GTT COMMUNICATIONS
This Management's Discussion and Analysis of Financial Condition and Results of
Operations ("MD&A") contains certain forward-looking statements within the
meaning of Section 21E of the Securities Exchange Act of 1934, as amended.
Historical results may not indicate future performance. Our forward-looking
statements reflect our current views about future events, are based on
assumptions, and are subject to known and unknown risks and uncertainties that
could cause actual results to differ materially from those contemplated by these
statements. Factors that may cause differences between actual results and those
contemplated by forward-looking statements include, but are not limited to,
those discussed in "Risk Factors" in Part I, Item 1A, of this Annual Report. We
undertake no obligation to publicly update or revise any forward-looking
statements, including any changes that might result from any facts, events, or
circumstances after the date hereof that may bear upon forward-looking
statements. Furthermore, we cannot guarantee future results, events, levels of
activity, performance, or achievements.
This MD&A is intended to assist in understanding and assessing the trends and
significant changes in our results of operations and financial condition. As
used in this MD&A, the words, "GTT", "we", "our", and "us" refer to GTT
Communications, Inc. and its consolidated subsidiaries. This MD&A should be read
in conjunction with our consolidated financial statements and related notes
included elsewhere in this Annual Report.
Company Overview
GTT Communications, Inc. ("GTT," "we," "us," and "our") serves large enterprise and carrier clients with complex national and global networking needs, and differentiates itself from the competition by providing an outstanding service experience built on our core values of simplicity, speed and agility. We operate a Tier 1 internet network ranked among the largest in the industry, and own a fiber network that includes an expansive pan-European footprint and subsea cables. Our global network includes over 600 unique points of presence (PoPs) spanning six continents, and we provide services in more than 140 countries. Our comprehensive portfolio of cloud networking services includes:
• Wide area networking, including software-defined wide area networking
("SD-WAN"), multiprotocol label switching ("MPLS"), and virtual private
LAN service ("VPLS");
• Internet, including IP transit, dedicated internet access, and broadband
internet;
• Ethernet transport, including dedicated Ethernet and video transport;
• Infrastructure, including wavelength, colocation, and dark fiber;
• Unified Communication ("UC"), including Session Initiation Protocol
("SIP") trunking, cloud unified communication service, and traditional
analog voice (POTS);
• Managed network, including managed equipment and managed security; and
• Advanced solutions, including hybrid cloud services, database and
application management, and premium security services.
Client and Network Contracts
Our client contracts are most commonly two to three years for the initial term but can range from one to five years or sometimes longer. Following the initial term, these agreements typically provide for automatic renewal for specified periods ranging from one month to one year. Our prices are fixed for the duration of the contract, and we typically bill monthly in advance for such services. If a client terminates its agreement, the terms of our client contracts typically require full recovery of any amounts due for the remainder of the term or, at a minimum, our liability to any underlying suppliers. Our revenue is composed of recurring revenue and non-recurring revenue. Recurring revenue relates to contracted ongoing service that is generally fixed in price and paid by the client on a monthly basis for the contracted term. For the year endedDecember 31, 2019 , recurring revenue was approximately 93% of our total revenue. Non-recurring revenue primarily includes installation and equipment charges to clients, one-time termination charges for clients who cancel their services prior to the contract termination date, and usage revenue which represents variable revenue based on whether a client exceeds its committed usage threshold as specified in the contract.
Our network supplier contracts do not have any market related net settlement provisions. We have not entered into, and do not plan to enter into, any supplier contracts which involve financial or derivative instruments. The supplier contracts are entered into solely for the direct purchase of telecommunications capacity, which is resold by us in the normal course of business.
Other than cost of telecommunication services provided, our most significant operating expenses are employment costs. As of
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December 31, 2019 , we had approximately 3,100 full-time equivalent employees.
For the year ended December 31, 2019 , the total employee cash compensation and
benefits represented approximately 12% of total revenue.
Recent Developments Affecting Our Results
Business Acquisitions
Since our formation, we have consummated a number of transactions accounted for as business combinations which were executed as part of our strategy of expanding through acquisitions. These acquisitions, which are in addition to our periodic purchases of client contracts, have allowed us to increase the scale at which we operate, which in turn affords us the ability to increase our operating leverage, extend our network, and broaden our client base. The accompanying consolidated financial statements include the operations of the acquired entities from their respective acquisition dates.
InDecember 2019 , we acquiredKPN International ("KPN"). We paid$53.6 million in cash consideration, of which$1.5 million was net cash acquired, on a debt-free basis. The results of KPN have been included fromDecember 1, 2019 . The acquisition was considered a stock purchase for tax purposes.
Access Point
InOctober 2018 , we acquired Access Point, Inc. ("Access Point"). We paid$36.3 million in cash consideration, of which$1.0 million was net cash acquired, and issued 115,194 unregistered shares of our common stock valued at$4.6 million at closing. The results of Access Point have been included fromOctober 1, 2018 . The acquisition was considered a stock purchase for tax purposes.
Interoute
InFebruary 2018 , we entered into an Agreement for the Sale and Purchase ofInteroute Communications Holdings S.A. ("Interoute"), a Luxembourg public limited liability company (the "Interoute Purchase Agreement") for €1,915.2 million in cash consideration, or$2,335.0 million using the exchange rate in effect on the date we entered into the Interoute Purchase Agreement. InFebruary 2018 , we also entered into a deal-contingent foreign currency hedge arrangement with a total notional amount of €1.260 billion at a spot rate of$1.23 to €1.00 to fix a portion of the purchase price. Fees associated with this arrangement were payable upon closing of the acquisition based on a pre-defined schedule in the hedge agreement. OnMay 31, 2018 , we closed on the transaction and acquired Interoute. We paid the €1,915.2 million, or$2,239.3 million in cash consideration using the exchange rate in effect at closing (which at$1.17 to €1.00 was lower than at announcement) of which$66.1 million was net cash acquired, and assumed$27.7 million in debt. Concurrent with closing of the acquisition, and as a result of the decline in exchange rate, we settled the deal-contingent foreign currency hedge arrangement for$105.8 million , inclusive of fees. The$105.8 million has been recorded as a loss in the consolidated statement of operations within other expense. The combination of the consideration paid at closing plus the settlement of the hedge was consistent with the total expected price of the transaction as announced inFebruary 2018 .
The results of Interoute have been included from
We partially funded the purchase price through the issuance of 9,589,094 shares of common stock to a group of institutional investors for proceeds of$425.0 million substantially concurrently with the closing of the Interoute acquisition. We also entered into a credit agreement to fund the remainder of the purchase price. Accelerated Connections
In
Custom Connect
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In December 2017 , we acquired Custom Connect International B.V. ("Custom
Connect"). We paid $28.9 million in cash consideration, of which $0.6 million
was net cash acquired, and issued 49,941 unregistered shares of our common stock
valued at $2.2 million at closing. The results of Custom Connect have been
included from December 31, 2017 . The acquisition was considered a stock purchase
for tax purposes.
Transbeam
In October 2017 , we acquired Transbeam, Inc. ("Transbeam"). We paid $26.4
million , of which $0.8 million was net cash acquired, and $2.0 million was
deferred as holdback consideration for a 12-month period, subject to reduction
for any indemnification claims made by us prior to such date. The results of
Transbeam have been included from October 1, 2017 . The acquisition was
considered a stock purchase for tax purposes.
Global Capacity
InSeptember 2017 , we acquired Global Capacity. We paid$104.0 million in cash consideration, of which$4.0 million was net cash acquired, and issued 1,850,000 unregistered shares of our common stock valued at$53.6 million at closing. The results of Global Capacity have been included fromSeptember 15, 2017 . The acquisition was considered an asset purchase for tax purposes.
Perseus
InJune 2017 , we acquiredPerseus Telecom ("Perseus"). We paid$37.5 million in cash consideration, of which$0.1 million was net cash acquired, and assumed$1.9 million in capital leases. The results of Perseus have been included fromJune 1, 2017 . The acquisition was considered a stock purchase for tax purposes.
Hibernia
InJanuary 2017 , we acquired Hibernia Networks ("Hibernia"). We paid for$529.6 million in cash consideration, of which$14.6 million was net cash acquired, and issued 3,329,872 unregistered shares of our common stock valued at$86.1 million at closing. The results of Hibernia have been included fromJanuary 1, 2017 . The acquisition was considered an asset purchase for tax purposes.
The acquisition of Access Point, Interoute, and Accelerated Connections are
collectively referred to as "the 2018 Acquisitions," the acquisitions of Custom
Connect,
Asset Purchases
Periodically we acquire client contracts that we account for as an asset purchase and record a corresponding intangible asset that is amortized over its assumed useful life.
During 2019 and 2018, we did not acquire any material client contracts. During
2017, we acquired client contracts for an aggregate purchase price of
Results of Operations of the Company
Year Ended
Overview. The information presented in the tables below is composed of the
consolidated financial information for the years ended
Year Ended December 31, Year-over-Year
2019 2018 2017 2019 to 2018 2018 to 2017
Revenue:
Telecommunications services $ 1,727.8 $ 1,490.8 $ 827.9 15.9 % 80.1 %
Operating expenses:
Cost of telecommunications
services 941.9 819.4 432.1 14.9 % 89.6 %
Selling, general and
administrative expenses 400.8 383.2 215.4 4.6 % 77.9 %
Severance, restructuring and
other exit costs 13.0 37.1 22.4 (65.0 )% 65.6 %
Depreciation and amortization 248.8 211.4 132.6 17.7 % 59.4 %
Total operating expenses 1,604.5 1,451.1 802.5 10.6 % 80.8 %
Operating income 123.3 39.7 25.4 210.6 % 56.3 %
Other expense:
Interest expense, net (194.7 ) (146.9 ) (71.2 ) 32.5 % 106.3 %
Loss on debt extinguishment - (13.8 ) (8.6 ) * *
Other (expense) income, net (31.3 ) (127.9 ) 0.2 (75.5 )% *
Total other expense (226.0 ) (288.6 ) (79.6 ) (21.7 )% 262.6 %
Loss before income taxes (102.7 ) (248.9 ) (54.2 ) (58.7 )% *
Provision for (benefit from)
income taxes 3.2 (5.5 ) 17.3 (158.2 )% *
Net loss $ (105.9 ) $ (243.4 ) $ (71.5 ) (56.5 )% *
* Not meaningful
Year Ended
Revenue
Our revenue increased by$237.0 million , or 15.9%, from$1,490.8 million for the year endedDecember 31, 2018 to$1,727.8 million for the year endedDecember 31, 2019 . Recurring revenue was approximately 93% of total revenue for both the years endedDecember 31, 2019 and 2018. The increase in revenue was primarily due to the 2018 Acquisitions.
On a constant currency basis using the average exchange rates in effect during
the year ended
Cost of Telecommunications Services Cost of telecommunications services increased by$122.5 million , or 14.9%, from$819.4 million for the year endedDecember 31, 2018 to$941.9 million for the year endedDecember 31, 2019 . Recurring cost of telecommunications services was approximately 22 -------------------------------------------------------------------------------- 93% and 94% of total cost of telecommunications services for the years endedDecember 31, 2019 and 2018, respectively. Consistent with our increase in revenue, the increase in cost of telecommunications services was principally driven by the 2018 Acquisitions. On a constant currency basis using the average exchange rates in effect during the year endedDecember 31, 2018 , cost of telecommunications services would have been higher by$21.6 million for the year endedDecember 31, 2019 . Operating Expenses Selling, General and Administrative Expenses. Selling, general and administrative expenses ("SG&A") increased by$17.6 million , or 4.6%, from$383.2 million for the year endedDecember 31, 2018 to$400.8 million for the year endedDecember 31, 2019 . The following table summarizes the major categories of selling, general and administrative expenses for the years endedDecember 31, 2019 and 2018 (amounts in millions): Year Ended December
31,
2019 2018 $ Variance % Change
Employee related compensation
(excluding share-based
compensation) $ 214.1 $ 191.0 $ 23.1 12.1 %
Share-based compensation 31.2 34.4 (3.2 ) (9.3 )%
Transaction and integration
expense 23.0 40.5 (17.5 ) (43.2 )%
Other SG&A(1) 132.5 117.3 15.2 13.0 %
Total $ 400.8 $ 383.2 $ 17.6 4.6 %
(1) Includes bad debt expense, professional fees, marketing costs, facilities, and other general support costs.
Employee related compensation increased primarily due to the 2018 Acquisitions. Share-based compensation expense decreases were driven by the previously issued 2015 performance awards becoming fully vested in the first quarter of 2019 partially offset by an increase in the aggregate value of employee equity awards. Transaction and integration expense decreases were driven by the decline in acquisitions completed during 2019 as compared to 2018. Other SG&A expense increases were principally driven by the 2018 Acquisitions. On a constant currency basis using the average exchange rates in effect during the year endedDecember 31, 2018 , selling, general and administrative expenses would have been higher by$8.7 million for the year endedDecember 31, 2019 . Severance, Restructuring and Other Exit Costs. For the year endedDecember 31, 2019 , we incurred severance, restructuring and other exit costs of$13.0 million relating primarily to the 2018 Acquisitions and charges incurred in connection the termination of certain facility leases. We incurred severance, restructuring and other exit costs of$37.1 million for the year endedDecember 31, 2018 relating to the 2018 Acquisitions. Depreciation and Amortization. Amortization of intangible assets decreased$1.2 million or 1.4%, from$86.4 million for the year endedDecember 31, 2018 to$85.2 million for the year endedDecember 31, 2019 , primarily due to intangibles from prior year acquisitions becoming fully amortized during the current and prior period. Depreciation expense increased$38.6 million , or 30.9% from$125.0 million to$163.6 million for the year endedDecember 31, 2019 , primarily due to assets acquired from the 2018 Acquisitions. Other Expense Other expense decreased by$62.6 million , or 21.7% from$288.6 million for the year endedDecember 31, 2018 to$226.0 million for the year endedDecember 31, 2019 . This is primarily due to a decrease of$97.2 million in loss on derivative financial instruments as well as the 2018 period including a loss on debt extinguishment of$13.8 million , partially offset by higher interest expense due to higher debt levels driven by the 2018 Acquisitions. Provision for (Benefit from) Income Taxes Our provision for income taxes for the year endedDecember 31, 2019 was$3.2 million . Our effective tax rate was lower than theU.S. federal statutory rate of 21% primarily due to a valuation allowance recorded againstU.S. and certain foreign net deferred tax assets and prior year true-ups related to the tax return filings due to differences in statutory accounting compared to US GAAP, which are estimated at the time of the provision. Our benefit from income taxes for the year endedDecember 31, 2018 was$5.5 million . Our effective tax rate was lower than theU.S. federal statutory rate of 21% primarily due to a valuation allowance recorded againstU.S. and certain foreign net deferred tax 23 -------------------------------------------------------------------------------- assets which also offset the impacts of tax expense associated with uncertain tax positions and the tax benefit from finalizing the 2017 impacts of the Tax Act.
Year Ended
Revenue
Our revenue increased by$662.9 million , or 80.1%, from$827.9 million for the year endedDecember 31, 2017 to$1,490.8 million for the year endedDecember 31, 2018 . Recurring revenue was approximately 93% and 94% of total revenue for the years endedDecember 31, 2018 and 2017, respectively. The increase in revenue was primarily due to the 2017 Acquisitions and 2018 Acquisitions. On a constant currency basis using the average exchange rates in effect during the year endedDecember 31, 2017 , revenue would have been lower by$24.1 million for the year endedDecember 31, 2018 . Cost of Telecommunications Services Cost of telecommunications services increased by$387.3 million , or 89.6%, from$432.1 million for the year endedDecember 31, 2017 to$819.4 million for the year endedDecember 31, 2018 . Recurring cost of telecommunications services was approximately 94% and 95% of total cost of telecommunications services for the years endedDecember 31, 2018 and 2017, respectively. Consistent with our increase in revenue, the increase in cost of telecommunications services was principally driven by the 2017 Acquisitions and 2018 Acquisitions. On a constant currency basis using the average exchange rates in effect during the year endedDecember 31, 2017 , cost of telecommunications services would have been lower by$12.2 million for the year endedDecember 31, 2018 .
Operating Expenses
Selling, General and Administrative Expenses. Selling, general and administrative expenses increased by$167.8 million , or 77.9%, from$215.4 million for the year endedDecember 31, 2017 to$383.2 million for the year endedDecember 31, 2018 . The following table summarizes the major categories of selling, general and administrative expenses for the years endedDecember 31, 2018 and 2017 (amounts in millions): Year Ended December 31, 2018 2017 $ Variance % Change Employee related compensation (excluding share-based compensation)$ 191.0 $ 97.3 $ 93.7 96.3 % Share-based compensation 34.4 22.2 12.2 55.0 % Transaction and integration expense 40.5 19.1 21.4 112.0 % Other SG&A(1) 117.3 76.8 40.5 52.7 % Total$ 383.2 $ 215.4 $ 167.8 77.9 %
(1) Includes bad debt expense, professional fees, marketing costs, facilities, and other general support costs.
Employee related compensation increased primarily due to the 2017 and 2018 Acquisitions. Share-based compensation expense increases were driven by the recognition of share-based compensation for performance awards and an increase in the aggregate value of employee equity awards. Transaction and integration expense increases were driven by the 2018 Acquisitions. Other SG&A expense increases were principally driven by the 2017 and 2018 Acquisitions. On a constant currency basis using the average exchange rates in effect during the year endedDecember 31, 2017 , selling, general and administrative expenses would have been lower by$5.7 million for the year endedDecember 31, 2018 . Severance, Restructuring and Other Exit Costs. For the year endedDecember 31, 2018 , we incurred severance, restructuring and other exit costs of$37.1 million relating primarily to the 2018 Acquisitions. We incurred severance, restructuring and other exit costs of$22.4 million for the year endedDecember 31, 2017 relating to the 2017 Acquisitions. Depreciation and Amortization. Amortization of intangible assets increased$17.4 million , or 25.2%, from$69.0 million for the year endedDecember 31, 2017 to$86.4 million for the year endedDecember 31, 2018 , primarily due to the additional definite-lived intangible assets recorded in connection with the 2017 Acquisitions and 2018 Acquisitions. Depreciation expense increased 24 --------------------------------------------------------------------------------$61.4 million , or 96.5%, from$63.6 million for the year endedDecember 31, 2017 to$125.0 million for the year endedDecember 31, 2018 , primarily due to assets acquired from the Interoute acquisition. Other Expense Other expense increased by$209.0 million , or 262.6%, from$79.6 million for the year endedDecember 31, 2017 to$288.6 million for the year endedDecember 31, 2018 . This is primarily attributable to higher interest expense due to higher debt levels driven by the 2017 Acquisitions and 2018 Acquisitions, loss on derivative financial instruments of$128.6 million primarily related to the cost of the currency hedge for the Interoute acquisition of$105.8 million and loss due to changes in fair value on the interest rate swaps of$22.4 million , and a loss on debt extinguishment of$13.8 million . Benefit from (Provision for) Income Taxes Our benefit from income taxes for the year endedDecember 31, 2018 was$5.5 million . Our effective tax rate was lower than theU.S. federal statutory rate of 21% primarily due to a valuation allowance recorded againstU.S. and certain foreign net deferred tax assets which also offset the impacts of tax expense associated with uncertain tax positions and the tax benefit from finalizing the 2017 impacts of the Tax Act. Our provision for income taxes for the year endedDecember 31, 2017 was$17.3 million Our effective tax rate for the year endedDecember 31, 2017 differed from theU.S. federal statutory rate of 35% due to the recording of a$29.0 million valuation allowance againstU.S. deferred tax assets and the one-time adjustments related to the Tax Act for which we recorded a provisional estimate of$17.3 million .
Liquidity and Capital Resources
Our primary sources of liquidity have been cash provided by operations and debt financing. Our principal uses of cash have been for acquisitions, working capital, capital expenditures, and debt service requirements. We anticipate our principal uses of cash in the foreseeable future will be for capital expenditures, working capital, and debt service. Management monitors cash flow and liquidity requirements on a regular basis, including an analysis of the anticipated working capital requirements for the next 12 months. This analysis assumes our ability to manage expenses, capital expenditures, indebtedness, and the anticipated growth of revenue. If our operating performance differs significantly from our forecasts, we may be required to reduce our operating expenses and curtail capital spending, and we may not remain in compliance with our debt covenants. In addition, if we are unable to fully fund our cash requirements through operations and current cash on hand, we may need to obtain additional financing through a combination of equity and debt financings and/or renegotiation of terms of our existing debt. If any such activities become necessary, there can be no assurance that we would be successful in obtaining additional financing or modifying our existing debt terms. Our capital expenditures increased by$24.5 million , or 31.5%, from$77.7 million (5.2% of revenue) for the year endedDecember 31, 2018 to$102.2 million (5.9% of revenue) for the year endedDecember 31, 2019 . The increase in capital expenditures was due mainly to 2018 Acquisitions. We anticipate that we will incur capital expenditures of approximately 5-6% of revenue going forward. We continue to expect that our capital expenditures will be primarily success-based (i.e., in support of specific revenue opportunities). We believe our cash flows from operating activities, in addition to cash on hand and available capacity on the Revolving Line of Credit Facility, will be sufficient to fund our operating activities and capital expenditures for the foreseeable future, and in any event for at least the next 12 to 18 months from the date of this filing. However, no assurance can be given that this will be the case. Cashflows
The following table summarizes the components of our cash flows for the years
ended
Year Ended December 31,
2019 2018 2017
Net cash provided by operating activities$ 107.1 $ 82.4 $ 63.4 Net cash used in investing activities (155.0 ) (2,426.3 ) (764.7 ) Net cash provided by financing activities 35.0 2,304.3 469.7 25
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Cash Provided by Operating Activities
Our largest source of cash provided by operating activities is monthly recurring revenue from our clients. Our primary uses of cash are payments to network suppliers, compensation-related costs, interest expense, and payments to third-party vendors such as agents, contractors, and professional service providers.
Net cash flows provided by operating activities increased by$24.7 million , from$82.4 million for the year endedDecember 31, 2018 to$107.1 million for the year endedDecember 31, 2019 . This increase was primarily due to the 2018 Acquisitions, partially offset by higher interest expense, as well as non-recurring cash payments for severance and exit costs, and for transaction and integration costs. Net cash flows provided by operating activities increased by$19.0 million , from$63.4 million for the year endedDecember 31, 2017 to$82.4 million for the year endedDecember 31, 2018 . This increase was primarily due to the 2017 Acquisitions and 2018 Acquisitions, partially offset by higher interest expense, as well as non-recurring cash payments for severance and exit costs, and for transaction and integration costs. Cash provided by operating activities during the year endedDecember 31, 2019 included$25.3 million cash paid for severance and exit costs and$20.9 million cash paid for transaction and integration costs. Cash provided by operating activities during the year endedDecember 31, 2018 included$34.7 million cash paid for severance and exit costs and$34.3 million cash paid for transaction and integration costs. Cash provided by operating activities during the year endedDecember 31, 2017 included$15.9 million cash paid for severance and exit costs and$19.1 million cash paid for transaction and integration costs.
Cash Used in Investing Activities
Our primary uses of cash include acquisitions, purchase of client contracts, and capital expenditures.
Net cash flows used in investing activities decreased by$2,271.3 million , from$2,426.3 million for the year endedDecember 31, 2018 to$155.0 million for the year endedDecember 31, 2019 . Net cash flows from investing activities increased by$1,661.6 million , from$764.7 million for the year endedDecember 31, 2017 to$2,426.3 million for the year endedDecember 31, 2018 . Cash used in investing activities for the year endedDecember 31, 2019 primarily consisted of$52.6 million for the 2019 acquisition of KPN, as well as capital expenditures of approximately$102.2 million .
Cash used in investing activities for the year ended
Cash used in investing activities for the year endedDecember 31, 2017 primarily consisted of$706.3 million for the 2017 Acquisition, as well as the purchase of certain client contracts for which we paid$14.9 million , and capital expenditures of approximately$42.0 million .
Cash Provided by Financing Activities
Our primary sources of cash from financing activities are proceeds from debt and equity issuances. Our primary use of cash for financing activities is the refinancing of our debt and repayment of principal pursuant to the debt agreements.
Net cash flows provided by financing activities decreased by$2,269.3 million , from$2,304.3 million for the year endedDecember 31, 2018 to$35.0 million for the year endedDecember 31, 2019 . Net cash flows from financing activities increased by$1,834.6 million , from$469.7 million for the year endedDecember 31, 2017 to$2,304.3 million for the year endedDecember 31, 2018 . Net cash flows provided by financing activities for the year endedDecember 31, 2019 was$35.0 million , consisting primarily of net proceeds from the Revolving Line of Credit Facility, partially offset by repayments of principal on term loans and other secured borrowings and payment of holdbacks. Net cash provided by financing activities for the year endedDecember 31, 2018 was$2,304.3 million consisting primarily of net proceeds from the new US Term Loan Facility and EMEA Term Loan Facility and proceeds from net equity issuance, partially offset by repayment of the prior term loan and payment of holdbacks. 26 -------------------------------------------------------------------------------- Net cash provided by financing activities for the year endedDecember 31, 2017 was$469.7 million , consisting primarily of net proceeds from the term loan and issuance of senior notes to fund the 2017 Acquisitions.
Supplemental cash flows
During the years endedDecember 31, 2019 , 2018 and 2017, we made cash payments for interest totaling$176.6 million ,$158.8 million , and$47.2 million , respectively. The increase in interest payments is a result of the incremental debt associated with acquisitions, as discussed further in Note 9 - Debt of the notes to the consolidated financial statements (Part II, Item 8 of this Form 10-K). The cash payments for interest expense are directly correlated to our outstanding indebtedness. During the years endedDecember 31, 2019 , 2018 and 2017, we made cash payments for taxes totaling$1.3 million ,$5.3 million , and$1.7 million , respectively. The increase in cash taxes paid in 2018 is primarily due to one-time events including a$1.5 million settlement of prior year uncertain tax positions and a$2.4 million payment related to an obligation assumed from a 2018 acquisition.
Indebtedness
As ofDecember 31, 2019 , andDecember 31, 2018 , long-term debt was as follows (amounts in millions): December 31, 2019 December 31, 2018 US Term loan $ 1,743.5 $ 1,761.2 EMEA Term loan 828.8 857.6 7.875% Senior unsecured notes 575.0 575.0 Revolving line of credit 140.0 59.0 Other secured loans 4.3 18.1 Total debt obligations 3,291.6 3,270.9 Unamortized debt issuance costs (28.0 ) (31.6 ) Unamortized original issuance discount, net (40.8 ) (47.8 ) Carrying value of debt 3,222.8 3,191.5 Less current portion (30.2 )
(39.9 ) Long-term debt less current portion $ 3,192.6 $ 3,151.6
2018 Credit Agreement InMay 2018 , we entered into a credit agreement (the "2018 Credit Agreement") that provides for (1) a$1,770.0 million term loan B facility (the "US Term Loan Facility"), (2) a €750.0 million term loan B facility (the "EMEA Term Loan Facility"), and (3) a$200.0 million revolving credit facility (the "Revolving Line of Credit Facility") (which includes a$50.0 million letter of credit facility). In addition, we may request incremental term loan commitments and/or incremental revolving loan commitments in an aggregate amount not to exceed the sum of$575.0 million and an unlimited amount that is subject to pro forma compliance with a net secured leverage ratio test. The US Term Loan Facility was issued at an original issuance discount of$8.9 million and the EMEA Term Loan Facility was issued at an original issuance discount of €3.8 million. OnJune 5, 2019 , the Company entered into an Incremental Revolving Credit Assumption Agreement ("Incremental Agreement") to the 2018 Credit Agreement. The Incremental Agreement establishes$50.0 million in new revolving credit commitments, bringing the total sum of revolving credit commitments under the 2018 Credit Agreement, as modified by the Incremental Agreement, to$250.0 million . The revolving credit commitments made pursuant to the Incremental Agreement have terms and conditions identical to the existing revolving credit commitments under the 2018 Credit Agreement. The obligations of the Company under the 2018 Credit Agreement are secured by the substantial majority of the tangible and intangible assets of the Company. The obligations of the Company under theU.S. Term Loan Facility and the Revolving Line of Credit Facility are guaranteed by certain of its domestic subsidiaries, but not by any of the Company's foreign subsidiaries. The obligations of the EMEA Borrower under the EMEA Term Loan Facility are guaranteed by the Company and certain of its domestic and foreign subsidiaries. None of the foreign subsidiary guarantors of the EMEA Term Loan Facility provide cross-guarantees of the guarantees of the EMEA Term Loan Facility provided by the Company and its domestic subsidiaries. 27 -------------------------------------------------------------------------------- The 2018 Credit Agreement does not contain a financial covenant for the US Term Loan Facility or the EMEA Term Loan Facility, but it does include a maximum Consolidated Net Secured Leverage Ratio applicable to the Revolving Line of Credit Facility in the event that utilization exceeds 30% of the revolving loan facility commitment. OnAugust 8, 2019 , the Company entered into Amendment No. 1 to the 2018 Credit Agreement ("Amendment No. 1"), which amends the Consolidated Net Secured Leverage Ratio applicable to the Revolving Line of Credit Facility for each fiscal quarter endingSeptember 30, 2019 throughDecember 31, 2020 . If triggered, the covenant requires the Company to maintain a Consolidated Net Secured Leverage Ratio, on a Pro Forma Basis, below the maximum ratio specified as follows: Fiscal Quarter Ending Maximum Ratio December 31, 2019 6.50:1 March 31, 2020 6.50:1 June 30, 2020 6.50:1 September 30, 2020 6.25:1 December 31, 2020 6.25:1 March 31, 2021 5.50:1 June 30, 2021 5.00:1 September 30, 2021 5.00:1 December 31, 2021 4.50:1 March 31, 2022 4.50:1 June 30, 2022 and thereafter 4.25:1 As ofDecember 31, 2019 , the Company's Consolidated Net Secured Leverage Ratio, as defined in the 2018 Credit Agreement, was approximately 6.0:1, which is below the maximum permitted ratio of 6.50:1. In addition, Amendment No. 1 to the 2018 Credit Agreement added certain restrictions, which remain in place from the effective date of the Amendment No. 1 until the delivery of the compliance certificate for the quarter endingMarch 31, 2021 , demonstrating compliance with the Consolidated Net Secured Leverage Ratio for that quarter, including without limitation the following: the Company and its restricted subsidiaries (as defined in the 2018 Credit Agreement) may not make certain dividends, distributions and other restricted payments (as defined in the 2018 Credit Agreement), including that the Company may not pay dividends; the Company and its restricted subsidiaries may not designate any subsidiary an "Unrestricted Subsidiary" (which would effectively remove such subsidiary from the restrictions of the 2018 Credit Agreement); the Company and its restricted subsidiaries may not make "permitted acquisitions" (as defined in the 2018 Credit Agreement) or certain other investments, unless the Company and its restricted subsidiaries have liquidity (i.e., unrestricted cash and cash equivalents and availability under the revolving credit facility under the 2018 Credit Agreement) of at least$250 million (other than the acquisition ofKPN Eurorings B.V. , a private limited liability company (besloten vennootschap met beperkte aansprakelijkheid) incorporated under the laws ofthe Netherlands with respect to which this liquidity requirement is not applicable); and the amount of incremental borrowings under the 2018 Credit Agreement that the Company and its subsidiaries may request when the Consolidated Net Secured Leverage Ratio is above 4.40 to 1.00 was reduced to$300 million minus amounts previously requested (which amount is$50 million requested under the Incremental Agreement described above). OnFebruary 28, 2020 , the Company entered into Amendment No. 2 to the 2018 Credit Agreement ("Amendment No. 2"), which established incremental term loan commitments for$140 million of EMEA term loans (the "2020 EMEA Term Loan Facility"), bringing the total amounts of EMEA term loans outstanding under the 2018 Credit Agreement, as modified by Amendment No. 2, to €750 million in Euro-denominated loans and$140 million in US Dollar-denominated loans. The EMEA term loans under the 2020 EMEA Term Loan Facility were incurred with an original issue discount of$5.6 million . The 2020 EMEA Term Loan Facility has terms substantially identical to the existing EMEA Term Loan Facility, except that: (1) each quarterly amortization payment on the 2020 EMEA Term Loan Facility will be$350,000 ; (2) the EMEA Term Loan Facility has call protection of 2.0% for certain mandatory and voluntary prepayments occurring on or prior to the one year anniversary of the effective date of the EMEA Term Loan Facility and 1.0% for certain mandatory and voluntary prepayments occurring following the one year anniversary of the effective date of the EMEA Term Loan Facility and until the second year anniversary thereof; (3) Amendment No. 2 added, for the benefit of the lenders under the 2020 EMEA Term Loan Facility, the same covenant restrictions contained in Amendment No. 1, except that (a) the amount of secured debt that can be incurred on a pari passu basis with the 2020 EMEA Term Loan Facility and certain types of debt incurred by non-credit parties is limited to$50 million in the aggregate and (b) certain excess asset sale proceeds will be required to prepay outstanding EMEA term loans or reinvest in long-term assets useful 28 -------------------------------------------------------------------------------- in the business within 30 days following receipt of such proceeds, which covenant restrictions will remain in place for so long as the existing Revolving Line of Credit Facility and the 2020 EMEA Term Loan Facility remain in effect; and (4) the applicable margin for the 2020 EMEA Term Loan Facility is (a) 3.25% for Base Rate Loans and 4.25% for Eurocurrency Loans for the first two years following the effective date of the 2020 EMEA Term Loan Facility and (b) 3.75% for Base Rate Loans and 4.75% for Eurocurrency Loans on and following the second anniversary of the effective date of the 2020 EMEA Term Loan Facility. Interest Rate Swaps During 2018, we entered into the following interest rate swap arrangements to partially mitigate the variability of cash flows due to changes in the Eurodollar rate, specifically related to interest payments on our term loans under the 2018 Credit Agreement: Trade date April 6, 2018 May 17, 2018 May 17, 2018 May 17, 2018 Notional amount (in millions) $ 500.0 $ 200.0 $ 300.0 € 317.0 Term (years) 5 7 3 7 Effective date 4/30/2018 6/29/2018 6/29/2018 6/29/2018 Termination date 4/30/2023 5/31/2025 6/30/2021 5/31/2025 Fixed rate 2.6430 % 3.0370 % 2.8235 % 0.8900 % Floating rate 1-month LIBOR 1-month LIBOR 1-month
LIBOR 1-month EURIBOR
The interest rate swaps do not qualify for hedge accounting.
7.875% Senior Unsecured Notes
During 2016 and 2017, we completed three private offerings for$575.0 million aggregate principal amount of our 7.875% senior unsecured notes due in 2024 (collectively the "7.875% Senior Unsecured Notes"). Each offering was treated as a single series of debt securities. The 7.875% Senior Unsecured Notes have identical terms other than the issuance date and offering price. The 7.875% Senior Unsecured Notes were issued at a combined premium of$16.5 million . In connection with the offerings, the Company incurred debt issuance costs of$17.3 million , of which$0.5 million was incurred in 2016 and the remainder was incurred in 2017.
Other Secured Loans
In connection with the Interoute acquisition in
Effective Interest Rate
The effective interest rate on the long-term debt at
Contractual Obligations and Commitments
The following table summarizes our significant contractual obligations as of
Less than 1 More than 5
Total year 1-3 years 3-5 years years
Term loans $ 2,572.3 $ 26.1 $ 52.2 $ 52.2 $ 2,441.8
7.875% senior note 575.0 - - 575.0 -
Revolving line of credit 140.0 - - 140.0 -
Other secured loans 4.3 4.1 0.2 - -
Operating leases 416.8 91.2 147.3 83.5 94.8
Finance leases 138.5 5.5 10.4 10.6 112.0
Network supplier
agreements (1) 1,163.2 485.9 571.3 52.4 53.6
Other (2) 34.6 11.8 10.3 5.3 7.2
$ 5,044.7 $ 624.6 $ 791.7 $ 919.0 $ 2,709.4
(1)Excludes contracts where the initial term has expired and we are currently in
month-to-month status.
(2) Primarily consists of vendor contracts associated with network monitoring
and maintenance services.
Off-Balance Sheet Arrangements
As ofDecember 31, 2019 , we did not have any off-balance sheet arrangements, other than those disclosed under contractual obligations, that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures, or capital resources that is material to investors. 29 --------------------------------------------------------------------------------
Non-GAAP Financial Measures
In addition to financial measures prepared in accordance with accounting principles generally accepted inthe United States ("GAAP"), from time to time we may use or publicly disclose certain "non-GAAP financial measures" in the course of our financial presentations, earnings releases, earnings conference calls, and otherwise. For these purposes, theSEC defines a "non-GAAP financial measure" as a numerical measure of historical or future financial performance, financial positions, or cash flows that (i) excludes amounts, or is subject to adjustments that effectively exclude amounts, included in the most directly comparable measure calculated and presented in accordance with GAAP in financial statements, and (ii) includes amounts, or is subject to adjustments that effectively include amounts, that are excluded from the most directly comparable measure so calculated and presented. Non-GAAP financial measures are provided as additional information to investors to provide an alternative method for assessing our financial condition and operating results. We believe that these non-GAAP measures, when taken together with our GAAP financial measures, allow us and our investors to better evaluate our performance and profitability. These measures are not in accordance with, or a substitute for, GAAP, and may be different from or inconsistent with non-GAAP financial measures used by other companies. These measures should be used in addition to and in conjunction with results presented in accordance with GAAP, and should not be relied upon to the exclusion of GAAP financial measures. Pursuant to the requirements of Regulation G, whenever we refer to a non-GAAP financial measure, we will also present the most directly comparable financial measure calculated and presented in accordance with GAAP, along with a reconciliation of the differences between the non-GAAP financial measure we reference with such comparable GAAP financial measure.
Adjusted Earnings before Interest, Taxes, Depreciation and Amortization ("Adjusted EBITDA")
Adjusted EBITDA is defined as net income or loss before interest, income taxes,
depreciation and amortization ("EBITDA") adjusted to exclude severance,
restructuring and other exit costs, acquisition-related transaction and
integration costs, losses on extinguishment of debt, share-based compensation,
and from time to time, other non-cash or non-recurring items.
We use Adjusted EBITDA to evaluate operating performance, and this financial
measure is among the primary measures we use for planning and forecasting future
periods. We further believe that the presentation of Adjusted EBITDA is relevant
and useful for investors because it allows investors to view results in a manner
similar to the method used by management and makes it easier to compare our
results with the results of other companies that have different financing and
capital structures. In addition, we have debt covenants that are based on a
leverage ratio that utilizes a modified EBITDA calculation, as defined in our
Credit Agreement. The modified EBITDA calculation is similar to our definition
of Adjusted EBITDA; however, it includes the pro forma Adjusted EBITDA of and
expected cost synergies from the companies acquired by us during the applicable
reporting period. Finally, Adjusted EBITDA results, along with other
quantitative and qualitative information, are utilized by management and our
compensation committee for purposes of determining bonus payouts to our
employees.
The following is a reconciliation of Adjusted EBITDA from Net loss (amounts in
millions):
Year Ended December 31,
2019 2018 2017
Net loss $ (105.9 ) $ (243.4 ) $ (71.5 )
Provision for (benefit from) income taxes 3.2 (5.5 ) 17.3
Interest and other expense, net 226.0 274.8 71.0
Loss on debt extinguishment - 13.8 8.6
Depreciation and amortization 248.8 211.4 132.6Severance, restructuring and other exit costs 13.0 37.1 22.4 Transaction and integration costs
23.0 40.5 19.1
Share-based compensation 31.2 34.4 22.2
Adjusted EBITDA $ 439.3 $ 363.1 $ 221.7 Free Cash Flow, Adjusted Free Cash Flow, and Adjusted Unlevered Free Cash Flow
Free Cash Flow is defined by us as net cash provided by operating activities
less purchases of property and equipment. Adjusted Free Cash Flow is defined by
us as Free Cash Flow adjusted to exclude cash paid for severance, restructuring
and other exit costs, and acquisition-related transaction and integration costs.
Adjusted Unlevered Free Cash Flow is defined as Adjusted Free Cash Flow
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before interest. Adjusted Free Cash Flow and Adjusted Unlevered Free Cash Flow
are not a measurement of our financial performance under GAAP and should not be
considered in isolation or as alternatives to net cash flows provided by
operating activities, total net cash flows, or any other performance measure
derived in accordance with GAAP.
We use Free Cash Flow and Adjusted Free Cash Flow as a measure to evaluate cash
generated through normal operating activities. We believe that the presentation
of Free Cash Flow and Adjusted Free Cash Flow is relevant and useful to
investors because they provide measures of cash available to pay the principal
on our debt and pursue acquisitions of businesses or other strategic investments
or uses of capital. We use Adjusted Unlevered Free Cash Flow as a measure to
evaluate cash generated through normal operating activities prior to debt
service as our debt capital structure will change over time. We believe that the
presentation of Adjusted Unlevered Free Cash Flow is relevant and useful for
investors because it allows investors to view results in a manner similar to the
method used by management and makes it easier to compare our results with the
results of other companies that have different financing and capital structures.
The following is a reconciliation of Adjusted Free Cash Flow and Adjusted
Unlevered Free Cash Flow from Cash provided by operating activities (amounts in
millions):
Year Ended December 31,
2019 2018 2017
Net cash provided by operating
activities $ 107.1 $ 82.4 $ 63.4
Purchases of property and
equipment (102.2 ) (77.7 ) (42.0 )
Free Cash Flow 4.9 4.7 21.4
Severance, restructuring and
other exit costs 25.3 34.7 15.9
Transaction and integration
costs 20.9 34.3 19.1
Adjusted Free Cash Flow 51.1 73.7 56.4
Cash paid for interest (1) 176.6 158.8 47.2
Adjusted Unlevered Free Cash
Flow $ 227.7 $ 232.5 $ 103.6
(1) Cash paid for interest for the year ended December 31, 2018 includes three semi-annual
interest payments on the 7.875% Senior Unsecured Notes.
Critical Accounting Policies and Estimates
The discussion of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with GAAP. In the preparation of our consolidated financial statements, we are required to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, as well as the related disclosures of contingent assets and liabilities. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. The results of our analysis form the basis for making assumptions about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions, and the impact of such differences may be material to our consolidated financial statements. Our critical accounting policies have been discussed with the Audit Committee of our Board of Directors. We believe that the following critical accounting policies affect the more significant judgments and estimates used in the preparation of our consolidated financial statements and believe that an understanding of these policies is important to a proper evaluation of the reported consolidated financial results. Our significant accounting policies are described in Note 2 - Significant Accounting Policies of the notes to the consolidated financial statements (Part II, Item 8 of this Form 10-K).
Certain prior year amounts have been reclassified for consistency with the current year presentation. These reclassifications had no effect on reported results of operations.
Segment Reporting
We report operating results and financial data in one operating and reporting
segment. Our Chief Executive Officer is the chief operating decision maker and
manages the Company as a single profit center in order to promote collaboration,
provide comprehensive service offerings across our entire client base, and
provide incentives to employees based on the success of the organization as a
whole. Although certain information regarding selected products or services is
discussed for purposes of promoting an understanding of our complex business,
the chief operating decision maker manages the Company and allocates resources
at the consolidated level.
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--------------------------------------------------------------------------------Revenue Recognition
Our revenue is derived primarily from telecommunications services, which includes both revenue from contracts with customers and lease revenues. Lease revenue services include dark fiber, duct, and colocation services. All other services are considered revenue from contracts with customers. Revenue from contracts with customers is recognized when services are provided to the customer, in an amount that reflects the consideration we expect to receive in exchange for those services. Lease revenue represents an arrangement where the customer has the right to use an identified asset for a specified term and such revenue is recognized over the term the customer is given exclusive access to the asset.
We deliver comprehensive cloud networking services to our customers which include wide area networking; internet; transport; infrastructure; unified communication; managed network; and advanced solutions.
Our services are provided under contracts that typically include an installation or provisioning charge along with payments of recurring charges on a monthly basis for use of the services over a committed term. Our contracts with customers specify the terms and conditions for providing such services, including installation date, recurring and non-recurring fees, payment terms, and length of term. These contracts call for us to provide the service in question (e.g., data transmission between point A and point Z), to manage the activation process, and to provide ongoing support (in the form of service maintenance and trouble-shooting) during the service term. The contracts do not typically provide the customer any rights to use specifically identifiable assets. Furthermore, the contracts generally provide us with discretion to engineer (or re-engineer) a particular network solution to satisfy each customer's data transmission requirement, and typically prohibit physical access by the customer to the network infrastructure used by us and our suppliers to deliver the services. Fees charged for ongoing services are generally fixed in price and billed on a recurring monthly basis (generally one month in advance) for a specified term. Fees may also be based on specific usage of the related services, or usage above a fixed threshold, which are billed monthly in arrears. The usage based fees represent variable consideration; however, the nature of the fees are such that we are not able to estimate these amounts with a high degree of certainty and therefore the usage based fees are excluded from the transaction price and are instead recognized as revenue based on actual usage charges billed using the rates and/or thresholds specified in each contract. At the end of the term, most contracts provide for a continuation of services on the same terms, either for a specified renewal period (e.g., one year) or on a month-to-month basis. Revenue is generally recognized over time for these contracts as the customers simultaneously receive and consume the benefit of the service as we perform. Fees may also be billed for early terminations based on contractually stated amounts. The early termination fees represent variable consideration. We estimate the amount of variable consideration we expect to be entitled to receive for such arrangements using the expected value method.
We do not disclose information about remaining performance obligations that have original expectation durations of one year or less.
Primary geographical market. Our operations are located primarily in
Contracts with multiple performance obligations. The majority of our contracts
with customers have a single performance obligation - telecommunication
services. The related installation services are generally considered not
material within the context of the contract and we do not recognize these
immaterial promised services as a separate performance obligation. Certain
contracts with customers may include multiple performance obligations,
specifically when the Company sells its connectivity services in addition to
customer premise equipment ("CPE"). For such arrangements, revenue is allocated
to each performance obligation based on its relative standalone selling price.
The standalone selling price for each performance obligation is based on
observable prices charged to customers in similar transactions or using expected
cost-plus margin.
We apply certain permitted practical expedients to our revenue recognition. We
do not adjust the promised amount of consideration for the effects of a
significant financing component if we expect, at contract inception, that the
period between when we transfer a promised good or service to a customer and
when the customer pays for that good or service will be one year or less.
Prepaid Capacity Sales and Indefeasible Right to Use. We sell capacity on a
long-term basis, where a certain portion of the contracted revenue is prepaid
upon acceptance of the service by the customer. This prepaid amount is initially
recorded as deferred revenue and amortized ratably over the term of the
contract. Certain of these prepaid capacity sales are in the form of
Indefeasible Rights to Use ("IRUs"), where the customer has the right to use the
capacity of the fiber optic cable for a specified term. We record revenues from
these prepaid leases of fiber optic cable IRUs over the term that the customer
is given exclusive access to the assets.
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Universal Service Fund ("USF"), Gross Receipts Taxes and Other Surcharges. We
are liable in certain cases for collecting regulatory fees and/or certain sales
taxes from our customers and remitting the fees and taxes to the applicable
governing authorities. Taxes assessed by a governmental authority that are both
imposed on and concurrent with a specific revenue-producing transaction, that
are collected by us from a customer, are excluded from revenue. Conversely, USF
contributions are assessed to us by and paid to the Universal Service
Administration Company ("USAC") and are based on our interstate and inter-nation
end-user revenues. We may assess our customers a separate fee to recoup our USF
expense. These fees are included in telecommunications services revenue and
costs of telecommunications services.
Share-Based Compensation
We issue three types of equity grants under our share-based compensation plan: time-based restricted stock, time-based stock options, and performance-based restricted stock. The time-based restricted stock and stock options generally vest over a four-year period, contingent upon meeting the requisite service period requirement. Performance awards typically vest over a shorter period, e.g., one to two years, starting when the performance criteria established in the grant have been met. The share price of our common stock as reported on the NYSE on the date of grant is used as the fair value for all restricted stock. We use the Black-Scholes option-pricing model to determine the estimated fair value for stock options. Critical inputs into the Black-Scholes option-pricing model include the following: option exercise price, fair value of the stock price, expected life of the option, annualized volatility of the stock, annual rate of quarterly dividends on the stock, and risk-free interest rate. Implied volatility is calculated as of each grant date based on our historical stock price volatility along with an assessment of a peer group. Other than the expected life of the option, volatility is the most sensitive input to our option grants. The risk-free interest rate used in the Black-Scholes option-pricing model is determined by referencing theU.S. Treasury yield curve rates with the remaining term equal to the expected life assumed at the date of grant. Forfeitures are estimated based on our historical analysis of attrition levels. Forfeiture estimates are updated quarterly for actual forfeitures. The share-based compensation expense for time-based restricted stock and stock options is recognized on a straight-line basis over the vesting period. We begin recognizing share-based compensation expense for performance awards when we consider the achievement of the performance criteria to be probable through the expected vesting period. Income Taxes Income taxes are accounted for under the asset and liability method pursuant to GAAP. Under this method, deferred tax assets and liabilities are recognized for the expected future consequences attributable to the differences between the financial statement carrying amounts and the tax basis of assets and liabilities. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in the period of the change. Further, deferred tax assets are recognized for the expected realization of available net operating loss and tax credit carryforwards. A valuation allowance is recorded on gross deferred tax assets when it is "more likely than not" that such asset will not be realized. When evaluating the realizability of deferred tax assets, all evidence, both positive and negative, is evaluated. Items considered in this analysis include the ability to carry back losses, the reversal of temporary differences, tax planning strategies, and expectations of future earnings. We review our deferred tax assets on a quarterly basis to determine if a valuation allowance is required based upon these factors. Changes in our assessment of the need for a valuation allowance could give rise to a change in such allowance, potentially resulting in additional expense or benefit in the period of change. Our income tax provision includesU.S. federal, state, local, and foreign income taxes and is based on pre-tax income or loss. In determining the annual effective income tax rate, we analyzed various factors, including our annual earnings and taxing jurisdictions in which the earnings were generated, the impact of state and local income taxes, and our ability to use tax credits and net operating loss carryforwards. Under GAAP, the amount of tax benefit to be recognized is the amount of benefit that is "more likely than not" to be sustained upon examination. We analyze our tax filing positions in all of theU.S. federal, state, local, and foreign tax jurisdictions where we are required to file income tax returns, as well as for all open tax years in these jurisdictions. If, based on this analysis, we determine that uncertainties in tax positions exist, a liability is established in the consolidated financial statements. We recognize accrued interest and penalties related to unrecognized tax positions in the provision for income taxes. Estimating Allowances
Allowance for Doubtful Accounts
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We establish an allowance for bad debts for accounts receivable amounts that may
not be collectible. We state our accounts receivable balances at amounts due
from the client net of an allowance for doubtful accounts. We determine this
allowance by considering a number of factors, including the length of time
receivables are past due, the client's payment history, and current ability to
pay its obligation to the Company, and the condition of the general economy. The
allowance for doubtful accounts was $14.3 million and $11.1 million as of
December 31, 2019 and 2018, respectively.
Allowance for Vendor Disputes
In the normal course of business, we identify errors by suppliers with respect to the billing of services. We perform bill verification procedures to ensure that errors in our suppliers' billed invoices are identified and resolved. If we conclude that a vendor has billed us inaccurately, we will record a liability only for the amount that we believe is owed. As ofDecember 31, 2019 , and 2018, we had$12.2 million and$9.1 million , respectively, in disputed billings from suppliers that were not accrued because we do not believe we owe them.
Goodwill represents the excess of the purchase price over the fair value of the net identifiable assets acquired in a business combination.Goodwill is reviewed for impairment at least annually, in October, or more frequently if a triggering event occurs between impairment testing dates. The Company operates as a single operating segment and as a single reporting unit for the purpose of evaluating goodwill impairment. The Company's impairment assessment begins with a qualitative assessment to determine whether it is more likely than not that fair value of the reporting unit is less than its carrying value. The qualitative assessment includes comparing the overall financial performance of the Company against the planned results used in the last quantitative goodwill impairment test. Additionally, the Company's fair value is assessed in light of certain events and circumstances, including macroeconomic conditions, industry and market considerations, cost factors, and other relevant entity and Company specific events. The selection and assessment of qualitative factors used to determine whether it is more likely than not that the fair value of a reporting unit exceeds the carrying value involves significant judgment and estimates. If it is determined under the qualitative assessment that it is more likely than not that the fair value of a reporting unit is less than its carrying value, then a quantitative impairment test is performed. Under the quantitative impairment test, the estimated fair value of the reporting unit would be compared with its carrying value (including goodwill). If the fair value of the reporting unit exceeds its carrying value then no impairment exists. If the estimated fair value of the reporting unit is less than its carrying value, an impairment loss would be recognized for the excess of the carrying value of the reporting unit over the fair value, not to exceed the carrying amount of goodwill. Fair value of the Company under the quantitative impairment test is determined using a combination of both income and market-based approaches, weighted 40% and 60%, respectively. The assumptions which have the most significant effect on fair value derived using the income approach are (1) revenue growth rates, (2) the discount rate, (3) terminal growth rates, and (4) foreign currency rates. The assumptions used in the market approach include (1) the stock price of the Company and (2) the selection of comparable companies. We identified a triggering event during the three months endedJune 30, 2019 due to the significant decline in our stock price. Accordingly, we performed an assessment of fair value using the policy outlined above and concluded no impairment existed at that time. We again identified a triggering event during the three months endedSeptember 30, 2019 due to the further decline in our stock price. Accordingly, we performed another assessment of fair value using the policy outlined above.
Based upon the results of our fair value analysis for the three months ended
We did not identify a triggering event during the three months endedDecember 31, 2019 , though we did update the quantitative assessment of fair value using the policy outlined above. Based upon the results of our analysis for the three months endedDecember 31, 2019 , the Company's estimated fair value exceeded our carrying value by approximately 21%. We consider the assumptions used in our analysis to be our best estimates across a range of possible outcomes based on available evidence at the time of the assessment. While we concluded no impairment existed at this time, our goodwill is at risk of future impairment in the event of significant unexpected changes in our foretasted future results and cash flows, or if there is a negative change in the long-term outlook for the business or in other factors such as the discount rate.
There were no triggering events or goodwill impairments identified for the years
ended
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Intangible assets arising from business combinations, such as acquired client
contracts and relationships (collectively "customer relationships"), trade
names, and/or intellectual property, are initially recorded at fair value. We
amortize these intangible assets over the determined useful life, which
generally ranges from 3 to 20 years. We review our intangible assets for
impairment whenever events or circumstances indicate that the carrying amount of
an asset may not be fully recoverable. There were no triggering events or
intangible asset impairments recognized for the years ended December 31, 2019 ,
2018, and 2017.
Further information is available in Note 4 - Goodwill and Intangible Assets of
the notes to the consolidated financial statements (Part II, Item 8 of this Form
10-K).
Business Combinations and Asset Purchases
We allocate the fair value of purchase consideration to the tangible assets acquired, liabilities assumed, and intangible assets acquired based on their estimated acquisition date fair values. The excess of the fair value of the purchase consideration over the fair values of the identifiable assets acquired and liabilities assumed is recorded as goodwill. When determining the fair values of assets acquired and liabilities assumed, we make significant estimates and assumptions, especially with respect to intangible assets. We recognize the purchase of assets and the assumption of liabilities as an asset purchase if the transaction does not constitute a business combination. The excess of the fair value of the purchase consideration is allocated on a relative fair value basis to the identifiable assets acquired and liabilities assumed. No goodwill is recorded in an asset purchase. Critical estimates in valuing certain intangible assets include but are not limited to future expected cash flows from client relationships and developed technology, discount rates, and terminal values. Our estimate of fair value is based upon assumptions believed to be reasonable, but actual results may differ from estimates. Other estimates associated with the accounting for acquisitions may change as additional information becomes available regarding the assets acquired and liabilities assumed, as more fully discussed in Note 3 - Business Acquisitions of the notes to the consolidated financial statements (Part II, Item 8 of this Form 10-K).
Derivative Financial Instruments
We may use derivatives to partially offset our business exposure to foreign currency or interest rate risk on expected future cash flows. There can be no assurance the hedges will offset more than a portion of the financial impact resulting from movements in foreign currency exchange or interest rates. We do not hold derivatives for trading or speculative purposes.
Our use of derivative financial instruments exposes us to credit risk to the extent that the counterparties may be unable to meet the terms of the agreements. We mitigate such risk on these transactions by limiting our counterparties to major, creditworthy financial institutions.
We record the fair value of our derivative financial instruments in the consolidated balance sheet as a component of prepaid expenses and other current assets when in a net asset position and as a component of accrued expenses and other current liabilities when in a net liability position. Derivatives that are not designated as hedging instruments are adjusted to fair value through earnings on the consolidated statement of operations as other expense, net.
As of
Leases
A lease is a contract, or part of a contract, that conveys the right to control the use of identified property, plant or equipment (i.e., an identified asset) for a period of time in exchange for consideration.
Lessee
Lease contracts from a lessee perspective are classified as either operating or
finance. Operating leases are included in Operating lease right of use assets,
Operating lease liabilities, and Operating lease liabilities, long-term portion.
Finance leases are included in Property and equipment, net, Finance lease
liabilities, and Finance lease liabilities, long-term portion.
For operating leases, we recognize a lease liability equal to the present value
of the remaining lease payments, and a right of use asset equal to the lease
liability, subject to certain adjustments. We use the incremental borrowing rate
for leases which do not have
35
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a readily determinable implicit rate to determine the present value of the lease
payments. Our incremental borrowing rates are the rates of interest that we
would have to borrow on a collateralized basis over a similar term in an amount
equal to the lease payments in a similar economic environment. Operating leases
result in a straight-line lease expense, while finance leases result in an
accelerated expense pattern.
The lease term at the lease commencement date is determined based on the
non-cancellable period for which we have the right to use the underlying asset,
together with any periods covered by an option to extend the lease if we are
reasonably certain to exercise that option. We consider a number of factors when
evaluating whether the options in our lease contracts are reasonably certain of
exercise, such as length of time before option exercise, expected value of the
leased asset at the end of the initial lease term, importance of the lease to
overall operations, costs to negotiate a new lease, and any contractual or
economic penalties.
Certain of our leases include variable lease costs to reimburse the lessor for
real estate tax and insurance expenses, and non-lease components that transfer
an additional service to us, such as common area maintenance services. We have
elected not to separate the accounting for lease components and non-lease
components for lessee contracts, for all classes of leased assets except for our
dark fiber arrangements.
Lessor
Lease contracts from a lessor perspective are classified as either sales-type,
direct financing, or operating. Lessor arrangements include dark fiber, duct,
and colocation services. The arrangements are operating leases that can also
include non-lease components such as operations and maintenance or power
services. For our dark fiber and duct arrangements, we account for lease and
non-lease components separately. Revenue attributable to the lease components in
these arrangements is recognized on a straight-line basis over the term of the
lease while revenue attributable to non-lease components is accounted for in
accordance with other applicable GAAP. We elected not to separate the accounting
for non-lease components from lease components in our accounting for colocation
arrangements.
Recent Accounting Pronouncements
Refer to Note 2 - Significant Accounting Policies of the notes to the consolidated financial statements (Part II, Item 8 of this Form 10-K) for further discussion.
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