10-Q 1 iqnt-10q_20160930.htm IQNT-Q3-20160930 iqnt-10q_20160930.htm

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-Q

 

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

For the quarterly period ended September 30, 2016

OR

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

For the transition period from                    to                    

Commission file number: 001-33778

 

INTELIQUENT, INC.

(Exact name of registrant as specified in its charter)

 

 

Delaware

 

31-1786871

(State or other Jurisdiction of

Incorporation or Organization)

 

(IRS Employer

Identification No.)

550 West Adams Street

Suite 900

Chicago, IL 60661

(Address of principal executive offices, including zip code)

(312) 384-8000

(Registrant’s telephone number, including area code)

 

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

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

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

 

Large accelerated filer

 

 

Accelerated filer

 

 

 

 

 

Non-accelerated filer

 

  (Do not check if a smaller reporting company)

  

Smaller reporting company

 

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

As of October 7, 2016, 34,424,115 shares of the registrant’s Common Stock, $0.001 par value, were outstanding.

 

 

 

 

 


INTELIQUENT, INC.

INDEX

 

 

 

 

Page

 

PART I. FINANCIAL INFORMATION

 

 

 

Item 1.

 

Financial Statements

 

 

 

 

 

 

 

Condensed Consolidated Balance Sheets (Unaudited) as of September 30, 2016 and December 31, 2015

 

3

 

 

 

 

 

Condensed Consolidated Statements of Income (Unaudited) for the Three and Nine Months Ended September 30, 2016 and September 30, 2015

 

4

 

 

 

 

 

Condensed Consolidated Statements of Cash Flows (Unaudited) for the Nine Months Ended September 30, 2016 and September 30, 2015

 

5

 

 

 

 

 

Notes to Condensed Consolidated Financial Statements (Unaudited)

 

6

 

 

 

Item 2.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

16

 

 

 

Item 3.

 

Qualitative and Quantitative Disclosure about Market Risk

 

24

 

 

 

Item 4.

 

Controls and Procedures

  

25

 

PART II. OTHER INFORMATION

 

 

 

Item 1.

 

Legal Proceedings

  

26

 

 

 

Item 1A.

 

Risk Factors

 

26

 

 

 

Item 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

 

27

 

 

 

Item 3.

 

Default Upon Senior Securities

 

27

 

 

 

Item 4.

 

Mine Safety Disclosure

 

27

 

 

 

Item 5.

 

Other Information

 

27

 

 

 

Item 6.

 

Exhibits

 

28

 

 

 

2


PART I. FINANCIAL INFORMATION

INTELIQUENT, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

 

 

September 30,

 

 

December 31,

 

(In thousands, except per share amounts)

2016

 

 

2015

 

ASSETS

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

Cash and cash equivalents

$

120,467

 

 

$

109,050

 

Receivables — net of allowance of $2,433 and $2,365, respectively

 

54,762

 

 

 

39,589

 

Prepaid expenses

 

3,613

 

 

 

9,376

 

Other current assets

 

591

 

 

 

219

 

Total current assets

 

179,433

 

 

 

158,234

 

Property and equipment—net

 

50,815

 

 

 

37,336

 

Goodwill

 

1,715

 

 

 

 

Restricted cash

 

2,820

 

 

 

345

 

Deferred income taxes-noncurrent

 

768

 

 

 

1,059

 

Other assets

 

2,974

 

 

 

1,075

 

Total assets

$

238,525

 

 

$

198,049

 

LIABILITIES AND SHAREHOLDERS’ EQUITY

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

Accounts payable

$

3,715

 

 

$

424

 

Accrued liabilities:

 

 

 

 

 

 

 

Taxes payable

 

2,578

 

 

 

624

 

Network and facilities

 

25,954

 

 

 

10,984

 

Rent

 

2,047

 

 

 

1,969

 

Payroll and related items

 

3,573

 

 

 

2,918

 

Other

 

2,682

 

 

 

1,297

 

Total current liabilities

 

40,549

 

 

 

18,216

 

Shareholders’ equity:

 

 

 

 

 

 

 

Preferred stock—par value of $.001; 50,000 authorized shares; no shares issued and outstanding at

   September 30, 2016 and December 31, 2015

 

 

 

 

 

Common stock—par value of $.001; 150,000 authorized shares; 37,507 and 34,424 shares

   issued and outstanding at September 30, 2016, respectively, and 37,242 and 33,891 shares issued

   and outstanding at December 31, 2015, respectively

 

37

 

 

 

34

 

Less treasury stock, at cost; 3,083 shares at September 30, 2016 and 3,351 shares at December 31, 2015

 

(50,106

)

 

 

(51,668

)

Additional paid-in capital

 

230,658

 

 

 

225,474

 

Retained earnings

 

17,387

 

 

 

5,993

 

Total shareholders’ equity

 

197,976

 

 

 

179,833

 

Total liabilities and shareholders' equity

$

238,525

 

 

$

198,049

 

 

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

 

 

3


INTELIQUENT, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

 

 

Three Months Ended

 

 

Nine Months Ended

 

 

September 30,

 

 

September 30,

 

(In thousands, except per share amounts)

2016

 

 

2015

 

 

2016

 

 

2015

 

Revenue

$

99,404

 

 

$

63,716

 

 

$

272,485

 

 

$

171,656

 

Operating expense:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Network and facilities expense (excluding depreciation and amortization)

 

65,794

 

 

 

34,858

 

 

 

174,606

 

 

 

78,918

 

Operations

 

9,660

 

 

 

7,955

 

 

 

27,473

 

 

 

22,966

 

Sales and marketing

 

1,370

 

 

 

690

 

 

 

3,288

 

 

 

2,098

 

General and administrative

 

4,285

 

 

 

4,648

 

 

 

12,874

 

 

 

14,145

 

Depreciation and amortization

 

3,826

 

 

 

2,894

 

 

 

10,656

 

 

 

8,137

 

Gain on sale of property and equipment

 

 

 

 

(4

)

 

 

(5

)

 

 

(120

)

Total operating expense

 

84,935

 

 

 

51,041

 

 

 

228,892

 

 

 

126,144

 

Income from operations

 

14,469

 

 

 

12,675

 

 

 

43,593

 

 

 

45,512

 

Other (income) expense:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest (income) expense

 

(69

)

 

 

9

 

 

 

(210

)

 

 

36

 

Other income

 

 

 

 

 

 

 

 

 

 

(1,290

)

Total other (income) expense

 

(69

)

 

 

9

 

 

 

(210

)

 

 

(1,254

)

Income before provision for income taxes

 

14,538

 

 

 

12,666

 

 

 

43,803

 

 

 

46,766

 

Provision for income taxes

 

5,165

 

 

 

4,399

 

 

 

16,319

 

 

 

17,317

 

Net income

$

9,373

 

 

$

8,267

 

 

$

27,484

 

 

$

29,449

 

Earnings per share:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

$

0.27

 

 

$

0.25

 

 

$

0.80

 

 

$

0.88

 

Diluted

$

0.27

 

 

$

0.24

 

 

$

0.80

 

 

$

0.86

 

Weighted average number of shares outstanding:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

34,409

 

 

 

33,620

 

 

 

34,179

 

 

 

33,562

 

Diluted

 

34,584

 

 

 

34,138

 

 

 

34,387

 

 

 

34,057

 

Dividends declared per share:

$

0.16

 

 

$

0.15

 

 

$

0.47

 

 

$

0.45

 

 

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

 

 

4


INTELIQUENT, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

 

Nine Months Ended

 

 

September 30,

 

(In thousands)

2016

 

 

2015

 

Operating

 

 

 

 

 

 

 

Net income

$

27,484

 

 

$

29,449

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

 

 

Depreciation and amortization

 

10,656

 

 

 

8,137

 

Deferred income taxes

 

(924

)

 

 

(1,349

)

Gain on sale of property and equipment

 

(5

)

 

 

(120

)

Gain on settlement of Tinet escrow

 

 

 

 

(1,290

)

Non-cash share-based compensation

 

2,938

 

 

 

4,049

 

Provision for uncollectible accounts

 

62

 

 

 

211

 

Excess tax benefit associated with share-based payments

 

(847

)

 

 

(1,299

)

Changes in assets and liabilities:

 

 

 

 

 

 

 

Receivables

 

(15,235

)

 

 

(6,203

)

Other current assets

 

5,391

 

 

 

(2,619

)

Other noncurrent assets

 

250

 

 

 

(140

)

Accounts payable

 

339

 

 

 

331

 

Accrued liabilities

 

18,970

 

 

 

12,924

 

Net cash provided by operating activities

 

49,079

 

 

 

42,081

 

Investing

 

 

 

 

 

 

 

Purchase of property and equipment

 

(17,284

)

 

 

(20,943

)

Proceeds from sale of property and equipment

 

5

 

 

 

173

 

Cash used in acquisitions

 

(3,650

)

 

 

 

Cash paid for other investments

 

(1,829

)

 

 

 

Issuance of note receivable

 

(320

)

 

 

 

Increase in restricted cash

 

(2,475

)

 

 

 

Net cash used for investing activities

 

(25,553

)

 

 

(20,770

)

Financing

 

 

 

 

 

 

 

Proceeds from the exercise of stock options

 

3,754

 

 

 

869

 

Restricted shares withheld to cover employee taxes paid

 

(620

)

 

 

(1,034

)

Dividends paid

 

(16,090

)

 

 

(15,105

)

Excess tax benefit associated with share-based payments

 

847

 

 

 

1,299

 

Net cash used for financing activities

 

(12,109

)

 

 

(13,971

)

Net increase in cash and cash equivalents

 

11,417

 

 

 

7,340

 

Cash and cash equivalents — Beginning

 

109,050

 

 

 

104,737

 

Cash and cash equivalents — Ending

$

120,467

 

 

$

112,077

 

Supplemental disclosure of cash flow information:

 

 

 

 

 

 

 

Cash paid for taxes

$

8,655

 

 

$

20,058

 

Cash paid for interest

$

 

 

$

 

Supplemental disclosure of noncash flow items:

 

 

 

 

 

 

 

Investing activity — Accrued purchases of property and equipment

$

2,971

 

 

$

1,002

 

Investing activity — Accrued acquisition contingent consideration

$

750

 

 

$

 

 

 

 

 

 

 

 

 

 

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

 

 

 

5


INTELIQUENT, INC. AND SUBSIDIARIES

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 Commission 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 frequently 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 below 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 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.

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 FASB 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 income 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 IQsm” 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 fraudulently 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 specific 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 pursuing 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 realized 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 considered 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 September 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 performance 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 tranches, 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 the 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 that 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 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.   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


Item 2. Management’s 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,” “efforts,” “expects,” “estimates,” “projects,” “proposed,” “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 effects of competition, including direct connects (also referred to as IP direct connects or peering), and downward pricing pressure resulting from such competition; our regular review of strategic alternatives; the impact of current and future regulation, including intercarrier compensation reform enacted by the FCC; our ability to perform under the three-year Telecom Master Services Agreement and a related services attachment (collectively and as amended, the “T-Mobile Agreement”) we announced with T-Mobile USA. Inc. on August 17, 2015, including the risk that the traffic we carry under the T-Mobile Agreement will not meet our targets for profitability, including EBITDA and Adjusted EBITDA, that we incur damages or similar costs if we fail to meet certain terms in the T-Mobile Agreement, or that T-Mobile terminates the T-Mobile Agreement; the risk that our costs to perform under the T-Mobile Agreement will be higher than we expect; our ability to market our Omni IQ voice and messaging service, including the risk that the service will not meet our targets for revenue or profitability, including EBITDA and Adjusted EBITDA; the risk that our costs to provide Inteliquent’s Omni IQ voice and messaging service will be higher than we expect; the risks associated with any receiving carrier’s refusal to accept terminating messages or other problems preventing us from providing the services; the risks associated with our ability to successfully develop and market new voice services, many of which are beyond our control and all of which could delay or negatively affect our ability to offer or market new voice services successfully; the ability to develop and provide other new services; 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; changes in general economic or market conditions; our ability to identify and successfully attract a highly qualified successor to our former Chief Financial Officer and his or her future performance; the length of time required to complete an executive search; cooperation by key parties during the Chief Financial Officer transition process; 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 fiscal year ended December 31, 2015 and included elsewhere in this report, as such risk factors may be updated from time to time in subsequent reports. 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 voice 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, and historically data and video. Our solutions enable telecommunication service providers to deliver voice 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 “interconnection” or “off-net” services. We generally provide our solutions to traditional certificated telecommunication carriers and next-generation telecommunication service providers. We were incorporated in Delaware on April 19, 2001 and commenced operations in 2004.

On August 17, 2015 we announced that we had entered into the T-Mobile Agreement, under which we will provide a full suite of IP voice services to T-Mobile. The T-Mobile Agreement provides that T-Mobile will generally use our company as its sole provider of voice interconnection services for all calls exchanged between T-Mobile and nearly all other voice providers in the United States (excluding certain traffic, such as traffic that is exchanged with other providers over peering arrangements, etc.). We have experienced a significant increase in the volume of traffic carried on our network as a result of the T-Mobile Agreement. Consequently, this will significantly increase our revenue and operating expenses during 2016 and beyond.

On May 13, 2016 we acquired all of the outstanding equity of Shopety, Inc. d/b/a Better Voice, a developer of communications software and next-generation switching technologies. The acquired technologies will be used to expand the capabilities and addressable market of our next-generation Omni IQ product line.  The total purchase price of $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.

On November 2, 2016, we entered into the Merger Agreement with Onvoy and Merger Sub, pursuant to which Merger Sub will merge with and into us on the terms and subject to the conditions set forth in the Merger Agreement. We will survive the Merger as a wholly-owned subsidiary of Onvoy.

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At the Effective Time, on the terms and subject to the conditions set forth in the Merger Agreement, each issued and outstanding share of our common stock outstanding immediately prior to the Effective Time, other than any Excluded Shares and Dissenting Shares, will be converted automatically into the right to receive the Merger Consideration. The completion of the Merger is subject to approval of our 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.

Our Services

We provide the following voice services:

 

Local Transit Service. Prior to the commencement of our operations in 2004, competitive carriers generally had two alternatives to send local voice traffic to other competitive carriers’ networks: sending the traffic indirectly through the tandems of an Incumbent Local Exchange Carrier (“ILEC”) or directly through connected switch pairs, commonly referred to as “direct connects.” We established our company to offer an alternative to these options and better facilitate the exchange of local traffic between competitive carriers by using our tandem switches instead of the ILECs’ tandems or direct connects.  Since initially marketing our local transit service in several major markets, we have expanded our coverage and now provide local transit service in almost all markets in the contiguous United States, Hawaii and Puerto Rico.

 

Long Distance Service.  In 2006, we installed a national IP backbone network connecting our major local markets and began offering long distance services. Our long distance service allows us to carry long distance traffic that originates from our local or non-carrier customers in one market and terminates in another market.  When we provide this service, we are operating as an interexchange carrier.

 

Switched Access Service. In 2008, we began offering terminating switched access and originating switched access services. Switched access services are provided in connection with long distance calls. Our terminating switched access service 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 and is financially responsible for the call.

 

International Voice Service.  As we began interconnecting with certain non-U.S. carriers in 2010, we began terminating voice traffic that originated outside of the U.S. and terminated on the networks of carriers located in the U.S.  When we provide this service, we are operating as an interexchange carrier.  Our customer is the non-U.S. carrier that originates the call.

 

Next-Generation Omni IQ Service.  In 2012, we began to market Direct Inward Dialing (“DID”) service primarily to various non-carriers, including OTT providers, conference calling providers, calling card companies and interconnected VoIP providers.   As part of our DID offering, we assign telephone numbers to these non-carriers and then terminate voice traffic, such as conference calling or calling card traffic, that is destined to the telephone numbers that we have assigned to those non-carriers.  In 2016, in order to better serve next-generation telecommunication service providers, we expanded our offerings to include our Omni IQ service. Next-generation telecommunication service providers include the types of non-carriers described above (e.g., OTT or interconnected VoIP Providers, calling card platforms), as well as other providers that use software to enable voice calling and messaging over internet connections.  These types of providers include cloud-based Unified Communications (UC) providers, cloud contact/call center providers, application programing interface (“API”) platform providers and Wi-Fi first mobile virtual network operators (MVNOs). Our Omni IQ service is a one-stop shop solution for the provision of message-enabled telephone numbers and the delivery of all of a customer’s inbound and outbound voice calls and text messages or other messages to or from those telephone numbers.  Inteliquent’s Omni IQ service is made available via a web portal and APIs for automation and integration.  In addition to receiving payment from our non-carrier customers for the provision of our Omni IQ service, an interexchange carrier will pay us switched access charges for terminating long distance traffic to our telephone numbers, while a local exchange carrier may owe us reciprocal compensation charges for terminating local traffic to our telephone numbers.

 

8XX (Toll-Free) Service.   In 2014, we began offering 8XX service. We market this service to customers that seek to provide a caller with the ability to call them on a toll-free basis.  Although many enterprises purchase toll-free services, we are initially marketing these services primarily to call centers or other non-enterprise users.  When we provide this service, we are operating as an interexchange carrier.

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Regulatory Treatment of Certain Intercarrier Compensation

We receive intercarrier compensation from interexchange carriers when we receive terminating access traffic from those long distance carriers. The intercarrier compensation we receive is based either on agreements we have with the respective carriers or rates set forth in our tariffs.

On November 18, 2011, the FCC issued an order establishing, among other things, an intercarrier compensation framework for terminating switched access traffic.  Under the framework, when an end user subscribes to a local carrier’s services, most intercarrier compensation that the local carrier receives from interexchange carriers for terminating switched access traffic will be reduced to zero over a transition period which began on July 1, 2012 and concludes on July 1, 2018. 

Where a carrier only provides the terminating tandem access service, or intermediate interconnection between the interexchange carrier and the terminating local carrier, the tandem provider’s rates are not reduced to zero under the FCC’s November 18, 2011 order.  However, under the FCC’s order, the intercarrier compensation that the tandem carrier receives for terminating this switched access traffic was capped at the interstate rate in effect as of July 1, 2013.    

In connection with our switched access services and our DID service, we provide terminating access service in both of the manners described above. We earn the majority of our terminating access service revenue from providing intermediate terminating tandem access service, where the rates are not currently scheduled to be reduced to zero, as opposed to providing terminating service for traffic bound for end users that we serve, where the rates are currently scheduled to be reduced to zero. Several states, industry groups and other telecommunications carriers filed petitions in federal court seeking to overturn the FCC’s framework, in whole or in part.  The federal appellate court affirmed the FCC’s framework in all respects on May 23, 2014.

Carrier Disputes

The Company has disputes with certain long distance companies regarding their payment to the Company of access charges in connection with the Company’s origination of traffic from VoIP providers that utilize OTT technology.  As described in Note 4 “Contingencies,” we have reached a settlement with one long distance carrier resolving the dispute concerning access charge payments through 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.  

As described in Note 4 “Contingencies,” we commenced an action against Free Conferencing Corporation asserting claims that the Defendants are improperly charging us 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 distance traffic. 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 our condensed consolidated financial statements.

The Need for Our Services

Prior to the introduction of our local transit service offering, competitive carriers generally had two alternatives for exchanging traffic with other competitive carriers’ networks: sending the traffic indirectly through the tandems of an ILEC or directly through connected switch pairs, 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 the growth of competitive carriers while the purchase of ILEC tandem services became an increasingly significant component of a competitive carrier’s costs.

The tandem switching services offered by ILECs consist of local transit service, which is 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 service to competitive carriers. ILECs generally set per minute rates and other charges for local transit service 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 FCC for interstate calls and by state public utility commissions for intrastate calls. In November 2011, the FCC released an order setting forth a multi-year transition plan that will reduce, and ultimately lead to the elimination of terminating switched access charges. For a further discussion on the FCC’s order, see “Regulatory Treatment of Certain Intercarrier Compensation” above. Our solution enables competitive carriers to exchange traffic between their networks without using an ILEC tandem for both local and long distance calls.

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Before we commenced operations, 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.

We established 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 service, we believe we became the first carrier to provide alternative tandem services capable of alleviating the ILEC tandem exhaust problem. Our solution enables competitive carriers to exchange traffic between their networks without using an ILEC tandem for both local and long distance calls. 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.

Following the introduction of our local transit service, we began to face competition from other non-ILEC carriers, including Level 3, Hypercube and Peerless Network. Over the past several years, intensified competition led to reduced minutes of use and caused us to charge materially lower rates in various markets, including with respect to our major customers in our largest markets. Moreover, as previously noted, the other alternative for exchanging traffic prior to the commencement of our operations was for competitive carriers to install direct connections between their switches. Despite the development of a competitive tandem market, this alternative still exists, and in fact, we believe that our customers are frequently establishing direct connections between their networks, even for what might be considered, by historical standards, to be lower traffic switch pair combinations, for various reasons, including to eliminate paying a transit fee to us or one of our competitors.

We have entered into voice services agreements with major competitive carriers and non-carriers and we operated in 190 markets as of September 30, 2016. Generally, these agreements do not provide for minimum revenue requirements and do not require our customers to continue to use our services.

Revenue

We generate revenue from sales of our voice services. We maintain tariffs and executed service agreements with each of our customers in which specific fees and rates are determined. Voice revenue is recorded each month on an accrual basis, when collection is probable, based upon minutes of traffic switched by the network by each customer, which is referred to as minutes of use.

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 provider or a customer experiencing a decrease in the volume of traffic it originates or receives.

The average rate 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 generally 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 rate per minute than our current average.

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 rates are intended to incorporate all of these services.

While generally not seasonal in nature, our 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 Expenses

Operating expenses typically include network and facilities expenses, operations expenses, sales and marketing expenses, general and administrative expenses, depreciation and amortization, and gains (or losses) on sale of property and equipment.

Network and Facilities Expenses. Our network and facilities expenses primarily include costs we pay to third parties to terminate traffic on their networks.  Our network and facilities expenses also include transport capacity, or circuits, signaling network costs, facility rents and utilities, and costs to terminate our traffic, together with other costs that directly support the physical location where we house our switch, which is referred to in the industry as a point of presence (“POP”).  

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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 third-party circuits utilized by us to carry traffic to or from 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 March 2028. For some types of voice traffic, we also pay monthly recurring charges to the originating carrier that sends the call to us and/or to the terminating carrier when we terminate calls on their network.  Additionally, we pay utilities and common area maintenance charges for our POP locations.

Operations Expenses. Operations expenses include compensation and related benefit costs for our POP location personnel as well as individuals located at our corporate offices who are directly responsible for the operation of our business and for maintaining, monitoring and expanding our network. Other primary components of operations expenses include repair and maintenance, software licenses, business taxes and fees, insurance and professional service fees.  Professional services principally consist of contract labor, consulting and independent third-party firms which we use to outsource certain business functions to, which we define as “external service providers.”

Sales and Marketing Expenses. Sales and marketing expenses represent the smallest component of our operating expenses and primarily include compensation and related benefit costs for our sales and marketing departments, advertising and marketing programs and other costs related to travel and customer meetings.

General and Administrative Expenses. General and administrative expenses consist primarily of compensation and related benefit costs for personnel associated with our executive, finance, human resource, legal and other general and administrative support departments.  Other primary components of general and administrative expenses include fees for professional services, insurance and bad debt expense, if applicable. Professional services principally consist of outside legal, audit, consulting tax service fees and may occasionally include transaction services.

Depreciation and Amortization Expense. Depreciation and amortization expense for property and equipment 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, and 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.

Gain on Sale of Property and Equipment. We dispose 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 asset’s carrying value, a gain on disposal is recorded.

Total Other (Income) Expense. Total other (income) expense includes interest income and expense as well as other income and expense.  

Provision for Income Taxes. The income tax provision includes United States federal, state and local 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.

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, 2015, which we filed with the Securities and Exchange Commission on February 18, 2016, 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 nine months of 2016.

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Results of Operations

The following table sets forth our results of operations for the three and nine months ended September 30, 2016 and 2015:

 

 

Three Months Ended

 

 

Nine Months Ended

 

 

September 30,

 

 

September 30,

 

(Dollars in thousands)

2016

 

 

2015

 

 

2016

 

 

2015

 

Revenue

$

99,404

 

 

$

63,716

 

 

$

272,485

 

 

$

171,656

 

Operating expense:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Network and facilities expense

   (excluding depreciation and

   amortization)

 

65,794

 

 

 

34,858

 

 

 

174,606

 

 

 

78,918

 

Operations

 

9,660

 

 

 

7,955

 

 

 

27,473

 

 

 

22,966

 

Sales and marketing

 

1,370

 

 

 

690

 

 

 

3,288

 

 

 

2,098

 

General and administrative

 

4,285

 

 

 

4,648

 

 

 

12,874

 

 

 

14,145

 

Depreciation and amortization

 

3,826

 

 

 

2,894

 

 

 

10,656

 

 

 

8,137

 

Gain on sale of property and equipment

 

 

 

 

(4

)

 

 

(5

)

 

 

(120

)

Total operating expense

 

84,935

 

 

 

51,041

 

 

 

228,892

 

 

 

126,144

 

Income from operations

 

14,469

 

 

 

12,675

 

 

 

43,593

 

 

 

45,512

 

Other (income) expense:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest (income) expense

 

(69

)

 

 

9

 

 

 

(210

)

 

 

36

 

Other income

 

 

 

 

 

 

 

 

 

 

(1,290

)

Total other (income) expense

 

(69

)

 

 

9

 

 

 

(210

)

 

 

(1,254

)

Income before provision for income taxes

 

14,538

 

 

 

12,666

 

 

 

43,803

 

 

 

46,766

 

Provision for income taxes

 

5,165

 

 

 

4,399

 

 

 

16,319

 

 

 

17,317

 

Net income

$

9,373

 

 

$

8,267

 

 

$

27,484

 

 

$

29,449

 

 

Three Months Ended September 30, 2016 Compared to Three Months Ended September 30, 2015

Revenue. Revenue increased to $99.4 million in the three months ended September 30, 2016 from $63.7 million in the three months ended September 30, 2015, representing an increase of 56.0%.

The increase in voice revenue is primarily due to a 55.0% increase in the minutes of use to 62.3 billion minutes for the three months ended September 30, 2016, compared to 40.2 billion minutes for the three months ended September 30, 2015. The average rate per minute was flat at $0.00159 for both the three months ended September 30, 2016 and the three months ended September 30, 2015. The increase in the minutes of use is primarily due to the increased traffic we are carrying as a result of the T-Mobile Agreement.  Additionally, $2.3 million of revenue was recognized in the three months ended September 30, 2016 related to a settlement of outstanding, but previously unrecorded, billed revenue.

Operating Expenses. Operating expenses for the three months ended September 30, 2016 increased 66.5% to $84.9 million, an increase of $33.9 million, compared to $51.0 million for the three months ended September 30, 2015. The components of operating expenses are discussed as follows.

Network and Facilities Expenses. Network and facilities expenses increased to $65.8 million in the three months ended September 30, 2016, or 66.2% of revenue, compared to $34.9 million in the three months ended September 30, 2015, or 54.8% of revenue. The increase of $30.9 million was primarily due to an increase in traffic resulting from the T-Mobile Agreement, and the costs associated with provisioning transport capacity due to traffic volume growth. The cost as a percent of revenue increased during the three months ended September 30, 2016, as a result of an increase in the costs we pay to third parties to terminate certain traffic.

Operations Expenses. Operations expenses increased to $9.7 million in the three months ended September 30, 2016, or 9.8% of revenue, compared to $8.0 million in the three months ended September 30, 2015, or 12.6% of revenue. The increase of $1.7 million primarily resulted from an increase in employee-related costs resulting from hiring additional employees to develop, market and provide our Omni IQ business. Additionally, our professional fees, which include contract labor, increased slightly for the three months ended September 30, 2016. Lastly, we incurred higher transaction taxes and regulatory charges related to the growth of our business during the three months ended September 30, 2016.

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Sales and Marketing Expenses. Sales and marketing expenses increased to $1.4 million in the three months ended September 30, 2016, or 1.4% of revenue, compared to $0.7 million in the three months ended September 30, 2015, or 1.1% of revenue. The increase of $0.7 million was primarily due to an increase in employee related costs due to additional headcount necessary to develop, market and provide our Next-Generation Omni IQ services.

General and Administrative Expenses. General and administrative expenses decreased to $4.3 million in the three months ended September 30, 2016, or 4.3% of revenue, compared to $4.6 million in the three months ended September 30, 2015, or 7.2% of revenue. The decrease of $0.3 million was primarily due to decrease in non-cash compensation expense during the three months ended September 30, 2016 resulting from equity cancellations from our former CFO’s departure in September 2016 and a general decrease in non-cash compensation. Additionally, there were less bad debt expense charges during the three months ended September 30, 2016. Partially offsetting the decrease in non-cash compensation expense and bad debt expense was an increase in professional fees resulting from litigation costs.  

Depreciation and Amortization Expense. Depreciation and amortization expense increased to $3.8 million in the three months ended September 30, 2016, or 3.8% of revenue, compared to $2.9 million in the three months ended September 30, 2015, or 4.6% of revenue. The $0.9 million increase is due to the significant increase in our property and equipment asset base necessary to accommodate the growth in traffic we carry as a result of the T-Mobile agreement.  

Gain on Sale of Property and Equipment. Gain on sale of property and equipment was zero for the three months ended September 30, 2016 compared to a gain on sale of property and equipment of less than $0.1 million for the three months ended September 30, 2015.

Total Other (Income) Expense. Total other income was $0.1 million for the three months ended September 30, 2016 compared to total other expense of less than $0.1 million for the three months ended September 30, 2015.

Provision for Income Taxes. The provision for income taxes of $5.2 million for the three months ended September 30, 2016 reflected an increase of $0.8 million, compared to $4.4 million for the three months ended September 30, 2015. The increase in income tax expense for the three months ended September 30, 2016, as compared to the three months ended September 30, 2015, was primarily due to more pre-tax book income.

Nine Months Ended September 30, 2016 Compared to Nine Months Ended September 30, 2015

Revenue. Revenue increased to $272.5 million in the nine months ended September 30, 2016 from $171.7 million in the nine months ended September 30, 2015, representing an increase of 58.7%.

The increase in voice revenue is primarily due to a 51.0% increase in the minutes of use to 165.6 billion minutes for the nine months ended September 30, 2016, compared to 109.7 billion minutes for the nine months ended September 30, 2015. Additionally, there was a 5.8% increase in the average rate per minute of $0.00165 for the nine months ended September 30, 2016, compared to the average rate per minute of $0.00156 for the nine months ended September 30, 2015. The increase in the minutes of use is primarily due to the increased traffic we are carrying as a result of the T-Mobile Agreement. Additionally, $2.3 million of revenue was recognized in the three months ended September 30, 2016 related to a settlement of outstanding, but previously unrecorded, billed revenue.

Operating Expenses. Operating expenses for the nine months ended September 30, 2016 increased 81.5% to $228.9 million, an increase of $102.8 million, compared to $126.1 million for the nine months ended September 30, 2015. The components of operating expenses are discussed as follows.

Network and Facilities Expenses. Network and facilities expenses increased to $174.6 million in the nine months ended September 30, 2016, or 64.1% of revenue, compared to $78.9 million in the nine months ended September 30, 2015, or 46.0% of revenue. The increase of $95.7 million was primarily due to an increase in traffic resulting from the T-Mobile Agreement, and the costs associated with provisioning transport capacity due to traffic volume growth. The cost as a percent of revenue increased during the nine months ended September 30, 2016, as a result of an increase in the costs we pay to third parties to terminate certain traffic.

Operations Expenses. Operations expenses increased to $27.5 million in the nine months ended September 30, 2016, or 10.1% of revenue, compared to $23.0 million in the nine months ended September 30, 2015, or 13.4% of revenue. The increase of $4.5 million primarily resulted from an increase in employee-related costs resulting from hiring additional employees to develop, market and provide our Omni IQ business as well as contract labor required to support the T-Mobile Agreement. Additionally, our hardware maintenance and software licensing costs increased as a result of our recent investments in network equipment. Lastly, we incurred higher transaction taxes and regulatory charges related to the growth of our business during the nine months ended September 30, 2016.

Sales and Marketing Expenses. Sales and marketing expenses increased to $3.3 million in the nine months ended September 30, 2016, or 1.2% of revenue, compared to $2.1 million in the nine months ended September 30, 2016, or 1.2% of

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revenue. The increase of $1.2 million was primarily due to an increase in employee related costs due to additional headcount necessary to develop, market and provide our Next-Generation Omni  IQ services.

General and Administrative Expenses. General and administrative expenses decreased to $12.9 million in the nine months ended September 30, 2016, or 4.7% of revenue, compared to $14.1 million in the nine months ended September 30, 2015, or 8.2% of revenue. The decrease of $1.2 million was primarily the result of non-recurring charges for the resolution of certain employee matters that occurred during the nine months ended September 30, 2015 as well as a decrease in non-cash compensation expense during the nine months ended September 30, 2016 due to equity cancellations resulting from our former CFO’s departure in September 2016 and a general decrease in non-cash compensation. These decreases were somewhat offset by higher professional fees during the nine months ended September 30, 2016 resulting from Shopety transaction costs and litigation costs.

Depreciation and Amortization Expense. Depreciation and amortization expense increased to $10.7 million in the nine months ended September 30, 2016, or 3.9% of revenue, compared to $8.1 million in the nine months ended September 30, 2015, or 4.7% of revenue. The $2.6 million increase is due to the significant increase in our property and equipment asset base necessary to accommodate the growth in traffic we carry as a result of the T-Mobile agreement.  

Gain on Sale of Property and Equipment. Gain on sale of property and equipment was less than $0.1 million for the nine months ended September 30, 2016 compared to a gain sale of property and equipment of $0.1 million for the nine months ended September 30, 2015.

Total Other (Income) Expense. Total other income was $0.2 million for the nine months ended September 30, 2016. During the nine months ended September 30, 2015, we recorded $1.3 million of other income from the receipt of an escrow fund.  Refer to Note 1 “Description of the Business” for more information regarding the escrow receipt.

Provision for Income Taxes. The provision for income taxes of $16.3 million for the nine months ended September 30, 2016 reflected a decrease of $1.0 million, compared to $17.3 million for the nine months ended September 30, 2015. The decrease in income tax expense for the nine months ended September 30, 2016, as compared to the nine months ended September 30, 2015, was primarily due to less pre-tax book income.

Liquidity and Capital Resources

At September 30, 2016, we had $120.5 million in cash and cash equivalents and $2.8 million in restricted cash. In comparison, at December 31, 2015, we had $109.1 million in cash and cash equivalents and $0.3 million in restricted cash. Cash and cash equivalents include highly liquid government and agency money market mutual funds. The restricted cash balance is pledged as collateral for certain commercial letters of credit.

 

 

September 30,

 

 

September 30,

 

 

2016

 

 

2015

 

Cash flows provided by operating activities

$

49,079

 

 

$

42,081

 

Cash flows used for investing activities

 

(25,553

)

 

 

(20,770