GTT Communications, Inc. (“GTT” or the "Company") is a provider of cloud networking services.services to multinational clients. The Company offers multinational clients a broad portfolio of global communications services including: EtherCloud® wide area network services;private networking services, Internet services;services, optical transport, managed network and security services; andservices, voice and unified communication services, and video transport services.

GTT's global Tier 1 IP network delivers connectivity to clients around the world. The Company provides services to leading multinational enterprises, carriersenterprise, carrier and government customers.

The accompanying unaudited condensed consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission ("SEC") and should be read in conjunction with the Company’s audited financial statements and footnotes thereto for the fiscal year ended December 31, 2015,2016, included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2015 filed on March 9, 2016.8, 2017. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP") have been omitted pursuant to such rules and regulations.

The condensed consolidated financial statements reflect all adjustments (consisting primarily of normal recurring adjustments) that are, in the opinion of management, necessary for a fair presentation of the Company’s consolidated financial position and its results of operations. The operating results for the three and nine months ended September 30, 2016March 31, 2017 are not necessarily indicative of the results to be expected for the full fiscal year 20162017 or for any other interim period. The December 31, 20152016 consolidated balance sheet is condensed from the audited financial statements as of that date, but does not include all disclosures required by GAAP.

 

The preparation of financial statements in accordance with GAAP requires management to make estimates and assumptions that affect certain reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Significant estimates are used when establishing allowances for doubtful accounts and accruals for billing disputes, determining useful lives for depreciation and amortization and accruals for exit activities, assessing the need for impairment charges (including those related to intangible assets and goodwill), determining the fair values of assets acquired and liabilities assumed in business combinations, accounting for income taxes and related valuation allowances against deferred tax assets and estimating the grant date fair values used to compute the share-based compensation expense. Management evaluates these estimates and judgments on an ongoing basis and makes estimates based on historical experience, current conditions, and various other assumptions that are believed to be reasonable under the circumstances. The results of these estimates form the basis for making judgments about the carrying values of assets and liabilities as well as identifying and assessing the accounting treatment with respect to commitments and contingencies. Actual results may differ from these estimates under different assumptions or conditions.

The Company reports operating results and financial data in one operating and reporting segment. The chief operating decision maker manages the Company as a single profit center in order to promote collaboration, provide comprehensive service offerings across its entire customer base, and provide incentives to employees based on the success of the organization as a whole. Although

The Company delivers foursix primary services to its customers — flexible Ethernet-based wide areaoptical transport, WAN connectivity services;services, high bandwidth internetInternet connectivity services;services, managed network services and security services; andservices, global communication and collaboration services, and video transport services. Certain of its revenuecurrent commercial activities have features that may be considered multiple elements, specifically when the Company sells its subscriptionconnectivity services in addition to customer premise equipment ("CPE"). The Company believes that there

The Company's services are provided under contracts that typically include an installation charge along with payments of recurring charges on a monthly basis for use of the services over a committed term. Its contracts with customers specify the terms and conditions for providing such services, including installation date, recurring and non-recurring fees, payment terms, and contract length.length of term. These contracts call for the Company 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 the Company 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 the Company and its suppliers to deliver the services.

The Company recognizes revenue as follows:

The Company records revenue only when collectability is reasonably assured.assured, irrespective of the type of revenue.

The Company is liable in certain cases for collecting regulatory fees and/or certain sales taxes from its customers and remitting the fees and taxes to the applicable governing authorities. Where the Company collects on behalf of a regulatory agency, the Company does not record any revenue. The Company records applicable taxes on a net basis.

Cost of telecommunications services includes direct costs incurred in accessing other telecommunications providers’ networks in order to maintain the Company's global IP network and provide telecommunication services to the Company's customers, including access, co-location, and expenses for connection to other carriers. The cost of the Company's core network is usually renewed on an annual basis. Connectivity from the Company's core network to a customer premise is typically contracted using matching terms to the customer. Cost of telecommunications services also includes co-location charges, usage-based access charges and professional services fees incurred pursuant to a customer's service contract.charges.

The Company recognizesissues three types of equity grants under its share-based compensation expense for share-based paymentplan: 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 basedtypically vest over a shorter period, e.g. two years, starting when the performance criteria established in the grant have been met.

The share price of the Company's common stock as reported on the grant date fair value.

The expense is recognized on a straight-line basis over the requisite servicevesting period. Share-based compensation expense also includes restricted stock grants for performance awards. The Company recognizes share-based compensation expense for these grantsperformance awards when the Company considers the achievement of the performance criteria is consideredto be probable.

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 resultsconsequences 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. The Company reviews its deferred tax assets on a quarterly basis to determine if a valuation allowance is required based upon these factors. Changes in the Company's 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.

The Company's income tax provision includes U.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, the Company analyzes various factors, including its annual earnings and taxing jurisdictions in which the earnings were generated, the impact of state and local income taxes and its ability to use tax credits and net operating loss carryforwards.

Under GAAP for income taxes, the amount of tax benefit to be recognized is the amount of benefit that is “more likely than not” to be sustained upon examination. The Company analyzes its tax filing positions in all of the U.S. federal, state, local and foreign tax jurisdictions where it is required to file income tax returns, as well as for all open tax years in these jurisdictions. If, based on this analysis, the Company determines that uncertainties in tax positions exist, a liability is established in the consolidated financial statements. The Company recognizes accrued interest and penalties related to unrecognized tax positions in the provision for income taxes.

In addition to net (loss) income, (loss), comprehensive loss(loss) income includes certain charges or credits to equity occurring other than as a result of transactions with stockholders. For the Company, this consists of foreign currency translation adjustments.

Basic (loss) earnings (loss) per share is computed by dividing net income or (loss) available to common stockholders by the weighted average number of common shares outstanding. Diluted earnings per share reflect, in periods with earnings and in which they have a dilutive effect, the effect of common shares issuable upon exercise of stock options.

  

 

The anti-dilutive common share items that were excluded in the computation of earnings per share were approximately 4,000 shares as of September 30, 2016. There were approximately 5,0001,046,000 anti-dilutive common shares as of September 30, 2015. 

Accounts receivable balances are stated at amounts due from the customer net of an allowance for doubtful accounts. Credit extended is based on an evaluation of the customer’s financial condition and is granted to qualified customers on an unsecured basis.

The Company, pursuant to its standard service contracts, is entitled to impose a monthly finance charge of a certain percentage per month with respect to amounts that are past due. The Company’s standard terms require payment within 30 days of the date of the invoice. The Company treats invoices as past due when they remain unpaid, in whole or in part, beyond the payment date set forth in the applicable service contract.

The Company determines its allowance for doubtful accounts by considering a number of factors, including the length of time trade receivables are past due, the customer’s payment history and current ability to pay its obligation to the Company, and the condition of the general economy and the industry as a whole.economy. Specific reserves are also established on a case-by-case basis by management. Credit losses have been within management's estimates. Actual bad debts, when determined, reduce the allowance.allowance, the adequacy of which management then reassesses. The Company periodically evaluates the collectability of accounts receivable and writes off accounts after a determination is madeby management that the amounts at issue are no longer likely

Installation costs related to provisioning of recurring communications services that the Company incurs from independent third party suppliers, directly attributable and necessary to fulfill a particular service contract, and which would not have been incurred but for the occurrence of that service contract, are recorded as deferred costs and expensed ratably over the contractual term of service in the same manner as the deferred revenue arising from that contract. Based on historical experience, the Company believes the initial contractual term is the best estimate for the period of earnings. If any installation costs exceed the amount of corresponding deferred revenue, the excess cost is recognized in the current period.

Property and equipment isare stated at cost, net of accumulated depreciation, computed using the straight-line method.depreciation. Depreciation on these assets is computed on a straight-line basis over the estimated useful lives of the assets. Assets are recorded at acquired cost plus any internal labor to prepare the asset for installation to become functional. Assets and liabilities under capital leases are recorded at the lesser of the present value of the aggregate future minimum lease payments or the fair value of the assets under lease. Leasehold improvements and assets under capital leases are amortized over the shorter of the term of the lease, excluding optional extensions, or the useful life. Expenditures for maintenance and repairs are expensed as incurred. Depreciable lives used by the Company for its classes of assets are as follows:

 

The Company reviews long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. If the carrying amount of an asset exceedswere to exceed its estimated future undiscounted cash flows, the asset iswould be considered to be impaired. Impairment losses arewould then be measured as the amount by which the carrying amount of the asset exceeds the fair value of the asset. Assets to be disposed of, if any, are reported at the lower of the carrying amount or fair value less costcosts to sell or dispose.sell.

Software development costs include costs to develop software programs to be used solely to meet the Company's internal needs. The Company capitalizes development costs related to these software applications once the preliminary project stage is complete and it is probable that the project will be completed andcompleted. Subsequent additions, modifications or upgrades to internal-use software are capitalized only to the extent that they allow the software will be used to perform a function it previously did not perform. Software maintenance, data conversion and training costs are expensed in the function intended.period in which they are incurred. The Company capitalized approximatelysoftware costs of $0.4 million and $1.2$0.4 million for developing such software applications during the three and nine months ended September 30, 2016. The capitalized costs were not material in 2015.

The Company records as goodwill,Goodwill represents the excess of the purchase price over the fair value of the net identifiable net assets acquired. The goodwillacquired in a business combination. Goodwill is assessedreviewed for impairment on at least an annual basis onannually, in October, 1 unless interim indicators ofor more frequently if a triggering event occurs between impairment exist. Goodwill is considered to be impaired when the net book value of a reporting unit exceeds its estimated fair value.testing dates. The Company operates as a single operating segment and as a single reporting unit for the purpose of evaluating goodwill. Accounting guidance prescribes a two-step process for impairment testing of goodwill and intangibles with indefinite lives.impairment. The guidance also allows preparers to qualitatively assess goodwill impairment through a screening process, referred to as "Step 0", which would permit companies to forgo Step 1 of their annual goodwill impairment process. The Company has elected to perform Step 0 for its annualCompany's impairment assessment of goodwill on October 1, 2016. The Step 0 analysis focused onbegins with a number of events and circumstancesqualitative assessment to determine whether it is more likely than not that may be considered when making this qualitative assessment. Upon careful consideration of these events and circumstances the Company concluded that its fair value (primarily based on market capitalization) of the reporting unit was greateris 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 amount. Duringvalue involves significant judgment and estimates. If it is determined under the ninequalitative assessment that

The Company's definite-lived intangibleIntangible assets are acquired inarising from business combinations, such as acquired customer contracts and relationships, (collectively "customer relationships"), trade names, intellectual property or know-how, are initially recorded at their fair value. The Company amortizes these intangible assets over the determined useful life which ranges from three to seven years. The Company reviews its recorded definite-lived intangible assets for impairment whenever events or circumstances indicate that the carrying amount of an asset may not be fully recoverable. If the total of the expected undiscounted future cash flows is less than the carrying amount of the asset, aan impairment loss is recognized for the difference between fair value and the carrying value of the asset. The Company's definite-lived intangible assets, consisting of customer relationships, restrictive covenants related to employment agreements, license fees, and intellectual property are amortized on a straight-line basis, over their estimated useful lives of periods up to seven years. FCC Licenses are accountedThere were no impairments recognized for as a definite-lived intangible asset and amortized over the average remaining useful life of such licenses which approximates three years. Intellectual property consisting of know-how related to the SIP trunking platform is amortized over the estimated useful life of ten years.

The Company includes the results of operations of the businesses that it acquires commencing on the respective dates of acquisition. The Company allocates the fair value of the purchase price of its acquisitions to the assets acquired and liabilities assumed based on their estimated fair values. The excess of the fair value of the purchase price over the fair values of these identifiable assets and liabilities is recorded as goodwill.

The Company accrues estimated charges owed to its suppliers for services. The Company bases this accrual on the supplier contract, the individual service order executed with the supplier for that service, and the length of time the service has been active.

It is common inIn the telecommunications industry for customers and suppliers to engage in disputes over amounts billed (or not billed) in error or over interpretationnormal course of contract terms. Management estimates a liability for the amountsbusiness, the Company believes are valid and that the Company owes to a supplier. This liability is reconciled with actual results as disputes are resolved, or as the appropriate statute of limitationsidentifies errors by suppliers with respect to the billing of services. The Company performs bill verification procedures to ensure that errors in the Company's suppliers' billed invoices are identified and resolved. If the Company concludes that a given dispute expires.vendor has billed inaccurately, the Company will record a liability only for the amount that it believes is owed. As of September 30, 2016,March 31, 2017, the Company had open disputes not accrued for, of $8.3$5.2 million. As of December 31, 2015,2016, the Company had open disputes of $5.8 million for which it had not accrued for, of $6.9 million.accrued.

Acquisition earn-outs and holdbacks represent either contingent consideration subject to re-measurement to fair value, or fixed deferred consideration due to be paid out at some point in the future, typically on the one-year anniversary of an acquisition's closing.acquisition. Contingent consideration is remeasured to fair value at each reporting period. The portion of the deferred consideration due within one year is recorded as a current liability until paid, and any consideration due beyond one year is recorded in other long-term liabilities.

Debt issuance costs represent costs that qualify for deferral associated with the issuance of new debt or the modification of existing debt facilities. The unamortized balance of debt issuance costs is presented as a reduction to the carrying value of long-term debt. Debt issuance costs are amortized and recognized on the condensed consolidated statements of operations as interest expense. The unamortized debt issuance costs were $9.2$29.6 million and $10.9$9.3 million as of September 30, 2016March 31, 2017 and December 31, 2015,2016, respectively.

For operations ofnon-U.S. subsidiaries, located outside the U.S., the local currency is the functional currency for financial reporting purposes. These condensed consolidated financial statements have been reported in U.S. Dollars by translating asset and liability amounts of foreign subsidiaries at the closing currency exchange rate, equity amounts at historical rates, and the results of operations and cash flow at the average currency exchange rate prevailing during the periods reported. The net effect of such translation gains and losses are reflected in accumulated other comprehensive loss(loss) income in the stockholders' equity section of the condensed consolidated balance sheets.

Transactions denominated in foreign currencies other than a subsidiary's functional currency are recorded at the rates of exchange prevailing at the time of the transaction. Monetary assets and liabilities denominated in foreign currencies are translated at the rate of exchange prevailing at the balance sheet date. Exchange differences arising upon settlement of a transaction are reported in the condensed consolidated statements of operations in other expense, net.

Accounting guidance defines fairFair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Under this guidance, theThe Company is required to classifyclassifies certain assets and liabilities based on the following hierarchy:hierarchy of fair value:

The changeschange in the carrying amount of goodwill for the period ended September 30, 2016 and DecemberMarch 31, 2015 are2017 was as follows (amounts in thousands):

 

The following table summarizes the Company’s intangible assets as of September 30, 2016March 31, 2017 and December 31, 20152016 (amounts in thousands):

Amortization expense was $10.1$16.0 million and $29.5$9.2 million for the three and nine months ended September 30,March 31, 2017 and 2016, respectively. Amortization expense was $6.1 million and $16.4 million for the three and nine months ended September 30, 2015, respectively.

Estimated amortization expense related to intangible assets subject to amortization at September 30, 2016March 31, 2017 in each of the years subsequent to September 30, 2016March 31, 2017 is as follows (amounts in thousands):

As of September 30, 2016March 31, 2017 and December 31, 2015,2016, long-term debt was as follows (amounts in thousands):

On October 22, 2015, the Company entered into a credit agreement (the “October 2015 Credit Agreement”) that provided for a $400.0 million term loan facility and a $50.0 million revolving line of credit (which includes a $15.0 million letter of credit facility and a $10.0 million swingline facility). In addition,As of December 31, 2016, the Company may request incremental term loan and/or incremental revolving loan commitments in an aggregate amount not to exceed the sum of $75.0had drawn $20.0 million and an unlimited amount that is subject to pro forma compliance with certain net secured leverage ratio tests, provided, however, that incremental revolving loan commitments may not exceed $25.0 million.

The Company grants share-based equity awards, including stock options and restricted stock, pursuant to three plans in effect as of September 30, 2016;March 31, 2017; the 2006 Plan adopted in October 2006, the 2011 Plan adopted in June 2011, and the 2015 Plan adopted in June 2015 (collectively referred to as the "GTT Stock Plan"). The GTT Stock Plan is limited to an aggregate 9,500,000 shares of which 7,680,3108,037,337 have been issued and are outstanding as of September 30, 2016.March 31, 2017.

The GTT Stock Plan permits the granting of time-based stock options, time-based restricted stock and performance awardsperformance-based restricted stock to employees (including employee directors and officers) and consultants of the Company, and non-employee directors of the Company.

RestrictedTime-based restricted stock granted under the GTT Stock Plan is valued at the closing stock price on the day of grant. Restricted stock generally vests over four years with 25% of the shares becoming unrestricted one year from the date of grant and the remaining 75% annually or quarterly over the following three years.

The Company uses the Black-Scholes option-pricing model to determine the fair value of its option awards at the time of grant. The fair value of the restricted stock awards was calculated using the value of GTT common stock on the grant date and is being amortized over the vesting periods in which the restrictions lapse.

Performance awards arePerformance-based restricted sharesstock is granted under the GTT Stock Plan subject to the achievement of certain performance measures. Once achievement of these performance measures is considered probable, the Company starts to expense the fair value of the grant over the requisite servicevesting period. The performance awardperformance-based restricted stock is valued at the closing stock price on the day of grant. The performance grant will vestvests annually or quarterly over the requisite servicevesting period once achievement of the performance measure has been met and approved by the Compensation Committee.

The Compensation Committee of the Board of Directors, as administrator of the Plan, has the discretion to authorize a different vesting schedule for any awards.

The following tables summarize the share-based compensation expense recognized as a selling, general and administrative expense in the condensed consolidated statements of operations (amounts in thousands):

    

As of September 30, 2016,March 31, 2017, there was $25.6$37.4 million of total unrecognized compensation cost related to unvested share-based compensation agreements.awards. The following table summarizes the unrecognized compensation cost and the weighted average period over which the cost is expected to be amortized (amounts in thousands):

The following tables summarize the stock options and restricted stock granted during the three and nine months ended September 30,March 31, 2017 and 2016, and 2015, respectively (amounts in thousands, except shares data):

In 2015, the Company granted $17.2$16.9 million of restricted stock contingent upon the achievement of certain performance criteria (the "2015 Performance Awards"). The fair value of the 2015 Performance Awards was calculated using the value of GTT common stock on the grant date. AsUpon announcement of the Hibernia acquisition in November 2016, the achievement of two of the four performance criteria is not yet considered probable,became probable. The awards started vesting in the full $17.2first quarter of 2017 and they will continue to vest ratably through the fourth quarter of 2018. Accordingly, the Company recognized share-based compensation expense of $1.1 million for the three months ended March 31, 2017. As of March 31, 2017, $8.4 million remains unamortized as of September 30, 2016 and hasunrecorded for the two performance criteria that have not been excluded frommet.

No additional performance awards were granted during the tables above.three months ended March 31, 2017.

The Company has an Employee Stock Purchase Plan ("ESPP") that permits eligible employees to purchase common stock through payroll deductions at the lessor of the opening stock price or 85% of the closing stock price of the common stock during each of the three-month offering periods. The offering periods generally commence on the first day and the last day of each quarter. At September 30, 2016, 422,721March 31, 2017, 409,513 shares were available for issuance under the ESPP. As of September 30, 2016,During the company has recognized $0.3 million ofthree months ended March 31, 2017, the compensation expense related to ESPP was immaterial. There was no ESPP expense for the ESPP.

The Company’s provision for income taxes is determined using an estimate of its annual effective tax rate, adjusted for certain items. the effect of discrete items arising in the quarter. Each quarter we update our estimate of the annual effective tax rate.

The quarterly tax provision and the quarterly estimate of the Company's annual effective tax rate areis subject to volatilitysignificant variation due to several factors, including the Company's ability tovariability in accurately project itspredicting pre-tax and taxable income (loss) before provision for income taxes in multipleand the mix of jurisdictions and theto which they relate, effects of acquisitions and integrations.integrations, audit-related developments, changes in the Company's stock price, foreign currency gains (losses), and tax law developments. Additionally, the Company's effective tax rate may be more or less volatile based on the amount of pre-tax income or loss and impact of discrete items.

For the three months ended September 30, 2016,March 31, 2017, the Company earned income before taxes of $5.0 million and incurredrecorded a tax benefit of $0.1$11.5 million, which resulted in an effectiveincluded $5.3 million of net discrete tax rate of (1.8)%, as comparedbenefits primarily attributable to an effectiveexcess tax rate of 6.0% for the three months ended September 30, 2015. The effective tax rate for the three months ended September 30, 2016 differsbenefits from the statutory U.S. federal income tax rate of 35.0% primarily due to changes in the amount of income before income taxes between the U.S. and foreign countries. The change in the current quarter effective tax rate compared to prior year was primarily due to the tax impact of U.S. losses in the prior year that did not produce a tax benefit.