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UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the Quarterly Period Ended March 31, 2012

 

Commission File Number 000-51211

 

Global Telecom & Technology, Inc.

(Exact Name of Registrant as Specified in Its Charter)

 

Delaware   20-2096338
(State or Other Jurisdiction of   (I.R.S. Employer Identification No.)
Incorporation or Organization)    

 

8484 Westpark Drive

Suite 720

McLean, Virginia 22102

(703) 442-5500

(Address including zip code, and telephone number, including area

code of principal executive officers)

 

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

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes R No £

 

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

 

Large Accelerated Filer £ Accelerated Filer £ Non-Accelerated Filer £ Smaller reporting company R
(Do not check if a smaller reporting company)

 

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

 

As of May 11, 2012, 18,921,798 shares of common stock, par value $.0001 per share, of the registrant were outstanding.

 

 

 
 

 

  Page
PART I — FINANCIAL INFORMATION  
Item 1. Financial Statements  
Condensed Consolidated Balance Sheets 3
Condensed Consolidated Statements of Operations 4
Condensed Consolidated Statement of Comprehensive Income (Loss) 5
Condensed Consolidated Statement of Stockholders’ Equity 6
Condensed Consolidated Statements of Cash Flows 7
Notes to Condensed Consolidated Financial Statements 8
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 17
Item 3. Quantitative and Qualitative Disclosures about Market Risk 22
Item 4. Controls and Procedures 22
PART II — OTHER INFORMATION  
Item 1. Legal Proceedings 23
Item 1A. Risk Factors 23
Item 6. Exhibits 34
SIGNATURES 35
CERTIFICATIONS 36

 

2
 

 

PART 1 – Financial Information

 

ITEM 1. FINANCIAL STATEMENTS

 

Global Telecom & Technology, Inc.

Condensed Consolidated Balance Sheets

(Unaudited)

(Amounts in thousands, except for share and per share data)

 

   March 31, 2012   December 31, 2011 
       (Note 1) 
         
ASSETS
Current assets:          
Cash and cash equivalents  $4,219   $3,249 
Accounts receivable, net of allowances of $1,603 and $1,516, respectively   10,208    10,855 
Deferred contract costs   1,757    1,831 
Prepaid expenses and other current assets   1,635    2,197 
Total current assets   17,819    18,132 
Property and equipment, net   3,003    3,262 
Intangible assets, net   11,090    11,828 
Other assets   4,158    4,153 
Goodwill   40,950    40,950 
Total assets  $77,020   $78,325 
           
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:          
Accounts payable  $17,090   $16,457 
Accrued expenses and other current liabilities   6,399    8,325 
Short-term debt   8,048    6,677 
Deferred revenue   5,903    6,157 
Total current liabilities   37,440    37,616 
Long-term debt   19,721    21,312 
Deferred revenue and other long-term liabilities   1,973    1,266 
Total liabilities   59,134    60,194 
           
Commitments and contingencies          
           
Stockholders' equity:          
Common stock, par value $.0001 per share, 80,000,000 shares authorized, 18,921,798 and 18,674,860 shares issued and outstanding as of March 31, 2012 and December 31, 2011, respectively   2    2 
Additional paid-in capital   62,589    62,442 
Accumulated deficit   (44,123)   (43,874)
Accumulated other comprehensive loss   (582)   (439)
Total stockholders' equity   17,886    18,131 
Total liabilities and stockholders' equity  $77,020   $78,325 

 

The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

 

3
 

 

  

Global Telecom & Technology, Inc.

Condensed Consolidated Statements of Operations

(Unaudited)

(Amounts in thousands, except for share and per share data)

 

   Three Months Ended 
   March 31, 2012   March 31, 2011 
         
Revenue:          
Telecommunications services sold  $24,718   $20,402 
           
Operating expenses:          
Cost of telecommunications services provided   17,467    14,383 
Selling, general and administrative expense   4,728    4,472 
Depreciation and amortization   1,138    676 
           
Total operating expenses   23,333    19,531 
           
Operating income   1,385    871 
           
Other income (expense):          
Interest expense, net   (850)   (316)
Other income (expense), net   (648)   (58)
Total other income (expense)   (1,498)   (374)
           
Income (loss)  before income taxes   (113)   497 
           
Provision for income taxes   136    34 
           
Net income (loss)  $(249)  $463 
           
Earnings (loss) per share:          
Basic  $(0.01)  $0.03 
Diluted  $(0.01)  $0.03 
           
Weighted average shares:          
Basic   18,782,701    18,239,307 
Diluted   18,782,701    18,463,174 

 

The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

 

4
 

 

Global Telecom & Technology, Inc.

Condensed Consolidated Statements of Comprehensive Income (Loss)

(Unaudited)

(Amounts in thousands)

 

   Three Months Ended 
   March 31, 2012   March 31, 2011 
         
Net (loss) income  $(249)  $463 
           
Other comprehensive income (loss):          
Change in accumulated foreign currency translation loss   (143)   (23)
Comprehensive income (loss)  $(392)  $440 

 

The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

 

5
 

 

Global Telecom & Technology, Inc.

Condensed Consolidated Statement of Stockholders’ Equity

(Unaudited)

(Amounts in thousands, except for share data)

 

               Accumulated     
       Additional       Other     
   Common Stock   Paid -In   Accumulated   Comprehensive     
   Shares   Amount   Capital   Deficit   Loss   Total 
Balance, December 31, 2011   18,674,860   $2   $62,442   $(43,874)  $(439)  $18,131 
                               
Share-based compensation for options issued   -    -    51    -    -    51 
                               
Share-based compensation for restricted stock issued   212,655    -    93    -    -    93 
                               
Stock options exercised   34,282    -    3    -    -    3 
                               
Net loss   -    -    -    (249)   -    (249)
                               
Comprehensive loss   -    -    -    -    (143)   (143)
                               
Balance, March 31, 2012   18,921,797   $2   $62,589   $(44,123)  $(582)  $17,886 

 

The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

  

6
 

 

Global Telecom & Technology, Inc.

Condensed Consolidated Statements of Cash Flows

(Unaudited)

(Amounts in thousands)

 

   Three months ended 
   March 31, 2012   March 31, 2011 
         
Cash flows from operating activities:          
Net income (loss)  $(249)  $463 
Adjustments to reconcile net income (loss) to net cash provided by operating activities:          
Depreciation and amortization   1,138    676 
Shared-based compensation   147    161 
Debt discount amortization   71    66 
Change in fair value of warrant liability   694    - 
           
Changes in operating assets and liabilities:          
Accounts receivable, net   785    862 
Deferred contract cost, prepaid expenses, income tax refund receivable and other current assets   689    (807)
Other assets   60    42 
Accounts payable   412    506 
Accrued expenses and other current liabilities   (1,963)   (1,677)
Deferred revenue and other long-term liabilities   (624)   (213)
           
Net cash provided by operating activities   1,160    79 
           
Cash flows from investing activities:          
Purchases of property and equipment   (101)   (74)
           
Net cash used in investing activities   (101)   (74)
           
Cash flows from financing activities:          
Principal payments on promissory note   (236)   (94)
Borrowing on line of credit   800    (838)
Repayment of term loan   (750)   (500)
Payment of subordinate notes payable   (105)   - 
Issuance of subordinated notes   -    153 
Issuance of units offering common shares   -    247 
           
Net cash used in financing activities   (291)   (1,032)
           
Effect of exchange rate changes on cash   202    85 
           
Net increase (decrease) in cash and cash equivalents   970    (942)
           
Cash and cash equivalents at beginning of year   3,249    6,562 
           
Cash and cash equivalents at end of year  $4,219   $5,620 
           
Supplemental disclosure of cash flow information:          
Cash paid for interest  $723   $208 

 

The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

  

7
 

 

Global Telecom & Technology, Inc.

Notes to Condensed Consolidated Financial Statements

 

NOTE 1 — ORGANIZATION AND BUSINESS

 

Organization and Business

 

Global Telecom & Technology (“GTT or the “Company”) is a global network operator delivering managed data services to large enterprise, government and carrier customers in over 80 countries worldwide. GTT provides customers with innovative connectivity solutions by utilizing our own network assets - linking over 100 Points of Presence across North America, Europe and Asia - and extending them through our 800 partners worldwide. Our Network as a Service proposition delivers flexible, reliable and scalable network infrastructure, capable of both public and secure private networking. We simplify network deployment by removing the complexity of multi-vendor solutions while offering the cost efficiencies of a single partner. For over 14 years, GTT has provided world class project management, rapid service implementation and global 24/7 end-to-end solution monitoring and support. GTT is headquartered in the Washington, DC metro region with offices in London, Dusseldorf and Denver.

 

Unaudited Interim Financial Statements

 

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 year ended December 31, 2011, included in the Company’s Annual Report on Form 10-K filed on March 27, 2012. 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. However, the Company believes that the disclosures are adequate to prevent the information from being misleading. 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 the results of operations. The operating results for the three months ended March 31, 2012, are not necessarily indicative of the results to be expected for the full fiscal year 2012 or for any other interim period. The December 31, 2011 condensed consolidated balance sheet has been derived from the audited financial statements as of that date, but does not include all disclosures required by GAAP.

 

There have been no significant changes in the Company’s significant accounting policies as of March 31, 2012 as compared to the significant accounting policies disclosed in Note 2, “Significant Accounting Policies” in the 2011 Annual Report on Form 10-K.

 

Use of Estimates and Assumptions

 

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. Actual results can, and in many cases will, differ from those estimates.

 

Accounting for Derivative Instruments

 

    The Company accounts for derivative instruments in accordance with Accounting Standard Codification (“ASC”) 815, Derivatives and Hedging, which establishes accounting and reporting standards for derivative instruments and hedging activities, including certain derivative instruments imbedded in other financial instruments or contracts. The Company also considers the ASC 815 Subtopic 40, Contracts in Entity’s Own Equity, which provides criteria for determining whether freestanding contracts that are settled in a company’s own stock, including common stock warrants, should be designated as either an equity instrument, an asset or as a liability.

 

The Company also considers in ASC 815 the guidance for determining whether an equity-linked financial instrument (or embedded feature) issued by an entity is indexed to the entity’s stock and, therefore, qualifying for the first part of the scope exception in paragraph 15-74 of ASC 718, Compensation—Stock Compensation. The Company recorded a warrant liability as of March 31, 2012 for $1.1 million, which is included in other long-term liabilities.  

 

8
 

 

Comprehensive Income

 

Comprehensive income consists of net income and other comprehensive income (loss). Other comprehensive income (loss) refers to revenues, expenses, gains and losses that are included in comprehensive income, but that are excluded from net income. Specifically, cumulative foreign currency translation adjustments are included in comprehensive income and accumulated other comprehensive loss.

 

NOTE 2 — RECENT ACCOUNTING PRONOUNCEMENTS

 

In May 2011, the FASB issued ASU No. 2011-04, “Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs,” which amends the current fair value measurement and disclosure guidance of ASC Topic 820, Fair Value Measurement, to include increased transparency around valuation inputs and investment categorization. The Company adopted the guidance provided in ASU No. 2011-04 for interim and annual periods beginning after December 15, 2011. The adoption of these provisions did not have a material impact on the unaudited condensed consolidated statements of operations and balance sheets.

 

In June 2011, the FASB issued ASU No. 2011-05, Comprehensive Income (Topic 220)—Presentation of Comprehensive Income (ASU 2011-05). ASU 2011-05 eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders’ equity. Instead, ASU 2011-05 requires entities to report all non-owner changes in stockholders’ equity in either a single continuous statement of comprehensive income, or in two separate, but consecutive statements. ASU 2011-05 does not change the items that must be reported in other comprehensive income, or when an item must be reclassified to net income. The Company adopted the guidance in ASU 2011-05 for the fiscal years, and interim periods within those years, beginning after December 15, 2011. ASU 2011-05 requires retrospective application and other than the presentational changes that will be required by ASU 2011-05, the adoption of ASU 2011-05 did not have any impact on our consolidated financial statements.

 

In September 2011, The FASB has issued ASU No. 2011-08, Intangibles—Goodwill and Other (Topic 350): Testing Goodwill for Impairment. ASU 2011-08 is intended to simplify how entities, both public and nonpublic, test goodwill for impairment. ASU 2011-08 permits an entity to first assess qualitative factors to determine whether it is “more likely than not” that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test described in Topic 350, Intangibles-Goodwill and Other. The more-likely-than-not threshold is defined as having a likelihood of more than 50%. The Company has adopted the guidance of ASU 2011-08 for the annual and interim goodwill impairment tests performed for fiscal years early after December 15, 2011, and, accordingly, has performed an assessment of qualitative factors.

 

NOTE 3 — FAIR VALUE MEASUREMENTS

 

The Company accounts for fair value measurements in accordance with ASC 820, Fair Value Measurements, as it relates to financial assets and financial liabilities. ASC 820 establishes a framework for measuring fair value in accounting principles generally accepted in the United States of America and expands disclosures about fair value measurements. ASC 820 applies under other previously issued accounting pronouncements that require or permit fair value measurements, but does not require any new fair value measurements.

  

ASC 820 defines fair value 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. ASC 820 establishes a fair value hierarchy that distinguishes between (1) market participant assumptions developed based on market data obtained from independent sources (observable inputs) and (2) an entity’s own assumptions about market participant assumptions developed based on the best information available in the circumstances (unobservable inputs).

 

The fair value hierarchy consists of three broad levels, which gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). The three levels of the fair value hierarchy under ASC 820 are described as follows:

 

  · Level 1- Unadjusted quoted prices in active markets for identical assets or liabilities that are accessible at the measurement date.

 

9
 

 

  · Level 2- Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. Level 2 inputs include quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; inputs other than quoted prices that are observable for the asset or liability; and inputs that are derived principally from or corroborated by observable market data by correlation or other means.

 

  · Level 3- Inputs that are unobservable for the asset or liability.

 

The following section describes the valuation methodologies that we used to measure financial instruments at fair value.

 

The Company considers the valuation of its warrant liability as a Level 3 liability based on unobservable inputs. The Company uses the Black-Scholes pricing model to measure the fair value of the warrant liability. The model required the input of highly subjective assumptions including volatility of 64%, expected term of 4 years, risk-free interest rate of 1.4% and a dividend yield of 0%.

 

The following table presents the liabilities that are measured and recognized at fair value on a recurring basis classified under the appropriate level of the fair value hierarchy as of March 31, 2012 (amounts in thousands):

 

   Level 1   Level 2   Level 3   Total 
Liabilities:                    
Warrant liability  $-   $-   $1,124   $1,124 

 

Rollforward of Level 3 liabilities is as follows (amounts in thousands):

 

Balance at December 31, 2011  $430 
Issuance of warrants   - 
Change in fair value of warrant liability   694 
Balance at March 31, 2011  $1,124 

 

The carrying amounts of cash equivalents, receivables, accounts payable and accrued expenses approximate fair value due to the immediate or short-term maturity of these financial instruments. The fair value of short-term and long-term debt is determined using current applicable rates for similar instruments as of the balance sheet date and approximates the carrying value of such debt.

 

NOTE 4 — EMPLOYEE SHARE-BASED COMPENSATION BENEFITS

 

The Company adopted its 2006 Employee, Director and Consultant Stock Plan (the “2006 Plan”) in October 2006. In addition to stock options, the Company may also grant restricted stock or other stock-based awards under the 2006 Plan. The maximum number of shares issuable over the term of the 2006 Plan, as amended, is limited to 3,500,000 shares.

 

The Company adopted its 2011 Employee, Director and Consultant Stock Plan (the “2011 Plan”) in June 2011.  In addition to stock options, the Company may also grant restricted stock or other stock-based awards under the 2011 Plan. The maximum number of shares issuable over the term of the 2011 Plan is limited to 3,000,000 shares.  The 2006 Plan will continue according to its terms.

 

The Plans permit the granting of stock options and restricted stock to employees (including employee directors and officers) and consultants of the Company and non-employee directors of the Company. Options granted under the Plan have an exercise price of at least 100% of the fair market value of the underlying stock on the grant date and expire no later than ten years from the grant date. The options generally vest over four years with 25% of the option shares becoming exercisable one year from the date of grant and the remaining 75% annually or quarterly over the following three years. The Compensation committee of the Board of Directors, as administrator of the Plan, has the discretion to use a different vesting schedule.

 

10
 

 

Stock Options

 

The Company recognized compensation expense for stock options of approximately $51,000 and $45,000 for the three months ended March 31, 2012 and 2011, respectively, related to stock options issued to employees and consultants, which is included in selling, general and administrative expense on the accompanying condensed consolidated statements of operations. The Company granted to employees 373,000 and 282,000 stock options with a total fair value of $390,000 and $264,000 during the three months ended March 31, 2012 and 2011, respectively.

 

Restricted Stock

 

During the three months ended March 31, 2012, the Company granted to certain employees and members of its Board of Directors restricted stock. This includes shares issued to non-employee members of the Company’s Board of Directors who elected to be paid a portion of their annual fees in restricted stock. Total noncash compensation expense is recorded in selling, general and administrative (“SG&A”) expenses.

 

Amounts in thousands  Employees   Non-Employee
Members of Board
of Directors
   Total 
Three months ended March 31, 2012               
Restricted stock shares granted   210    16    226 
Fair value of shares granted  $368   $37   $405 
Restricted stock compensation expense  $56   $37   $93 

 

NOTE 5 — DEBT

 

The following summarizes the debt activity of the Company during the three months ended March 31, 2012 (amounts in thousands):

 

   Total Debt   SVB Term Loan   SVB Line of
Credit
   BIA Note   Subordinated
Notes
   Promissory Note 
                         
Debt obligation as of December 31, 2011  $27,989   $13,500   $3,100   $8,078   $2,602   $709 
Debt discount amortization   71    -    -    23    48    - 
Draw on Line of Credit   800    -    800    -    -    - 
Principal payments   (1,091)   (750)   -    -    (105)   (236)
                               
Debt obligation as of March 31, 2012  $27,769   $12,750   $3,900   $8,101   $2,545   $473 

 

Term Loan and Line of Credit

 

On June 6, 2011, immediately following the PacketExchange acquisition, the Company and its subsidiaries GTTA, GTTE, WBS Connect LLC, a Colorado limited liability company (“WBS”, and together with the Company, GTTA and GTTE, collectively, the “Existing Borrower”), PacketExchange (Ireland) Limited, a company incorporated and existing under the laws of Ireland (“PEIRL”), PacketExchange (Europe) Limited, a private limited company incorporated and registered in England and Wales (“PELTD”), PacketExchange (USA), Inc., a Delaware corporation (“PEUSA”), PacketExchange, Inc., a Delaware corporation (“PEINC”, and together with PEIRL, PELTD and PEUSA, collectively, the “New Borrower”) (the New Borrower and the Existing Borrower together are the “Borrower”) entered into a joinder and first loan modification agreement (the “Modification Agreement”) with Silicon Valley Bank, which amends that certain Loan and Security Agreement (the “Loan Agreement”), dated September 30, 2010, by and among Silicon Valley Bank and the Existing Borrower.

 

11
 

 

The Modification Agreement increases the amount of the term loan facility from $10 million to $15 million (the “Term Loan”), while the revolving line of credit facility in the aggregate principal amount of up to $5 million (the “Line of Credit”) remains unchanged. The Modification Agreement contains customary representations, warranties and covenants of the Borrower and customary events of default. In connection with negotiating the terms of the Modification Agreement, it was noted that the Company would benefit by separating the financing provided under the Loan Agreement into separate U.S. and non-U.S. financings. Accordingly, the Company and Silicon Valley Bank restructured the terms of the Loan Agreement on June 29, 2011 to implement this separation. The obligations of the Borrower under the Modification Agreement are secured by substantially all of Borrower’s tangible and intangible assets pursuant to the Loan Agreement.

 

The Term Loan matures on June 1, 2016. The Borrower shall repay the Term Loan in sixty (60) equal installments of principal and interest, with interest accruing at a floating per annum rate equal to Silicon Valley Bank’s prime rate plus 3.75%, unless the Borrower achieves certain performance criteria, in which case the interest rate shall be equal to Silicon Valley Bank’s prime rate plus 2.75%.

 

The Line of Credit will continue to mature on September 29, 2012 and the principal amount outstanding under the Line of Credit shall continue to accrue interest at a floating per annum rate equal to Silicon Valley Bank’s prime rate plus 2%, unless the Borrower achieves certain performance criteria, in which case the interest rate shall be equal to Silicon Valley Bank’s prime rate plus 1.0%.

 

On April 30, 2012, the Line of Credit and the Term Loan were both modified. For a more detailed description of these changes, please refer to Note 8 “Subsequent Events”.

 

Note Purchase Agreement for Second Lien Credit Facility

 

Concurrent with entering in to the Modification Agreement, on June 6, 2011, the Company and its subsidiaries GTTA, WBS, PEUSA and PEINC (collectively, the “Note Borrower”) entered into a note purchase agreement (the “Purchase Agreement”) with the BIA Digital Partners SBIC II LP (“BIA”).  The Purchase Agreement provided for a total commitment of $12.5 million, of which $7.5 million was immediately funded (the “Notes”).  The Notes were issued at a discount to face value of $0.4 million and the discount is being amortized into interest expense over the life of the Notes. The remaining $5.0 million of the committed financing was available to be called by the Note Borrower on or before August 11, 2011, subject to extension to December 31, 2011, at the sole option of BIA.  On September 19, 2011, BIA agreed to extend the commitment period and funded the Note Borrower an additional $1.0 million. As of March 31, 2012, there was no additional availability with BIA. The additional funding was issued at a discount to face value of $45,000, due to the warrants issued, and the discount is being amortized into interest expense over the life of the Notes. The Purchase Agreement contains customary representations, warranties and covenants of the Note Borrower and customary events of default. The obligations of the Note Borrower under the Purchase Agreement are secured by substantially all of Borrower’s tangible and intangible assets pursuant to the Purchase Agreement.

 

The Notes mature on June 6, 2016. The obligations evidenced by the Notes shall bear interest at a rate of 13.5% per annum, of which (i) at least 11.5% per annum shall be payable, in cash, monthly (“Cash Interest Portion”) and (ii) 2.0% per annum shall be, at the Note Borrower’s option, paid in cash or paid-in-kind. If the Note Borrower achieves certain performance criteria, the obligations evidenced by the Notes shall bear interest at a rate of 12.0% per annum, with a Cash Interest Portion of at least 11.0% per annum.

 

The obligations of the Note Borrower under the Note Purchase Agreement are guaranteed by TEK and GTGS (GTGS and TEK, together, the “Note Guarantors”) pursuant to unconditional guaranties executed by each Guarantor in favor of BIA (each a “Note Guaranty”). Each Guaranty is secured by a second lien on each Guarantor’s tangible and intangible assets pursuant to a security agreement containing representations, warranties and covenants substantially similar to those made under the Note Purchase Agreement with respect to the Note Borrower. Pursuant to a pledge agreement (the “Pledge Agreement”) dated June 6, 2011, by and between BIA and the Company and GTTA, the obligations of the Note Borrower under the Note Purchase Agreement are also secured by a pledge in all of the equity interests of the Company and GTTA in their respective United States subsidiaries and a pledge of 65% of the voting equity interests and all of the non-voting equity interests of the Company and GTTA in their respective non-United States subsidiaries.

 

Concurrent with entering into the Note Purchase Agreement, Silicon Valley Bank and BIA entered into an Intercreditor and Subordination Agreement which governs, among other things, ranking and collateral access for the respective lenders.

 

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Warrants

 

On June 6, 2011, pursuant to the Purchase Agreement, the Company issued to BIA a warrant to purchase from the Company 634,648 shares of the Company’s common stock, at an exercise price equal to $1.144 per share (as adjusted from time to time as provided in the Purchase Agreement). Upon the additional $1.0 million funding, the Company issued to BIA an additional warrant (together the “Warrants”) to purchase from the Company 63,225 shares of the Company’s common stock, at an exercise price equal to $1.181 per share.

 

The Company evaluated the down round ratchet feature embedded in the Warrants and after considering ASC 480, Distinguishing Liabilities from Equity which establishes standards for how an issuer classifies and measures in its statement of financial position certain financial instruments with characteristics of both liabilities and equity, and ASC 815,  Derivatives and Hedging, the Company concluded the Warrants should be treated as a derivative and recorded a liability for the original fair value amount of $0.5 million during 2011.  At March 31, 2012, the warrant liability was marked to market which resulted in an expense of $0.7 million.  The balance of the warrant liability was $1.1 million as of March 31, 2012, which is included in other long-term liabilities.

 

Subordinated Notes

 

On February 8, 2010, the Company completed a units offering (“February 2010 Units”) in which it sold 500 units, consisting of debt and common stock at a purchase price of $10,000 per unit, resulting in $5.0 million of proceeds to the Company.  Each unit consisted of 2,970 shares of the Company’s common stock and $7,000 in principal amount of the Company’s subordinated promissory notes due February 8, 2012.  The subordinated promissory notes were issued at a discount to face value of $0.2 million and the discount is being amortized, into interest expense over the life of the Notes. Interest on the subordinated promissory notes accrues at 10% per annum.  Accrued but unpaid interest was $204,000 as of March 31, 2012.

  

The proceeds from the February 2010 Units were to be applied by the Company to finance a portion of the purchase price under an asset purchase agreement with a potential acquisition target. On April 30, 2010, the asset purchase agreement with the potential acquisition target expired without consummation of the acquisition.  On May 13, 2010, investors representing $1.5 million in aggregated principal amount of the Company’s subordinated promissory notes and $0.9 million of the Company’s common stock waived the right to receive their refund and elected to retain some or all of their subordinated promissory notes. In May 2011, $1.4 million of the February 2010 Units subordinated notes were amended to mature in four equal installments on March 31, June 30, September 30 and December 31, 2013. The remaining $0.1 million of the February 2010 Units subordinated notes were paid in February 2012. The $0.7 million of subordinate notes that mature on March 31, 2013 are included in short-term debt and the remaining notes of $1.9 million are included in long-term debt as of March 31, 2012.

 

On December 31, 2010, the Company completed a financing transaction in which it issued 212 units, valued at $10,000 per unit (“December 2013 Units”).  Each unit consisted of 5,000 shares of the Company’s common stock, and $5,000 in principal amount of the Company’s subordinated promissory notes due December 31, 2013.   The subordinated promissory notes were issued at a discount to face value of $0.2 million and the discount is being amortized, into interest expense, over the life of the notes.  Interest on the subordinated promissory notes accrues at 10% per annum. In total, the Company issued 1,060,000 shares of the Company’s common stock and $1.1 million in principal amount of subordinated promissory notes.

 

On February 16, 2011, the Company and the holders of the December 2013 Units amended the offering solely to increase the aggregate principal amount available for issuance from $1.1 million to $1.6 million. On February 16, 2011, the Company also completed a financing transaction in which it issued 40 units, at a purchase price of $10,000 per unit, for gross proceeds of $0.4 million. Each unit was comprised of 5,000 shares of the Company’s common stock, and $5,000 in principal amount of subordinated promissory notes.  The subordinated promissory notes were issued at a discount to face value of $47,000 and the discount is being amortized into interest expense over the life of the Notes.

 

As of March 31, 2012, the subordinated notes payable had a balance of $2.5 million. The balance includes notes totaling $2.1 million due to a related party, Universal Telecommunications, Inc. H. Brian Thompson, the Company’s Executive Chairman of the Board of Directors, is also the head of Universal Telecommunications, Inc., his own private equity investment and advisory firm. Also, included in the balance is $0.1 million of the notes held by officers and directors of the Company.

 

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Promissory Note

 

As part of the June 2011 acquisition of PacketExchange, the Company assumed a promissory note of approximately $0.7 million. As of March 31, 2012, the remaining balance due was $0.5 million.

 

NOTE 6 — INCOME TAXES

 

Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and for operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the year in which those temporary differences are expected to be recovered or settled. Valuation allowances are recorded against deferred tax assets when it is more likely than not that some portion or all of a deferred tax asset will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the period in which those temporary differences become deductible. The scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies are evaluated in determining whether it is more likely than not that deferred tax assets will be realized.

 

The Company and certain of its subsidiaries file income tax returns in the U.S. federal jurisdiction, various states and foreign jurisdictions. The Company’s foreign jurisdictions are primarily the United Kingdom and Germany.

 

A valuation allowance has been recorded against the Company’s deferred tax assets to the extent those assets are not offset by deferred tax liabilities which have a structural certainty of reversal or those assets that cannot be realized against prior period taxable income.

 

NOTE 7 — EARNINGS PER SHARE

 

Basic income per share is computed by dividing net income 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, warrants, and convertible securities.

 

The table below details the calculations of earnings per share (in thousands, except for share amounts):  

 

   Three Months Ended March 31, 
   2012   2011 
Numerator for basic and diluted EPS – income (loss) available to common stockholders  $(249)  $463 
Denominator for basic EPS – weighted average shares   18,782,701    18,239,307 
Effect of dilutive securities   -    223,867 
Denominator for diluted EPS – weighted average shares   18,782,701    18,463,174 
           
Earnings (loss) per share: basic and diluted  $(0.01)  $0.03 

 

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The table below details the anti-dilutive items that were excluded in the computation of earnings per share (in thousands):

 

   Three Months Ended March 31, 
   2012   2011 
Class Z warrants   12,090    12,090 
BIA warrant   698    - 
Stock options   1,400    321 
Totals   14,188    12,411 

 

At March 31, 2012, we had 12,090,000 Class Z warrants outstanding, each of which entitled the holder to purchase a share of our common stock at an exercise price of $5.00 per share on or before April 10, 2012.

 

NOTE 8 — SUBSEQUENT EVENTS

 

On April 10, 2012, the Class Z warrants expired. No Class Z warrants were exercised to purchase common stock.

 

On April 30, 2012, the Company entered into an agreement (the “Acquisition Agreement”) to acquire nLayer Communications, Inc. (“nLayer”) through the acquisition of all of the equity interests in nLayer. The closing of the acquisition occurred simultaneously with the signing of the Acquisition Agreement. In consideration for the equity interests in nLayer, GTTA paid the sellers an aggregate purchase price of $18.0 million, in cash, subject to a working capital adjustment and a reduction if nLayer’s revenue is lower than specified target levels during the two-year period after the closing of the acquisition.

 

At the closing, GTTA paid $12.0 million of the purchase price, and the remaining $6.0 million of the purchase price, subject to adjustment, will be paid over the two-year period after the closing. The sellers may elect to receive up to one-half of the post-closing payments to which they become entitled in the form of common stock of the Company, valued for this purpose at $2.45 per share.

 

To fund the Company’s acquisition of nLayer, the Company arranged financing with its existing senior lender, Silicon Valley Bank (“SVB”), in the form of modifications to the Company’s existing loan and security agreements with SVB that, among other matters, expands the amount of borrowing under the Company’s term loan facility. In addition, the Company arranged financing through an increase in the Company’s existing mezzanine financing arrangement, in the form of a modification to its existing Purchase Agreement with BIA that expands the amount of borrowing under the Purchase Agreement and adds Plexus Fund II, L.P. (“Plexus”) as a new note purchaser and lender thereunder.

 

On April 30, 2012, in connection with the nLayer acquisition, the Company entered into a Joinder and Second Loan Modification Agreement (the “Second Modification Agreement”) with SVB, which amends the Modification Agreement, dated June 29, 2011, as amended, by and among SVB and the Company.

 

The Second Modification Agreement increases the outstanding amount of the Term Loan by $7.5 million. The Term Loan matures on May 1, 2016. The Company will repay the Term Loan in sixteen (16) equal quarterly installments of principal, with each payment of principal being accompanied by a payment of accrued interest. Interest accrues on the outstanding balance of the Term Loan at a floating per annum rate equal to SVB’s prime rate plus 3.75%, unless the Company achieves certain performance criteria, in which case the interest rate will be equal to SVB’s prime rate plus 2.75%.

 

The aggregate principal amount of up to $5 million remains unchanged for the Line of Credit. The Line of Credit will mature on April 30, 2016, and the principal amount outstanding under the Line of Credit accrues interest at a floating per annum rate equal to SVB’s prime rate plus 2.75%, unless the Borrower achieves certain performance criteria, in which case the interest rate will be equal to SVB’s prime rate plus 1.75%.

 

Concurrent with the nLayer acquisition, on April 30, 2012, the Company entered into an Amended and Restated Note Purchase Agreement (the “Amended Note Purchase Agreement”) with BIA and Plexus (together with BIA, the “Note Holders”). The Amended Note Purchase Agreement provides for an increase in the total financing commitment by $8.0 million, of which $6.0 million was immediately funded. The remaining $2.0 million of the committed financing may be called by the Company, subject to certain conditions, on or before December 31, 2012, which may be extended at the sole option of the Note Holders. The Amended Note Purchase Agreement contains customary representations, warranties and covenants of the Note Borrower and customary events of default. The obligations of the Note Borrower under the Amended Note Purchase Agreement are secured by substantially all of the Note Borrower’s tangible and intangible assets pursuant to the Amended Note Purchase Agreement. In addition to the promissory note issued to Plexus, in connection with the Amended Note Purchase Agreement the Note Borrower issued an amended and restated promissory note to BIA, which note is on substantially the same terms as the note previously issued to BIA.

 

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The Notes mature on June 6, 2016. The obligations evidenced by the Notes will bear interest at a rate of 13.5% per annum, of which (i) at least 11.5% per annum is payable, in cash, monthly in arrears on the last calendar day of each month (“Interest Payment Date”) in each year (“Cash Interest Portion”) and (ii) 2.0% per annum is, at the Company’s option, payable in cash or payable in-kind. If the Company achieves certain performance criteria, the obligations evidenced by the Notes will bear interest at a rate of 12.0% per annum, with a Cash Interest Portion of at least 11.0% per annum payable in arrears on each Interest Payment Date of each year.

 

On April 30, 2012, pursuant to the Amended Note Purchase Agreement, the Company issued to Plexus a Warrant (the “Warrant”) to purchase from the Company 535,135 shares of the Company’s common stock at an exercise price equal to $2.208 per share (as adjusted from time to time as provided in the Warrant). Upon a change of control (as defined in the Amended Note Purchase Agreement), the repayment of the Notes prior to the maturity date of the Notes, the occurrence of an event of default under the Notes or the maturity date of the Notes, the holder of the Warrant shall have the option to require the Company to repurchase from the holder the Warrant and any shares received upon exercise of the Warrant and then held by the holder, which repurchase would be at a price equal to the greater of the closing price of the Company’s common stock on such date or a price determined by reference to the Company’s adjusted enterprise value on such date, in each case, with respect to any Warrant, less the exercise price per share. The Warrant contains customary representations, warranties and covenants. The Warrant was issued in reliance on the exemption from registration set forth in Section 4(2) of the Securities Act of 1933, as amended, and Regulation D promulgated thereunder.

 

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our financial statements and related notes that appear elsewhere in this report and in our annual report on Form 10-K for the year ended December 31, 2011. In addition to historical consolidated financial information, the following discussion contains forward-looking statements that reflect plans, estimates and beliefs of management of the Company. When used in this document, the words “anticipate”, “believe”, “plan”, “estimate” and “expect” and similar expressions, as they relate to the Company or its management, are intended to identify forward-looking statements. Such statements reflect the current views of management with respect to future events and are subject to certain risks, uncertainties and assumptions. Our actual results could differ materially from those discussed in the forward-looking statements. For a more detailed description of these risks and factors, please see the Company’s 2011 Annual Report on Form 10-K filed with the Securities and Exchange Commission and Part II Item 1A of this quarterly report on Form 10-Q.

 

Overview

 

GTT is a global network operator delivering managed data services to large enterprise, government and carrier customers in over 80 countries worldwide. GTT provides customers with innovative connectivity solutions by utilizing our own network assets - linking over 100 Points of Presence across North America, Europe and Asia - and extending them through our 800 partners worldwide. Our Network as a Service proposition delivers flexible, reliable and scalable network infrastructure, capable of both public and secure private networking. We simplify network deployment by removing the complexity of multi-vendor solutions while offering the cost efficiencies of a single partner. For over 14 years, GTT has provided world class project management, rapid service implementation and global 24/7 end-to-end solution monitoring and support. GTT is headquartered in the Washington, DC metro region with offices in London, Dusseldorf and Denver.

 

The Company sells services largely through a direct sales force located across the globe, as well as strong agent channel relationships. The Company generally competes with traditional, facilities-based providers and other services providers in each of our global markets. As of March 31, 2012, our customer base was comprised of over 1,000 businesses. Our five largest customers accounted for approximately 20% of consolidated revenues during the quarter ended March 31, 2012.

 

Costs and Expenses

 

The Company’s cost of revenue consists of the expenses directly related to the services provided to customers. The key terms and conditions appearing in both supplier and customer agreements are substantially the same, with margin applied to the suppliers’ costs. There are no wages or overheads included in these costs. From time to time, the Company has agreed to certain special commitments with vendors in order to obtain better rates, terms and conditions for the procurement of services from those vendors. These commitments include volume purchase commitments and purchases on a longer-term basis than the term for which the applicable customer has committed.

 

Our supplier contracts do not have any market related net settlement provisions. The Company has not entered into, and has no plans 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 the Company in its normal course of business.

 

Other than cost of revenue, the Company’s most significant operating expenses are employment costs. As of March 31, 2012, the Company had 90 employees and employment costs comprised approximately 11% of total operating expenses for the three months ended March 31, 2012.

 

Locations of Offices and Origins of Revenue

 

We are headquartered just outside of Washington, DC, in McLean, Virginia, and have offices in London, Düsseldorf and Denver. For the three months ended March 31, 2012, approximately 72% of our consolidated revenue was earned from operations based in the United States. Approximately 22% of our revenue was generated from operations based in the United Kingdom and 6% from operations in other countries.

 

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Critical Accounting Policies and Estimates

 

There have been no significant changes in the Company’s critical accounting policies and estimates as of March 31, 2012, as compared to the critical accounting policies and estimates disclosed in Note 2, “Significant Accounting Policies” in the 2011 Annual Report on Form 10-K.

 

Results of Operations of the Company

 

Three months ended March 31, 2012 compared to three months ended March 31, 2011

 

Overview. The financial information presented in the tables below is comprised of the unaudited condensed consolidated financial information of the Company for the three months ended March 31, 2012 and 2011 (amounts in thousands):

 

   Three Months Ended March 31, 
   2012   2011 
         
Revenue  $24,718   $20,402 
Cost of revenue   17,467    14,383 
           
Gross margin   7,251    6,019 
    29.3%   29.5%
Operating expenses, depreciation and amortization   5,866    5,148 
           
Operating income  $1,385   $871 
           
Net (loss) income  $(249)  $463 

 

Revenue. Revenue for the three months ended March 31, 2012, was $24.7 million. Revenue for the three months ended March 31, 2011, was $20.4 million. The increase in revenue is primarily due to the acquisition of PacketExchange in June 2011 as well as increased sales to new and existing customers.

 

Cost of Revenue and Gross Margin. Cost of revenue and gross margin for the three months ended March 31, 2012, were $17.5 million and $7.3 million, respectively. For the three months ended March 31, 2011, cost of revenue and gross margin were $14.4 million and $6.0 million, respectively. The primary cause of the increase is primarily due to the PacketExchange acquisition as well as increased sales to new and existing customers.

 

Operating Expenses. Operating expenses, exclusive of cost of revenue, were $5.9 million and $5.2 million for the three months ended March 31, 2012 and 2011, respectively. The increase was due primarily the depreciation and amortization of the network and intangible assets obtained in the PacketExchange acquisition. These changes are illustrated in the table below (amounts in thousands):

 

   Three Months Ended March 31, 
   2012   2011 
         
Selling, general and administrative expenses (excluding noncash compensation)  $4,584   $4,311 
Noncash compensation   144    161 
Amortization of intangible assets   722    461 
Depreciation   416    215 
Totals  $5,866   $5,148 

 

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Liquidity and Capital Resources

 

Debt

 

The following summarizes the debt activity of the Company during the three months ended March 31, 2012 (amounts in thousands):

 

   Total Debt   SVB Term Loan   SVB Line of
Credit
   BIA Note   Subordinated
Notes
   Promissory Note 
                         
Debt obligation as of December 31, 2011  $27,989   $13,500   $3,100   $8,078   $2,602   $709 
Debt discount amortization   71    -    -    23    48    - 
Draw on Line of Credit   800    -    800    -    -    - 
Principal payments   (1,091)   (750)   -    -    (105)   (236)
                               
Debt obligation as of March 31, 2012  $27,769   $12,750   $3,900   $8,101   $2,545   $473 

 

Term Loan and Line of Credit

 

On June 6, 2011, immediately following the PacketExchange acquisition, the Company and its subsidiaries GTTA, GTTE, WBS Connect LLC, a Colorado limited liability company (“WBS”, and together with the Company, GTTA and GTTE, collectively, the “Existing Borrower”), PacketExchange (Ireland) Limited, a company incorporated and existing under the laws of Ireland (“PEIRL”), PacketExchange (Europe) Limited, a private limited company incorporated and registered in England and Wales (“PELTD”), PacketExchange (USA), Inc., a Delaware corporation (“PEUSA”), PacketExchange, Inc., a Delaware corporation (“PEINC”, and together with PEIRL, PELTD and PEUSA, collectively, the “New Borrower”) (the New Borrower and the Existing Borrower together are the “Borrower”) entered into a joinder and first loan modification agreement (the “Modification Agreement”) with Silicon Valley Bank, which amends that certain Loan and Security Agreement (the “Loan Agreement”), dated September 30, 2010, by and among Silicon Valley Bank and the Existing Borrower.

 

The Modification Agreement increases the amount of the term loan facility from $10 million to $15 million (the “Term Loan”), while the revolving line of credit facility in the aggregate principal amount of up to $5 million (the “Line of Credit”) remains unchanged. The Modification Agreement contains customary representations, warranties and covenants of the Borrower and customary events of default. In connection with negotiating the terms of the Modification Agreement, it was noted that the Company would benefit by separating the financing provided under the Loan Agreement into separate U.S. and non-U.S. financings. Accordingly, the Company and Silicon Valley Bank restructured the terms of the Loan Agreement on June 29, 2011 to implement this separation. The obligations of the Borrower under the Modification Agreement are secured by substantially all of Borrower’s tangible and intangible assets pursuant to the Loan Agreement.

 

The Term Loan matures on June 1, 2016. The Borrower shall repay the Term Loan in sixty (60) equal installments of principal and interest, with interest accruing at a floating per annum rate equal to Silicon Valley Bank’s prime rate plus 3.75%, unless the Borrower achieves certain performance criteria, in which case the interest rate shall be equal to Silicon Valley Bank’s prime rate plus 2.75%.

 

The Line of Credit will continue to mature on September 29, 2012 and the principal amount outstanding under the Line of Credit shall continue to accrue interest at a floating per annum rate equal to Silicon Valley Bank’s prime rate plus 2%, unless the Borrower achieves certain performance criteria, in which case the interest rate shall be equal to Silicon Valley Bank’s prime rate plus 1.0%.

 

On April 30, 2012, the Line of Credit and the Term Loan were both modified. For a more detailed description of these changes, please refer to Note 8, “Subsequent Events”.

 

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Note Purchase Agreement for Second Lien Credit Facility

 

Concurrent with entering in to the Modification Agreement, on June 6, 2011, the Company and its subsidiaries GTTA, WBS, PEUSA and PEINC (collectively, the “Note Borrower”) entered into a note purchase agreement (the “Purchase Agreement”) with the BIA Digital Partners SBIC II LP (“BIA”).  The Purchase Agreement provided for a total commitment of $12.5 million, of which $7.5 million was immediately funded (the “Notes”).  The Notes were issued at a discount to face value of $0.4 million and the discount is being amortized into interest expense over the life of the Notes. The remaining $5.0 million of the committed financing was available to be called by the Note Borrower on or before August 11, 2011, subject to extension to December 31, 2011, at the sole option of BIA.  On September 19, 2011, BIA agreed to extend the commitment period and funded the Note Borrower an additional $1.0 million. As of March 31, 2012, there was no additional availability with BIA. The additional funding was issued at a discount to face value of $45,000, due to the warrants issued, and the discount is being amortized into interest expense over the life of the Notes. The Purchase Agreement contains customary representations, warranties and covenants of the Note Borrower and customary events of default. The obligations of the Note Borrower under the Purchase Agreement are secured by substantially all of Borrower’s tangible and intangible assets pursuant to the Purchase Agreement.

 

The Notes mature on June 6, 2016. The obligations evidenced by the Notes shall bear interest at a rate of 13.5% per annum, of which (i) at least 11.5% per annum shall be payable, in cash, monthly (“Cash Interest Portion”) and (ii) 2.0% per annum shall be, at the Note Borrower’s option, paid in cash or paid-in-kind. If the Note Borrower achieves certain performance criteria, the obligations evidenced by the Notes shall bear interest at a rate of 12.0% per annum, with a Cash Interest Portion of at least 11.0% per annum.

 

The obligations of the Note Borrower under the Note Purchase Agreement are guaranteed by TEK and GTGS (GTGS and TEK, together, the “Note Guarantors”) pursuant to unconditional guaranties executed by each Guarantor in favor of BIA (each a “Note Guaranty”). Each Guaranty is secured by a second lien on each Guarantor’s tangible and intangible assets pursuant to a security agreement containing representations, warranties and covenants substantially similar to those made under the Note Purchase Agreement with respect to the Note Borrower. Pursuant to a pledge agreement (the “Pledge Agreement”) dated June 6, 2011, by and between BIA and the Company and GTTA, the obligations of the Note Borrower under the Note Purchase Agreement are also secured by a pledge in all of the equity interests of the Company and GTTA in their respective United States subsidiaries and a pledge of 65% of the voting equity interests and all of the non-voting equity interests of the Company and GTTA in their respective non-United States subsidiaries.

 

Concurrent with entering into the Note Purchase Agreement, Silicon Valley Bank and BIA entered into an Intercreditor and Subordination Agreement which governs, among other things, ranking and collateral access for the respective lenders.

 

Warrants

 

On June 6, 2011, pursuant to the Purchase Agreement, the Company issued to BIA a warrant to purchase from the Company 634,648 shares of the Company’s common stock, at an exercise price equal to $1.144 per share (as adjusted from time to time as provided in the Purchase Agreement). Upon the additional $1.0 million funding, the Company issued to BIA an additional warrant (together the “Warrants”) to purchase from the Company 63,225 shares of the Company’s common stock, at an exercise price equal to $1.181 per share.

 

The Company evaluated the down round ratchet feature embedded in the Warrants and after considering ASC 480, Distinguishing Liabilities from Equity, which establishes standards for how an issuer classifies and measures in its statement of financial position certain financial instruments with characteristics of both liabilities and equity, and ASC 815,  Derivatives and Hedging, the Company concluded the Warrants should be treated as a derivative and recorded a liability for the original fair value amount of $0.5 million during 2011.  At March 31, 2012, the warrant liability was marked to market which resulted in an expense of $0.7 million.  The balance of the warrant liability was $1.1 million as of March 31, 2012, which is included in other long-term liabilities.

 

Subordinated Notes

 

On February 8, 2010, the Company completed a units offering (“February 2010 Units”) in which it sold 500 units, consisting of debt and common stock at a purchase price of $10,000 per unit, resulting in $5.0 million of proceeds to the Company.  Each unit consisted of 2,970 shares of the Company’s common stock and $7,000 in principal amount of the Company’s subordinated promissory notes due February 8, 2012.  The subordinated promissory notes were issued at a discount to face value of $0.2 million and the discount is being amortized, into interest expense over the life of the Notes. Interest on the subordinated promissory notes accrues at 10% per annum.  Accrued but unpaid interest was $204,000 as of March 31, 2012.

 

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The proceeds from the February 2010 Units were to be applied by the Company to finance a portion of the purchase price under an asset purchase agreement with a potential acquisition target. On April 30, 2010, the asset purchase agreement with the potential acquisition target expired without consummation of the acquisition.  On May 13, 2010, investors representing $1.5 million in aggregated principal amount of the Company’s subordinated promissory notes and $0.9 million of the Company’s common stock waived the right to receive their refund and elected to retain some or all of their subordinated promissory notes. In May 2011, $1.4 million of the February 2010 Units subordinated notes were amended to mature in four equal installments on March 31, June 30, September 30 and December 31, 2013. The remaining $0.1 million of the February 2010 Units subordinated notes were paid in February 2012. The $0.7 million of subordinate notes that mature on March 31, 2013 are included in short-term debt and the remaining notes of $1.9 million are included in long-term debt as of March 31, 2012.

 

On December 31, 2010, the Company completed a financing transaction in which it issued 212 units, valued at $10,000 per unit (“December 2013 Units”).  Each unit consisted of 5,000 shares of the Company’s common stock, and $5,000 in principal amount of the Company’s subordinated promissory notes due December 31, 2013.   The subordinated promissory notes were issued at a discount to face value of $0.2 million and the discount is being amortized, into interest expense, over the life of the notes.  Interest on the subordinated promissory notes accrues at 10% per annum. In total, the Company issued 1,060,000 shares of the Company’s common stock and $1.1 million in principal amount of subordinated promissory notes.

 

On February 16, 2011, the Company and the holders of the December 2013 Units amended the offering solely to increase the aggregate principal amount available for issuance from $1.1 million to $1.6 million. On February 16, 2011, the Company also completed a financing transaction in which it issued 40 units, at a purchase price of $10,000 per unit, for gross proceeds of $0.4 million. Each unit was comprised of 5,000 shares of the Company’s common stock, and $5,000 in principal amount of subordinated promissory notes.  The subordinated promissory notes were issued at a discount to face value of $47,000 and the discount is being amortized into interest expense over the life of the Notes.

 

As of March 31, 2012, the subordinated notes payable had a balance of $2.5 million. The balance includes notes totaling $2.1 million due to a related party, Universal Telecommunications, Inc. H. Brian Thompson, the Company’s Executive Chairman of the Board of Directors, is also the head of Universal Telecommunications, Inc., his own private equity investment and advisory firm. Also, included in the balance is $0.1 million of the notes held by officers and directors of the Company.

 

Promissory Note

 

As part of the June 2011 acquisition of PacketExchange, the Company assumed a promissory note of approximately $0.7 million. As of March 31, 2012, the remaining balance due was $0.5 million.

  

Liquidity Assessment

 

Cash provided by operating activities for the three months ended March 31, 2012 was $1.2 million. Cash provided by operating activities for the three months ended March 31, 2011, was $0.1 million.

 

Cash used in financing activities was approximately $0.3 million for the three months ended March 31, 2012, driven primarily by the repayment on the Term Loan and promissory note net of advances on the line of credit. Cash flows used in financing activities were $1.0 million for the three months ended March 31, 2011.

 

Management monitors cash flow and liquidity requirements. Based on the Company’s cash and cash equivalents, the availability under the Silicon Valley Bank credit facility, and analysis of the anticipated working capital requirements, management believes the Company has sufficient liquidity to fund the business and meet its contractual obligations. The Company’s current planned cash requirements for 2011 are based upon certain assumptions, including its ability to manage expenses and the growth of revenue from services arrangements. In connection with the activities associated with the services, the Company expects to incur expenses, including provider fees, employee compensation and consulting fees, professional fees, sales and marketing, insurance and interest expense. Should the expected cash flows not be available, management believes it would have the ability to revise its operating plan and make reductions in expenses.

 

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The Company believes that cash currently on hand, expected cash flows from future operations and existing borrowing capacity are sufficient to fund operations for the next twelve months, including the scheduled repayment, of indebtedness pursuant to the Silicon Valley Bank Term Loan. 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 the Company were unable to fully fund its cash requirements through operations and current cash on hand, the Company would need to obtain additional financing through a combination of equity and subordinated debt financings and/or renegotiation of terms of its existing debt. If any such activities become necessary, there can be no assurance that the Company would be successful in obtaining additional financing or modifying its existing debt terms.

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Interest Rate Sensitivity

 

Interest due on the Company’s loans is based upon the applicable stated fixed contractual rate with the lender. Interest earned on the Company’s bank accounts is linked to the applicable base interest rate. For the three months ended March 31, 2012 and 2011, the Company had interest expense, net of interest income, of approximately $0.9 million and $0.3 million, respectively. The Company believes that its results of operations are not materially affected by changes in interest rates.

 

Exchange Rate Sensitivity

 

Approximately 28% of the Company’s revenues for the three months ended March 31, 2012 are derived from services provided outside of the United States. As a consequence, a material percentage of the Company’s revenues are billed in British Pounds Sterling or Euros. Since we operate on a global basis, we are exposed to various foreign currency risks. First, our consolidated financial statements are denominated in U.S. Dollars, but a significant portion of our revenue is generated in the local currency of our foreign subsidiaries. Accordingly, changes in exchange rates between the applicable foreign currency and the U.S. Dollar will affect the translation of each foreign subsidiary’s financial results into U.S. Dollars for purposes of reporting consolidated financial results.

 

In addition, because of the global nature of our business, we may from time to time be required to pay a supplier in one currency while receiving payments from the underlying customer of the service in another currency. Although it is the Company’s general policy to pay its suppliers in the same currency that it will receive cash from customers, where these circumstances arise with respect to supplier invoices in one currency and customer billings in another currency, the Company’s gross margins may increase or decrease based upon changes in the exchange rate. Such factors did not have a material impact on the Company’s results in the three months ended March 31, 2012.

 

ITEM 4. CONTROLS AND PROCEDURES

 

Evaluation of Disclosure Controls and Procedures

 

The Company’s management carried out an evaluation required by Rule 13a-15 under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), under the supervision of and with the participation of its Chief Executive Officer (“CEO”) and Principal Accounting Officer (“PAO”), of the effectiveness of our disclosure controls and procedures as defined in Rule 13a-15 and 15d-15 under the Exchange Act (“Disclosure Controls”).

 

Based on our evaluation, our CEO and PAO concluded that our disclosure controls and procedures are designed at a reasonable assurance level and are effective to provide reasonable assurance that information we are required to disclose in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms and that such information is accumulated and communicated to our management, including our CEO and PAO, as appropriate, to allow timely decisions regarding required disclosure.

 

The CEO and the PAO, with assistance from other members of management, have reviewed the effectiveness of our disclosure controls and procedures as of March 31, 2012 and, based on their evaluation, have concluded that the disclosure controls and procedures were effective as of such date.

 

Changes in Internal Control over Financial Reporting

 

There have not been any changes in the Company’s internal control over financial reporting during the quarter ended March 31, 2012 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

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Limitations on the Effectiveness of Controls

 

Management, including our CEO and PAO, does not expect that disclosure controls and internal controls will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people or by management override of the controls.

 

The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, a control may become inadequate because of changes in conditions or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and may not be detected.

 

PART II – Other Information

 

ITEM 1. LEGAL PROCEEDINGS

 

As of March 31, 2012, the Company was not subject to any material legal proceedings. From time to time, however, the Company or its operating companies may be involved in legal actions arising from normal business activities.

 

ITEM 1A. RISK FACTORS

 

The Company operates in a rapidly changing environment that involves a number of risks, some of which are beyond its control. In addition to the other information set forth in this report, the reader should carefully consider the factors discussed in Part I, “Item 1A.  Risk Factors” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011, which could materially affect our business, financial condition or future results.  Additional risks and uncertainties not presently known to us, which we currently deem to be immaterial or which are similar to those faced by other companies in this industry or business in general, may also affect our business, financial condition and/or operating results.  If any of these risks or uncertainties actually occur, our business, financial condition and operating results would likely suffer. We do not believe that the risks and uncertainties described in the Risk Factors included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011, have materially changed other than as set forth below.

  

Risks Relating to Our Business and Operations

 

We depend on several large customers, and the loss of one or more of these customers, or a significant decrease in total revenue from any of these customers, would likely reduce our revenue and income.

 

For the three months ended March 31, 2012, our five largest customers accounted for approximately 20% of our total service revenue. If we were to lose all of the underlying services from one or more of our large customers, or if one or more of our large customers were to significantly reduce the services purchased from us or otherwise renegotiate the terms on which services are purchased from us, our revenue could decline and our results of operations would suffer.

 

If our customers elect to terminate their agreements with us, our business, financial condition and results of operations may be adversely affected.

 

Our services are sold under agreements that generally have initial terms of between one and three years. Following the initial terms, these agreements generally automatically renew for successive month-to-month, quarterly or annual periods, but can be terminated by the customer without cause with relatively little notice during a renewal period. In addition, certain government customers may have rights under Federal law with respect to termination for convenience that can serve to minimize or eliminate altogether the liability payable by that customer in the event of early termination. Our customers may elect to terminate their agreements as a result of a number of factors, including their level of satisfaction with the services they are receiving, their ability to continue their operations due to budgetary or other concerns and the availability and pricing of competing services. If customers elect to terminate their agreements with us, our business, financial condition and results of operation may be adversely affected.

 

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Competition in the industry in which we do business is intense and growing, and our failure to compete successfully could make it difficult for us to add and retain customers or increase or maintain revenue.

 

The markets in which we operate are rapidly evolving and highly competitive. We currently or potentially compete with a variety of companies, including some of our transport suppliers, with respect to their products and services, including global and regional telecommunications service providers such as AT&T, British Telecom, NTT, Level 3, Qwest and Verizon, among others.

 

The industry in which we operate is consolidating, which is increasing the size and scope of our competitors. Competitors could benefit from assets or businesses acquired from other carriers or from strategic alliances in the telecommunications industry. New entrants could enter the market with a business model similar to ours. Our target markets may support only a limited number of competitors. Operations in such markets with multiple competitive providers may be unprofitable for one or more of such providers. Prices in the data transmission and internet access business have declined in recent years and may continue to decline.

 

Many of our potential competitors have certain advantages over us, including:

 

substantially greater financial, technical, marketing, and other resources, including brand or corporate name recognition;

 

substantially lower cost structures, including cost structures of facility-based providers who have reduced debt and other obligations through bankruptcy or other restructuring proceedings;

 

larger client bases;

 

longer operating histories;

 

more established relationships in the industry; and

 

larger geographic presence.

  

Our competitors may be able to use these advantages to:

 

develop or adapt to new or emerging technologies and changes in client requirements more quickly;

 

take advantage of acquisitions and other opportunities more readily;

 

enter into strategic relationships to rapidly grow the reach of their networks and capacity;

 

devote greater resources to the marketing and sale of their services;

 

adopt more aggressive pricing and incentive policies, which could drive down margins; and

 

expand their offerings more quickly.

  

If we are unable to compete successfully against our current and future competitors, our revenue and gross margin could decline and we would lose market share, which could materially and adversely affect our business.

 

We might require additional capital to support business growth, and this capital might not be available on favorable terms, or at all.

 

Our operations or expansion efforts may require substantial additional financial, operational and managerial resources. As of March 31, 2012, we had approximately $4.2 million in cash and cash equivalents and current liabilities $19.6 million greater than current assets. We may have insufficient cash to fund our working capital or other capital requirements and may be required to raise additional funds to continue or expand our operations. If we are required to obtain additional funding in the future, we may have to sell assets, seek debt financing, or obtain additional equity capital. Our ability to sell assets or raise additional equity or debt capital will depend on the condition of the capital and credit markets and our financial condition at such time. Accordingly, additional capital may not be available to us, or may only be available on terms that adversely affect our existing stockholders, or that restrict our operations. For example, if we raise additional funds through issuances of equity or convertible debt securities, our existing stockholders could suffer dilution, and any new equity securities we issue could have rights, preferences, and privileges superior to those of holders of our common stock. Also, if we were forced to sell assets, there can be no assurance regarding the terms and conditions we could obtain for any such sale, and if we were required to sell assets that are important to our current or future business, our current and future results of operations could be materially and adversely affected. We have granted security interests in substantially all of our assets to secure the repayment of our indebtedness maturing in 2012 and 2016, and if we are unable to satisfy our obligations, the lenders could foreclose on their security interests.

 

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Because our business consists primarily of reselling telecommunications network capacity purchased from third parties, the failure of our suppliers and other service providers to provide us with services, or disputes with those suppliers and service providers, could affect our ability to provide quality services to our customers and have an adverse effect on our operations and financial condition.

 

The majority of our business consists of integrating and reselling network capacity purchased from facility-based telecommunications carriers. Accordingly, we will be largely dependent on third parties to supply us with services. Occasionally in the past, our operating companies have experienced delays or other problems in receiving services from third party providers. Disputes also arise from time to time with suppliers with respect to billing or interpretation of contract terms. Any failure on the part of third parties to adequately supply us or to maintain the quality of their facilities and services in the future, or the termination of any significant contracts by a supplier, could cause customers to experience delays in service and lower levels of customer care, which could cause them to switch providers. Furthermore, disputes over billed amounts or interpretation of contract terms could lead to claims against us, some of which if resolved against us could have an adverse impact on our results of operations and/or financial condition. Suppliers may also attempt to impose onerous terms as part of purchase contract negotiations. Although we know of no pending or threatened claims with respect to past compliance with any such terms, claims asserting any past noncompliance, if successful, could have a material adverse effect on our operations and/or financial condition. Moreover, to the extent that key suppliers were to attempt to impose such provisions as part of future contract negotiations, such developments could have an adverse impact on the company’s operations. Finally, some of our suppliers are potential competitors. We cannot guarantee that we will be able to obtain use of facilities or services in a timely manner or on terms acceptable and in quantities satisfactory to us.

  

Industry consolidation may affect our ability to obtain services from suppliers on a timely or cost-efficient basis.

 

A principal method of connecting with our customers is through local transport and last mile circuits we purchase from incumbent carriers such as AT&T and Verizon, or competitive carriers such as Time Warner Telecom, XO, or Level 3. In recent years, AT&T, Verizon, and Level 3 have acquired competitors with significant local and/or long-haul network assets. Industry consolidation has occurred on a lesser scale as well through mergers and acquisitions involving regional or smaller national or international competitors. Generally speaking, we believe that a marketplace with multiple supplier options for transport access is important to the long-term availability of competitive pricing, service quality, and carrier responsiveness. It is unclear at this time what the long-term impact of such consolidation will be, or whether it will continue at the same pace as it has in recent years; we cannot guarantee that we will continue to be able to obtain use of facilities or services in a timely manner or on terms acceptable and in quantities satisfactory to us from such suppliers.

 

We may occasionally have certain sales commitments to customers that extend beyond the Company’s commitments from its underlying suppliers.

 

The Company’s financial results could be adversely affected if the Company were unable to purchase extended service from a supplier at a cost sufficiently low to maintain the Company’s margin for the remaining term of its commitment to a customer. While the Company has not encountered material price increases from suppliers with respect to continuation or renewal of services after expiration of initial contract terms, the Company cannot be certain that it would be able to obtain similar terms and conditions from suppliers. In most cases where the Company has faced any price increase from a supplier following contract expiration, the Company has been able to locate another supplier to provide the service at a similar or reduced future cost; however, the Company’s suppliers may not provide services at such cost levels in the future.

 

We may make purchase commitments to vendors for longer terms or in excess of the volumes committed by our underlying customers.

 

The Company attempts to match its purchase of network capacity from its suppliers and its service commitments from its customers. However, from time to time, the Company has obligations to its suppliers that exceed the duration of the Company’s related customer contracts or that are for capacity in excess of the amount for which it has Customer commitments. This could arise based upon the terms and conditions available from the Company’s suppliers, from an expectation of the Company that we will be able to utilize the excess capacity, as a result of a breach of a customer’s commitment to us, or to support fixed elements of the Company’s network. Under any of these circumstances, the Company would incur the cost of the network capacity from its supplier without having corresponding revenue from its customers, which could result in a material and adverse impact on the Company’s operating results.

 

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The networks on which we depend may fail, which would interrupt the network availability they provide and make it difficult to retain and attract customers.

 

Our customers depend on our ability to provide network availability with minimal interruption. The ability to provide this service depends in part on the networks of third party transport suppliers. The networks of transport suppliers may be interrupted as a result of various events, many of which they cannot control, including fire, human error, earthquakes and other natural disasters, disasters along communications rights-of-way, power loss, telecommunications failures, terrorism, sabotage, vandalism, or the financial distress or other event adversely affecting a supplier, such as bankruptcy or liquidation.

 

We may be subject to legal claims and be liable for losses suffered by customers due to our inability to provide service. If our network failure rates are higher than permitted under the applicable customer contracts, we may incur significant expenses related to network outage credits, which would reduce our revenue and gross margin. Our reputation could be harmed if we fail to provide a reasonably adequate level of network availability, and in certain cases, customers may be entitled to seek to terminate their contracts with us in case of prolonged or severe service disruptions or other outages.

  

System disruptions could cause delays or interruptions of our service due to terrorism, natural disasters and other events beyond our control, which could cause us to lose customers or incur additional expenses.

 

Our success depends on our ability to provide reliable service. Although we have attempted to design our network services to minimize the possibility of service disruptions or other outages, in addition to risks associated with third party provider networks, our services may be disrupted by problems on our own systems, including events beyond our control such as terrorism, computer viruses, or other infiltration by third parties that affect our central offices, corporate headquarters, network operations centers, or network equipment. Such events could disrupt our service, damage our facilities and damage our reputation. In addition, customers may, under certain contracts, have the ability to terminate services in case of prolonged or severe service disruptions or other outages. Accordingly, service disruptions or other outages may cause us to, among other things, lose customers and could harm our results of operations.

 

If the products or services that we market or sell do not maintain market acceptance, our results of operations will be adversely affected.

 

Certain segments of the telecommunications industry are dependent on developing and marketing new products and services that respond to technological and competitive developments and changing customer needs. We cannot assure you that our products and services will gain or obtain increased market acceptance. Any significant delay or failure in developing new or enhanced technology, including new product and service offerings, could result in a loss of actual or potential market share and a decrease in revenue.

 

The communications market in which we operate is highly competitive; we could be forced to reduce prices, may lose customers to other providers that offer lower prices and have problems attracting new customers.

 

The communications industry is highly competitive and pricing for some of our key service offerings, such as our dedicated IP transport services, have been generally declining. If our costs of service, including the cost of leasing underlying facilities, do not decline in a similar fashion, we could experience significant margin compression, reduction of profitability and loss of business.

 

If carrier and enterprise connectivity demand does not continue to expand, we may experience a shortfall in revenue or earnings or otherwise fail to meet public market expectations.

 

The growth of our business will be dependent, in part, upon the increased use of carrier and enterprise connectivity services and our ability to capture a higher proportion of this market. Increased usage of enterprise connectivity services depends on numerous factors, including:

 

the willingness of enterprises to make additional information technology expenditures;

 

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the availability of security products necessary to ensure data privacy over the public networks;

 

the quality, cost, and functionality of these services and competing services;

 

the increased adoption of wired and wireless broadband access methods;

 

the continued growth of broadband-intensive applications; and

 

the proliferation of electronic devices and related applications.

 

Our long sales and service deployment cycles require us to incur substantial sales costs that may not result in related revenue.

 

Our business is characterized by long sales cycles, which are often in the range of 45 days or more, between the time a potential customer is contacted and a customer contract is signed. Furthermore, once a customer contract is signed, there is typically an extended period of between 30 and 120 days before the customer actually begins to use the services, which is when we begin to realize revenue. As a result, we may invest a significant amount of time and effort in attempting to secure a customer, which investment may not result in near term, if any, revenue. Even if we enter into a contract, we will have incurred substantial sales-related expenses well before we recognize any related revenue. If the expenses associated with sales increase, if we are not successful in our sales efforts, or if we are unable to generate associated offsetting revenue in a timely manner, our operating results could be materially and adversely affected.

 

Because much of our business is international, our financial results may be affected by foreign exchange rate fluctuations.

 

Approximately 28% of our revenue comes from countries outside of the United States. As such, other currencies, particularly the Euro and the British Pound Sterling, can have an impact on the Company’s results (expressed in U.S. Dollars). Currency variations also contribute to variations in sales in impacted jurisdictions. Accordingly, fluctuations in foreign currency rates, most notably the strengthening of the dollar against the euro and the pound, could have a material impact on our revenue growth in future periods. In addition, currency variations can adversely affect margins on sales of our products in countries outside of the United States and margins on sales of products that include components obtained from suppliers located outside of the United States.

 

Because much of our business is international, we may be subject to local taxes, tariffs, or other restrictions in foreign countries, which may reduce our profitability.

 

Revenue from our foreign subsidiaries, or other locations where we provide or procure services internationally, may be subject to additional taxes in some foreign jurisdictions. Additionally, some foreign jurisdictions may subject us to additional withholding tax requirements or the imposition of tariffs, exchange controls, or other restrictions on foreign earnings. Any such taxes, tariffs, controls, and other restrictions imposed on our foreign operations may increase our costs of business in those jurisdictions, which in turn may reduce our profitability.

 

If our goodwill or amortizable intangible assets become further impaired we may be required to record a significant charge to earnings.

 

Under generally accepted accounting principles, we review our amortizable intangible assets for impairment when events or changes in circumstances indicate the carrying value may not be recoverable. Goodwill is tested for impairment at least annually. Factors that may be considered a change in circumstances indicating that the carrying value of our goodwill or amortizable intangible assets may not be recoverable include reduced future cash flow estimates, a decline in stock price and market capitalization, and slower growth rates in our industry. During the years ended December 31, 2011 and 2010, the Company recorded no impairment to goodwill and amortizable intangible assets. We may be required to record a significant charge to earnings in our financial statements during the period in which any impairment of our goodwill or amortizable intangible assets is determined, negatively impacting our results of operations.

 

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The ability to implement and maintain our databases and management information systems is a critical business requirement, and if we cannot obtain or maintain accurate data or maintain these systems, we might be unable to cost-effectively provide solutions to our customers.

 

To be successful, we must increase and update information in our databases about network pricing, capacity and availability. Our ability to provide cost-effective network availability and access cost management depends upon the information we collect from our transport suppliers regarding their networks. These suppliers are not obligated to provide this information and could decide to stop providing it to us at any time. Moreover, we cannot be certain that the information that these suppliers share with us is accurate. If we cannot continue to maintain and expand the existing databases, we may be unable to increase revenue or to facilitate the supply of services in a cost-effective manner.

 

Furthermore, we are in the process of reviewing, integrating, and augmenting our management information systems to facilitate management of client orders, client service, billing, and financial applications. Our ability to manage our businesses could be materially adversely affected if we fail to successfully and promptly maintain and upgrade the existing management information systems.

  

If we are unable to protect our intellectual property rights, competitors may be able to use our technology or trademarks, which could weaken our competitive position.

 

We own certain proprietary programs, software and technology. However, we do not have any patented technology that would preclude competitors from replicating our business model; instead, we rely upon a combination of know-how, trade secret laws, contractual restrictions, and copyright, trademark and service mark laws to establish and protect our intellectual property. Our success will depend in part on our ability to maintain or obtain (as applicable) and enforce intellectual property rights for those assets, both in the United States and in other countries. Although our Americas operating company has registered some of its service marks in the United States, we have not otherwise applied for registration of any marks in any other jurisdiction. Instead, with the exception of the few registered service marks in the United States, we rely exclusively on common law trademark rights in the countries in which we operate.

 

We may file applications for patents, copyrights and trademarks as our management deems appropriate. We cannot assure you that these applications, if filed, will be approved or that we will have the financial and other resources necessary to enforce our proprietary rights against infringement by others. Additionally, we cannot assure you that any patent, trademark, or copyright obtained by us will not be challenged, invalidated, or circumvented, and the laws of certain foreign countries may not protect intellectual property rights to the same extent as do the laws of the United States or the member states of the European Union. Finally, although we intend to undertake reasonable measures to protect the proprietary assets of our combined operations, we cannot guarantee that we will be successful in all cases in protecting the trade secret status of certain significant intellectual property assets. If these assets should be misappropriated, if our intellectual property rights are otherwise infringed, or if a competitor should independently develop similar intellectual property, this could harm our ability to attract new clients, retain existing customers and generate revenue.

 

Intellectual property and proprietary rights of others could prevent us from using necessary technology to provide our services or otherwise operate our business.

 

We utilize data and processing capabilities available through commercially available third-party software tools and databases to assist in the efficient analysis of network engineering and pricing options. Where such technology is held under patent or other intellectual property rights by third parties, we are required to negotiate license agreements in order to use that technology. In the future, we may not be able to negotiate such license agreements at acceptable prices or on acceptable terms. If an adequate substitute is not available on acceptable terms and at an acceptable price from another software licensor, we could be compelled to undertake additional efforts to obtain the relevant network and pricing data independently from other, disparate sources, which, if available at all, could involve significant time and expense and adversely affect our ability to deliver network services to customers in an efficient manner.

 

Furthermore, to the extent that we are subject to litigation regarding the ownership of our intellectual property or the licensing and use of others’ intellectual property, this litigation could:

 

be time-consuming and expensive;

 

divert attention and resources away from our daily business;

 

impede or prevent delivery of our products and services; and

 

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require us to pay significant royalties, licensing fees, and damages.

 

Parties making claims of infringement may be able to obtain injunctive or other equitable relief that could effectively block our ability to provide our services and could cause us to pay substantial damages. In the event of a successful claim of infringement, we may need to obtain one or more licenses from third parties, which may not be available at a reasonable cost, if at all. The defense of any lawsuit could result in time-consuming and expensive litigation, regardless of the merits of such claims, and could also result in damages, license fees, royalty payments, and restrictions on our ability to provide our services, any of which could harm our business.

 

We continue to evaluate merger and acquisition opportunities and may purchase additional companies in the future, and the failure to integrate them successfully with our existing business may adversely affect our financial condition and results of operations.

 

We continue to explore merger and acquisition opportunities and we may face difficulties if we acquire other businesses in the future including:

 

integrating the personnel, services, products and technologies of the acquired businesses into our existing operations;

 

retaining key personnel of the acquired businesses;

 

failing to adequately identify or assess liabilities of acquired businesses;

 

failing to achieve the synergies, revenue growth and other expected benefits we used to determine the purchase price of the acquired businesses;

 

failing to realize the anticipated benefits of a particular merger and acquisition;

 

incurring significant transaction and acquisition-related costs;

 

incurring significant amounts of additional debt;

 

creating significant contingent earn-out obligations and other financial liabilities;

 

incurring unanticipated problems or legal liabilities;

 

being subject to business uncertainties and contractual restrictions while an acquisition is pending that could adversely affect our business; and

 

diverting our management’s attention from the day-to-day operation of our business.

 

These difficulties could disrupt our ongoing business and increase our expenses. As of the date of the filing of this Form 10-K, we have no agreement or memorandum of understanding to enter into any acquisition transaction.

 

In addition, our ability to complete acquisitions may depend, in part, on our ability to finance these acquisitions, including both the costs of the acquisition and the cost of the subsequent integration activities. Our ability may be constrained by our cash flow, the level of our indebtedness, restrictive covenants in the agreements governing our indebtedness, conditions in the securities and credit markets and other factors, most of which are generally beyond our control. If we proceed with one or more acquisitions in which the consideration consists of cash, we may use a substantial portion of our available cash to complete such acquisitions, thereby reducing our liquidity. If we finance one or more acquisitions with the proceeds of indebtedness, our interest expense and debt service requirements could increase materially. Thus, the financial impact of future acquisitions, including the costs to pursue acquisitions that do not ultimately close, could materially affect our business and could cause substantial fluctuations in our quarterly and yearly operating results.

 

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Our efforts to develop new service offerings may not be successful, in which case our revenue may not grow as we anticipate or may decline.

 

The market for telecommunications services is characterized by rapid change, as new technologies are developed and introduced, often rendering established technologies obsolete. For our business to remain competitive, we must continually update our service offerings to make new technologies available to our customers and prospects. To do so, we may have to expend significant management and sales resources, which may increase our operating costs. The success of our potential new service offerings is uncertain and would depend on a number of factors, including the acceptance by end-user customers of the telecommunications technologies which would underlie these new service offerings, the compatibility of these technologies with existing customer information technology systems and processes, the compatibility of these technologies with our then-existing systems and processes, and our ability to find third-party vendors that would be willing to provide these new technologies to us for delivery to our users. If we are unsuccessful in developing and selling new service offerings, our revenue may not grow as we anticipate or may decline.

  

If we do not continue to train, manage and retain employees, clients may reduce purchases of services.

 

Our employees are responsible for providing clients with technical and operational support, and for identifying and developing opportunities to provide additional services to existing clients. In order to perform these activities, our employees must have expertise in areas such as telecommunications network technologies, network design, network implementation and network management, including the ability to integrate services offered by multiple telecommunications carriers. They must also accept and incorporate training on our systems and databases developed to support our operations and business model. Employees with this level of expertise tend to be in high demand in the telecommunications industry, which may make it more difficult for us to attract and retain qualified employees. If we fail to train, manage, and retain our employees, we may be limited in our ability to gain more business from existing clients, and we may be unable to obtain or maintain current information regarding our clients’ and suppliers’ communications networks, which could limit our ability to provide future services.

 

The regulatory framework under which we operate could require substantial time and resources for compliance, which could make it difficult and costly for us to operate the businesses.

 

In providing certain interstate and international telecommunications services, we must comply, or cause our customers or carriers to comply, with applicable telecommunications laws and regulations prescribed by the FCC and applicable foreign regulatory authorities. In offering services on an intrastate basis, we may also be subject to state laws and to regulation by state public utility commissions. Our international services may also be subject to regulation by foreign authorities and, in some markets, multinational authorities, such as the European Union. The costs of compliance with these regulations, including legal, operational and administrative expenses, may be substantial. In addition, delays in receiving or failure to obtain required regulatory approvals or the enactment of new or adverse legislation, regulations or regulatory requirements may have a material adverse effect on our financial condition, results of operations and cash flow.

 

If we fail to obtain required authorizations from the FCC or other applicable authorities, or if we are found to have failed to comply, or are alleged to have failed to comply, with the rules of the FCC or other authorities, our right to offer certain services could be challenged and/or fines or other penalties could be imposed on us. Any such challenges or fines could be substantial and could cause us to incur substantial legal and administrative expenses as well; these costs in the forms of fines, penalties, and legal and administrative expenses could have a material adverse impact on our business and operations. Furthermore, we are dependent in certain cases on the services other carriers provide, and therefore on other carriers’ abilities to retain their respective licenses in the regions of the world in which they operate. We are also dependent, in some circumstances, on our customers’ abilities to obtain and retain the necessary licenses. The failure of a customer or carrier to obtain or retain any necessary license could have an adverse effect on our ability to conduct operations.

 

Future changes in regulatory requirement, new interpretations of existing regulatory requirements, or determinations that we violated existing regulatory requirements may impair our ability to provide services, result in financial losses or otherwise reduce our profitability.

 

Many of the laws and regulations that apply to providers of telecommunications services are subject to frequent changes and different interpretations and may vary between jurisdictions. Changes to existing legislation or regulations in particular markets may limit the opportunities that are available to enter into markets, may increase the legal, administrative, or operational costs of operating in those markets, or may constrain other activities, including our ability to complete subsequent acquisitions, or purchase services or products, in ways that we cannot anticipate. Because we purchase telecommunications services from other carriers, our costs and manner of doing business can also be adversely affected by changes in regulatory policies affecting these other carriers.

 

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In addition, any determination that we, including companies that we have acquired, have violated applicable regulatory requirements could result in material fines, penalties, forfeitures, interest or retroactive assessments. For example, a determination that we have not paid all required universal service fund contributions could result in substantial retroactive assessment of universal service fund contributions, together with applicable interest, penalties, fines or forfeitures.

 

We depend on key personnel to manage our businesses effectively in a rapidly changing market, and our ability to generate revenue will suffer if we are unable to retain key personnel and hire additional personnel.

 

The future success, strategic development and execution of our business will depend upon the continued services of our executive officers and other key sales, marketing and support personnel. We do not maintain “key person” life insurance policies with respect to any of our employees, nor are we certain if any such policies will be obtained or maintained in the future. We may need to hire additional personnel in the future and we believe the success of the combined business depends, in large part, upon our ability to attract and retain key employees. The loss of the services of any key employees, the inability to attract or retain qualified personnel in the future, or delays in hiring required personnel could limit our ability to generate revenue and to operate our business.

 

Interruption or failure of our information technology and communications systems could hurt our ability to effectively provide our products and services, which could damage our reputation and harm our operating results.

 

The availability of our products and services depends on the continuing operation of our information technology and communications systems. Our systems are vulnerable to damage or interruption from earthquakes, terrorist attacks, floods, fires, power loss, telecommunications failures, computer viruses, computer denial of service attacks or other attempts to harm our systems. Some of our systems are not fully redundant and our disaster recovery planning cannot account for all eventualities. The occurrence of a natural disaster, a decision to close a facility we are using without adequate notice for financial reasons, or other unanticipated problems at our data centers could result in lengthy interruptions in our service.

 

Risks Relating to Our Indebtedness

 

Our failure to comply with covenants in our Loan Agreement could result in our indebtedness being immediately due and payable and the loss of our assets.

 

Pursuant to the terms of our Loan Agreement with Silicon Valley Bank, we have pledged substantially all of our assets to the lender as security for our payment obligations under the Loan Agreement. If we fail to pay any of our indebtedness under this Loan Agreement when due, or if we breach any of the other covenants in the Loan Agreement, it may result in one or more events of default. An event of default under our Loan Agreement would permit the lender to declare all amounts owing to be immediately due and payable and, if we were unable to repay any indebtedness owed, the lender could proceed against the collateral securing that indebtedness.

 

Covenants in our Loan Agreement and outstanding notes, and in any future debt agreement, may restrict our future operations.

 

The indenture governing the notes and the Loan Agreement will impose financial restrictions that limit our discretion on some business matters, which could make it more difficult for us to expand our business, finance our operations and engage in other business activities that may be in our interest. These restrictions include compliance with, or maintenance of, certain financial tests and ratios and restrictions that limit our ability and that of our subsidiaries to, among other things:

 

incur additional indebtedness or place additional liens on our assets;

 

pay dividends or make other distributions on, redeem or repurchase our capital stock;

 

make investments or repay subordinated indebtedness;

 

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enter into transactions with affiliates;

 

sell assets;

 

engage in a merger, consolidation or other business combination; or

  

change the nature of our businesses.

 

Any additional indebtedness we may incur in the future may subject us to similar or even more restrictive conditions.

 

Our substantial level of indebtedness and debt service obligations could impair our financial condition, hinder our growth and put us at a competitive disadvantage.

 

As of March 31, 2012, our indebtedness was substantial in comparison to our available cash. Our substantial level of indebtedness could have important consequences for our business, results of operations and financial condition. For example, a high level of indebtedness could, among other things:

 

make it more difficult for us to satisfy our financial obligations;

 

increase our vulnerability to general adverse economic and industry conditions, including interest rate fluctuations;

 

increase the risk that a substantial decrease in cash flows from operating activities or an increase in expenses will make it difficult for us to meet our debt service requirements and will require us to modify our operations;

 

require us to dedicate a substantial portion of our cash flow from operations to make payments on our indebtedness, thereby reducing the availability of our cash flow to fund future business opportunities, working capital, capital expenditures and other general corporate purposes;

 

limit our ability to borrow additional funds to expand our business or ease liquidity constraints;

 

limit our ability to refinance all or a portion of our indebtedness on or before maturity;

 

limit our ability to pursue future acquisitions;

 

limit our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate; and

 

place us at a competitive disadvantage relative to competitors that have less indebtedness.

 

Risks Related to our Common Stock and the Securities Markets

 

Because we do not currently intend to pay dividends on our common stock, stockholders will benefit from an investment in our common stock only if it appreciates in value.

 

We do not currently anticipate paying any dividends on shares of our common stock. Any determination to pay dividends in the future will be made by our Board of Directors and will depend upon results of operations, financial conditions, contractual restrictions, restrictions imposed by applicable law and other factors our Board of Directors deems relevant. Accordingly, realization of a gain on stockholders’ investments will depend on the appreciation of the price of our common stock. There is no guarantee that our common stock will appreciate in value or even maintain the price at which stockholders purchased their shares.

 

Our outstanding warrants may have an adverse effect on the market price of our common stock.

 

As of March 31, 2012, we had 12,090,000 Class Z warrants, each of which entitled the holder to purchase a share of our common stock at an exercise price of $5.00 per share on or before April 10, 2012. On April 10, 2012, the Class Z warrants expired. As of March 31, 2012, we had 634,648 warrants at an exercise price equal to $1.144 per share and 63,225 warrants, at an exercise price equal to $1.181 per share. The common stock underlying the warrants has been registered for sale under the Securities Act or is entitled to registration rights or are otherwise generally eligible for sale in the public market at or soon after exercise or conversion. If, and to the extent, these warrants are exercised, stockholders may experience dilution to their ownership interests in the Company. The presence of this additional number of shares of common stock and warrants eligible for trading in the public market may have an adverse effect on the market price of our common stock.

 

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The concentration of our capital stock ownership will likely limit a stockholder’s ability to influence corporate matters, and could discourage a takeover that stockholders may consider favorable and make it more difficult for a stockholder to elect directors of its choosing.

 

H. Brian Thompson, the Company’s Executive Chairman of the Board of Directors, and Universal Telecommunications, Inc., his own private equity investment and advisory firm, owned 5,646,171 shares of our common stock. Based on the number of shares of our common stock outstanding on March 31, 2012, these funds would beneficially own approximately 30% of our common stock. Based on public filings with the SEC made by J. Carlo Cannell, we believe that, as of March 31, 2012, funds associated with Cannell Capital LLC owned 3,472,080 shares of our common stock. Based on the number of shares of our common stock outstanding on March 31, 2012, these funds would beneficially own approximately 18% of our common stock. In addition, as of March 31, 2012, our executive officers, directors and affiliated entities, excluding H. Brian Thompson and Universal Telecommunications, together beneficially owned common stock, without taking into account their unexercised and unconverted warrants and options, representing approximately 14% of our common stock. As a result, these stockholders have the ability to exert significant control over matters that require approval by our stockholders, including the election of directors and approval of significant corporate transactions. The interests of these stockholders might conflict with your interests as a holder of our securities, and it may cause us to pursue transactions that, in their judgment, could enhance their equity investments, even though such transactions may involve significant risks to you as a security holder. The large concentration of ownership in a small group of stockholders might also have the effect of delaying or preventing a change of control of our company that other stockholders may view as beneficial.

 

It may be difficult for you to resell shares of our common stock if an active market for our common stock does not develop.

 

Our common stock is not actively traded on a securities exchange and we currently do not meet the initial listing criteria for any registered securities exchange, including the NASDAQ National Market System. It is quoted on the less recognized Over-the-Counter Bulletin Board. This factor, in addition to the concentrated ownership of our capital stock, may further impair your ability to sell your shares when you want and/or could depress our stock price. As a result, you may find it difficult to dispose of, or to obtain accurate quotations of the price of our securities because smaller quantities of shares could be bought and sold, transactions could be delayed, and security analyst and news coverage of our company may be limited. These factors could result in lower prices and larger spreads in the bid and ask prices for our shares.

 

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ITEM 6. EXHIBITS

 

The following exhibits, which are numbered in accordance with Item 601 of Regulation S-K, are filed herewith or, as noted, incorporated by reference herein:

 

Exhibit  
Number Description of Document
   
31.1* Certification of Chief Executive Officer pursuant to Rules 13a-15e and 15d-15e – page 34 promulgated under the Securities Exchange Act of 1934.
   
31.2* Certification of Chief Principal Accounting Officer pursuant to Rules 13a-15e and 15d-15e – page 34 promulgated under the Securities Exchange Act of 1934.
   
32.1* Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
   
32.2* Certification of Principal Accounting Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
   
101.INS** XBRL Instance Document
   
101.SCH** XBRL Taxonomy Extension Schema Document
   
101.CAL** XBRL Taxonomy Extension Calculation Linkbase Document
   
101.DEF** XBRL Taxonomy Extension Definition Linkbase Document
   
101.LAB** XBRL Taxonomy Extension Label Linkbase Document
   
101.PRE** XBRL Taxonomy Extension Presentation Linkbase Document

 

* Filed herewith
** XBRL (Extensible Business Reporting Language) information is furnished and not filed or a part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, is deemed not filed for purposes of Section 18 of the Securities Exchange Act of 1934, and otherwise is not subject to liability under these sections.

 

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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

  GLOBAL TELECOM & TECHNOLOGY, INC.
     
  By: /s/ Richard D. Calder, Jr.
    Richard D. Calder, Jr.
    President and Chief Executive Officer
     
Date:  May 11, 2012    

 

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EXHIBIT INDEX

 

Exhibit  
Number Description of Document
   
31.1* Certification of Chief Executive Officer pursuant to Rules 13a-15e and 15d-15e – page 34 promulgated under the Securities Exchange Act of 1934.
   
31.2* Certification of Chief Principal Accounting Officer pursuant to Rules 13a-15e and 15d-15e – page 34 promulgated under the Securities Exchange Act of 1934.
   
32.1* Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
   
32.2* Certification of Chief Principal Accounting Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
   
101.INS** XBRL Instance Document
   
101.SCH** XBRL Taxonomy Extension Schema Document
   
101.CAL** XBRL Taxonomy Extension Calculation Linkbase Document
   
101.DEF** XBRL Taxonomy Extension Definition Linkbase Document
   
101.LAB** XBRL Taxonomy Extension Label Linkbase Document
   
101.PRE** XBRL Taxonomy Extension Presentation Linkbase Document

 

* Filed herewith
** XBRL (Extensible Business Reporting Language) information is furnished and not filed or a part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, is deemed not filed for purposes of Section 18 of the Securities Exchange Act of 1934, and otherwise is not subject to liability under these sections.

 

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