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TMCNet:  NEUTRAL TANDEM INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations

[November 09, 2012]

NEUTRAL TANDEM INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations

(Edgar Glimpses Via Acquire Media NewsEdge) This Quarterly Report on Form 10-Q contains "forward-looking statements" that involve substantial risks and uncertainties. All statements, other than statements of historical fact, included in this Quarterly Report on Form 10-Q are forward-looking statements. The words "anticipates," "believes," "efforts," "expects," "estimates," "projects," "proposed," "plans," "intends," "may," "will," "would," and similar expressions are intended to identify forward-looking statements, although not all forward-looking statements contain these identifying words. Actual results or events could differ materially from the plans, intentions and expectations disclosed in the forward-looking statements we make. Factors that might cause such differences include, but are not limited to: the effects of competition, including direct connects, and downward pricing pressure resulting from such competition; our regular review of strategic alternatives; the impact of current and future regulation, including intercarrier compensation reform enacted by the Federal Communications Commission; the risks associated with our ability to successfully develop and market new services, many of which are beyond our control and all of which could delay or negatively affect our ability to offer or market new services; the risk that our business and the Tinet S.p.A. business will not be integrated successfully; technological developments; the ability to obtain and protect intellectual property rights; the impact of current or future litigation; the potential impact of any future acquisitions, mergers or divestitures; natural or man-made disasters, including the effects of Hurricane Sandy and its aftermath on our business; the ability to attract, develop and retain executives and other qualified employees; changes in general economic or market conditions, including currency fluctuations; financing facilities and related availability and terms; changes in our capital structure, including but not limited to the reduction of our cash balance that occurred in connection with the payment of the special cash dividend transaction discussed below under "Liquidity and Capital Resources-Special cash dividend", and other important factors included in our reports filed with the Securities and Exchange Commission, particularly in the "Risk Factors" section of our Annual Report on Form 10-K for the fiscal year ended December 31, 2011 and included elsewhere in this report. Furthermore, such forward-looking statements speak only as of the date of this report. We undertake no obligation to update any forward-looking statements to reflect events or circumstances after the date of such statements.


Overview We provide voice, IP Transit, and Ethernet telecommunications services primarily on a wholesale basis. We offer these services using an all-IP network, which enables us to deliver global connectivity for a variety of media, including voice, data and video. Our solutions enable carriers and other providers to deliver telecommunications traffic or other services where they do not have their own network or elect not to use their own network. These solutions are sometimes called "off-net" services. We also provide our solutions to customers, such as content providers, who also typically do not have their own network. We were incorporated in Delaware on April 19, 2001 and commenced operations in 2004.

Voice Services We provide voice interconnection services primarily to competitive carriers, including wireless, wireline, cable and broadband telephony companies.

Competitive carriers use our tandem switches to interconnect and exchange local and long distance traffic between their networks without the need to establish direct switch-to-switch connections. Competitive carriers are carriers that are not Incumbent Local Exchange Carriers, or ILECs, such as AT&T, Verizon and CenturyLink.

13 -------------------------------------------------------------------------------- Table of Contents Prior to the introduction of our local voice service, competitive carriers generally had two alternatives for exchanging traffic between their networks.

The two alternatives were interconnecting to the ILEC tandems or directly connecting individual switches, commonly referred to as "direct connects". Given the cost and complexity of establishing direct connects, competitive carriers often elected to utilize the ILEC tandem as the method of exchanging traffic.

The ILECs typically required competitive carriers to interconnect to multiple ILEC tandems with each tandem serving a restricted geographic area. In addition, as the competitive telecommunications market grew, the process of establishing interconnections at multiple ILEC tandems became increasingly difficult to manage and maintain, causing delays and inhibiting competitive carrier growth, and the purchase of ILEC tandem services became an increasingly significant component of a competitive carrier's costs.

The tandem switching services offered by ILECs consist of local transit services, which are provided in connection with local calls, and switched access services, which are provided in connection with long distance calls. Under certain interpretations of the Telecommunications Act of 1996 and implementing regulations, ILECs are required to provide local transit services to competitive carriers. ILECs generally set per minute rates and other charges for tandem transit services according to rate schedules approved by state public utility commissions, although the methodology used to review these rate schedules varies from state to state. ILECs are also required to offer switched access services to competing telecommunications carriers under the Telecommunications Act of 1996 and implementing regulations. ILECs generally set per minute rates and other charges for switched access services according to mandated rate schedules set by the Federal Communications Commission for interstate calls and by state public utility commissions for intrastate calls. Our solution enables competitive carriers to exchange traffic between their networks without using an ILEC tandem for both local and long distance calls.

A loss of ILEC market share to competitive carriers escalated competitive tensions and resulted in an increased demand for tandem switching. Growth in intercarrier traffic switched through ILEC tandems created switch capacity shortages known in the industry as ILEC "tandem exhaust," where overloaded ILEC tandems became a bottleneck for competitive carriers. This increased call blocking and gave rise to service quality issues for competitive carriers.

We founded our company to solve these interconnection problems and better facilitate the exchange of traffic among competitive carriers and non-carriers.

With the introduction of our services, we believe we became the first carrier to provide alternative tandem services capable of alleviating the ILEC tandem exhaust problem. By utilizing our managed tandem service, our customers benefit from a simplified interconnection network solution that reduces costs, increases network reliability, decreases competitive tension and adds network diversity and redundancy. We have signed agreements with major competitive carriers and non-carriers and we operated in 189 markets as of September 30, 2012.

Our business originally connected only local traffic among carriers within a single metropolitan market. In 2006, we installed a national IP backbone network connecting our major local markets. In 2008, we began offering terminating switched access services and originating switched access services. Switched access services are provided in connection with long distance calls. Our terminating switched access services allows interexchange carriers to send calls to us and we then terminate those calls to the appropriate terminating carrier or end user in the local market in which we operate. Our originating switched access service allows the originating end user or carrier in the local market in which we operate to send calls to us that we then deliver to the appropriate interexchange carrier that has been selected to carry that call. In both instances, the interexchange carrier is our customer, which means that it is financially responsible for the call. On October 1, 2010, we acquired Tinet S.p.A., an Italian corporation that operates a global IP backbone network. As a result of the foregoing, our service offerings now include the capability of switching and carrying local, long distance and international voice traffic.

Data Services As part of our long-term growth strategy, we acquired Tinet S.p.A., an Italian corporation. Tinet S.p.A. provides IP Transit and Ethernet services primarily to carriers, service providers and content providers worldwide.

With this acquisition, we evolved from a primarily U.S. voice interconnection company into a global IP-based network services company focused on delivering global connectivity for a variety of media, including voice, data and video. The acquisition expanded our IP-based network internationally, enabling global end-to-end delivery of wholesale voice, IP Transit and Ethernet solutions.

We have IP Transit and Ethernet service agreements with over 1,000 customers in over 80 countries. We have over 120 points of presence (POPs) where we operate our equipment in carrier neutral facilities. Our core IP Transit network uses all Juniper equipment, which reduces complexity and allows for faster service deployment and easier customer support. We also deploy Cisco routers at the edge of our network where we connect with certain of our customers.

Hosted Services In 2011 we began to offer hosted services. A hosted service is an application (such as software) that we "host" on our network enabling our customer to avoid the capital expenses associated with purchasing the equipment and associated software licenses that they would need to provide the service to themselves.

During the third quarter of 2012, we ceased offering hosted services and put a plan in place to sell the related equipment. As a result, the Company recorded a charge of approximately $1.3 million related to the asset impairment on the equipment. As of September 30, 2012, the fair value of the equipment available for sale was $1.7 million and is included in "Other current assets" on the condensed consolidated balance sheet.

14-------------------------------------------------------------------------------- Table of Contents Revenue We generate revenue from sales of our voice, IP Transit and Ethernet services.

Revenue is recorded each month based upon documented minutes of traffic switched or data traffic carried for which service is provided, when collection is probable. Voice revenue is recorded each month on an accrual basis based upon minutes of traffic switched by our network by each customer, which we refer to as minutes of use. The rates charged per minute are determined by contracts between us and our customers or by filed and effective tariffs.

Minutes of use of voice traffic increase as we increase our number of customers, increase the penetration of existing markets, either with new customers or with existing customers, and increase our service offerings. The minutes of use decrease due to direct connection between existing customers, consolidation between customers, a customer using a different interconnection provider or a customer experiencing a decrease in the volume of traffic it carries.

The average fee per minute of voice traffic varies depending on market forces and type of service, such as switched access or local transit. The market rate in each market is based upon competitive conditions along with the switched access or local transit rates offered by the ILECs. Depending on the markets we enter, we may enter into contracts with our customers with either a higher or lower fee per minute than our current average.

Our service solution incorporates other components beyond switching. In addition to switching voice calls, we generally provision trunk circuits between our customers' switches and our network locations at our own expense and at no direct cost to our customers. We also provide quality of service monitoring, call records and traffic reporting and other services to our customers as part of our voice service solution. Our per-minute fees are intended to incorporate all of these services.

IP Transit revenue and Ethernet services revenue are recorded each month on an accrual basis based upon bandwidth used by each customer. The rates charged are the total of a monthly fee for bandwidth (the Committed Traffic Rate) plus additional charges for the sustained peak bandwidth used monthly in excess of the Committed Traffic Rate.

While generally not seasonal in nature, our voice revenues are affected by certain events such as holidays, the unpredictable timing of direct connects between our customers, and installation and implementation delays. These factors can cause our revenue to both increase or decrease unexpectedly.

Operating Expense. Operating expenses include network and facilities expense, operations expenses, sales and marketing expenses, general and administrative expenses, depreciation and amortization and the gain or loss on the disposal of fixed assets.

Network and Facilities Expense. Our network and facilities expense includes transport capacity, or circuits, signaling network costs for voice services, transport capacity for our data services, and facility rents and utilities, together with other costs that directly support our POPs. We do not defer or capitalize any costs associated with the start-up of new POPs. The start-up of an additional POP can take between three months to six months. During this time we typically incur facility rent, utilities, payroll and related benefit costs along with initial non-recurring installation costs. Revenues generally follow approximately six months after POP installation.

Network transport costs typically occur on a repeating monthly basis, which we refer to as recurring transport costs, or on a one-time basis, which we refer to as non-recurring transport costs. Recurring transport costs primarily include monthly usage and other charges from telecommunication carriers and are related to the circuits utilized by us to connect to our customers. As our traffic increases, we must utilize additional circuits. Non-recurring transport costs primarily include the initial installation of such circuits. Facility rents include the leases on our POPs, which expire through February 2025.

Additionally, we pay the cost of all the utilities for all of our POP locations.

Operations Expenses. Operations expenses include payroll and benefits for our POP location personnel as well as individuals located at our offices who are directly responsible for maintaining and expanding our network. Other primary components of operations expenses include repair and maintenance, property taxes, property insurance and supplies.

Sales and Marketing Expense. Sales and marketing expenses represent the smallest component of our operating expenses and primarily include personnel costs, sales bonuses, marketing programs and other costs related to travel and customer meetings.

General and Administrative Expense. General and administrative expenses consist primarily of compensation and related costs for personnel and facilities associated with our executive, finance, human resource and legal departments and fees for professional services. Professional services principally consist of outside legal, audit, tax and transaction costs.

Depreciation and Amortization Expense. Depreciation and amortization expense for fixed assets is applied using the straight-line method over the estimated useful lives of the assets after they are placed in service, which are five years for network equipment and test equipment, three years for computer equipment, computer software and furniture and fixtures. Leasehold improvements are amortized on a straight-line basis over an estimated useful life of five years or the life of the respective leases, whichever is shorter. Intangible assets, which consist of customer relationships, have a definite life and are amortized on an accelerated basis based on the discounted cash flows recognized over their estimated useful lives of 15 years.

Impairment of Fixed Assets. The carrying value of long-lived assets, primarily property and equipment, is evaluated whenever events or changes in circumstances indicate that a potential impairment has occurred. A potential impairment has occurred if projected undiscounted cash flows are less than the carrying value of the assets. The estimated cash flows include management's assumptions of cash inflows and outflows directly resulting from the use of that asset in operation.

The impairment test is a two-step process. If the carrying value of the asset exceeds the expected future cash flows from the asset, impairment is indicated.

The impairment loss recognized is the excess of the carrying value of the asset over its fair value. Typically, the fair value of the asset is determined by estimating future cash flows associated with the asset.

15-------------------------------------------------------------------------------- Table of Contents Gain on Disposal of Fixed Assets. We dispose of network equipment in connection with converting to new technology and computer equipment to replace old or damaged units. When there is a carrying value of these assets, we record the write-off of these amounts to loss on disposal. In some cases, this equipment is sold to a third party. When the proceeds from the sale of equipment identified for disposal exceeds the asset's carrying value, we record a gain on disposal.

Other Income. Other income includes interest income and foreign exchange gains and losses resulting from changes in exchange rates between the functional currency and the foreign currency in which the transaction was denominated.

Income Taxes. Income tax provision includes U.S. federal, state and local, and foreign income taxes and is based on pre-tax income or loss. In determining the estimated annual effective income tax rate, we analyze various factors, including projections of our annual earnings and taxing jurisdictions in which earnings will be generated, the impact of state and local income taxes and our ability to use tax credits and net operating loss carryforwards.

Critical Accounting Policies and Estimates The preparation of our financial statements requires us to make estimates, judgments and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses during the periods presented. Our Annual Report on Form 10-K for the fiscal year ended December 31, 2011, which we filed with the Securities and Exchange Commission on March 15, 2012, includes a summary of the critical accounting policies we believe are the most important to aid in understanding our financial results. There have been no changes to those critical accounting policies that have had a material impact on our reported amounts of assets, liabilities, revenues or expenses during the first nine months of 2012.

Results of Operations The following table sets forth our results of operations for the three and nine months ended September 30, 2012 and 2011: Three Months Ended Nine Months Ended September 30, September 30, (Dollars in thousands) 2012 2011 2012 2011 Revenue $ 68,820 $ 67,310 $ 207,788 $ 198,818 Operating expense: Network and facilities expense (excluding depreciation and amortization) 32,377 28,724 92,936 80,797 Operations 13,496 10,334 36,475 29,107 Sales and marketing 3,989 3,383 12,001 9,851 General and administrative 5,960 6,352 19,364 22,771 Depreciation and amortization 7,703 7,520 22,798 22,040 Carrier dispute 9,000 - 9,000 - Impairment of fixed assets 1,257 - 1,257 - (Gain) loss on disposal of fixed assets (55 ) 159 (164 ) 147 Total operating expense 73,727 56,472 193,667 164,713 (Loss) income from operations (4,907 ) 10,838 14,121 34,105 Total other (income) expense (213 ) 2,126 116 71 (Loss) income before income taxes (4,694 ) 8,712 14,005 34,034 (Benefit) provision for income taxes (1,959 ) 2,864 6,379 12,950 Net (loss) income $ (2,735 ) $ 5,848 $ 7,626 $ 21,084 Three Months Ended September 30, 2012 Compared to Three Months Ended September 30, 2011 Revenue. Revenue increased to $68.8 million in the three months ended September 30, 2012 from $67.3 million in the three months ended September 30, 2011, an increase of 2.2%. The increase in revenue of $1.5 million was due primarily to a $1.3 million increase in revenue generated from our voice business, with the remaining increase of $0.2 million related to an increase in data revenue.

The increase in voice revenue was primarily due to the increase in the average fee per voice minute and an increase in minutes of use billed. The average fee per voice minute for the three months ended September 30, 2012 of $.00158 increased from $0.00154 for the three months ended September 30, 2011. We processed 33.1 billion minutes in the three months September 30, 2012 compared to 32.9 billion minutes processed in the three months ended September 30, 2011, an increase of 0.5%.

The increase in data revenue was primarily due to the increase in traffic, measured in terabits. Traffic increased to 8.2 terabits processed in the three months ended September 30, 2012 from 5.8 terabits processed in the three months ended September 30, 2011. Offsetting the increase in terabits was a decrease in the average fee from $2.86 per megabit for the three months ended September 30, 2011 to $2.01 per megabit for the three months ended September 30, 2012.

16-------------------------------------------------------------------------------- Table of Contents Operating Expense. Operating expenses for the three months ended September 30, 2012 of $73.7 million increased $17.2 million, or 30.6%, from $56.5 million for the three months ended September 30, 2011. The components making up operating expenses are discussed further below.

Network and Facilities Expenses. Network and facilities expenses increased to $32.4 million in the three months ended September 30, 2012, or 47.0% of revenue, from $28.7 million in the three months ended September 30, 2011, or 42.7% of revenue. The increase in network and facilities expense was due to changes in the mix of the voice services we provide and an increase in our IP Transit and Ethernet services. Due to the change in the mix of services provided, higher network and facilities expenses were incurred.

Operations Expenses. Operations expenses increased to $13.5 million in the three months ended September 30, 2012, or 19.6% of revenue, from $10.3 million in the three months ended September 30, 2011, or 15.4% of revenue. The increase of $3.2 million in our operations expenses primarily resulted from a $1.4 million increase in repairs and maintenance, $0.9 million of which was due to our hosted service offering which was ceased during third quarter of 2012, $1.2 million in amounts due to the federal universal service fund, state governments and value added taxes in various countries as we increased the provision of our data services, an increase of $0.9 million in payroll and benefits, primarily attributable to increases in headcount, and $0.5 million in non-cash compensation, contract labor and rent expenses. Expenses of $0.8 million were included in the third quarter of 2011, resulting from the settlement of a dispute with a landlord.

Sales and Marketing Expense. Sales and marketing expense increased to $4.0 million in the three months ended September 30, 2012, or 5.8% of revenue, compared to $3.4 million in the three months ended September 30, 2011, or 5.0% of revenue. The increase of $0.6 million in sales and marketing expenses for the three months ended September 30, 2012 was primarily due to an increase of $0.5 million in payroll and benefits related to increased headcount as we expand our data services.

General and Administrative Expense. General and administrative expense decreased to $6.0 million in the three months ended September 30, 2012, or 8.7% of revenue, compared with $6.4 million in the three months ended September 30, 2011, or 9.4% of revenue. The decrease of $0.4 million in our general and administrative expense was primarily due to a decrease of $0.5 million decrease in payroll, benefits and non-cash compensation.

Depreciation and Amortization Expense. Depreciation and amortization expense increased to $7.7 million in the three months ended September 30, 2012, or 11.2% of revenue, compared to $7.5 million in the three months ended September 30, 2011, or 11.2% of revenue. The increase of $0.2 million in our depreciation and amortization expense resulted from capital expenditures primarily related to the expansion of POP capacity in existing markets and the installation of POP capacity in new markets, as we expand our data services.

Carrier Dispute. We reached a preliminary verbal agreement to settle a dispute with one of our largest customers regarding the termination of traffic. We expect that the pending settlement will include a $9.0 million one-time payment to the customer prior to December 31, 2012, and accordingly, we recorded a $9.0 million expense in the three month period ended September 30, 2012. There can be no assurance that the Company and the carrier will reach a definitive final settlement.

Impairment of Fixed Assets. During the three months ended September 30, 2012, we ceased operations related to our hosted services business offering. The equipment related to this business has no further use in our network and is being held for sale. As a result, the Company recorded an asset impairment charge of approximately $1.3 million. During the same period in 2011, no impairments were recognized.

Other Expense (Income). Other income increased to $0.2 million for the three months ended September 30, 2012, compared to other expense of $2.1 million for the three months ended September 30, 2011. Other income of $0.2 million consisted primarily of a net foreign exchange gain resulting from the remeasurement of our receivable and payable balances between the functional currency and currency in which the transactions are denominated. In the three months ended September 30, 2011, we recognized $1.9 million related to foreign exchange loss recognized on the remeasurement of an intercompany loan denominated in Euros.

(Benefit) Provision for Income Taxes. In the three months ended September 30, 2012, we had a (benefit) for income taxes of $2.0 million as compared to a provision for income taxes of $2.9 million for the three months ended September 30, 2011. The effective tax rate for the three months ended September 30, 2012 and 2011 was 41.7% and 32.9%, respectively. The difference in the effective income tax rate was primarily due to the loss as a result of operations for the quarter and our change in estimated valuation allowance recorded against our Illinois EDGE Credit tax carryforward.

Nine Months Ended September 30, 2012 Compared to Nine Months Ended September 30, 2011 Revenue. Revenue increased to $207.8 million in the nine months ended September 30, 2012 from $198.8 million in the nine months ended September 30, 2011, an increase of 4.5%. The increase in revenue of $9.0 million was due primarily to a $5.1 million increase in revenue generated from our voice business, with the remaining increase of $3.9 million related to an increase in data revenue.

The increase in data revenue is primarily due to an increase of traffic to 23.3 terabits processed in the nine months ended September 30, 2012 from 15.7 terabits processed in the nine months ended September 30, 2011. Offsetting the increase in terabits was a decrease in the average fee from $3.03 per megabit for the nine months ended September 30, 2011 to $2.20 per megabit for the nine months ended September 30, 2012. The increase in voice revenue is primarily due to the increase in minutes of use to 100.1 billion minutes processed in the nine months ended September 30, 2012 from 97.2 billion minutes processed in the nine months ended September 30, 2011, an increase of 3.0%.

17-------------------------------------------------------------------------------- Table of Contents Operating Expenses. Operating expenses for the nine months ended September 30, 2012 of $193.7 million increased $29.0 million, or 17.6% from $164.7 million for the nine months ended September 30, 2011. The components making up operating expenses are discussed further below.

Network and Facilities Expenses. Network and facilities expenses increased to $92.9 million in the nine months ended September 30, 2012, or 44.7% of revenue, from $80.8 million in the nine months ended September 30, 2011, or 40.6% of revenue. The increase in network and facilities expense was due to changes in the mix of the voice services we provide and an increase in our IP Transit and Ethernet services. Due to the change in the mix of services provided, higher network and facilities expenses were incurred.

Operations Expenses. Operations expenses increased to $36.5 million in the nine months ended September 30, 2012, or 17.6% of revenue, from $29.1 million in the nine months ended September 30, 2011, or 14.6% of revenue. The increase of $7.4 million in our operations expenses primarily resulted from an increase of $3.0 million in payroll and benefits, primarily attributable to increases in headcount, $2.5 million increase in repairs and maintenance, $1.7 million of which was due to our hosted service offering which was ceased during third quarter of 2012, $1.6 million in amounts due to the federal universal service fund, state governments and value added taxes in various countries as we increase the provision of our data services and $0.8 million in non-cash compensation, contract labor, rent expenses. Expenses of $0.8 million were included in the third quarter of 2011, resulting from the settlement of a dispute with a landlord.

Sales and Marketing Expense. Sales and marketing expense increased to $12.0 million in the nine months ended September 30, 2012, or 5.8% of revenue, compared to $9.9 million in the nine months ended September 30, 2011, or 5.0% of revenue. The increase of $2.1 million in sales and marketing expenses for the nine months ended September 30, 2012 was primarily due to an increase of $1.8 million in payroll, benefits and travel costs, as well as $0.6 million of marketing fees related to the company re-branding.

General and Administrative Expense. General and administrative expense decreased to $19.4 million in the nine months ended September 30, 2012, or 9.3% of revenue, compared with $22.8 million in the nine months ended September 30, 2011, or 11.5% of revenue. The decrease of $3.4 million in our general and administrative expense was primarily due to a decrease of $3.6 million in non-cash share-based compensation. The decrease in non-cash share-based compensation was primarily due to the accelerated vesting of options and non-vested shares related to the retirement of Rian J. Wren during the first quarter of 2011, as further discussed in footnote 5 to the condensed consolidated financial statements - "Stock Options and Non-vested Shares" Depreciation and Amortization Expense. Depreciation and amortization expense increased to $22.8 million in the nine months ended September 30, 2012, or 11.0% of revenue, compared to $22.0 million in the nine months ended September 30, 2011, or 11.1% of revenue. The increase of $0.8 million in our depreciation and amortization expense resulted from capital expenditures primarily related to the expansion of POP capacity in existing markets and the installation of POP capacity in new markets, as we expand our data services.

Carrier Dispute.We reached a preliminary verbal agreement to settle a dispute with one of our largest customers regarding the termination of traffic. We expect that the pending settlement will include a $9.0 million one-time payment to the customer prior to December 31, 2012, and accordingly, we recorded a $9.0 million expense in the three month period ended September 30, 2012. There can be no assurance that the Company and the carrier will reach a definitive final settlement.

Impairment of Fixed Assets. During the nine months ended September 30, 2012, we ceased operations related to our hosted services business offering. The equipment related to this business has no further use in our network and is being held for sale. As a result, the Company recorded a charge of approximately $1.3 million related to the combined asset impairment and accelerated the depreciation on the equipment. During the same period in 2011, no impairments were recognized.

Other Expense (Income). Other expense of $0.1 million for the nine months ended September 30, 2012, was consistent with other expense of $0.1 million for the nine months ended September 30, 2011. Other expense of $0.1 million consists primarily of a net unrealized foreign exchange loss resulting from the remeasurement of our receivable and payable balances between the functional currency and the currency in which the transactions are denominated. In the nine months ended September 30, 2011, we recognized $0.8 million related to foreign exchange gain recognized on the remeasurement of an intercompany loan denominated in Euros during 2011. This gain was offset by $0.3 million of expenses incurred related to the modified "Dutch auction" tender offer to repurchase common shares during the second quarter of 2011 and a $0.5 million net unrealized foreign exchange loss resulting from the remeasurement of our receivable and payable balances between the functional currency and the currency in which the transactions are denominated.

Provision for Income Taxes. Provision for income taxes of $6.4 million for the nine months ended September 30, 2012 decreased by $6.6 million compared to $13.0 million for the nine months ended September 30, 2011. The effective tax rate for the nine months ended September 30, 2012 and 2011 was 45.5% and 38.1%, respectively. The difference in the effective income tax rate was primarily due to our foreign entities' transaction tax which is not deductible in the foreign jurisdictions of our foreign operations. In addition, the rate increased due to changes in the Company's estimated valuation allowance recorded against the Company's Illinois EDGE Credit tax carryforward, which was recorded during the second quarter of 2012.

18 -------------------------------------------------------------------------------- Table of Contents Liquidity and Capital Resources At December 31, 2011, we had $90.3 million in cash and cash equivalents, and $1.0 million in restricted cash. In comparison, at September 30, 2012, we had $113.8 million in cash and cash equivalents and $1.0 million in restricted cash.

Cash and cash equivalents consist of highly liquid money market mutual funds.

The restricted cash balance is pledged as collateral for certain commercial letters of credit.

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