The accompanying notes are an integral part of these condensed consolidated financial statements.
The accompanying notes are an integral part of these condensed consolidated financial statements.
The accompanying notes are an integral part of these condensed consolidated financial statements.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. DESCRIPTION OF THE BUSINESS
Organization
— Inteliquent, Inc. (the “Company”) provides voice 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 and, historically, data and video. The Company’s solutions enable telecommunication service providers to deliver voice telecommunication 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 “interconnection” or “off-net” services. The Company generally provides its
solutions to traditional certificated telecommunications carriers and next-generation telecommunication service providers.
During the three months ended March 31, 2015, the Company received a $1.3 million payment from an escrow fund that had been established in connection with the Company’s purchase of the Tinet global data business in 2010. The Company received this payment as a result of a settlement with the sellers of Tinet. The settlement related to a dispute regarding the Company’s claim that certain tax liabilities were not properly represented to the Company at the time the transaction closed. This payment was recorded as other income in the company’s condensed consolidated statements of income for the three months ended March 31, 2015 and the nine months ended September 30, 2015, and as an operating cash inflow in the condensed consolidated statement of cash flows for the nine months ended September 30, 2015.
On November 2, 2016, the Company, Onvoy, LLC, a Minnesota limited liability company and a portfolio company of GTCR LLC (“Onvoy”), and Onvoy Igloo Merger Sub, Inc., a Delaware corporation (“Merger Sub”), entered into an Agreement and Plan of Merger (the “Merger Agreement”), pursuant to which Merger Sub will merge with and into the Company on the terms and subject to the conditions set forth in the Merger Agreement (the “Merger”), with the Company surviving the Merger as a wholly-owned subsidiary of Onvoy.
At the effective time of the Merger (the “Effective Time”), on the terms and subject to the conditions set forth in the Merger Agreement, each issued and outstanding share of the Company’s common stock outstanding immediately prior to the Effective Time, other than any Excluded Shares and Dissenting Shares (each as defined in the Merger Agreement), will be converted automatically into the right to receive $23.00 per share in cash without interest (the “Merger Consideration”). The completion of the Merger is subject to approval of the Company’s stockholders and certain regulatory approvals and other customary closing conditions. The completion of the Merger is expected to occur during the first half of 2017.
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.
The Company entered into a non-material investment in a privately held entity during the third quarter ended September 30, 2016 that has been determined to be a variable interest entity (“VIE”). However, the Company evaluated qualitative factors regarding the VIE and determined that the Company is not the primary beneficiary as the Company does not have the power to direct the activities that most significantly impact the entity’s economic performance. As a result, the VIE has been accounted for as an equity method investment, as the Company has the ability to exercise significant influence over, but not control, over the VIE. This investment is classified as an other long term asset on the balance sheet.
The Company entered into an unrelated investment during the third quarter ended September 30, 2016 in a privately held entity. The Company does not have the ability to exercise significant influence over this entity and thus it is accounted for as a cost method investment. This investment is also classified as an other long term asset on the balance sheet.
Interim Condensed Consolidated Financial Statements
— The accompanying condensed consolidated balance sheets as of September 30, 2016 and December 31, 2015, the condensed consolidated statements of income for the three and nine months ended September 30, 2016 and 2015, and the condensed consolidated statements of cash flows for the nine months ended September 30, 2016 and 2015 are unaudited. The condensed consolidated balance sheet data as of December 31, 2015 was derived from the audited consolidated financial statements which are included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2015. The accompanying condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and related notes contained in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2015.
6
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 Commiss
ion applicable to interim periods. Certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP 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 September 30, 2016 and for the three and nine months ended September 30, 2016 and 2015 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 and nine months ended September 30, 2016 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. The carrying values of the Company’s cash and cash equivalents approximate
fair value. At September 30, 2016, the Company had $30.3 million of cash in banks and $90.2 million among four government and agency money market funds. At December
31, 2015, the Company had $22.2 million of cash in banks and $86.9 million among three money market funds.
Fair Value Measurements
— Certain assets and liabilities are required to be recorded at fair value on a recurring basis. Fair value is determined based on the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants. Assets measured at fair value on a nonrecurring basis include long-lived assets held and used. The fair value of cash and cash equivalents, accounts receivable, accounts payable and accrued liabilities approximate their carrying values. The three-tier fair value hierarchy, which prioritizes valuation methodologies based on the reliability of the inputs, is:
Level 1— Valuations based on quoted prices for identical assets and liabilities in active markets.
Level 2— Valuations based on observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets and liabilities in markets that are not active, or other inputs that are observable or can be corroborated by observable market data.
Level 3— Valuations based on unobservable inputs reflecting the Company’s own assumptions, consistent with reasonably available assumptions made by other market participants.
Accounts Receivable and Allowance for Doubtful Accounts
— Accounts receivable consist of trade receivables recorded upon recognition of revenue from sales of voice services, reduced by reserves for estimated bad debts. Trade accounts receivable are generally recorded at the invoiced amount and do not bear interest. Credit is extended based on evaluation of the customer’s financial condition. The Company makes judgments as to its ability to collect outstanding receivables and provides allowances for a portion of receivables when collection becomes doubtful. The specific identification method is applied to outstanding invoices to determine this provision. Our allowance for doubtful accounts was $2.4 million at both September 30, 2016 and December 31, 2015.
Property and Equipment
— Property and equipment is recorded at cost. These values 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 evaluated when events or changes in circumstances indicate that a potential impairment has occurred.
Long-lived Assets
— The carrying value of long-lived assets, including property and equipment, are reviewed whenever events or changes in circumstances indicate that the related carrying amounts may not be recoverable. Impairment of assets with definite lives is generally determined by comparing projected undiscounted cash flows to be generated by the asset, or appropriate grouping of assets, to its carrying value. If an impairment is identified, a loss is recorded equal to the excess of the asset’s net book value over its fair value. The fair value becomes the new cost basis of the asset. Determining the extent of an impairment, if any, typically requires various estimates and assumptions including using management’s judgment, cash flows directly attributable to the asset, the useful life of the asset and residual value, if any. In addition, the remaining useful life of the impaired asset is revised, if necessary. There were no property and equipment or intangible asset impairment charges in 2015 or during the nine months ended September 30, 2016.
7
Goodwill
— Goodwill represents the excess of the purchase price of an acquired business over the amounts assigned to assets and liabilities assumed in the business combination. Goodwill is not amortized
but
is tested for impairment at least annually during the fourth quarter of each year, or more frequent
ly if indicators of impairment arise
. Goodwill is tested for impairment at the reporting unit level. A reporting unit is an operating segment or one level b
elow an operating segment, referred to as a component. The Company has not identified any components within its single operating segment and, hence, has a single reporting unit for purposes of the goodwill impairment analysis.
Revenue Recognition
— The Company generates revenue from sales of its voice services. The Company maintains tariffs and executed service agreements with each of its customers in which specific fees and rates are determined. One customer agreement contains multiple voice service elements and is accounted for as a multiple-element arrangement under Accounting Standards Codification (“ASC”) topic 605-25,
Revenue Recognition-Multiple Element Arrangements.
Following the requirements of ASC 605-25, the Company evaluated the multiple-element arrangement to determine which deliverables represented separate units of accounting and then allocated consideration to each unit of accounting based on their selling prices using relative fair values. Some of these deliverables are treated as non-monetary transactions which are also recorded at fair value. Voice revenue is recorded each month on an accrual basis, when collection is probable, based upon minutes of traffic switched by the Company’s network by each customer, which is referred to as minutes of use.
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
|
|
|
Nine Months Ended
|
|
|
September 30,
|
|
|
September 30,
|
|
(In thousands, except per share amounts)
|
2016
|
|
|
2015
|
|
|
2016
|
|
|
2015
|
|
Numerator:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
$
|
9,373
|
|
|
$
|
8,267
|
|
|
$
|
27,484
|
|
|
$
|
29,449
|
|
Denominator:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average common shares outstanding
|
|
34,409
|
|
|
|
33,620
|
|
|
|
34,179
|
|
|
|
33,562
|
|
Effect of dilutive securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock options and performance stock units
|
|
175
|
|
|
|
518
|
|
|
|
208
|
|
|
|
495
|
|
Denominator for diluted earnings per share
|
|
34,584
|
|
|
|
34,138
|
|
|
|
34,387
|
|
|
|
34,057
|
|
Earnings per share
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic - as reported
|
$
|
0.27
|
|
|
$
|
0.25
|
|
|
$
|
0.80
|
|
|
$
|
0.88
|
|
Diluted - as reported
|
$
|
0.27
|
|
|
$
|
0.24
|
|
|
$
|
0.80
|
|
|
$
|
0.86
|
|
Certain awards were not included in the computation of diluted earnings per share because the effect would have been antidilutive. Outstanding share-based awards of 0.1 million were outstanding during both the three and nine months ended September 30, 2016, while 0.7 million were outstanding during both the three and nine months ended September 30, 2015, but were not included in the computation of diluted earnings per share because the effect would have been antidilutive.
The undistributed earnings allocable to participating securities were $0.1 million for both the three and nine months ended September 30, 2016, respectively.
Accounting for Stock-Based Compensation
— The Company records stock-based compensation expense related to stock options, non-vested shares and performance stock units based on fair value. The amount of non-cash share-based expense recorded in the three months ended September 30, 2016 and 2015 was $0.8 million and $1.3 million, respectively. The amount of non-cash share-based expense recorded in the nine months ended September 30, 2016 and 2015 was $2.9 million and $4.0 million, respectively. Refer to Note 6, “Stock Options, Non-Vested Shares and Performance Stock Units.”
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.
8
The fair value of non-vested shares is measured ba
sed 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.
The fair value of each performance stock unit granted is estimated using a Monte Carlo pricing model.
The Monte Carlo simulation model is based on a discounted cash flow approach, with the simulation of a large number of possible stock price outcomes for the Company’s stock and the applicable index.
This model considers a risk-free interest rate, historical stock volatility, correlations of returns, and expected life. The risk-free interest rate reflects the yield on a U.S. Treasury bond commensurate with the expected life of the performance stock unit. The Company uses historic volatility and correlations to value awards. Market and service conditions must both be met in order for the performance stock units to vest. As such, compensation cost will be recognized on a straight-line basis over the vesting period. Except for termination of an individual’s service by the Company without cause in certain circumstances,
termination of an individual’s service prior to fulfilling the requisite service period will result in forfeiture of units and compensation cost will be reversed.
In the event the participant’s employment is terminated without cause and more than half of the performance period has passed, the number of performance stock units issued shall be adjusted proportionately to the number of days of service rendered in the performance period over the total performance period.
The estimation of stock awards that will ultimately vest requires judgment, and to the extent actual results or updated estimates differ from the Company’s 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 Company’s current estimates.
Stock Retirement
— During the quarter ended June 30, 2016, the Company retired certain shares previously held in treasury. The stock repurchases have been accounted for under the cost method whereby the entire cost of the repurchased and retired shares, net of par value, were recorded to additional paid-in capital.
Recent Accounting Pronouncements
— In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09,
Revenue from Contracts with Customers (Topic 606)
, which outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. The ASU is based on the principle that an entity should recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The ASU also requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to fulfill a contract. Entities have the option of using either a full retrospective or a modified retrospective approach for the adoption of the new standard. The ASU is effective for annual reporting periods beginning after December 15, 2017 and early adoption as of December 15, 2016 is permitted. The Company is currently assessing the impact of this standard on the Company’s
consolidated financial statements and disclosures
.
In May 2015, the FASB issued ASU No. 2015-08,
Business Combinations (Topic 805): Pushdown Accounting
-
Amendment to SEC Paragraphs Pursuant to Staff Accounting Bulletin No. 115
. This ASU was issued to amend various SEC paragraphs pursuant to the issuance of Staff Accounting Bulletin No. 115. This ASU is effective for annual periods beginning after December 15, 2015 and has not had a significant impact on the Company’s
consolidated financial statements and disclosures
.
In September 2015, the FASB issued
ASU No. 2015-16,
Business Combinations (Topic 805): Simplifying the Accounting for Measurement-Period Adjustments,
which eliminates the requirement to retrospectively account for adjustments made to provisional amounts recognized in a business combination. The new guidance requires the cumulative impact of measurement period adjustments, including the impact on prior periods, to be recognized in the reporting period in which the adjustment is recorded. This ASU is effective for annual periods beginning after December 15, 2015 and has not had a significant impact on the Company’s
consolidated financial statements and disclosures
.
In March 2016, the FASB issued ASU No. 2016-02,
Leases (Topic 842),
which provides guidance for accounting for leases.
The new guidance requires lessees to recognize leases on the balance sheet as assets and liabilities to reflect the rights and obligations created by those leases. Leases will continue to be classified as either financing or operating, with classification affecting the recognition, measurement and presentation of expenses and cash flows arising from the leases.
Additional qualitative and quantitative disclosures will be required.
The ASU is effective for annual reporting periods beginning after December 15, 2018 and early adoption is permitted. The Company is currently assessing the impact of this standard on the Company’s
consolidated financial statements and disclosures
.
9
In March 2016, the FAS
B issued ASU No. 2016-09,
Compensation—Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting,
which simplifies several aspects of the accounting for employee share-based payment transactions
including the accounting for in
come taxes, forfeitures, and statutory tax withholding requirements, as well as classification in the statement of cash flows. The ASU is
effective for annual periods beginning after December 15, 2016, and early adoption is permitted.
The Company is currently assessing the impact of this standard on the Company’s
consolidated financial statements and disclosures
.
In April, 2016 the FASB issued ASU No. 2016-10,
Revenue from Contracts with Customers (Topic 606)
:
Identifying Performance Obligations and Licensing
, which .amends certain aspects of ASU 2014-09, by providing additional guidance on identifying performance obligations related to customer contracts as well understanding of the licensing implementation guidance. In
May, 2016, the FASB issued ASU No. 2016-12,
Revenue from Contracts with Customers (Topic 606)
:
Narrow-Scope Improvements and Practical Expedients,
which amends certain aspects of ASU 2014-09, by providing additional guidance and clarification on certain implementation issues. Both of these ASU’s are effective in conjunction with the timing of ASU 2014-09. The Company is currently assessing the impact of these standards on the Company’s
consolidated financial statements and disclosures
.
In August 2016, the FASB issued
ASU No. 2016-15,
Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments
, which clarifies or adds guidance on the classification of several cash flow issues which currently have diversity in practice. The ASU is effective for annual periods beginning after December 15, 2017, and early adoption is permitted. The Company early adopted this ASU for the third quarter ended September 30, 2016 and found it did not have an impact on its consolidated financial statements and disclosures.
3. BUSINESS COMBINATION
On May 13, 2016, the Company acquired all of the outstanding equity of Shopety, Inc. d/b/a Better Voice (“Shopety”), a developer of communications software and next-generation switching technologies. The acquired technologies expand the capabilities and addressable market of the Company’s next-generation “Omni IQ
sm
” product line. The total purchase price was $4.4 million, of which $0.8 million is in the form of an earn-out based on the delivery of certain software enhancements and $0.3 million is subject to a 12-month escrow agreement. The purchase was financed through available cash on hand. In addition to the cash, the Company recorded approximately $0.2 million in acquisition-related costs, including legal and advisory services, in its condensed consolidated statement of income. The allocation of the purchase price is as follows:
(dollars in thousands)
|
|
|
|
Property and equipment
|
$
|
3,900
|
|
Goodwill
|
|
1,715
|
|
Net deferred income tax liability
|
|
(1,215
|
)
|
Total consideration
|
$
|
4,400
|
|
The fair values of assets acquired and liabilities assumed were based on a preliminary valuation and the estimates and assumptions are subject to change within the measurement period of one year from the acquisition date. Subsequently, a $16 thousand adjustment to the net deferred tax liability and goodwill was recorded in the three months ended September 30, 2016. Any further changes to the preliminary estimates during the measurement period will be recorded as adjustments to those assets and liabilities and residual amounts will be allocated to goodwill.
Goodwill is not deductible for tax purposes.
The final purchase price allocation is dependent upon the finalization of tax information still in progress.
4. CONTINGENCIES
Legal Proceedings
From time to time, the Company is a party to legal proceedings arising in the normal course of its business. Aside from the matters discussed below, the Company does not believe that it is a party to any pending legal action that could reasonably be expected to have a material effect on its business or operating results, financial position or cash flows.
Free Conferencing Corporation
On July 5, 2016, the Company commenced an action against Free Conferencing Corporation, individually and doing business as HD Tandem; HD Tandem and Wide Voice, LLC (collectively the “Defendants”), in the United States District Court for the Northern District of Illinois. The Company asserts claims under the Racketeer Influenced and Corrupt Organizations Act (“RICO”) and various state laws, asserting that the Defendants are improperly charging the Company for telecommunications services and seeking recovery of access fees and other telecommunications charges paid to the Defendants in connection with the termination of certain long
10
distance traffic (
Inteliquent, Inc. v. Free Conferencing Corporation individually and d/b/a HD Tandem; HD Tandem; Wide Voice, LLC; and John Does 1-10
, 1:16-cv-06976). The Company alleges that the Defendants, acting as an enterprise, have conspired to f
raudulently invoice and overcharge Inteliquent for traffic delivery services purportedly provided. The Company is seeking declaratory and injunctive relief, as well as damages to recover fraudulently invoiced amounts. The Company has not claimed a specif
ic figure in damages at this stage of the litigation but anticipates that its damages claim will become more specific as the litigation progresses. The Company is also seeking treble damages under RICO, as well as recovery of attorney’s fees incurred purs
uing the litigation.
The Company filed a first amended complaint on July 25, 2016. The Defendants filed an answer, counterclaims, and a motion to dismiss the Company’s amended complaint on September 6, 2016. In response to the motion to dismiss, the Company filed a second amended complaint on October 6, 2016. In addition to the allegations described above, the second amended complaint includes allegations seeking damages arising from the Defendants’ suspension of services to the Company in July 2016. Free Conferencing Corporation and HD Tandem filed an answer and counterclaims, and Wide Voice LLC filed a motion to dismiss the second amended complaint, on October 27, 2016. The Company’s response to the motion to dismiss and answer to the counterclaims are due on November 29, 2016. A hearing on the motion to dismiss is scheduled for January 5, 2017.
Since the filing of the lawsuit, the Company has not paid a material portion of the invoices which it asserts are improperly billed. There can be no assurance regarding how, whether and when this matter will be resolved and whether the ultimate disposition will have a material effect on the Company’s condensed consolidated financial statements.
On August 1, 2016, Free Conferencing Corporation (“Free Conferencing”) filed a complaint against the Company in the United States District Court for the Northern District of Illinois:
Free Conferencing Corp. v. Inteliquent, Case No. 1:16-7768
. The complaint alleges that the Company has violated the Federal Communications Act, as well as various state laws, in connection with the routing of telecommunications traffic allegedly bound for Free Conferencing. Free Conferencing voluntarily dismissed the complaint without prejudice on September 2, 2016.
OTT Access Charge Dispute
On November 18, 2011, the Federal Communications Commission (the “FCC”) issued an order establishing, among other things, an intercarrier compensation framework for the exchange of switched access traffic. In its order, the FCC attempted to clarify the circumstances under which local exchange carriers are eligible to receive access charges when they deliver access traffic in partnership with entities that utilize Voice over Internet Protocol, or (“VoIP”) technology. The FCC determined that, under certain circumstances, local exchange carriers are eligible to receive access charges when delivering access traffic in partnership with VoIP providers. The FCC has referred to its determination on this issue as the “VoIP Symmetry Rule.”
Subsequent to the FCC’s November 2011 order, further disputes developed within the industry concerning the interpretation of the VoIP Symmetry Rule. A number of long distance carriers took the position that, notwithstanding the VoIP Symmetry Rule, local exchange carriers were still not eligible to receive access charges when delivering access traffic in partnership with VoIP providers that deliver service using over-the-top (“OTT”) technology.
On February 11, 2015, the FCC released an order clarifying that, pursuant to its VoIP Symmetry Rule, local exchange carriers are entitled to receive access charges when delivering access traffic in partnership with VoIP providers that utilize OTT technology under certain circumstances. This order has been appealed to a federal appellate court.
The Company has disputes with certain long distance carriers regarding the payment of access charges to the Company relating to the origination and termination of traffic to VoIP providers that utilize OTT technology. The Company has reached a settlement with one long distance carrier, pursuant to which the long distance carrier has paid the Company a portion of the access charges in dispute, and will pay access charges at an agreed rate for traffic delivered through the end of 2016. The settlement agreement does not address access charge payments the long distance carrier will make for traffic delivered after the end of 2016. The Company has made judgments as to its ability to collect based on known facts and circumstances and has only recorded revenue when collection has been deemed reasonably assured.
5. INCOME TAXES
Income taxes were computed using an effective tax rate, which is subject to ongoing review and evaluation by the Company. The Company’s estimated effective income tax rate was 35.5% and 37.3% for the three and nine months ended September 30, 2016, respectively, compared to 34.7% and 37.0% for the three and nine months ended September 30, 2015, respectively. The Company’s estimated effective income tax rate varies from the statutory federal income tax rate of 35% primarily due to the impact of state income taxes.
11
The Company has recorded a valuation allowance against the capital loss created by the sale of its global data business on April 30, 2013 and the Illinois EDGE Credit. The Company believes it is more likely than not that these assets will not be fully real
ized in the foreseeable future. The realization of deferred tax assets is dependent upon whether the Company can generate future taxable income in the appropriate character and jurisdiction to utilize the assets. The amount of the deferred tax assets consi
dered realizable is subject to adjustment in future periods.
The Company files United States federal, state and local income tax returns in the jurisdictions in which it is required to do so. With few exceptions, the Company is no longer subject to an audit of its federal tax filings for years before 2014, and is no longer subject to audits of its state tax filings for years before 2013. The Internal Revenue Service (“IRS”) concluded an examination of the Company’s 2013 federal income tax return during the quarter ended September 30, 2016, which resulted in no material adjustments to the income tax return.
6. STOCK OPTIONS, NON-VESTED SHARES AND PERFORMANCE STOCK UNITS
The Company established the 2003 Stock Option and Stock Incentive Plan (the “2003 Plan”), which provided for issuance of up to 4.7 million options, non-vested shares, and performance stock units to directors, employees and other individuals (whether or not employees) who render services to the Company. In 2007, the Company adopted the 2007 Long-Term Equity Incentive Plan (the “2007 Plan”) and ceased awarding equity grants under the 2003 Plan. As of September 30, 2016, the Company had granted a total of 1.1 million options, 0.4 million non-vested shares, and 0.1 million performance stock units that remained outstanding under the 2007 Plan. Awards for 2.5 million shares, representing approximately 7.3% of the Company’s outstanding common stock as of September 30, 2016, remained available for additional grants under the 2007 Plan.
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 both the three months ended September 30, 2016 and September 30, 2015, the Company did not grant any options. During the nine months ended September 30, 2016, the Company granted 0.1 million options at a weighted average exercise price of $16.70. Additionally, during the nine months ended September 30, 2015, the Company granted 0.1 million options at a weighted average exercise price of $17.02.
The fair value of each option granted is estimated on the date of grant using the Black-Scholes option-pricing model. For the nine months ended September 30, 2016 and September 30, 2015, fair value of stock options were measured using the following assumptions:
|
September 30,
|
|
|
September 30,
|
|
|
2016
|
|
|
2015
|
|
Expected life
|
7.0 years
|
|
|
7.0 years
|
|
Risk-free interest rate
|
|
1.5%
|
|
|
|
1.9%
|
|
Expected dividends
|
|
3.6%
|
|
|
|
3.9%
|
|
Volatility
|
|
46.1%
|
|
|
|
49.6%
|
|
The weighted average fair value of options granted, as determined by using the Black-Scholes valuation model, during the nine months ended September 30, 2016 and 2015 was $5.40 and $6.03, respectively. The total grant date fair value of options that vested during the nine months ended September 30, 2016 and 2015 was approximately $0.4 million and $0.6 million, respectively. The total intrinsic value (market value of stock option less option exercise price) of stock options exercised was $3.3 million and $2.7 million during the nine months ended September 30, 2016 and 2015, respectively.
12
A summary of the Company’s stock option activity and related information for the nine months ended Sept
ember 30, 2016 is as follows:
|
|
|
|
|
Weighted
|
|
|
Aggregate
|
|
|
Weighted
|
|
|
|
|
|
|
Average
|
|
|
Intrinsic
|
|
|
Average
|
|
|
Shares
|
|
|
Exercise
|
|
|
Value
|
|
|
Remaining
|
|
|
(000)
|
|
|
Price
|
|
|
($000)
|
|
|
Term (yrs)
|
|
Options outstanding — January 1, 2016
|
|
1,430
|
|
|
$
|
15.10
|
|
|
|
|
|
|
|
|
|
Granted
|
|
95
|
|
|
|
16.70
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
(362
|
)
|
|
|
10.30
|
|
|
|
|
|
|
|
|
|
Cancelled
|
|
(39
|
)
|
|
|
18.91
|
|
|
|
|
|
|
|
|
|
Options outstanding — September 30, 2016
|
|
1,124
|
|
|
$
|
16.64
|
|
|
$
|
2,459
|
|
|
|
4.14
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options Vested and expected to vest — September 30, 2016
|
|
1,117
|
|
|
$
|
16.64
|
|
|
$
|
2,455
|
|
|
|
4.11
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options Exercisable — September 30, 2016
|
|
876
|
|
|
$
|
17.82
|
|
|
$
|
1,409
|
|
|
|
3.07
|
|
The unrecognized compensation cost associated with options outstanding at September 30, 2016 and December 31, 2015 was $0.9 million and $0.8 million, respectively. The weighted average remaining term over which the compensation will be recorded is 2.6 years and 2.7 years as of September 30, 2016 and December 31, 2015, respectively.
Non-vested Shares
During the three and nine months ended September 30, 2016, the Company granted zero and 0.2 million non-vested shares pursuant to the 2007 Plan. During the three and nine months ended September 30, 2015, the Company also granted zero and 0.2 million non-vested shares pursuant to the 2007 plan. The shares typically vest over a period ranging from six months to four years. The fair value of the non-vested shares is determined using the Company’s 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.
A summary of the Company’s non-vested share activity and related information for the nine months ended September 30, 2016 is as follows:
|
|
|
|
|
Weighted
|
|
|
Aggregate
|
|
|
|
|
|
|
Average
|
|
|
Intrinsic
|
|
|
Shares
|
|
|
Grant Date
|
|
|
Value
|
|
|
(000)
|
|
|
Fair Value
|
|
|
($000)
|
|
Non-vested shares outstanding — January 1, 2016
|
|
334
|
|
|
$
|
13.77
|
|
|
|
|
|
Granted
|
|
213
|
|
|
|
16.65
|
|
|
|
|
|
Vested
|
|
(112
|
)
|
|
|
14.28
|
|
|
|
|
|
Cancelled
|
|
(38
|
)
|
|
|
11.63
|
|
|
|
|
|
Non-vested shares outstanding — September 30, 2016
|
|
397
|
|
|
$
|
15.37
|
|
|
$
|
6,408
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-vested shares vested and expected to vest —September 30, 2016
|
|
386
|
|
|
$
|
15.34
|
|
|
$
|
6,230
|
|
The aggregate intrinsic value represents the total pre-tax intrinsic value based on the Company’s closing stock price of $16.14 on September 30, 2016. The amount changes based upon the fair market value of the Company’s common stock.
The unrecognized compensation cost associated with non-vested shares was $4.3 million and $3.0 million at September 30, 2016 and December 31, 2015, respectively. The weighted average remaining term that the compensation will be recorded was 2.4 years and 2.3 years as of September 30, 2016 and December 31, 2015, respectively.
Performance Stock Units
During both the three months ended September 30, 2016 and September 30, 2015, the Company awarded zero performance stock units, respectively, to members of the Company’s executive management team. During both the nine months ended September 30, 2016 and September 30, 2015, the Company awarded 0.1 million performance stock units, to members of the Company’s executive management team. These performance stock units represent a target number of shares (“Target Award”) of the Company’s
13
common stock that the recipient would receive upon the Company’s attainment of the applicable perfor
mance goal. These performance stock units were first issued in three tranches under the 2007 Plan with performance being determined based on total shareholder return (“TSR”) during an 18-month, two- and three-year performance period for each of the three t
ranches, respectively. The performance stock units issued in 2016 are measured on a three year performance period only. At the end of each performance period, the performance stock units will be distributed (to the extent earned and vested) in shares of t
he Company’s common stock based upon the level of achievement of the Company’s TSR performance targets set for the performance periods. Awards are payable on a graduated basis based on thresholds that measure the Company's performance relative to peers tha
t comprise the applicable index on which each years' awards are measured. Awards can be paid up to 200% of the Target Award or forfeited with no payout if performance is below a minimum established performance threshold. In the event the participant’s emp
loyment is terminated without cause and more than half of the performance period has passed, the number of performance stock units issued shall be adjusted proportionately to the number of days of service rendered in the performance period over the total p
erformance period. Each vested performance stock unit will be settled by delivery of common stock no later than March 15th of the calendar year following the calendar year in which the performance stock unit becomes vested.
A summary of the Company’s performance stock unit activity and related information for the nine months ended September 30, 2016 is as follows:
|
Performance
|
|
|
Weighted
|
|
|
Stock
|
|
|
Average
|
|
|
Units
|
|
|
Grant Date
|
|
|
(000)
|
|
|
Fair Value
|
|
Performance stock units outstanding — January 1, 2016
|
|
99
|
|
|
$
|
23.19
|
|
Granted
|
|
56
|
|
|
|
23.22
|
|
Vested
|
|
—
|
|
|
|
—
|
|
Cancelled
|
|
(23
|
)
|
|
|
22.08
|
|
Performance stock units outstanding — September 30, 2016
|
|
132
|
|
|
$
|
23.39
|
|
The unrecognized compensation cost associated with performance stock units outstanding at both September 30, 2016 and December 31, 2015 was $1.6 million. The weighted average remaining term that the compensation will be recorded is 1.8 years and 1.7 years as of September 30, 2016 and December 31, 2015, respectively.
7. FAIR VALUE MEASUREMENT
The Company’s money market funds are recognized and disclosed at fair value in the financial statements on a recurring basis. Fair value is defined as the price that would be received to sell an asset in an orderly transaction between market participants as of the measurement date. Fair value is measured using the fair value hierarchy and related valuation methodologies as defined in the authoritative literature. This guidance specifies a hierarchy of valuation techniques based on whether the inputs to each measurement are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Company’s assumptions about current market conditions. The prescribed fair value hierarchy and related valuation methodologies are as follows:
Level 1
- Quoted prices for identical instruments in active markets.
Level 2
- Quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active and model-derived valuations, in which all significant inputs are observable in active markets.
Level 3
- Valuations derived from valuation techniques, in which one or more significant inputs are unobservable.
The fair value of the Company’s financial assets and liabilities by level in the fair value hierarchy as of September 30, 2016 and December 31, 2015 was as follows:
September 30, 2016
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
|
Total
|
|
Assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Money Market Funds
|
$
|
90,170
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
90,170
|
|
Liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Contingent Consideration
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
750
|
|
|
$
|
750
|
|
December 31, 2015
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
|
Total
|
|
Assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Money Market Funds
|
$
|
86,871
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
86,871
|
|
14
Valuation methodology
Level 1—Quoted market prices in active markets are available for investments in money market funds. As such, these investments are classified within Level 1.
Level 3—
The estimated fair
value of the Level
3 contingent consideration
liability is based on a weighted probability assessment of achieving certain deliverables, related to the acquisition of Shopety, Inc., which will be determined within one year from the acquisition date.
The following table presents the Company's reconciliation of the changes in the fair value of Level 3 assets in the fair value hierarchy for the three months and nine months ended September 30, 2016, respectively:
|
Contingent Consideration
|
|
|
|
Contingent Consideration
|
|
June 30, 2016
|
$
|
750
|
|
|
December 31, 2015
|
$
|
—
|
|
Issuances/purchases
|
|
—
|
|
|
Issuances/purchases
|
|
750
|
|
Realized and unrealized gains/(losses)
|
|
—
|
|
|
Realized and unrealized gains/(losses)
|
|
—
|
|
Transfers in/(out)
|
|
—
|
|
|
Transfers in/(out)
|
|
—
|
|
Settlements/sales
|
|
—
|
|
|
Settlements/sales
|
|
—
|
|
Three months ended September 30, 2016
|
$
|
750
|
|
|
Nine months ended September 30, 2016
|
$
|
750
|
|
During October 2016, the Shopety, Inc. deliverables subject to the earn-out were met. As a result, the level 3 contingent consideration was paid out in full.
8. SEGMENT 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 Company’s 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 interconnection services via the Company’s telecommunications network to fulfill customer agreements. Therefore, the Company has concluded that it has one operating segment.
9. SUBSEQUENT EVENTS
As previously announced, on November 2, 2016, the Company, Onvoy, and Merger Sub entered into the Merger Agreement, pursuant to which Merger Sub will merge with and into the Company on the terms and subject to the conditions set forth in the Merger Agreement, with the Company surviving the Merger as a wholly-owned subsidiary of Onvoy.
At the Effective Time, on the terms and subject to the conditions set forth in the Merger Agreement, each issued and outstanding share of the Company’s common stock outstanding immediately prior to the Effective Time, other than any Excluded Shares and Dissenting Shares (each as defined in the Merger Agreement), will be converted automatically into the right to receive the Merger Consideration. The completion of the Merger is subject to approval of the Company’s stockholders and certain regulatory approvals and other customary closing conditions. The completion of the Merger is expected to occur during the first half of 2017. Each party to the Merger Agreement retains certain financial termination rights should the Merger Agreement be terminated under certain circumstances.
15