A loss of ILEC market share to competitive carriers escalated competitive tensions and resulted in
an increased demand for tandem switching. Growth in intercarrier traffic switched through ILEC tandems created switch capacity shortages known in the industry as ILEC tandem exhaust, where overloaded ILEC tandems became a bottleneck for
competitive carriers. This increased call blocking and gave rise to service quality issues for competitive carriers.
13
We founded our company to solve these interconnection problems and better facilitate the
exchange of traffic among competitive carriers and non-carriers. With the introduction of our services, we believe we became the first carrier to provide alternative tandem services capable of alleviating the ILEC tandem exhaust problem. By
utilizing our managed tandem service, our customers benefit from a simplified interconnection network solution that reduces costs, increases network reliability, decreases competitive tension and adds network diversity and redundancy. We have signed
agreements with major competitive carriers and non-carriers and we operated in 189 markets as of March 31, 2012.
Our
business originally connected only local traffic among carriers within a single metropolitan market. In 2006, we installed a national IP backbone network connecting our major local markets. In 2008, we began offering terminating switched access
services and originating switched access services. Switched access services are provided in connection with long distance calls. Our terminating switched access services allows interexchange carriers to send calls to us and we then terminate those
calls to the appropriate terminating carrier in the local market in which we operate. Our originating switched access service allows the originating carrier in the local market in which we operate to send calls to us that we then deliver to the
appropriate interexchange carrier that has been selected to carry that call. In both instances, the interexchange carrier is our customer, which means that it is financially responsible for the call. On October 1, 2010, we acquired Tinet, an
Italian corporation that operates a global IP backbone network. As a result of the foregoing, our service offerings now include the capability of switching and carrying local, long distance and international voice traffic.
Data and International Services
As part of our long-term growth strategy, we acquired Tinet, an Italian corporation. Tinet provides IP Transit and Ethernet services primarily to carriers, service providers and content providers
worldwide.
With this acquisition, we evolved from a primarily U.S. voice interconnection company into a global IP-based
network services company focused on delivering global connectivity for a variety of media, including voice, data and video. The acquisition expanded our IP-based network internationally, enabling global end-to-end delivery of wholesale voice, IP
Transit and Ethernet solutions.
We have IP Transit and Ethernet service agreements with over 800 customers in over 80
countries. We have over 120 points of presence (POPs) where we operate our equipment in carrier neutral facilities. Our core IP Transit network uses all Juniper equipment, which reduces complexity and allows for faster service deployment and easier
customer support.
Hosted Services
We recently began to offer hosted services. A hosted service is an application (such as software) that we host on our network enabling our customer to avoid the capital expenses associated
with purchasing the equipment and associated software licenses that they would need to provide the service to themselves. For example, we host a suite of unified communication and collaboration applications that operate premise-based phone systems,
including voicemail, integrated messaging, video calling and WebEx integration. This allows our customers to avoid paying the large upfront fee associated with buying a premise-based phone operating system. We sell this offering on a
monthly subscription basis. Our solution supports single site, multi-site and hybrid premise-based implementations. We have not yet begun to generate material revenue from providing hosted services.
Revenue
We generate revenue from sales of our voice, IP Transit and Ethernet services. Revenue is recorded each month based upon documented
minutes of traffic switched or data traffic carried for which service is provided, when collection is probable. Voice revenue is recorded each month on an accrual basis based upon minutes of traffic switched by our network by each customer, which we
refer to as minutes of use. The rates charged per minute are determined by contracts between us and our customers or by filed and effective tariffs.
Minutes of use of voice traffic increase as we increase our number of customers, increase the penetration of existing markets, either with new customers or with existing customers, and increase our
service offerings. The minutes of use decrease due to direct connection between existing customers, consolidation between customers, a customer using a different interconnection provider or a customer experiencing a decrease in the volume of traffic
it carries.
The average fee per minute of voice traffic varies depending on market forces and type of service, such as
switched access or local transit. The market rate in each market is based upon competitive conditions along with the switched access or local transit rates offered by the ILECs. Depending on the markets we enter, we may enter into contracts with our
customers with either a higher or lower fee per minute than our current average.
14
Our service solution incorporates other components beyond switching. In addition to
switching, we generally provision trunk circuits between our customers switches and our network locations at our own expense and at no direct cost to our customers. We also provide quality of service monitoring, call records and traffic
reporting and other services to our customers as part of our service solution. Our per-minute fees are intended to incorporate all of these services.
IP Transit revenue and Ethernet services revenue, comprised of both Ethernet Private Line (EtherCloud P2P) and EtherCloud Extension (EtherCloud E2E) revenues, are recorded each month on an accrual basis
based upon bandwidth used by each customer. The rates charged are the total of a monthly fee for bandwidth (the Committed Traffic Rate) plus additional charges for the sustained peak bandwidth used monthly in excess of the Committed Traffic Rate.
While generally not seasonal in nature, our voice revenues are affected by certain events such as holidays, the unpredictable
timing of direct connects between our customers, and installation and implementation delays. These factors can cause our revenue to both increase or decrease unexpectedly.
Operating Expense.
Operating expenses include network and facilities expense, operations expenses, sales and marketing expenses, general and administrative expenses, depreciation and amortization
and the gain or loss on the disposal of fixed assets.
Network and Facilities Expense.
Our network and facilities
expense includes transport capacity, or circuits, signaling network costs for voice services, transport capacity for our data services, and facility rents and utilities, together with other costs that directly support our POPs. We do not defer or
capitalize any costs associated with the start-up of new POPs. The start-up of an additional POP can take between three months to six months. During this time we typically incur facility rent, utilities, payroll and related benefit costs along with
initial non-recurring installation costs. Revenues generally follow sometime after the sixth month.
Network transport
costs typically occur on a repeating monthly basis, which we refer to as recurring transport costs, or on a one-time basis, which we refer to as non-recurring transport costs. Recurring transport costs primarily include monthly usage and other
charges from telecommunication carriers and are related to the circuits utilized by us to connect to our customers. As our traffic increases, we must utilize additional circuits. Non-recurring transport costs primarily include the initial
installation of such circuits. Facility rents include the leases on our POPs, which expire through February 2025. Additionally, we pay the cost of all the utilities for all of our POP locations.
Operations Expenses.
Operations expenses include payroll and benefits for our POP location personnel as well as individuals
located at our offices who are directly responsible for maintaining and expanding our network. Other primary components of operations expenses include repair and maintenance, property taxes, property insurance and supplies.
Sales and Marketing Expense
. Sales and marketing expenses represent the smallest component of our operating expenses and
primarily include personnel costs, sales bonuses, marketing programs and other costs related to travel and customer meetings.
General and Administrative Expense.
General and administrative expenses consist primarily of compensation and related costs for
personnel and facilities associated with our executive, finance, human resource and legal departments and fees for professional services. Professional services principally consist of outside legal, audit, tax and transaction costs.
Depreciation and Amortization Expense.
Depreciation and amortization expense for fixed assets is applied using the straight-line
method over the estimated useful lives of the assets after they are placed in service, which are five years for network equipment and test equipment, three years for computer equipment, computer software and furniture and fixtures. Leasehold
improvements are amortized on a straight-line basis over an estimated useful life of five years or the life of the respective leases, whichever is shorter. Intangible assets, which consist of customer relationships, have a definite life and are
amortized on an accelerated basis based on the discounted cash flows recognized over their estimated useful lives of 15 years.
Gain on Disposal of Fixed Assets
. We have disposed of network equipment in connection with converting to new technology and
computer equipment to replace old or damaged units. When there is a carrying value of these assets, we record the write-off of these amounts to loss on disposal. In some cases, this equipment is sold to a third party. When the proceeds from the sale
of equipment identified for disposal exceeds the assets carrying value, we record a gain on disposal.
Other
Income
. Other income includes interest income and foreign exchange gains and losses resulting from changes in exchange rates between the functional currency and the foreign currency in which the transaction was denominated.
Income Taxes
. Income tax provision includes U.S. federal, state and local, and foreign income taxes and is based on pre-tax
income or loss. In determining the estimated annual effective income tax rate, we analyze various factors, including projections of our annual earnings and taxing jurisdictions in which earnings will be generated, the impact of state and local
income taxes and our ability to use tax credits and net operating loss carryforwards.
15
Critical Accounting Policies and Estimates
The preparation of our financial statements requires us to make estimates, judgments and assumptions that affect the reported amounts of
assets, liabilities, revenues and expenses during the periods presented. Our Annual Report on Form 10-K for the fiscal year ended December 31, 2011, which we filed with the Securities and Exchange Commission on March 15, 2012, includes a
summary of the critical accounting policies we believe are the most important to aid in understanding our financial results. There have been no changes to those critical accounting policies that have had a material impact on our reported amounts of
assets, liabilities, revenues or expenses during the first three months of 2012.
Results of Operations
The following table sets forth our results of operations for the three months ended March 31, 2012 and 2011:
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
March 31,
|
|
(Dollars in thousands)
|
|
2012
|
|
|
2011
|
|
Revenue
|
|
$
|
70,696
|
|
|
$
|
66,418
|
|
Operating expense:
|
|
|
|
|
|
|
|
|
Network and facilities expense (excluding depreciation and amortization)
|
|
|
30,515
|
|
|
|
25,819
|
|
Operations
|
|
|
11,551
|
|
|
|
9,419
|
|
Sales and marketing
|
|
|
4,034
|
|
|
|
3,359
|
|
General and administrative
|
|
|
6,738
|
|
|
|
10,058
|
|
Depreciation and amortization
|
|
|
7,300
|
|
|
|
7,106
|
|
Gain on disposal of fixed assets
|
|
|
(105
|
)
|
|
|
(6
|
)
|
|
|
|
|
|
|
|
|
|
Total operating expense
|
|
|
60,033
|
|
|
|
55,755
|
|
|
|
|
|
|
|
|
|
|
Income from operations
|
|
|
10,663
|
|
|
|
10,663
|
|
|
|
|
|
|
|
|
|
|
Total other income
|
|
|
(243
|
)
|
|
|
(1,762
|
)
|
Income before income taxes
|
|
|
10,906
|
|
|
|
12,425
|
|
Provision for income taxes
|
|
|
4,251
|
|
|
|
4,241
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
6,655
|
|
|
$
|
8,184
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31, 2012 Compared to Three Months Ended March 31, 2011
Revenue.
Revenue increased to $70.7 million in the three months ended March 31, 2012 from $66.4 million in
the three months ended March 31, 2011, an increase of 6.4%. The increase in revenue was due to an increase of voice revenue of $3.2 million, with the remaining increase of $1.0 million related to an increase in data revenue. The increase in
voice revenue is primarily due to the increase in minutes of use billed to 34.4 billion minutes processed in the three months ended March 31, 2012 from 31.7 billion minutes processed in the three months ended March 31, 2011, an increase of
8.5%. The increase in the number of minutes processed by the network was a result of further penetration of current markets and customers. Offsetting the increase in minutes was a decrease in the average fee billed per minute from .00159 for the
three months ended March 31, 2011 to $.00155 for the three months ended March 31, 2012.
Operating
Expenses
. Operating expenses for the three months ended March 31, 2012 of $60.0 million increased $4.3 million, or 7.7%, from $55.8 million for the three months ended March 31, 2011. The components making up operating expenses are
discussed further below.
Network and Facilities Expenses.
Network and facilities expenses increased to $30.5 million
in the three months ended March 31, 2012, or 43.2% of revenue, from $25.8 million in the three months ended March 31, 2011, or 38.9% of revenue. Due to the nature of the IP Transit and EtherCloud businesses, higher network and facilities
expenses were incurred as we increased activity in these businesses.
Operations Expenses.
Operations expenses
increased to $11.6 million in the three months ended March 31, 2012, or 16.3% of revenue, from $9.4 million in the three months ended March 31, 2011, or 14.2% of revenue. The increase of $2.2 million in our operations expenses primarily
resulted from an increase of $1.2 million in payroll and benefits, primarily attributable to increases in headcount, $0.5 million increase in repairs and maintenance and $0.2 million in amounts due to the federal universal service fund and state
governments as we increase our data services in the United States.
16
Sales and Marketing Expense
. Sales and marketing expense increased to $4.0
million in the three months ended March 31, 2012, or 5.7% of revenue, compared to $3.4 million in the three months ended March 31, 2011, or 5.1% of revenue. The increase of $0.6 million sales and marketing expenses for the three months
ended March 31, 2012 is primarily due to an increase of $0.2 million in payroll and benefits and $0.1 million in non-cash compensation related to increased headcount as we expand our IP Transit and EtherCloud businesses, with the remaining
balance to due to other sales related expenses.
General and Administrative Expense.
General and administrative expense
decreased to $6.7 million in the three months ended March 31, 2012, or 9.5% of revenue, compared with $10.1 million in the three months ended March 31, 2011, or 15.1% of revenue. The decrease of $3.3 million in our general and
administrative expense is primarily due to a decrease of $3.6 million in non-cash compensation, offset by an increase of $0.2 million in payroll and benefits and an increase of $0.1 million in professional fees. The decrease in non-cash compensation
in primarily due to the accelerated vesting of options and non-vested shares related to the retirement of Rian J. Wren during the first quarter of 2011, as further discussed in footnote 5 to the condensed consolidated financial statements
Stock Options and Non-vested Shares
Depreciation and Amortization Expense.
Depreciation and amortization
expense increased to $7.3 million in the three months ended March 31, 2012, or 10.3% of revenue, compared to $7.1 million in the three months ended March 31, 2011, or 10.7% of revenue. The increase of $0.2 million increase in our
depreciation and amortization expense resulted from capital expenditures primarily related to the expansion of POP capacity in existing markets and the installation of POP capacity in new markets, as we build our data and hosted services.
Other Income.
Other income decreased to $0.2 million for the three months ended March 31, 2012, compared to $1.8
million for the three months ended March 31, 2011. Other income of $0.2 million consists primarily of net unrealized foreign exchange gains resulting from the remeasurement of our receivable and payable balances between the functional currency
and the foreign currency in which the transactions are denominated. In the three months ended March 31, 2011, we recognized $1.8 million related to foreign exchange gain recognized on the remeasurement of an intercompany loan denominated in
Euros.
Provision for Income Taxes.
Provision for income taxes of $4.3 million for the three months ended
March 31, 2012 increased by $0.1 million compared to $4.2 million for the three months ended March 31, 2011. The effective tax rate for the three months ended March 31, 2012 and 2011 was 39.0% and 34.1%, respectively. This difference
results primarily due to changes in the our estimated valuation allowance recorded against its Illinois EDGE Credit tax carryforward.
Liquidity and Capital Resources
At December 31, 2011, we had
$90.3 million in cash and cash equivalents, and $1.0 million in restricted cash. In comparison, at March 31, 2012, we had $97.7 million in cash and cash equivalents and $1.0 million in restricted cash. Cash and cash equivalents consist of
highly liquid money market mutual funds. The restricted cash balance is pledged as collateral for certain commercial letters of credit.
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|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
March 31, 2012
|
|
|
March 31, 2011
|
|
Net cash flows from operating activities
|
|
$
|
16,616
|
|
|
$
|
18,983
|
|
Net cash flows from investing activities
|
|
|
(9,022
|
)
|
|
|
(5,584
|
)
|
Net cash flows from financing activities
|
|
|
(310
|
)
|
|
|
(601
|
)
|
Cash flows from operating activities
Net cash provided by operating activities was $16.6 million for the first three months of 2012 compared to $19.0 for the same period last
year. Operating cash inflows are largely attributable to payments from customers which are generally received between 35 to 45 days following the end of the billing month. Operating cash outflows are largely attributable to personnel related
expenditures, and network maintenance costs. The slight decrease in operating cash flow reflects lower operating earnings driven mainly by increased network and facilities expenses, and an increase in prepaid expenses, offset by the timing of cash
collections.
Cash flows from investing activities
Net cash used in investing activities was $9.0 million for the first three months of 2012, compared to net cash used in investing
activities of $5.6 million for the same period last year. Investing cash flows are primarily related to purchases of network equipment. The increase in investing cash flow used is the result of an increase in the purchase of equipment in 2012 for
the expansion of our data services and hosted services into new locations and the expansion and upgrades of current locations.
17
In the next twelve months, capital expenditures are expected to be in the range of
approximately $30 to $35 million, primarily for the expansion of our data services and hosted services into new locations and the expansion and upgrades of current locations.
Cash flows from financing activities
Net cash used for financing
activities was $0.3 million for the first three months of 2012, compared to net cash used for financing activities of $0.6 million for the same period last year. The changes in cash flows from financing activities primarily relates to a decrease in
the cash used to cover employee taxes paid on the vesting of restricted shares.
We regularly review acquisitions and
strategic opportunities, which may require additional debt or equity financing. We currently do not have any pending agreements with respect to any acquisitions or strategic opportunities which would require additional debt or equity financing.
Investments
As of March 31, 2012, we had $85.8 million in cash and cash equivalents invested in two money market mutual funds. As of December 31, 2011, we had $78.8 million in cash and cash equivalents
invested in two money market mutual funds.
Effect of Inflation
Inflation generally affects us by increasing our cost of labor and equipment. We do not believe that inflation had any material effect on
our results of operations for the three month periods ended March 31, 2012 and 2011.
Item 3.
|
Qualitative and Quantitative Disclosure about Market Risk
|
Interest rate exposure
We had cash, cash equivalents and restricted
cash totaling $98.7 million at March 31, 2012. This amount was allocated primarily in two money market mutual funds. The unrestricted cash and cash equivalents are held for working capital purposes. We do not enter into investments for
speculative purposes.
Based upon our overall interest rate exposure at March 31, 2012, we do not believe that a
hypothetical 10 percent change in interest rates over a one year period would have a material impact on our earnings, fair values or cash flows from interest rate risk sensitive instruments discussed above.
Foreign Currency
The Company is exposed to the effect of foreign currency fluctuations in certain countries in which it operates. The functional currency of each of the Companys subsidiaries is the currency of the
country in which the subsidiary operates. The exposure to foreign currency movements is limited in most countries because the operating revenues and expenses of its various subsidiaries and business units are substantially in the local currency of
the country in which they operate. To the extent borrowings, sales, purchases, revenues, expenses or other transactions are not in the local currency of the subsidiary, the Company is exposed to currency risk. Accordingly, earnings are affected by
changes in foreign currency exchange rates, particularly the Euro and British Pound. Collectively, these currencies represent less than 21.1% of the Companys operating income. As a result, earnings are affected by changes in the exchange rate
between the Euro and the dollar. We do not believe that a 10 percent change in these currencies over a one-year period would have a material impact on our earnings.
Item 4.
|
Controls and Procedures
|
We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in the
Companys reports under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the SECs rules and forms, and that such information is accumulated and
communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures,
management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in
evaluating the cost-benefit relationship of possible controls and procedures.
18
Evaluation
We carried out an evaluation, under the supervision, and with the participation, of our management, including our Chief Executive Officer
and our Chief Financial Officer, of the effectiveness of our disclosure controls and procedures as of March 31, 2012. Based on the foregoing, our Chief Executive Officer and principal financial officers concluded that our disclosure controls
and procedures were effective as of March 31, 2012 at the reasonable assurance level.
There have been no changes during
the three months ended March 31, 2012 covered by this report in our internal control over financial reporting or in other factors that could materially affect or are reasonably likely to materially affect internal control over financial
reporting.
PART II. OTHER INFORMATION
Item 1.
|
Legal Proceedings
|
Refer
to Note 3 Legal Proceedings in Notes to Condensed Consolidated Financial Statements of this Quarterly Report on Form 10-Q for information on legal proceedings.
See Risk Factors in our Annual Report on Form 10-K for the fiscal year ended December 31, 2011. As of March 31, 2012, there had been no material change in this information.
(a) Exhibits
|
|
|
Exhibit 31.1
|
|
Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
|
|
|
Exhibit 31.2
|
|
Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
|
|
|
Exhibit 32.1
|
|
Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
|
|
|
101.INS
|
|
XBRL Instance Document.
|
|
|
101.SCH
|
|
XBRL Taxonomy Extension Schema Document.
|
|
|
101.CAL
|
|
XBRL Taxonomy Extension Calculation Linkbase Document.
|
|
|
101.DEF
|
|
XBRL Taxonomy Extension Definition Linkbase Document
|
|
|
101.LAB
|
|
XBRL Taxonomy Extension Label Linkbase Document.
|
|
|
101.PRE
|
|
XBRL Taxonomy Extension Presentation Linkbase Document.
|
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.
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NEUTRAL TANDEM, INC.
|
|
|
|
|
Date: May 9, 2012
|
|
|
|
By:
|
|
/S/ G. E
DWARD
E
VANS
|
|
|
|
|
|
|
G. Edward Evans,
Chief Executive Officer
(Principal Executive
Officer)
|
|
|
|
|
Date: May 9, 2012
|
|
|
|
By:
|
|
/S/ R
OBERT
J
UNKROSKI
|
|
|
|
|
|
|
Robert Junkroski,
Chief Financial Officer
(Principal Financial and Accounting
Officer)
|
19
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